The Hong Kong Stock Exchange was in the news recently with the launch of the world’s fifth largest seller of smartphones Xiaomi’s initial public offering (IPO) in July. Our lawyers from the corporate team in Hong Kong share some issues to consider when planning an IPO launch there.
1. Why do I need separate advice given that my company will be engaging advisers for the IPO?
There are a number of areas where your interests as founder/controller and those of the company conflict. There may be non-core assets which you wish to extract from the group prior to IPO or businesses outside the group. You will therefore need to negotiate the terms of any such pre IPO reorganisation and you need independent legal representation to ensure that the reorganisation is implemented on terms favourable to you and acceptable to the listing criteria set out in the Listing Rules.
2. What level of confidence can I have in the bookrunners’ views on valuation?
For larger IPOs, we would usually recommend that companies seeking a listing (‘issuers’) take advice from an independent investment bank which can look over the shoulders of the bookrunners and ensure that they are not leaving too much money on the table for investors. The perceived wisdom is that it is sensible to price an IPO so that the share price rises immediately following admission to the market because if a stock starts trading at below its issue price, it is much more difficult to subsequently regain investors’ confidence in the stock. There is an inherent conflict, however, in banks keeping their key clients who are investing in the IPO happy – through an uplift in value in their investment following the IPO – as opposed to making sure the founders/controlling shareholders receive full value for their stock, which reduces the profits made by the investors.
3. What obligations will I have to take on as part of the IPO process?
You will be asked to enter into a lock-up arrangement pursuant to which you are not able to sell your shares for 12 months, or six months if you are not a controlling shareholder. You would usually want to negotiate some carve outs to any such lock-in e.g. to allow you to transfer shares into a family trust or foundation or to family members.
3.2 Representations and warranties under the underwriting agreement
Back-to-back confirmations by the controlling shareholders, proposed directors and the company are usually required. If the founders/owners have stepped away from the day-to-day running of the business and/or they are not on the board, they would want to ensure that any warranties were qualified by their awareness and, in any event, their liability should be made subject to limitations both as regards the length of time in which warranty claims can be brought and their overall limit of liability.
3.3 Statutory liability as a director of the company
Directors collectively and individually accept full responsibility of the information disclosed in the prospectus, which includes a session in relation to the underwriting agreement.
3.4 Service agreement/letter of appointment/non-competition
Normally, a new arm’s length service agreement or letter of appointment would be put in place in anticipation of the IPO. You would want to ensure that you had the benefit of a separate contractual indemnity for directors’ liabilities from the company and ensure that the company maintains cover for you under a directors’ and officers’ insurance policy. You would also want to review the provisions of any service agreement or letter of appointment. Typical issues to negotiate in a service agreement include termination provisions, the ability for the company to put you on garden leave, the scope of your duties and your overall compensation package. You may also be asked to enter into a non-competition deed which would need to be carefully reviewed.
4. What role can my relatives and I have in the management of the company post-IPO?
For a Hong Kong IPO, the Listing Rules require a company to have at least three independent non-executive directors comprising of at least one-third of the board. Relevant qualifications for being an independent non-executive director include having a knowledge in finance, accounting or law.
5. Voting/non-voting shares
Dual-class shares may now be listed in Hong Kong, with Xiaomi as the first dual-class share structure to have listed. Hong Kong requires the special rights attached to dual class shares to be cancelled if the founder dies, is incapacitated or otherwise ceases to be a director. The founder's shares do not have to be held personally but can be held in a trust, limited partnership or private company. A Hong Kong listed company with a dual class listing is required to establish a corporate governance committee comprised entirely of independent non-executive directors appointed on a one-share-one-vote basis.
6. Do I need to address the structure of my holding above the company in view of the potential liabilities identified above and for tax reasons?
It is important, both commercially and from a tax point of view, that you take steps in advance of the IPO to adopt the optimal structure for your holding. At the very least, you will need to ensure that the jurisdiction chosen for the IPO vehicle does not jeopardise your personal tax position or, if that is not possible, ensure that it is held through an appropriate holding structure to shield you from any unwanted liabilities.