hankun law - cross border us china fund formation and investment 11172016

Cross-border Fund Formation, VC/PE Investment

&

Transaction Risk Management

James Wang & Mike Chiang

2016.11.16

Introduction to Han Kun Law Offices

Part I. How to Form a China Fund (with/out Cross-border Element)

I. Purely Domestic RMB Fund vs. RMB Fund with Foreign Element vs. Cayman Fund

II. Role of Fund Lawyer

III. Formation of Purely Domestic RMB Fund

IV. Formation of RMB Fund with Foreign Element

V. Outbound Investment Fund

Part II. Cross-border PE/VC Investment and Financing

1. Corporate Structure (Illustration of several common structure adopted by PRC Ventures)

2. PRC FDI Industrial Policies

3. Corporate Control

Part III. Dispute Resolution in China-focused PE/VC Investments

Table of Content

Introduction to Han Kun

Introduction

12-Year Leading Investment & Financing Law Firm

Investment Funds

Leading National

Investment & Financing

Law Firm

Capital Markets

Antitrust

&

Competition

Banking/

Aircraft

Leasing

Intellectual

Property

Litigation

& Dispute

Resolution

FDI

VC/PE Transaction

2004

Beijing

Beijing

Shanghai

Shenzhen

Hong Kong

M&A

PE/VC Transactions

5 Lawyers

2016

250+Lawyers

Office Location

Beijing (HQs) Shanghai

Shenzhen Hong Kong

Market Accolades

Tier 1 TMT China Firm, Legal500 Asia Pacific (2016-2017)

Private Equity Law Firm of the Year, ALB (2016)

Tier 1 Private Equity - Local Firms, IFLR1000 (2013-2017)

Tier 1 Investment Funds - Local Firms, IFLR1000 (2014, 2017)

Outstanding PRC Firm for Corporate/M&A, Investment Funds, IT, Telco & Media,

Private Equity, Asialaw Profiles（2017）

Band I Investment Funds PRC Firm, Chambers Asia Pacific (2016)

Private Equity & Venture Capital Firm of the Year, China Law and Practice (2016)

Most innovative Firm of the Year, China Law and Practice (2016)

Tier 1 M&A China Firm, ALB (2014-2016)

Outstanding PRC Firm in Capital Markets, Corporate/M&A and IT, Telco & Media,

Asialaw Profiles（2016）

Tier 1 Corporate and M&A China Firm, Legal500 Asia Pacific (2015)

PRC firm of the year- TMT, China Law and Practice (2014-2015)

Top 10 Power Law Firms, ALB (2015-2016)

Market Accolades (Cont’d)

Firm of the Year in China - Corporate and M&A, Asian-Mena Counsel (2015)

Top 10 law firms for China PE exit deals (by value), Top 10 PRC law firms by value of

M&A deals in China, China Business Law Journal (2016)

M&A Deal of the Year, ALB (2014-2015)

Private equity deal of the year - Yongye International privatization, Outbound deal of

the year - COFCO’s acquisition of Noble Agri and Nidera, China Law and Practice

（2015)

Top 10 PRC law firms by inbound M&A deal value, Top 10 PRC law firms by the

number of inbound M&A deals, China Business Law Journal (2015)

Leading PRC Law Firm in Capital Markets, Corporate/M&A, Investment Funds,

Private Equity, Chambers Asia Pacific (2013-2015)

Technology, media and telecommunications firm of the year, China Business Law

Journal (2015)

Private equity & venture capital firm of the year, China Business Law Journal (2014-

2015)

Band 1 Healthcare PRC Firms, Chambers Asia Pacific (2013-2014)

Market Accolades (Cont’d)

Top 5 China Venture Capital & Private Equity Legal Advisor of the Year, China

Venture (2014)

Tier 1 PRC Domestic PE Firms, ALB（2013）

Top 10 VC/PE-backed Overseas IPO Lead Legal Advisors, Zero2IPO Group (2011-

2012, 2014）

China M&A Legal Advisor of the Year (Domestic),China IPO Legal Advisor of the

Year (Cross-border),Top 5 China Venture Capital & Private Equity Legal Advisor of

the Year, China Venture (2013)

Debt & Equity-linked deal of the year - Baidu SEC-registered bond, China Law and

Practice (2013)

Boutique PRC Law Firm of the Year, Chambers China（2012）

Up-and-Coming Firm of the Year, China Law and Practice （2012）

Chinese Private Equity Law Firm of the Year, Acquisition International（2012）

M&A Law Firm of the Year, DealMakers（2012）

Tier 1 TMT Domestic Firm, Asialaw Profiles（2011-2012）

China Employer of Choice, ALB（2012, 2014-2016）

But I know what’s on your ...

Introduction

WHO CARES?

Introduction

What really makes us different?

Introduction

What really makes us different

Law Firm of the New Generation → 3 things that make us different

New Economy

VC&PE

Cross-border


New Economy

New Economy – But Not By Choice…

Example - Domestic M&A: 6 high profile mergers of No. 1 + No. 2 players in TMT

market in China in past 2 years. Our involvement → 100%

+

+ + + + + +

Outbound M&A: Ranked by Thompson Reuters as No. 1 Firm for Outbound

Investment by both # of Deals and Volume of Deals


VC&PE

PE & VC

One of the first PRC law firms to specialize in providing high-end

professional legal services to Western VC/PE firms such as Sequoia,

IDG, Matrix on VC/PE investments and financings in China.

