What does investing in China’s tech companies’ VIE structure mean for investors?
Foreign ownership is prohibited in a number of sectors in China. To raise money and enjoy dual-share listing, many China-based companies (e.g. Alibaba, Tencent, etc) are structured as Variable Interest Entity (VIE).
In short, this means that investors do not actually own the companies. Investors would own the contract that states that they have rights to dividends, voting rights, etc.
Under this VIE structure, investors own an offshore shell company, commonly referred to as a wholly foreign-owned enterprise (WFOE), and usually in the Cayman Islands. And this shell company would enter into a contract with the China company, which is 100% owned by Chinese citizens.
Essentially, investors do not have ownership of the Chinese companies. They own the contract that spells out the agreement.
Is this a problem?
Ant Financial was abruptly spun out of Alibaba in 2011 because of concerns that the Chinese Government do not want foreign ownership on third-party payment services.
Major investors Yahoo and Softbank was furious at that time because Ant Financial, one of Alibaba’s crown jewel was ripped out from under their nose.
Alibaba, Softbank and Yahoo eventually reached an amicable deal. And the Chinese Government has recently clarified that they are not against the VIE structure. But it is important for investors to be aware of this risk when investing in Chinese companies.
Bonus content: A common misconception is that you can circumvent this by investing in HKEX instead, but actually both the listing in HKEX and NYSE are all under the VIE structure. The issue is with foreign ownership, not with the place of listing.