There has been a trend in M&A activities in Taiwan whereby foreign and domestic M&A transactions have intensified since 2018 in an effort to reduce the risk of US-China trade wars and to enhance the competitiveness of local enterprises in international markets. However, COVID-19 has had a significant impact on the global economy, and M&A activities have suffered a serious decline recently due to uncertainty as to when the economy will recover. It appears that domestic M&A activities rise and become popular in Taiwan when international M&A activities across neighbouring countries are impeded. In short, the current trend essentially focuses on how to enhance the competitiveness of local enterprises, expand market share, and effect industrial transformation by way of M&A activities.
Because of the impact of COVID-19 this year, market-oriented small and medium-sized enterprises may encounter a short-term funding gap or have insufficient funds to carry out larger-scale M&A activities, and the participation and involvement of foreign and domestic private equity funds tend to increase the capacity to effect M&A transactions and create higher values. In addition, it also appears that private equity fund buyers have effected an increasing number of M&A activities to de-list public companies from stock exchanges and then return them to a different securities market as public companies, or to effect subsequent sales to gain profits.
Recent M&A activities primarily focus on 5G cellular networks, the Internet of Things (IoT), electric vehicles, artificial intelligence-related industries, including chips, semiconductors, and IC-packaging and test and IC design. Biotech and pharmaceuticals are also rising industries in M&A transactions.
The Limited Partnership Act
To increase the diversity of business associations and provide flexibility of business operations, the Limited Partnership Act was enacted and announced on 24 June 2015. A limited partnership organised and registered in accordance with the Limited Partnership Act is considered a juridical person that is capable of having rights and undertaking obligations. The Limited Partnership Act makes a new business format available to a variety of investors, which is beneficial to the economic development of Taiwan.
Listing Standards for Venture Capital Companies
Another major development was the announcement of standards for listing applications by a venture capital company. For example, Article 20-2 of the Taiwan Stock Exchange Corporation Rules Governing Review of Securities Listings (amended and announced on 25 January 2016) sets forth the conditions and/or requirements for the granting of a listing application of a venture capital company. With the aforesaid development and availability of a public securities market, a venture capital company is more likely to invest in new ventures and stimulate industrial transformation.
Limited Partnership as a Pass-Through Entity
Thirdly, to assist with the development of an innovative start-up business, Article 23-1 of the Statute for Industrial Innovation (amended and announced on 24 July 2019) provides that certain eligible venture capital firms may calculate each year’s total income in accordance with applicable income tax rules, and calculate each partner’s profit-seeking income according to the earning distribution proportion provided under the Limited Partnership Act, and the partner may be taxed or exempt from income tax on such income in accordance with the Income Tax Act. Essentially, a venture capital firm in the form of a limited partnership will not be subject to taxation, but rather, a partner thereof will have to pay personal income tax for profits distributed and received. Article 3 and Article 11 of Regulations Governing Venture Capital Business (amended and announced on 21 September 2018) provide further standards for determining the annual contributing capital of a venture capital firm and stipulate that such standards are given retroactive effect commencing from 1 January 2018.
Primary Regulatory Issues and Regulators
In addition to the previously mentioned rules and regulations, M&A activity involves several other rules, such as the Statute for Investment by Foreign Nationals, the Act Governing Relations between the People of the Taiwan Area and the Mainland Area, the Securities and Exchange Act (the chapters on public tender offers and private placement) and the Business Mergers and Acquisitions Act. The primary regulators are the Investment Commission of the Ministry of Economic Affairs of Taiwan, the Securities and Futures Bureau of the Financial Supervisory Commission, and the Fair Trade Commission.