We have represented more than 200 VC/PE firms and companies in

over 2,000 transactions such as Sequoia, Qiming Ventures, KPCB,

MBK, FountainVest, IDG, DCM, Fidelity Asia, GGV, Northern Light,

Legend Capital, FreeS Fund, Gobi, Vertex, Zhen Fund, 01VC,DT

Capital, Spring Capital, JAFCO Asia, Vivo Ventures, SIG, Vickers

Venture, Burrill, OrbiMed, Merrill Lynch, GE Capital, Intel Capital,

Bertelsmann and Siemens Venture, closing 400-500 of VC/PE

investments/year on average in recent years.

Representative PE/VC Clients

National fund team of dedicated fund lawyers

600+ funds formed (PRC / Cayman / BVI / HK / US / EU)

Total capital commitments in excess of RMB 300 billion

Investment Fund & Asset Management

Representative Investment Fund & Asset Management Clients


Cross-border

Cross-border is in the firm’s genes.

Most of our partners were with leading international law

firms for many years or held senior in-house positions at

major global corporations.

Most of our 200+ lawyers are dual-qualified in the US (or

another foreign jurisdiction) in addition to China.


How To Form a China Fund (with/out Cross-border Elements)?

PART I

Where to form the fund?

Purely RMB Fund?

RMB Fund with Foreign Element (foreign “tainted”)?

Foreign Fund (Cayman vs. BVI vs. Delaware vs. European)?

3 Key Considerations

Who are your LPs (currency of capital and nationality)?

Who are your GP team members (nationality / tax residency)?

Where do you want to invest?

How To Form a China Fund (with/out Cross-border Elements) - General

If RMB Fund, 3 Key Considerations too!

How To Form a China Fund (with/out Cross-border Elements) - General

I. Fundamentals of RMB Fund Formation

GP/MC

(LLC)

RMB Fund I

(LLP)

Investors

PRC

Venture PRC

Venture

Structure: Common Structures for RMB Funds

GP LP

GP

(LLP)

RMB Fund II

(LLP)

Investors

PRC

Venture PRC

Venture

GP LP

UGP

(LLC) Team

GP LP

GP

(LLP)

RMB Fund III

(LLP)

Investors

PRC

Venture PRC

Venture

GP LP

UGP

(LLC) Team

GP LP

MC

Management agreement Option I:UGP as MC

Structure I1 Two-layered Structure Structure 2: Three-Layered

Structure

Structure 3: Three-Layered Structure + Separate MC

Option II:GP as MC


Role of Fund Lawyer

Fund Formation Process

As GP Lawyer → Soldiers Laying Landmines

As LP Lawyer → Soldiers Removing Landmines

What happens if try to go thru landmine field w/o a good fund lawyer


Fund Terms : Top 10 Most Negotiated Terms

1. Carry Construct (US vs. European waterfall; GP/All Partner Clawback)

2. Management Fee

3. Term, Extension, Who has to approve

4. Re-investment (recycling)

5. Successor Fund (often tied to investment period / % invested)

6. Conflicts / Affiliated Transactions

7. Allocation of Investment Opportunity

8. Key Man Provision / Time & Attention Commitment (Suspension/Termination of Investment Period,

Termination of Fund)

9. LP Remedies against GP Bad Acts (Fault/No-fault GP Removal/Termination of Fund, Carry Hair-cut)

10. Investment restrictions (concentration risk, investment in public companies, other funds, real estate,

oil & gas, hostile deals, bridge financing, borrowing)


Fund Terms: Top 10 Most Negotiated Terms – Distribution Waterfall

1、Return of such

LP’ Contribution

(all /attributable to

realized investment)

2、Such LP’s

Preferred Return

3、GP Catch-up on

such LP Preferred

Return

4、GP 20% Carried

Interest, LP 80%

1、Return of All

Partners’

Contribution (all

/attributable to


2、All Partners

Preferred Return

(including GP and LP)

3、GP Catch-up on

all Partners Preferred

Return

4、GP 20% Carried

Interest, all Partners

80%

1、Return of all

LPs’ Contribution

(all /attributable to


2、All LPs’

Preferred Return

3、GP Catch-up

on all LP s’

Preferred Return

4、GP 20%

Carried Interest, all

LPs 80%

#1 Without

Preliminary

Apportionmen

t of GP

#2 With

Preliminary

Apportionmen

t of GP

Partner by

Partner

Accounting

Return to All

Partners


Fund Terms: Top 10 Most Negotiated Terms – GP Clawback

Upon liquidation vs. Mid-term Clawback

before tax vs. after tax（team

members）

Individual members’ carry clawback

guarantee

Do not forget PR

Escrow :

• 25%-50%

• Until satisfaction of Fair Value Test / Minimum Valuation Test / other


Terms: Top 10 Most Negotiated Terms – All Partners Clawback

Amount Limit:

[25%] of capital Commitment , and/or

[100%//50%] of aggregated distribution

Temporal Limit:

[1.5-2 yrs] after fund liquidation, and/or

[2//3 yrs] after receiving such distribution

Distinguish btw :

clawback obligation relating to indemnification obligation of the fund

clawback obligation relating to portfolio investment


Fund Terms: Top 10 Most Negotiated Terms - Management Fees


Allocation of Carry

Founding

Member Others Members

carry

Member

Member

carry

Member Member

Member

Member

Others?

