From our over 20 years of experience advising foreign investors/owners of
companies in China and advising local Chinese companies with foreign investors,
we've received countless inquiries about VIE structures.
The VIE structure is a business structure widely used by Chinese companies
in certain business sectors that have restrictions on foreign investment.
Some famous Chinese companies listed on U.S. stock exchanges,
such as Alibaba and JD.com, use a VIE structure. If you read their prospectus
carefully, the structure is described quite thoroughly but not in a way
that’s easy to understand.
How does a VIE work?
VIE stands for “Variable Interest Entity” and is a inter-company group structure set up using contracts that give an investor a controlling interest despite not having direct share ownership. The first well-known case using a VIE structure goes back to last century the year 1998 when Sina.com listed in the US. From the examples we have seen in China, the set up is a foreign entity or individual who does not hold shares in a Chinese operating company but controls it. The foreign company in our example can enter various contracts with the Chinese company and its owners with the aim of passing the economic benefits of the business to the foreign party.
One example of a VIE structure in China:
Investors hold equity in a Cayman holding company; Cayman holding company sets up a Hong Kong company; Hong Kong company sets up a wholly foreign owned company (“WFOE”) in China; Local Chinese citizens hold 100% equity of a Chinese operating company (“domestic company”); and WFOE has contractual agreements with the domestic company.
For internet businesses where this structure is often applied, the domestic company, which is the ICP license holder will carry out the licensed activities for the Chinese market.
(Read more about ICP here: How to Apply for an ICP Commercial License)
Do you need a VIE? And what do you have to be aware of?
A VIE structure is commonly seen in the education technology industry, market communications field, SaaS and e-commerce companies. There are other areas that VIE arrangements exist but the diversity of its application is not the focus of this article.
There are multiple kinds of agreements that need to be executed depending on the arrangement including a loan agreement, call option agreement, service agreement etc. This part will be handled by some experienced legal practitioners.
We have dealt with some challenges relating to the VIE structure such as the resignation of the domestic company equity holders, tax issues between the WFOE and the domestic company as part of their agreements, explaining complicated consolidation structures (involving 5 to 6 companies) for the stakeholders to see the whole picture of how well the business is doing; and many more.
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