It is worth noting that the industries to which a private limited company belongs are also relevant in M&A activity. A foreign investor is prohibited from investing in industries which are prohibited by the law. The Executive Yuan is responsible for prescribing industries in which a foreign investor is prohibited from investing (hereinafter referred to as the “Prohibited Industries”) and industries in which an individual, juristic person, organisation, or other institution of the Mainland Area (hereinafter referred to as a “Chinese Investor”) is allowed to invest. In light of the above, the Executive Yuan announces a Negative List for Investment by Overseas Chinese and Foreign Nationals (hereinafter referred to as the “Negative List”) setting out the Prohibited Industries. On the other hand, a Chinese Investor is allowed to invest in such industries as set forth in the Positive List for Investment into Taiwan by the People of the Mainland Area (hereinafter referred to as the “Positive List”).
Introducing a More Stringent Approach
The Ministry of Economic Affairs of Taiwan is considering imposing a more stringent standard (currently proposing amendments to regulations) to determine whether an investor is a Chinese Investor. Under the current standard, an investor will not be considered a Chinese Investor if it invests in Taiwan through a company or an enterprise it establishes in any area (other than Mainland China) as long as the overall equity interests held by it fall below 30%. For example, if 40% of the equity interests in a Cayman entity are owned by a Samoan entity, 40% of whose equity interests are owned by Chinese investors, the overall equity interests of the Chinese investors in the Cayman entity are 16%. Because the overall equity interests of the Chinese investors fall below 30%, the regulator will not consider the Cayman entity as a Chinese Investor. However, with the more stringent standard considered, an entity will be considered as a Chinese Investor if Chinese investors hold 30% or more in equity interests in any level of interest in such an entity as demonstrated in the above example. With the latest development of relevant legal framework, the regulator might request that a private equity fund buyer who invests in a Taiwanese target company should provide sufficient supporting documents, designated in the sole discretion of the regulator, to evidence each level of ownership behind a private equity fund so as to allow the regulator to drill down and identify whether the ultimate beneficial owners of the private equity fund fall under the definition of a Chinese Investor.
Reporting Requirements and Mandatory Public Tender Offer
If a private equity fund buyer acquires, either individually or jointly with other persons, more than 10% of the total issued shares of a public company, it has to meet the reporting requirements prescribed by Article 43-1 of the Securities and Exchange Act (amended and announced on 19 May 2020). Where the amount of shares in a public company to be acquired increases to 20% or more, the private equity fund buyer is required to follow public tender offer procedures. Apart from the above, any person who acquires more than 10% of the total shares of a public company for the purpose of M&A must report to the competent securities authority the purpose of the M&A and other particulars required to be reported in accordance with the Business Mergers and Acquisitions Act (amended and announced on 8 July 2015).
“Merger” under Fair Trade Act
A private equity fund must also pay attention to provisions under the Fair Trade Act pursuant to which, in the event of a merger or acquisition of one third or more of the equity interests in a target company (Merger), the Merger must be filed with the Fair Trade Commission. This must be done in advance in a situation where the market share of either party amounts to a certain percentage, or a certain percentage of the market share will be reached after the completion of the transaction. If the parties violate the above laws, the Fair Trade Commission may prohibit such Merger, or prescribe a period during which the buyer must dispose of all or part of the shares acquired.
The level of due diligence exercise to be adopted usually depends on the background of the transaction and the needs of the transacting parties. Sometimes, a detailed due diligence review will be done when the investment amount is significant. Typically, a high-level due diligence review is taken on and conducted by a lawyer appointed by the buyer. The key areas covered are certain legal aspects of the target company, including disputes and litigations, labour (including but not limited to payment of mandatory contributions and health insurance premiums), environmental protection and pollution control, administrative disposition, asset control (to confirm ownership interests and the existence of mortgages or pledges), tax compliance, identification of change in management or control of the target company, material contracts (assessing whether there are terms adverse to the target company in contracts such as supply/sales contracts, lease agreements, technical co-operation contracts, engineering/construction contracts, or other material contracts affecting the company’s operations) and good faith verification on the target or certain key persons (eg, credit status or criminal records).