II. Formation of RMB Fund with Foreign Element

What does “foreign element” mean?

1. Foreign LPs,

2. Foreign GP members, or

3. Foreign investment destination

III. Formation of China Fund with Foreign Elements

PRC OFFSHORE

PRC ONSHORE

FIE PFM

QFLP Fund I

Foreign

PFM

Qualified Foreign

Investors

GP QFLP

Foreign Private Fund Manager (PFM)

− Restrictions on operation of Foreign PFM in PRC

Foreign-invested PFM (FIE PFM)

− Private Securities Investment Fund Manager vs. Private PE/VC Fund Manager

− Obstacles in establishing a FIE PEM in PRC (Requirements & Procedures)

− AMAC Registration of FIE PFM

Qualified Foreign Limited Partnership (QFLP) Pilot Programs

− Shanghai, Tianjin, Beijing, Shenzhen, etc.

− Source of Fund: QFLP, PRC LPs, or Both

− Pros & Cons

Foreign Element adds complexity to an already overly complex

fund formation process in China

QFLP Fund II

PRC

Investors

GP LP

PRC Venture PRC Venture

PRC Venture PRC Venture

Foreign-invested PFM & QFLP Fund

PROS & CONS

− RMB Fund may invest in all industries, including those are prohibited or

restricted from foreign investment.

− Additional turnover tax burden

− Uncertainties and risks still exist with regard to:

− Compliance with PRC Laws；

− Effective control over operational of RMB GP;

− Enforcement of contractual arrangement

III. Formation of China Fund with Foreign Elements

Domestic RMB Fund with VIE Structure

IV. Formation of Outbound Investment Fund

Procedures of ODI by RMB Fund

− Filing for ODI record filing with NDRC or its local counterpart

− Applying for ODI approval by MOFCOM or its local counterpart

− Applying for ODI foreign exchange registration with SAFE or its local counterpart

− Applying for ODI approval by other competent authorities (if any)

Limitation on ODI

− ODI in oversea financial institutions (including offshore investment funds) may not be allowed,

as ODI is defined as investment by PRC non-financial enterprises into offshore Non-Financial

enterprise

− Large amount of investment is subject to higher level of scrutiny and PRC authorities’

discretional approvals

Other channel for Outbound Investment

− Qualified Domestic Institutional Investor(QDII)

− Qualified Domestic Limited Partnership (QDLP)

− Qualified Domestic Investment Enterprise (QDIE)

Cross-border PE/VC Investment & Financing

- Key Legal Issues to Consider from Founder’s Perspective -

PART II

5 Key Factors to Consider When Determining Corporate Structure for a PRC Venture

Where are you from? → Background of Founder(s)

− Sole Founder or Co-Founders

− PRC citizen or Non-PRC citizen

What do you do? → Type of Business & Foreign Restrictions

− Prohibited, Restricted, Permitted or Encouraged Industries from Foreign Investment in PRC

(whether it is subject to restrictions imposed by PRC FDI Industrial Policies)

Where are your investors from? → Channels for Financing

− Own Money, Friends and/or Relatives, Banks, Angel Investors, VC/PE, IPO, strategic investor

(such as BAT)…

How do you plan to sell the business? → Exit Routes for Investors

− IPO (PRC or Overseas) or Trade Sale…

Tax Consideration

I. Choosing the Right Corporate Structure

4 Options:


Pure Domestic

Co.

VIE

WOFE

JV Structure

PRC OFFSHORE

PRC ONSHORE

PRC Venture

PRC

Founder(s) VC/PE

PRC OFFSHORE

PRC ONSHORE

PRC Venture

PRC

Founder(s)

VC/PE

Structure 1: Pure Domestic Co.

Operating in industries prohibited and/or

restricted from foreign investment (O)

Financing from PRC VC/PE (O)

Financing from Oversea VC/PE (X)

Listing on PRC Stock Exchange (O)

Listing on Oversea Stock Exchange (X)

Structure 2: JV Structure

Operating in industries prohibited and/or restricted from

foreign investment (*)

Financing from PRC VC/PE (O)

Financing from Oversea VC/PE (O)

Listing on PRC Stock Exchange (O)

Listing on Oversea Stock Exchange (X)

VC/PE

Common Corporate Structures of VC/PE-backed PRC Ventures (1/2)


(Assuming Founders are all PRC citizens)

* PRC Ventures adopting Structure II

may not operate in industries prohibited

from foreign investment, but may

operate in certain industries restricted

from foreign investment, provided

restrictions imposed (e.g., limitation on

shareholding structure) are all complied

with.

HK Co.

WFOE

PRC Venture

PRC

Founder(s)

Contractual Arrangement

Cayman Co.

