PE funds: check your buyback terms have the PRC’s seal of approval

As a common international practice, private equity (PE) funds will regularly write equity or share buyback terms into the investment agreements they execute with investee enterprises. The reason for these terms is that in the investment process, PE funds seldom have a sufficient understanding and knowledge of the investee enterprises so the investment decisions they make face numerous uncertainties and risks. Another reason is that the analysis of, and judgment on, the enterprises by their management generally lean toward the optimistic.

As potential investment risks exist, the main intention of investors to include such terms is to reserve for themselves the opportunity to revise the valuation of an investee enterprise and add a channel for withdrawing from it when specific circumstances arise. In other words, when a company’s performance does not reach the promised value, or another circumstance arises (e.g. mass departure by senior management and core technical personnel, failure to list by the specified date, discovery of an existing error in the enterprise’s operations and management, etc.) the investor has the right to request to sell its equity to the company, recover its initial investment costs and obtain a certain premium pursuant to the specified buyback provisions.

Furthermore, the conditions set by the equity buyback terms incentivise the existing shareholders to use their best efforts to realise their undertakings initially given to the investor.

Zhang Yichi is a partner at Concord & Partners, and Zuo Kun is the firm’s associate