As mentioned in 4.1 General Information, a due diligence review is usually conducted by a lawyer appointed by the buyer. Accordingly, vendor due diligence is rare in Taiwan and it is mostly buy-side diligence. However, lawyers are sometimes appointed by vendors to issue vendor due diligence reports, and buyers and their advisers may give credence to such vendor due diligence reports. Note, though, that it is common for transacting parties to negotiate the distribution of costs arising out of a due diligence review, and under such a circumstance, a vendor is required to bear the relevant costs arising out of the due diligence exercise.
In Taiwan, most M&A activities in which private equity funds are involved are carried out by means of private treaty sale and purchase agreements. Procedures similar to court-approved schemes primarily apply to situations where the authorities take the necessary measures to dispose of the assets of banks or financial institutions that have suffered serious deterioration in business or financial status. However, as banks or financial institutions are expected to meet certain requirements, a private equity fund is rarely involved in this.
In an M&A activity, a public tender offer is usually adopted in addition to a purchase agreement. However, even if a buyer is effecting an M&A transaction by way of public tender offer procedures, the buyer will be subject to various limitations in situations of hostile takeover. More often than not, a private equity fund does not effect an M&A transaction through public tender offer procedures. A private auction sale (restricting participation to limited persons) is usually conducted or the seller may contact a few buyers to negotiate more favourable price terms. Large-scale or public auction sale is rarely adopted in an M&A activity. Essentially, the key terms for various M&A transactions have a lot in common.
Taiwanese private equity funds typically effect individual investments only by creating special purpose vehicles as the transacting parties rather than getting directly involved in M&A transactions. In a situation where a merger or certain strategic purposes are intended, a private equity fund may acquire shares in an operating company, and thereafter invest in a target company through the operating company. Most of the time, private equity funds will not be a party to transactions.
Private equity funds usually fund their deals by using the cash contributed by limited partners, and debt financing from banks is sought only when a buyout is intended. An equity commitment letter, however, is commonly used between a private equity fund and its limited partners. With that said, it is rare to provide an equity commitment letter as evidence of funding certainty.
Historically, it is more typical for private equity funds to hold a minority stake. However, the recent trend is for private equity funds to acquire majority or controlling equity interests in a target company.
It is common for multiple private equity funds to co-invest in a target company and for limited partners to co-invest alongside a general partner in a large-scale private equity fund. On the other hand, external co-investors are rarely invited, unless such investors are strategic investors whose participation is required to meet certain strategic needs.
In private equity fund transactional practice, it is common to use completion accounts as the consideration mechanism. Usually, parties agree on a purchase price range in a memorandum of understanding or letter of intent, and the price terms will be determined prior to closing. The locked-box mechanism is rarely used.
Valuation adjustment terms are common in an M&A transaction. However, if a target company intends to apply for listing in Taiwan, the parties have to terminate the relevant terms prior to the listing application because such terms impair the principle of equality of shareholders.
Generally, when a private equity fund is involved in a transaction, regardless of whether as a buyer or seller, the level of protection as to consideration mechanisms is higher, in favour of a private equity fund, to protect its rights.
As mentioned previously, it is common to use completion accounts as the consideration mechanism. Since locked-box consideration is rarely, if ever, used, it is not possible to ascertain whether interest is charged on leakage.
The dispute resolution clause will usually be agreed in a purchase agreement and generally governs all disputes arising out of a transaction. The price adjustment mechanism is an aspect to be negotiated by transacting parties rather than being resolved by triggering the dispute resolution clause.
Conditional clauses typically relate to mandatory and suspensory regulatory conditions, including approval by the Investment Commission of the Ministry of Economic Affairs of Taiwan, the Securities and Futures Bureau of the Financial Supervisory Commission, and the Fair Trade Commission, and consent by board or general meeting. Third party consent is rarely required, but if a change in management or control of a target company occurs, obtaining approval from the banks might be necessary in accordance with certain facilities loan agreements entered into by the target company and banks.