PRC

Founder(s)

BVI Holding

Co.

PRC OFFSHORE

PRC ONSHORE

VC/PE

HK Co.

PRC Venture

Cayman Co.

PRC

Founder(s)

BVI Holding

Co.

PRC OFFSHORE

PRC ONSHORE

VC/PE

Structure 3: WOFE Structure

Operating in industries prohibited and/or restricted

from foreign investment (X)

Financing from PRC VC/PE (*)


Listing on PRC Stock Exchange (X)

Listing on Oversea Stock Exchange (O)

Structure 4: VIE Structure

Operating in industries prohibited and/or

restricted from foreign investment (O)

Financing from PRC VC/PE (*)


Listing on PRC Stock Exchange (X)

Listing on Oversea Stock Exchange (O)

VC/PE VC/PE

Common Corporate Structures of VC/PE-backed PRC Ventures (2/2)


(Assuming Founders are all PRC citizens)

* Investment by PRC VC/PE in to PRC Ventures adopting Structure III and IV

constitute round-trip investments by domestic enterprises, and whether such

investments may be made are subject to PRC authorities' discretional approval.

II. PRC Foreign Investment Regulation Regime

Foreign Investment Guidance Catalogue

Updated every few years

1.Prohibited

2.Restricted

3.Encouraged

4.Permitted

Revamping Foreign Investment Regime (as of 10/1/2016)

From Approval to Registration (Negative List) Regime

PRC OFFSHORE

PRC ONSHORE


PRC FDI Industrial Policies – further explained (1/4)

Foreign Investors

PRC Venture

（FDI Permitted or

Encouraged)

PRC Venture

（FDI Restricted)

PRC Venture

（FDI Prohibited)

WFOE Sino-Foreign JV Sino-Foreign

Cooperative JV

Foreign Investors

Foreign-invested

investment

company

PRC Venture

（FDI Permitted or

Encouraged)

PRC Venture

（FDI Restricted)

PRC Venture

（FDI Prohibited)

PRC OFFSHORE

PRC ONSHORE

Foreign Direct Investment by Foreign Investors Re-Investment by Foreign-invested Enterprises (FIEs)



Investment by Enterprises invested by FIEs


Cooperative JV

Foreign Investors

Foreign-invested

investment

company

PRC Venture

（FDI Permitted or

Encouraged)

PRC Venture

（FDI Restricted) PRC Venture

（FDI Prohibited)

PRC OFFSHORE

PRC ONSHORE

Enterprises invested by FIEs

(Categorized as domestic enterprises for business registration purpose, but for other purposes?)

Categories of

Investors with foreign investment

Whether such Investors will be deemed as

domestic companies for deciding application of PRC FDI Industrial Policies

H-share Companies

(i.e., PRC established

Companies listed on

Hong Kong Stock Exchange)

may be deemed as a domestic company if: (1)

percentage of shares held by foreign investors in

it is less than 10%; or (2) it has obtained an

approval from competent authority to classify it as

a domestic company

A-share Companies

with foreign factor

(i.e., PRC established

Companies listed on PRC Stock Exchange)

may be deemed a domestic company if: (1）percentage of shares held by foreign investors in

t is less than 10%; and (2) it does not have any foreign strategic Investors

Offshore enterprises

established by state-owned enterprises

Controversies exist, but there are several

precedents in which such investors are treated as domestics enterprises

Others Unless it has obtained an approval from

competent authority to classify it as a domestic

company, it will be deemed as a “foreign investor”

no matter how may layers of intermediary

companies have been inserted between it and

PRC Venture, and regardless of specific

shareholding percentage of its investors with foreign investment




Cooperative JV

Foreign Investors

Foreign-invested

company limited

by Shares

PRC Venture

（FDI Permitted or

Encouraged)

PRC Venture

（FDI Restricted) PRC Venture

（FDI Prohibited)

PRC OFFSHORE

PRC ONSHORE

Enterprises invested by FIEs

(Categorized as domestic enterprises for business registration purpose, but for other purposes?)

PRC Authorities Reviews on application of FDI Industrial Policies

MIIT and its

Local

Counterparts

- Regulator for Telecommunication industry

- Will conduct substantial review and look through to

ultimate investors to determine whether an

enterprise has any foreign investment and therefore

shall be subject to restrictions imposed by FDI

Industrial Policies

MOC and its

Local

Counterparts

- Regulator for Cultural industry

- Will not conduct substantial review but rely on

representation made by each enterprise to determine

whether it shall be subject to restrictions imposed by

FDI Industrial Policies

SAPPRFT and its

Local

Counterparts

- Regulator for Press, Publication, Radio, Film and

Television industry

- Will not conduct substantial review but rely on

representation made by each enterprise to determine

whether it shall be subject to restrictions imposed by

FDI Industrial Policies

CSRC and its

Local

Counterparts

- Regulator for securities industry and approval of

company listing

- De facto Controller are required to disclose its

ultimate investors, and other shareholder are only

required to disclose its direct investors

Investment by Enterprises invested by FIEs



Work-around: VIE Structure (Revisited)

HK Co.

