Avoiding risks to listing success from R&D co-operation

By Liu Tao and Huang Qingfeng, Commerce & Finance Law Offices

Innovative tech companies wanting to increase their R&D capacity or overcome technical thresholds will often form tie-ups with universities, research institutes and other technological entities. This approach has been used by many Star Market-listed companies, including Luster Lighttech, HSC, Orbecc and Longda Superalloy, to name a few. However, tech companies must beware of unwanted side effects from these co-operation agreements – ones that may even plague any eventual IPO.

Liu Tao
Commerce & Finance Law Offices
Tel: +86 21 6019 3260
E-mail: liutao@tongshang.com

Excessive share of R&D. If co-operative R&D takes up an excessively high proportion of the total, the issuer may find investors doubt its ability to independently develop its core technology, capacity for innovation, and even the authenticity of its technological and innovative attributes.

For example, Haihe Pharmaceutical’s Star Market application was twice rejected after review by the listing committee, mainly because all core products at or over phase II clinical trials were licensed or developed co-operatively, and the R&D of core products was continually outsourced to third parties during the reporting period. The Shanghai Stock Exchange (SSE) questioned whether the company had independently made substantial improvements to its licensed or co-operatively developed core products, and whether it over-relied on third parties for technology.

Huahai Qingke, during its listing, also came under scrutiny from the SSE over whether its applied research and industrialised technological development were based on theoretical study and basic experiments conducted at Tsinghua University–in other words, its reliance on Tsinghua’s research and experiment capacity instead of its own.

Co-operative R&D fails to resonate with its specialty or major investment. If the company only provides equipment, funding, instruments and other resources in a co-operation project, but does not have core R&D personnel, or has not contributed technical results or patented technologies, it will likely be called into question over R&D independence and technical reliance. This rings especially true if the co-operative results are highly relevant to the tech company’s main business and products, or heavily used in its core products or technologies.

Huang Qingfeng
Commerce & Finance Law Offices
Tel: +86 21 6019 2695
E-mail: huangqingfeng@tongshang.com

During Canvest Biotechnology’s application to the Star Market, its ability to innovate was called into question by the listing committee, becoming one of the reasons for its eventual rejection. This was because its core operational technology stemmed from the proprietary technology that resulted from co-operative R&D, while its own technological R&D input was relatively low, and its numbers of tech personnel were few and fluctuating during the reporting period.

Orbbec, in contrast, took charge in its co-operative R&D projects with external parties, while staying focused on its own 3D visual perception technologies. The results from the co-operative R&D served as beneficial supplements to the issuer’s own operations. Neither the stock exchange nor the China Securities Regulatory Commission made any public enquiry into the co-operative R&D activities during the reporting period, reflecting their acceptance of such an approach.

Co-operative R&D with related parties risks more horizontal competition and related party transactions. While R&D co-operation will not necessarily hinder a listing on the Star Market, companies should take note of the implications of any commercialisation of R&D results on horizontal competition and related party transactions, so as to not violate any related rules and avoid any suspicion pertaining to conflict of interest or pay-to-play.

For example, due to Keqian Biology’s in-depth co-operative R&D with a related party, the listing committee focused on such matters as how it handled conflict of interest with the related party, and how it ensured the fairness and transparency of the transaction considerations during the co-operation.

By formulating a special R&D co-operation system, entering into the co-operative R&D framework agreement that specified related party transactions involved, adding special clauses in the articles of association on disclosing important results by phase, and enhancing supervision and special audit measures before, during and after the co-operation, it eventually obtained approval from the securities regulators and successfully went public.

Guobo Electronics, during the reporting period, co-operated with its controlling shareholder and sister company in developing radio frequency front-end for 5G terminals. Guobo was chiefly responsible for the design and module-integrated packaging of the 5G terminal amplifier module, and other technological aspects, while the sister company developed the filter.

They could each demonstrate independently achieved research results, while collective results may be claimed by all three parties.

During the first-round review, the SSE questioned whether Guobo’s co-operation would add to the related party transactions and horizontal competition, and the attribution of R&D results. After Guobo explained the R&D objective, each party’s role and positioning in the co-operation and future arrangement for commercialisation, the matter did not come up again.

Other than the above-mentioned matters of note, we recommend that, in R&D co-operation agreements, tech companies should ensure their independent right to commercially apply the R&D results, clarify profit sharing arrangements and avoid any unnecessary title dispute or other discord. This should serve to clear the path for a smooth IPO on the Star Market.