Fundamental methods for the dismantling of VIE structures

A captive structure, or a variable interest entity (VIE) structure, is a method of compromise used by foreign investors for their investment in certain domestic industries in China. The reasons behind its adoption include restrictions on foreign investment in certain industries in China, as well as the relatively high threshold for entry into the domestic capital market, which has caused start-ups operating in China to turn to foreign investment and listings on overseas capital markets.

In recent years, with the progressive opening of relevant industries to foreign investment, the state’s vigorous support of start-ups, and the development of the domestic capital market, numerous enterprises that previously obtained foreign financing through a VIE have completed, or are contemplating, the dismantling of their existing structures in order to return to the Chinese market for financing or listing. This article describes the fundamental steps to take to accomplish such a restructuring.

VIE structure

Common practice for setting up a VIE involves the following:

1. The founders establish offshore holding companies (usually BVI companies);
2. The offshore holding companies establish another offshore company (usually a Cayman Islands company) to serve as the entity for purposes of financing, establishing employee stock ownership plans (ESOPs), and seeking public listing in the future;
3. The Cayman company establishes a wholly-owned Hong Kong company out of tax planning considerations, which in turn establishes a wholly foreign-owned enterprise (WFOE) in China;
4. The WFOE, the domestic company in China (usually the company that actually operates the business, i.e. the VIE company) and its registered shareholders execute a series of control agreements (VIE agreements, or control documents).

Under such a structure, the Cayman company can realize consolidated financial statements under generally accepted accounting principles in foreign jurisdictions for public listing purposes.