WFOE

PRC Venture

PRC

Founder(s)

Contractual Arrangement

Cayman Co.

PRC

Founder(s)

BVI Holding

Co.

PRC OFFSHORE

PRC ONSHORE

VC/PE

VC/PE

Initially adopted by Sina.com in its U.S. IPO, and currently employed by

numerous PRC Ventures, especially in TMT sector(such as Tencent, Baidu,

Alibaba, VIPS, NOE, etc.).

The contractual arrangement consists of a series of agreements and documents

that allow the WFOE to exercise effective control over the PRC Venture, receive

substantially all of the economic benefits of the PRC Venture, and have an

exclusive option to purchase all of the equity interests in the PRC Venture when

such purchase is permitted by the PRC law.

Uncertainties and risks still exist with regard to:

− Compliance with PRC Laws；

− Effective control over operational of PRC Venture (Moral Hazard)

（disputes concerning Alipay, XDF, Tudou, etc.）;

− Enforcement of contractual arrangement (Rely on PRC court to

enforce the contractual arrangement).

On VIE Structure:

III. Diversifying Ownership while Keeping Control over PRC Venture

Key Factors Affect Control over Venture (1/2)

Within team - Preliminary Allocation of Equity Interests among Founders

− Startup capital put in by each Founder

− Willingness to work for the Venture (full time or part time indefinitely or for a period only)

− Contributions to the operation of the Venture (technology, management, marketing, etc.)

− Resources each Founder may bring to the Venture (financing, strategic cooperation, etc.)

Toward outside investors - Arrangement to Guarantee Founder’s Control over Venture

− Partnership-like Arrangement

− Voting Trust Arrangement

− Dual-shares Structure

− Agreement to Act in Concert

III. Diversifying Ownership while Keeping Control over PRC Venture

Key Factors Affect Control over Venture (2/2)

Partnership-like Arrangement

− Alibaba adopted a partnership-like arrangement in its articles of association

that allow the “partners” consist of Founders and key management to

nominate more than half of the Board members, which in fact allows the

“partners” an effective control over Board.

− Allowed in U.S., but not allowed in PRC or Hong Kong.

Voting Trust Arrangement

− JD adopted voting trust arrangement before its U.S. IPO. As a pre-

condition to accept the investment by investor, JD required investors

to sign a POA to entrust their voting rights to Richard Liu.

− Only applicable when PRC Ventures have adequate leverage to

negotiate, and not allowed when PRC Ventures go public.

Dual-shares Structure

− Baidu, JD, and various PRC Ventures with oversea structure (WFOE or

VIE structure) have adopted dual-share structure. The PRC Ventures issue

different classes of shares to Founders and investors, respectively, and

each share issued to the Founders have multiple of voting rights that each

share issued to the Investors have.

− Allowed in U.S., but not allowed in PRC or Hong Kong.

Agreement to Act in Concert

− Founders of Tencent have entered into an Agreement to Act in

Concert with investor MIH back in 2004, according to which the MIH

agrees to act in concert with Founders with respect to matters

including significate investment, re-organization, etc.

− Only applicable when PRC Ventures have adequate leverage to

negotiate, and not allowed when PRC Ventures go public.

Risks inherent in Vagueness of PRC Law / Regulation

→ 3 things about law you may not know :

1. What the law means;

2. How it will be implemented in practice; and

3. Where the law is

• Access to law and regulation (to select group of industry participants)

Managing Risks of Doing Business in China

State policy

Swift changes and unpredictability

Forex/ODI Policy 2014 vs. 2015-2016

Financial innovation vs. cramming down (CBRC innovation department)

Regulation on private funds

Local government attitude toward certain industries such as private fund

and P2P

Window guidance (in areas such as financial regulation)

Summer 2015 Stock Crash

Insider trading and violation of securities regulation allegations

Foreign hedge funds and domestic stock market participants were penalized

Managing Risks of Doing Business in China

One Advice

Two Things to Keep in Mind when Doing Business in China

One Observation : Chinese law, regulation and policy could

change overnight, so always have a Plan B.

: Get it a good lawyer. Resist the temptation to

ask for heavy fee discount - it may not serve your own

interest at the end of the day.

Resolving Disputes in China-focused PE & VC Investments

PART III

Typical Investment Structures

Introduction to

VIE Structure

Without VIE Arrangement

Founders

BVI or Cayman

Holding Company

Investors

Hang Kong

Holding Company

WFOE

Offshore

PRC

100%

100%

Typical Investment Structures

With VIE Arrangement

Founder A Founder B

BVI Co. BVI Co. VC/PE Investors

Cayman Holding Company

Hong Kong Holding Company

WFOE Domestic Company (OPCO)

Founder A Founder B

100% 100%

100%

100%

100%

100%

VIE Agreements

Offshore

PRC

Transaction Documents

Introduction to

VIE Structure

1. Share Subscription and/or Share Purchase Agreement(s)

2. Shareholders Agreement or Investors’ Rights Agreement

3. Ancillary Agreements

VIE Agreements

Founder’s Employment Agreement

Non-Compete and Confidentiality Agreement

Share Charge or Pledge Agreements

Typical Governing Law and Dispute Resolution Provisions in the Transaction Documents

Introduction to

VIE Structure

Governing Law

Any dispute, controversy or claim arising out of or in connection with this Agreement shall be governed by and

construed in accordance with the Laws of Hong Kong regardless of the Laws that might otherwise govern under

applicable principles of conflicts of law.

