Gansu case helps with design of a valuation adjustment mechanism

In recent years, valuation adjustment mechanisms have gradually been accepted and used by transaction parties in private equity (PE) investments in China. In a PE transaction, “value adjustment” means revision, at some time after closing, of the valuation of the investee company based on its actual operations, whereupon the investment price, post-investment equity and other rights and obligations of the investor, the investee company and the original shareholders are redefined.

The reason for adopting a valuation adjustment mechanism lies in the asymmetry of the information on the operations of the enterprise that is available to the investor, and to the investee company and the original shareholders, when negotiating the valuation of the investee company, with the investor never as clear on the investee company’s operations as the investee company itself.

The case

In the Gansu valuation adjustment case, the investor, Haifu, the investee company, Shiheng (originally Zhongxing), and the Shiheng shareholders executed a capital increase agreement providing that Haifu and Shiheng would carry out a valuation adjustment in light of Shiheng’s performance.

Wang Wei is a partner at Zhonglun W&D Law Firm in Beijing and is the chairman of the Private Equity Fund Practice