It is also common to have material adverse change/effect provisions in place as part of the warranties provided by a buyer in M&A transactions.
As a private equity fund has stronger bargaining power in negotiating terms in an M&A transaction, it is rare for a private equity fund buyer to accept a “hell or high water” undertaking.
It is also rare to see transacting parties agree on a break fee. Although a break fee in favour of the seller is sometimes included, the existence of such a clause nonetheless depends on the bargaining power of the parties. Arrangements similar to reverse break fees have been made, whereby a private equity fund (or buyer) seeks recovery for damages when the transaction fails because of breach of contract of the other party. The parties may also agree on the liquidated damages representing the total amount of (estimated) damages arising out of a breach of contract. However, it should be noted that Article 252 of the Civil Code of Taiwan provides that the court may reduce the amount of liquidated damages in the event that it finds the agreed amount is disproportionately high.
A private equity fund seller or buyer will typically terminate a purchase agreement for the following reasons:
Generally speaking, if a private equity fund is a transacting party, regardless of whether as a buyer or seller, it seeks to minimise the potential risks and pass them on to the other party. The main limitation on liability usually involves an agreed cap on the amount to be compensated.
In addition to warranties commonly provided by a seller (eg, valid existence and good standing, corporate power and due authorisation), a private equity fund usually provides a buyer with warranties on full title and ownership interests in shares to be sold upon exit. Additional warranties are provided to the buyer by the management team on exit in connection with business operation, truthfulness of financial status (eg, revenue or profit), and no outstanding litigation, tax liability or indebtedness.
Generally speaking, a contract or regulations under the Civil Code of Taiwan do not provide for limitation of liability for breach of warranties. Instead, any dispute arising out of warranties is resolved by means of claims for breach of contract or in accordance with relevant provisions under the Civil Code governing contract of sale. If a private equity fund is a buyer, it usually demands greater protections offered by warranties.
As warranties are contractual obligations with which the party giving the warranties must comply, full disclosure of the data room is not allowed against the warranties.
In a transaction document involving a private equity fund, it is rare to find protections other than commonly provided warranties, representations and condition precedents. In a situation where a certain interval exists between the execution of a transaction document and closing the transaction, it is possible that the business operation of the target company will be subject to limitations (eg, no material change) or the buyer will make an escrow payment to ensure certain conditions in a transaction are met prior to performance. However, when a private equity fund is the seller, it is uncommon to have escrow or retention in place to back the obligations, whereas such a mechanism may be used when a management team is the seller.
Indemnities are usually provided by the target company or management team. Indemnity clauses are rarely applicable to a private equity fund, however, unless the private equity fund holds majority equity interests in the target company.
Taiwanese insurance providers generally do not provide warranty and indemnity insurance.
A private equity fund rarely files litigation against a target company, and amicable negotiation between the parties is usually the preferred method of dispute resolution.
Public-to-private transactions are rare in recent private equity transactions in Taiwan.
According to the Company Act and the Securities and Exchange Act, any person with equity interests of more than 10% in a company, regardless of whether it is a public company or private company, has to satisfy certain disclosure requirements. A person who holds more than 10% equity interest in a public company has to meet further reporting requirements, and is subject to certain restrictions in connection with the transfer of shares.
Additionally, according to the Securities and Exchange Act and the Business Mergers and Acquisitions Act, a buyer who acquires more than 10% equity interest in a public company is required to report the purpose of the acquisition and other particulars to the competent securities authority.
As mentioned in 3.1 Primary Regulators and Regulatory Issues, a buyer who acquires 20% or more equity interest in a public company is required to follow public tender offer procedures.
Acquisition by cash is the primary form of consideration in an M&A transaction effected by a private equity fund in Taiwan.