Dispute Resolution

Any dispute, controversy or claim arising out of or relating to this Agreement, including the existence, validity,

interpretation, performance, breach or termination thereof or any dispute regarding non-contractual obligations arising

out of or relating to it shall be referred to and finally resolved by arbitration administered by the Hong Kong

International Arbitration Centre (the “HKIAC”) under the Hong Kong International Arbitration Centre Administered

Arbitration Rules (the “Rules”) then in effect when the Notice of Arbitration is submitted. The arbitration shall be

conducted in English language by three arbitrators with one arbitrator appointed by the claimant(s), one arbitrator

appointed by the respondent(s) and the third arbitrator appointed by the mutual agreement of the two arbitrators

appointed by the parties of the arbitration, and if no agreement can be reached for the appointment of the third

arbitrator within thirty (30) Working Days after the other two arbitrators have been appointed, then the third arbitrator

shall be appointed by the HKIAC. The arbitration shall take place in Hong Kong and the judgment upon any award

rendered in such arbitration will be final and binding.

Possible Disputes

Breaches of Protective Covenants Sample Protective Covenants Clause.

Prior to the Listing of the Company, each of the Group Companies (where applicable) shall not,

without the prior approval of sixty-six point seventy percent (66.70%) of the total number of the

Board of such Group Company (which shall include the approval of the Investor Director for such

Group Company), take or do or agree to take or do any of the following actions or transactions:

(a) alter or change the rights, preferences, privileges, or powers of, or the restrictions of

provided for the benefit of, the Target Shares;

(b) authorize, create, issue any shares of the Group Companies or increase or decrease

the number of issued shares in any of the Group Companies;

Possible Disputes

(c) reclassify any outstanding securities, registered capital or other equity interest in any

Group Company;

(d) authorize, create or issue of any debt securities or interest, or any securities or

interest exercisable, convertible or exchangeable for any shares or other equity or debt

securities or interest by each such Group Company to any third party;

(e) lend money to, borrow money from third parties;

(f) declare or pay any special dividend;

(g) conduct any acquisition, merge, consolidation, expansion, scheme of arrangement,

recapitalization, reclassification, split–off, spin-off or sale or other disposition of all or

substantially all of the business, goodwill, assets and/or equity equivalents of any of the

Group Companies;

Possible Disputes

(h) purchase, repurchase, redeem or cancel, directly or indirectly of any share capital or

other equity securities (or any securities exercisable for or convertible or exchangeable

into such securities of any Group Company), except as expressly provided in the M&AA

in respect of the redemption of the Target Shares at the election of the Investors;

(i) sell, lease, charge, pledge, mortgage, grant a security interest in, encumber, transfer

or dispose of the assets or equity interest of the Group Companies;

(j) adopt or amend the annual business plan and/or budget of the Group Company or

adopt any items which deviate any Group Company’s business from the core business as

contained in the annual business plan or budget;

(k) incur capital expenditures in excess of US$500,000 during any fiscal year, except for

capital expenditures incurred pursuant to the then current business plan or annual budget

approved by the Board;

Possible Disputes

(l) conduct transactions with any related or affiliated parties (other than the enterprises

included in the consolidated financial statement of the Group Companies, or those

transactions which occurred in previous year(s) and subsisting as at the Closing Date);

(m) adopt any amendment to the M&AA, articles of association, certificate of

incorporation, by-laws or any similar constitutive documents;

(n) materially change its accounting principles, procedures, policies (other than those

required under the applicable accounting standards);

(o) appoint or change an auditor of the Group Companies that is not a Big-four

international accounting firm;

Possible Disputes

(p) proceed with dissolution, liquidation, winding-up, re-capitalization, reorganization, or

bankruptcy (other than for the purpose of the Listing) of any Group Company;

(q) initiate or settle any material lawsuit, proceedings, or disputes that involve amounts of

more than five percent (5%) of any Group Company audited net assets, except those

lawsuits, proceedings, or disputes arising from or in connection with matters in relation to

the ordinary course of business of the Group Companies;

(r) determination of the listing venue, timing, valuation, auditor, underwriter(s) and other

terms of any initial public offering of the Company's ordinary Shares; and

(s) adopt any employee incentive plan, including but not limited to cash bonus and share

option plan.

Possible Disputes

Failure to meet the performance benchmark

Sample Performance Adjustment Clause.

The Total Subscription Price is calculated based on that the post-money valuation of the Company

on a fully-diluted basis (the “Post Money Valuation”) immediately after the Closing and without

taking into account any adjustment as provided in this Subscription Agreement, equaling to sixty

million US dollars (US$60,000,000).

The Parties agree that (i) the Net Profit for the fiscal year ended on December 31, 2017 (i.e.

January 1, 2017 to December 31, 2017) (the “2017 Net Profit”) shall not be less than six million

US dollars (US$6,000,000) (the “2017 Target Net Profit”).

