Provisional Regulations for the Administration of Venture Capital Enterprises

After the recent enactment of the far-reaching revisions to the PRC Company Law and the release of the Hui Fa No.75 which encourages the cross-border restructurings through special purpose vehicles (for more details of the revised PRC Company Law and Hui Fa No.75, please refer to our China Law Update – Sept.-Oct. 2005), the National Development & Reform Commission ("NDRC") have issued Provisional Regulations for the Administration of Venture Capital Enterprises ("Provisional Regulations") following approval by the State Council of the People's Republic of China. The Provisional Regulations establish partially uniform rules for both domestic and foreign-invested venture capital enterprises.

Autonomous Registration & Conditional Preferential Treatment

The Provisional Regulations do not require the establishment of venture capital enterprises ("VCEs") to be approved by government agencies. Instead, they create an autonomous registration mechanism. VCEs can voluntarily register with VCE authorities (i.e. at the national level with the NDRC, and at the provincial level with other governmental agencies as specifically determined by provincial government or semi-provincial municipal government, collectively "VCE Authorities") and accept supervision by the VCE Authorities. VCEs may decide not to register with VCE Authorities, but as a result of non-registration, they will not be eligible for certain preferential treatments as stipulated in the Provisional Regulations or to be stipulated by relevant government agencies.

Uniform Rules Available, But Old Specific Rules Still Govern Foreign Investment

The Regulations for the Administration of Foreign Invested Venture Capital Enterprises issued by the then existent Ministry of Foreign Trade & Economic Cooperation ("MOFTEC") and four other government agencies on January 30, 2003 will still govern foreign invested venture capital enterprises. For example, the establishment of foreign invested VCEs will still be subject to approval by the Ministry of Commerce ("MOC"), the successor of the MOFTEC. Foreign invested VCEs, however, may also enjoy the relevant preferential treatments under the Provisional Regulations if their investment and operations meet relevant conditions stipulated therein. This makes the Provisional Regulations somewhat uniform with respect to conditional preferential treatments for registered VCEs.

Establishment and Legal Form

VCEs may take the form of a limited liability company, a company limited by shares, or another enterprise form stipulated by the law. The VCEs that take the form of a limited liability company or a company limited by shares may authorize another VCE or venture capital management consulting enterprise ("VCMCE") to be their management consultants. To establish a VCE or VCMCE, an applicant may directly register with administrations of industry and commerce ("AICs").

Authorities and Criteria of Registration

VCEs that are registered with the State Administration of Industry and Commerce ("SAIC") will file with the NDRC for registration; and those registered with AICs at or below provincial levels will file with provincial or semi-provincial VCE Authorities. To be registered by VCE Authorities, a VCE must: (a) have been registered with SAIC or AICs; (b) have a business scope which is limited to (i) venture capital business, (ii) agency of others venture capital business, (iii) venture capital consulting, (iv) management services for start-up enterprises, and (v) participation in the establishment of a VCE or VCMCE; (c) have (i) a paid-up registered capital no less than RMB 30 million, or (ii) have a first paid-up registered capital no less than RMB 10 million with a commitment from all of its investors to increase the paid-up registered capital to no less than RMB 30 million within 5 years after SAIC/AIC registration; (d) have no more than 200 investors (if it is a limited liability company, then no more than 50 investors). Each single investor should contribute no less than RMB 1 million and all investors should make their capital contributions in currency; and (e) have at least 3 senior management members with more than 2 years' experience in venture capital or other relevant business, or in the event it entrusts other VCEs or VCMCEs to manage its venture capital business, then such entrusted VCE or VCMCE must have at least 3 senior management members with more than 2 years' experience, who will be specifically responsible for the management of its venture capital business.

Requirements or Restrictions for Venture Capital Operations

VCEs should not deal in guaranty business or real estate business. VCEs may use all of their assets to make investments, but investments can only be made to non-listed enterprises. The investment of VCEs in a single enterprise should not be more than 20% of their total assets. VCEs may determine their operating terms, but they should be no less than 7 years.

Preferential Treatment Policies

The central and local governments may establish some funds to guide the establishment and development of VCEs by buying shares or providing financing security. The state will use preferential tax treatment to support the development of VCEs and will encourage VCEs to increase their investment in small-and-medium-sized enterprises, especially high-tech enterprises. VCEs may exit the invested enterprises by means of equity transfer (by listing on the stock markets or by agreement), equity redemption of invested enterprises, or some other means. The Provisional Regulations do not provide detailed rules for the implementation of such preferential policies. Relevant government authorities will work on the specific implementing rules.

Reporting Duties & Annual Inspection

VCEs and their VCMCEs should submit an annual financial report (audited by a CPA) and business report to the relevant authorities within 4 months after each fiscal year and promptly report material events such as the amendment of articles of association, an increase or decrease of capital, a division or merger, the change of senior management or VCMCE or liquidation or termination. Within 5 months of the end of each fiscal year, the relevant authorities will conduct an annual inspection of VCEs and VCMCEs. Serious violation of relevant requirements will be subject to the revocation of registration, and a reapplication will not be accepted within 3 years of the revocation.

Registration of Companies & Company Capital

After China released the amended PRC Company Law on October 27, 2005, as summarized in our China Law Update – September-October 2005, the State Council and the State Administration of Industry and Commerce respectively issued amended or new rules regarding the registration of companies and companies' capital.

As a supplement to the summary of the newly amended Company Law in our last update, it is necessary to mention that the Company Law only stipulates general rules for companies. Therefore, the specific different rules under the PRC Sino-Foreign Joint Venture Enterprises Law and PRC Wholly Foreign Owned Enterprises Law will still govern foreign invested companies. For example, the amended Company Law removes the 20% limit of capitalization by means of industrial property rights and non-patented technologies, which theoretically permits up to 70% of the capitalization to be in the form of IP rights. However, the 20% limit has not been removed from the PRC Wholly Foreign Owned Enterprises Law, therefore WOFEs will still be subject to the 20% limit.