Private equity firms seeking to exit their US technology investments to Chinese strategic buyers will need to rethink their strategy once the Foreign Investment Risk Review Modernisation Act becomes law in the next few months.
FIRRMA will increase the authority and jurisdiction of the Committee on Foreign Investment in the US that reviews overseas investment in the country.
“For a lot of these Chinese private equity firms that acquire a US tech company, what they have in mind is to sell it eventually to a Chinese strategic buyer,” Edmond Ng, co-founder and managing partner at fund of funds Axiom Asia Private Capital, told Private Equity International.
“Here’s how they think: ‘I’m buying this asset for 13x net income, I can flip it to a state-owned enterprise at 25x.’ With heightened scrutiny from CFIUS and the Trump government, this now becomes a concern. Will the GP be even able to get approval to sell the company to a Chinese company later on? This will definitely dampen the sentiment of Chinese fund managers investing in US tech companies.”
Ng added that GPs have come to the realisation that they will face difficulty flipping their US tech companies to Chinese SOEs and they must recalibrate their exit strategy.
FIRRMA seeks to widen CFIUS’s jurisdiction over transactions. The US Senate passed the new bill on 18 June and the House of Representatives then passed its version of FIRRMA on 26 June.
Key elements of FIRRMA include increasing CFIUS’s reviews of investments in any critical technology company or critical infrastructure company, regardless of whether it would result in foreign control. Critical technologies are subject to various export control regimes. The provision will also now involve CFIUS more closely for start-ups and breakthrough technologies.
CFIUS’s reviews will also include the purchase or lease of real estate located at land ports or border crossings, as well as air or maritime ports, or those near a military installation or other sensitive government facility.
Transactions in “countries of special concern”, which include China, Russia, Iran, Venezuela, North Korea, Syria and Sudan, will be covered if the investor could influence the US business’s use, development or acquisition of critical technologies.
The US Congress is expected to form a conference committee to reconcile the differences in the legislation and put forth a final bill for vote by both the House and the Senate. US president Trump said in a statement on 27 June that upon enactment of FIRRMA, he will direct his administration “to implement it promptly and enforce it rigorously.”
Scott Peterman, partner and member of the M&A and private equity group at law firm Orrick, noted Chinese buyers could look elsewhere for tech acquisitions.
“Perhaps former Eastern Bloc countries can provide a source of opportunities for People’s Republic of China investors since there is talent in those countries, as well as a need for financing as tech businesses in those countries are often overlooked. Israel and South Africa may be other sources of pipeline opportunities.”
Both Ng and Peterman noted that receiving approvals for tech acquisitions will be tougher, especially if the buyers are government-linked. This is not an issue for Chinese GPs with an international LP base. However, high profile, government-sponsored technology funds that were set up to acquire US, European or Japanese companies will face difficulty getting deals approved, Ng added.