No specific regulation is available to govern a private equity-backed takeover offer in Taiwan, and the only regulatory conditions of the takeover offer are those applicable to acquisition of a public company. As mentioned in 3.1 Primary Regulators and Regulatory Issues, a buyer who acquires 20% or more equity interest in a public company is required to follow public tender offer procedures, pursuant to which such a buyer (also known as an “Offeror”) has to meet certain conditions in the procedures (ie, restriction from revising purchasing conditions) and comply with applicable rules, such as the prescribed public tender offer period and public tender offer procedures. More particularly, the Offeror must provide satisfactory proof evidencing its ability to pay the tender offer consideration. More often than not, the tender offer consideration is in the form of cash, and the Offeror may furnish either of the following as satisfactory proof:
The requirements of satisfactory proof are regulated by the Regulations Governing Public Tender Offers for Securities of Public Companies (amended and announced on 18 November 2016).
Although a shareholder of a public company is not obliged to accept a public tender offer furnished by the Offeror, a shareholder who determines to offer its shares for sale must deliver its shares to a shareholder services institution mandated by the Offeror. Unless otherwise provided by law, once the Offeror announces publicly that the conditions of the public tender offer have been achieved, the seller may not revoke its offer to sell.
Acquisition of 100% equity interest in a target company is not mandatory in a public tender offer procedure. On the contrary, a buyer who acquires 20% or more equity interest in a public company is required to follow public tender offer procedures. Additionally, if a person controls more than two thirds of the equity interest in a company (eg, 67% or more), it is possible to acquire 100% equity interest in such a company by way of merger or share exchange. In such a situation, a shareholder expressing its dissent in accordance with applicable laws may request the company to purchase all of its shares at a fair price.
If the target company is a public company, an irrevocable commitment to tender or vote must be negotiated prior to initiating a public tender offer procedure, and this is usually agreed in the form of a contract. The parties should be careful not to violate rules governing insider trading in negotiating relevant terms. Upon commencement of a public tender offer procedure, principal shareholders are only allowed to make recommendations as to whether to approve or object to the tender offer. The Offeror must purchase the shares of all the shareholders who determine to offer their shares for sale on the same conditions, and no prejudicial treatment is permitted. Importantly, if the number of shares offered for sale exceeds the proposed number of shares to be acquired, the Offeror has to purchase the shares on a pro rata basis from all the shareholders who offer shares for sale, and may not show prejudice in favour of the principal shareholders.
It is legally permitted to effect a hostile takeover by way of a public tender offer procedure, but from a policy perspective, it is not encouraged. Accordingly, it is difficult to effect a hostile takeover through a public tender offer. If the Offeror fails to acquire the proposed number of shares within the tender offer period or the public tender offer is suspended by the competent authority, the Offeror may not carry out another public tender offer on the same company within one year of the failed transaction, unless otherwise approved by the competent authority. Accordingly, a private equity fund rarely effects hostile takeover by means of public tender offer.
It is common to have equity incentivisation available to the management team. When a private equity fund acquires controlling equity interests in a company, it usually offers equity incentivisation to the original management team to preserve the stability of the business operation. The level of equity ownership for the management team is offered on a case-by-case basis, and no specific standard is available.
A private equity fund historically held a minority stake only, and did not offer more favourable terms to the management team. With the increasing number of buyouts by private equity funds, management participation in equity interests has become available as a tool to enhance the efficiency of the business operation. A commonly available method is the granting of employee stock options, and members of the management team may acquire shares at an agreed subscription price. In addition, the Company Act provides that a company must reserve a certain proportion (10–15%) of new shares for subscription by the employees upon issuance of new shares, and must specify in the articles of association a fixed amount or ratio of profit distributable each year as employees’ compensation (either in the form of cash or shares). This employee stock option is, however, subject to certain restrictions in connection with the type of shares and the subscription price, and therefore sweet equity/institutional strip structure is not explicitly provided under the applicable laws in Taiwan. Most of the time, the shares issued to employees are ordinary shares, but another form of employee compensation (restricted stock for employees) was recently introduced, whereby a company may issue restricted stock to employees as an incentive.