Possible Disputes

In addition to any other rights the Investors may be entitled to hereunder, in the event that the

2017 Net Profit is lower than the 2017 Target Net Profit, the Investors shall have the right to

request a one-time performance adjustment. Such right shall be exercised by the Lead Investor

on behalf of the Investors by a written notice to the Existing Shareholder (the “2017 Adjustment

Notice”). Upon receipt of such 2017 Adjustment Notice, the Company shall adjust the

shareholding percentage of the Investors pursuant to Section XXX below, or (ii) provide cash

compensations pursuant to Section XXX below, or (iii) a combination of a shareholding percentage

adjustment and cash compensations such that the Investors receive the same aggregate

economic benefit as they would be entitled to ……..

Possible Disputes

Sample Qualified IPO Clause.

The Group Companies shall, with the goal of achieving the Qualified IPO within twenty-four (24)

months after the Closing or such later date as the Company and the Lead Investor mutually agree

to, submit an application for the Listing at a time that can be reasonably expected to achieve the

Qualified IPO by the above date.

In the event that the Company fails to achieve the Qualified IPO within twenty-four (24) months

after the Closing or such later day as mutually agreed to by the Company and the Lead Investor,

the Investors shall be entitled to exercise the First Put Option Right as set forth in Section XXX of

this Agreement.

Possible Disputes

Unable to honor Investor’s put option right

Sample Put Option Right Clause.

In the event that (i) the Company fails to meet the Qualified IPO requirements or the Qualified IPO as set forth

in Section XXX has not been accomplished within twenty-four (24) months after the Closing Date; or (ii) the

Company fails to meet its 70% of 2017 Target Net Profit, each of the Investors shall have the right (“Put

Option Right”) to sell all or any part of (as specified in the Put Option Notice (as defined below)) the Target

Shares (for the purpose of this Section XXX, Target Shares shall include all 2017 Compensation Shares or

other shares or Securities of the Company (if any) held by the Investors at time of exercise of the Put Option

Right) (“Put Option Right Shares”) to the Guarantors, at the sole discretion of the Lead Investor, and the

Guarantors shall purchase all of the Put Option Right Shares from the Investors at a purchase price (“Put

Option Right Price”) equal to the Subscription Price and/or the Purchase Price applicable to such Put Option

Right Shares plus an annual interest of 10% on a compounding basis (in US$ terms) (the “Put Option

Interest”) and all accrued and unpaid dividends on the First Put Option Right Shares…………..

Possible Disputes

Unable to honor the Investor’s redemption rights

Sample Redemption Clause.

In addition to other rights the Investors may have under the Transaction Documents or the

applicable laws and regulations, the Investors shall be entitled to request the redemption of the

remaining Convertible Bonds (if not converted in full) and the payment in cash and US$ of the

principal amount of such remaining Convertible Bonds and an amount of interest representing

20% of the internal rate of return (“IRR”) of the Principal Amount from the date of issuance of the

Convertible Bonds to the payment date, upon giving forty-five (45) days’ notice in writing, if:-

(1) the Company has breached the use of proceeds provisions as stipulated in this Agreement and

failed to cure such breach within two (2) months upon receiving notification of the breach from the

Investors; or

Possible Disputes

(2) the Company has involved in any material misrepresentation regarding the financial statements

or Latest Audited Accounts of the Company; or

(3) the Company ceases to be listed or admitted to trading suspension up to thirty (30) days on the

Hong Kong Stock Exchange; or

(4) if there has been a breach of any representation, warranty, covenant or agreement on the part

of the Company set forth in the Transaction Documents, which breach has not been cured within

two (2) months after receiving the notification of breach from the Investors, except for which that

will not, individually or in the aggregate, have a material adverse effect on the operation or

financial position of the Company; or

Possible Disputes

(5) the Company issues any new Shares in aggregate in excess of its general mandate starting

from the date of the issuance of the Convertible Bonds to the maturity of the Convertible Bonds,

except for the issuance pursuant to the refreshed general mandate to be approved by the

shareholders in the extraordinary general meeting to be held prior to May 31 2019 provided that

the number of which shall not be more than XXXXX; or

(6) the occurrence of any of the following events (a) the insolvency of the Company, (b) the

commission of any act of bankruptcy by the Company, (c) the execution by the Company of a

general assignment for the benefit of creditors, (d) the filing by or against the Company of a

petition in bankruptcy or any petition for relief under the applicable bankruptcy law or the

continuation of such petition without dismissal for a period of ninety (90) days or more, (e) the

appointment of a receiver or trustee to take possession of the property or assets of the Company

or (f) the appointment by the Company of an administrator or administrative receiver.

Possible Disputes

Breaches Founders’ and the company’s representations and warranties

Sample Representations and Warranties Clause.

Each of the Company, PRC Co., PRC Co. Shareholders (with respect to PRC Co. Shareholders,

only with respect to the representations and warranties applicable to PRC Co. and PRC Co.

Shareholders) and the WFOE (each, a “Representing Party” and collectively, the

“Representing Parties”) hereby represents and warrants to the Investor, except as set forth in

the Disclosure Schedule (the “Disclosure Schedule”) attached to this Agreement as Exhibit E,

as of the date hereof and, where appropriate, the date of each Closing, as follows:

Possible Disputes

Organization, Standing and Qualification.

