Dan Loeb and the team looking to shake up the leadership of Yahoo! are naturally very interested in how they can use their stake in Alibaba to create more value for their shareholders. But if they are looking to take the road of an activist investor in the China internet sector it is important that they learn from the ChinaCast and GigaMedia examples and understand how a VIE will influence their position.
ChinaCast’s problems started when a group of investors wanted to shake up management of the company by ousting Ron Chan and some other senior people from the company. However, it seems like they have seriously misunderstood the strength of their position. Perhaps they should have learned from what happened at GigaMedia before storming in to change management in a company using a VIE.
This case is different from GigaMedia in that the person at the centre of the dispute doesn’t hold any equity in the VIE, however, other parties involved hold at least 40% of the VIE equity. And considering the VIE holds the vital licenses to operate the business this dispute is certainly no trifling matter.
When foreign players in the internet market in China come in and try to force aggressive changes like they would in any other market they are misjudging their negotiating position toward the VIE equity owners. If the company itself had equity ownership over all the entities forcing this type of change would be routine, but in a VIE situation the position of the company is potentially secondary to the VIE equity owners who work for them.
Only having contractual control of an entity comes with certain problems when disputes like this emerge. Even if we assume that the contracts are all valid and enforceable (we have no info on whether the equity pledge is registered or not), the company still has to go through the courts to regain control of their entity, something that can be expensive and time consuming. For instance, GigaMedia has set up an entirely new China operation while the legal proceedings appear to be on going.
With so much uncertainty and the potential of a lengthy court battle investors and owners need to plan ahead before they act against management holding VIE equity. In fact, getting your VIE related affairs in order beforehand is likely not just prudent, but necessary as witnessed by the outcome for GigaMedia.
These two examples clearly show the perilous situation companies can get into when they misjudge their position towards the VIE owners. Yahoo! have already been burned once in a VIE related affair, but if they want to be more active in their China assets they need a plan for how to deal with the VIE equity holders or they risk getting burned again.
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