Mechanisms similar to vesting provisions are in place under the laws of Taiwan. For example, the exercise of stock options, subscription rights upon issuance of new shares, and distribution of employee compensation (as part of a profit distribution scheme) all depend on the seniority of the employees. A company is also permitted to include relevant provisions in an employment agreement.
It is worth noting that the articles of association of a Taiwanese company may not restrict transfer of shares. However, shareholders with majority equity interests in a company may enter into agreements with employees pursuant to which the employees are obliged to transfer their shares to specific persons upon resignation.
In Taiwan, manager shareholders are required to comply with the non-competition, non-solicitation and confidentiality obligations imposed by private treaties. Non-competition clauses are, however, unenforceable if a company does not pay an employee reasonable compensation or if the scope and period of restriction are unreasonably restrictive against the employee.
In private equity fund transactional practice, it is very rare to have protective mechanisms available to manager shareholders such as veto rights, anti-dilution protection or the right to control or influence the exit of a private equity fund. Instead, such protective mechanisms are more commonly available to the private equity fund.
The levels of control for a private equity shareholder differ on a case-by-case basis, and usually depend on the investment purposes and the percentage of equity interests held. However, common clauses include board appointment rights, the right to appoint the general manager, veto rights over key decisions (ie, transactions involving a certain amount or greater loan, guarantee, dissolution, liquidation, reorganisation, merger, acquisition, and amendments to articles of association), information rights and anti-dilution.
In Taiwan, each company has an individual legal personality, and bears its own liabilities. If a target company causes damage to a third party in an “Event”, it has to bear liability for compensation. However, if the Event indirectly results in harm to the interests of the target company, and a private equity fund serves as the corporate director thereof, the shareholders of the target company may hold the private equity fund liable for breach of reasonable care or fiduciary duty. Even if a private equity fund does not serve as the director of the target company, it may still be liable pursuant to the principle of piercing the corporate veil (introduced in 2013 and regulated under the Company Act), provided that the private equity fund has control over the company and it has abused the target company’s status as a legal entity, causing the target company to conduct irregular or detrimental operations.
Imposition of the compliance policy of a private equity fund usually depends on the investment purposes and the percentage of equity interests held by such private equity fund.
There is no specific pattern in connection with the holding period for private equity transactions prior to exit. The applicable holding period differs on a case-by-case basis depending on the investment period of each private equity fund and the status of the target company. The exit methods usually adopted by a Taiwanese private equity fund include listing application, merger, spin-off, sale of the portfolio company (including secondary buyout or transfer to other strategic investors), and post-privatisation listing. As an investment agreement executed by a private equity fund does not contain restrictive clauses in connection with the method of exit, it is possible for a private equity fund to effect exit by way of initial public offering and sale of the portfolio company as long as such methods create sufficient profits. Such exit strategy is not only adopted by a private equity fund, but also welcomed by the company. Reinvestment by a Taiwanese private equity fund with exit proceeds depends on the provisions of the limited partnership agreement or the applicable investment period.
Drag rights are typical arrangements in an investment agreement. Generally speaking, drag rights are not regulated under the laws of Taiwan, but similar rights are permissible in an agreement when certain conditions under the Business Mergers and Acquisitions Act are met.
Tag rights are adopted when a private equity fund holds minority equity interests, but it is rare to allow management shareholders to enjoy tag rights. Like drag rights, tag rights are not regulated under the laws of Taiwan.
On an exit by way of initial public offering, a shareholder with more than 10% equity interests is subject to mandatory lock-up and permitted to transfer only 50% of its shares after the expiry of a six-month period commencing from the listing date, and then all its shares after the expiry of a one-year period commencing from the listing date. A private equity fund is subject to mandatory lock-up as long as it meets the above equity-holding threshold, and accordingly, the percentage of equity interests held by a private equity fund is usually below 10%. Finally, it is common for a private equity fund to enter into a shareholder agreement setting forth any private arrangement with controlling shareholders.