Due Authorization.

Compliance with Laws; Consents and Permits.

Compliance with Other Agreements and Documents.

Capitalization.

Use of Proceeds.

Valid Issuance of Series A Shares and Common Shares.

Financial Statements.

Title to Properties and Assets.

Possible Disputes

Intellectual Property.

Material Liabilities.

Litigation.

Tax Matters.

Employee Matters.

Material Contracts and Obligations.

Interested Party Transactions.

Changes in Condition.

Possible Disputes

Breaches Founder’s post-closing covenants

Sample Post-Closing Restructuring Clause.

(a) Within three (3) months after the Closing, the Selling Shareholder, Mr. X and Mr. Y shall

complete the sale and purchase of XXXX Ordinary Shares of the Company and obtain all the

governmental approvals and registrations required for such sale and purchase of XXXX Ordinary

Shares, including but not limited to the approvals and registrations required under Circular 37, and

upon the completion of such sale and purchase, the Selling Shareholder, Mr. X and Mr. Y shall

own XXX, XXX and XXX Ordinary Shares of the Company respectively, being approximately XXX

percent (XXX%), XXX percent (XXX%) and XXX (XXX%) of all the issued shares of the Company

as enlarged by the Subscribed Shares agreed to be subscribed for by the Investors under this

Agreement.

Possible Disputes

(b) If for any reason, Mr. X and Mr. Y cannot complete their respective individual foreign exchange

registration in accordance with Circular 37 for their respective purchase of XXX and XXX Ordinary

Shares of the Company from the Selling Shareholder: (i) Mr. X and Mr. Y shall jointly establish a

limited liability company in the PRC (the “Founder Holding Co.”), while Mr. X and Mr. Y shall

respectively hold XXX percent (XXX%) and XXX (XXX%) of the total equity interest of the Founder

Holding Co.; (ii) Mr. Z shall sell to the Founder Holding Co., and the Founder Holding Co. shall

purchase from Mr. Z XXX shares of the Selling Shareholding, and upon the completion of such

sale and purchase, Mr. Z and the Founder Holding Co. shall own XXX and XXX shares of the

Selling Shareholder respectively…..

Possible Disputes

Sample Circular 698 Filing Clause.

Within thirty (30) days after the signing date of this Agreement, the Selling Shareholder and WOFE

shall submit tax filing documents to the competent PRC tax authority with respect to the Purchase

Price to be paid by the Investors and received by the Selling Shareholder in accordance with the

provisions of Circular 698 and Circular 7 and other requirements of the relevant tax authority. The

Investors are hereby authorized to use any or all of the Withheld Tax Amount to pay any enterprise

income tax amount imposed by the relevant tax authority on the Selling Shareholder. The costs of

the foregoing tax declaration and any amount of the enterprise income tax imposed by the tax

authority which exceeds the Withheld Tax Amount shall be solely borne and promptly paid by the

Selling Shareholder.

Possible Disputes

Sample Full Time Commitment Clause.

Each of the Founders respectively undertakes and covenants to the Investors that commencing

from the date of this Agreement until a Qualified IPO of the Group Companies, he shall commit all

of his efforts to furthering the business of the Group Companies and shall not, without the prior

written consent of the Investors, either on his own account or through any of his Affiliates, or in

conjunction with or on behalf of any other person, (i) possess, directly or indirectly, the power to

direct or cause the direction of the management and business operation of any entity whether (A)

through the ownership of any equity interest in such entity, or (B) by occupying half or more of the

board seats of the entity; or (C) by contract or otherwise; or (ii) devote time to carry out the

business operation of any other entity.

Mechanism for Resolving Disputes

Arbitration vs. Court Litigation

Neutrality

Expertise

Confidentiality

Flexibility

Finality

Speed and Cost

Enforceability

New York Convention

Arrangement Concerning Mutual Enforcement of Arbitral Awards Between the Mainland

and the Hong Kong Special Administrative Region (“Arrangement”)

Others

Venue for Resolving Disputes

Hong Kong International Arbitration Centre (“HKIAC”) vs. Singapore International Arbitration

Centre (“SIAC”)

China International Economic and Trade Arbitration Commission (“CIETAC”) a new option

Ancillary Proceedings

Actions on offshore holding company level

Actions in connection with onshore operation or onshore companies

Arbitration/litigation a means but not an end

Exit by forcing the Founders to buy back the Invested Shares

Exit by having the Invested Shares purchased by the new investors

Exit by having the Invested Company or its assets bought by the new investors or third party

Other Exit Strategies

Q&A

Question

Answer Discussion

James Yong Wang (王勇)

Han Kun Law Offices

Email: [email protected]

Cell (China) & WeChat : (86) 138 1149 9450

Cell (China) : (86) 185 1188 0418

Cell (New York) : (001) 646 285 1100

Mike Chiang （蒋尚仁）

Han Kun Law Offices

Email: [email protected]

Cell (China) : (86) 136 6189 6350

General: (86) 216080 0909

Direct: (86) 216080 0919