"HKEx Issues New Guidance on Pre-IPO Investments"

by Skadden, Arps, Slate, Meagher & Flom LLP

[authors: Christopher W. Betts, Edward Lam, Alec P. Tracy]

More than two years have passed since the Listing Committee of The Stock Exchange of Hong Kong Limited (the HKEx) issued the Guidance on Pre-IPO Investments Pending Consultation on Possible Listing Rule Amendments (the Interim Guidance). Despite the suggestion in its title that the Interim Guidance might be a prelude to a consultation process leading to the introduction of a clearer and more comprehensive set of rules governing pre-IPO investments, the consultation process has not yet eventuated and the principal effect of the Interim Guidance largely has been restricted to establishing a bright-line test for the timing of pre-IPO investments,1 with the remaining parameters of pre-IPO investments left to the market to interpret based on the principle of fair and equal treatment set out in Rule 2.03 of The Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the Listing Rules) and a number of listing decisions issued both prior to and after the Interim Guidance. The issue by the HKEx on October 25, 2012 of Guidance Letter GL43-22, “Guidance on Pre-IPO investments” and Guidance Letter GL44-12, “Guidance Letter on Pre-IPO investments in convertible instruments” (together, the Guidance Letters), therefore comes as a welcome development.

The Guidance Letters consolidate several of the rules set out in the various listing decisions and lay out a specific list of what is “allowed” and “disallowed” with respect to some of the commonly encountered terms set out in pre-IPO investment agreements. We set out below a list of these terms, as well as (where relevant) the conditions that must be fulfilled for these terms to be considered acceptable either pre- or post-IPO.


  • Director appointment rights, provided that post-IPO they are available generally to all shareholders (i.e., any shareholder holding more than a certain level of voting rights has the same right). Pre-IPO investors may nominate or appoint directors prior to IPO, but those persons must be subject to the usual retirement and reappointment requirements post-IPO;
  • Profit guarantees requiring a shareholder of the listed company (but not the listed company itself) to pay compensation to pre-IPO investors in the event the company’s profit does not meet a certain level;
  • Anti-dilution rights granted to specific investors, provided that (a) any rights exercised concurrently with the IPO are done so at IPO price and are fully disclosed in the prospectus and IPO allotment results announcement and (b) the rights terminate upon IPO;
  • Contractual veto rights (provided that they terminate upon IPO);
  • Put or exit options granted to pre-IPO investors to put back their shares to the company (provided that they terminate upon IPO);
  • Negative pledges, provided they are widely accepted provisions in loan agreements. The two specific negative pledges identified as being acceptable (with all other pledges to be reviewed by the HKEx on a case-by-case basis) are pledges:
    • not to create or effect any mortgage, charge, pledge, lien or other security interest on an applicant’s assets and revenues; and
    • not to dispose of any interest in the economic rights or entitlements of a share the controlling shareholder owns or controls to any person;
  • Information rights, provided that upon IPO the pre-IPO investor is only entitled to receive published information or information that is made available to the general public at the same time, with a view to avoiding unequal dissemination of information;
  • Rights to nominate senior management and committee representatives (on the basis that they are merely nominations and the board is not contractually obligated to approve them), provided that if they survive post-IPO they are available generally to all shareholders (i.e., any shareholder holding more than a certain level of voting rights has the same right);
  • Rights of first refusal and tag-along rights granted by a shareholder of the listed company to a pre-IPO investor (but not involving the listed company itself);
  • Covenants by the applicant not to issue or offer any shares, options warrants or rights to any direct competitor of the pre-IPO investor or to other investors on terms more favorable than the terms on which the shares are issued to the pre-IPO investor, provided that they are modified to include an explicit “fiduciary out” clause so that directors are allowed to ignore the terms if complying with the terms would constitute a breach of their fiduciary duties;
  • Partial conversion of convertible instruments into ordinary shares at IPO (as opposed to full conversion), provided that all other atypical special rights are terminated at IPO; and
  • Convertible instruments that provide for redemption at a price equivalent to a fixed internal rate of return (either early at the option of the holder or upon maturity).


  • Profit guarantees to be settled by the listed company or linked to the market price or capitalization of its shares;
  • Any price adjustment provisions that have the effect of creating two different prices for the same securities for pre-IPO investors and other shareholders investing at the time of listing. For example, a convertible bond conversion price expressed as a discount to IPO price or linked to a particular market capitalization will not be allowed;
  • Conversion price reset mechanisms for convertible instruments (for example, a reset mechanism that allows conversion based on the lower of a fixed price and a floating market price); and
  • Terms requiring prior consent from a pre-IPO investor for certain corporate actions (such as changes in articles, declarations of dividends and director changes) that survive the IPO unless the company can demonstrate that the relevant terms are not egregious and do not contravene fundamental principles to the disadvantage of other shareholders.

Separately, the HKEx also gave guidance on “Qualified IPO” terms that are regularly contained in pre-IPO investment agreements. These terms typically require the company to complete an IPO of a certain valuation within a specified period of time, failing which the pre-IPO investor’s consent will be required for the IPO to proceed (this consent, as a practical matter, is often provided subject to the payment of compensation to the investor). The HKEx has made it clear that the pre-IPO investment agreement should provide a clear mechanism for the calculation of the amount of compensation payable to pre-IPO investors in the event that the IPO does not meet any “Qualified IPO” criteria. Failing this, if the company is required to negotiate and agree upon a level of compensation with the pre-IPO investors, the HKEx will view that as an amendment to the original terms and therefore the company will need to wait either (a) 28 clear days before filing a renewed listing application or (b) 180 days between the compensation being paid and the IPO proceeding.

Although helpful, the Guidance Letters still leave some questions unanswered. For example, it is unclear whether compensation payable under a profit guarantee can only be paid in cash or whether it can also be paid in shares. It is also unclear whether conversion price reset mechanisms are disallowed in all circumstances or are permissible so long as any resets occur prior to IPO (or the time limits set out in the Interim Guidance). Furthermore, the HKEx did not elaborate on what it viewed as being “atypical” rights of holders of convertible instruments or what terms requiring prior consent from a pre-IPO investor for certain corporate actions it might view as being “egregious."

It is important that pre-IPO investors and potential listing applicants work with their legal advisers to ensure that any investments conform as closely as possible to the requirements set out in the Guidance Letters and other subsisting rules, failing which the HKEx may require the parties to unwind or amend certain provisions. This, in turn, could lead to the HKEx “restarting the clock” on the time between the new terms of the investment being agreed and the IPO proceeding.


1 The bright line-test for the timing of pre-IPO investments established by the Interim Guidance was that pre-IPO investments must be irrevocably settled either (a) 28 clear days prior to the submission of the listing application to the HKEx or (b) 180 clear days before the IPO date.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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