Closed loop: Stabilizer of Star Market company equity structure

By Zhang Di and Cai Hang, AnJie Law Firm

Employee shareholding plans are not unfamiliar to companies and their management, and are particularly common in listed companies. The implementation is conducive to establishing and improving a mechanism for the sharing of benefits between workers and owners, improving the level of corporate governance, enhancing employee cohesion and company competitiveness, and results in the optimal allocation of private funds through the capital markets. In the work of creating the Science and Technology Innovation Board (Star Market) listing rules system, the system arrangements for employee shareholding plans are essential.

Star market
Zhang Di
AnJie Law Firm

In line with the Star Market’s positioning, companies listed on the Star Market are innovative tech enterprises that have their own key core technologies. Compared with the average high-tech enterprises, Star Market-listed companies’ requirements for innovative tech talent are higher, and that for the stability of their core technical personnel are stronger.

The implementation of an employee shareholding plan allows innovative tech talent to obtain equity in the company’s shares and realize a fusion of their own interests with those of the company, motivating such persons to greater innovation and better meeting the actual requirements of companies listed on the Star Market.

However, an employee shareholding plan presents a dilemma during a company’s listing review, namely that the incentive plan shares held by employees may not be transferred during the review period, failing which such transfers could give rise to unnecessary time costs and review risks, and mobility of the company’s employees also cannot be avoided.

If an employee leaves the company during the above-mentioned period, he or she must, pursuant to an agreement or in keeping with the original intent for the establishment of the employee shareholding plan, transfer the incentive plan shares he or she holds. Accordingly, the conflict between the transfer of the incentive plan shares held by this employee leaving the company and the prohibition against the transfer of such shares during the review period makes things extremely inconvenient for the company and the employee.

star market
Cai Hang
AnJie Law Firm

In current A-share issue review practice, if the issuer has an employee shareholding plan, it has become common to total the number of investors after a penetrative review. If a relatively large number of employees hold shares and after the review it is determined that the total number of beneficial shareholders exceeds 200 persons, this will be deemed a violation of the provision in Chinese laws prohibiting the number of shareholders of an unlisted joint stock limited company exceeding 200, placing an obstacle in the path to the company’s offering and listing.

Compared with rules of other boards, the stock listing rules of the Star Market have realized a system innovation, namely, when doing the penetrative calculation of an employee shareholding plan, the “closed loop principle” may be used. Pursuant to the Questions and Answers on Review of the Issuance and Listing of Stocks on the Star Market of the Shanghai Stock Exchange, the closed loop principle means that, during the lockup period of at least 36 months from the listing date, when company shares are held by the employee shareholding plan, if equity held by an employee is transferred to an employee enrolled in the employee shareholding plan or another qualified employee, the issuer may, when calculating the number of shareholders, count the same as one shareholder. After the lockup period, when an employee transfers and divests relevant equity held by him or her, matters may be handled based on the charter of the employee shareholding plan or the relevant agreement.

The closed loop operation of employee shareholding plans provides an effective solution for the above-mentioned dilemma, giving rise to a stable employee “share pool” during the IPO and listing review and for at least three years after the listing, where the shares in the pool can circulate among specific employees and, when the company calculates the number of shareholders, such plan itself can be counted as just one shareholder.

More specifically, during the company’s listing review, and for a specific period after its listing, if an employee enrolled in the employee shareholding plan leaves the company, or for an objective reason needs to transfer his or her incentive plan shares, he or she may transfer them to employees enrolled in the employee shareholding plan, or other qualified employees. In this way, there is no change in the number of shares held by the plan itself, so the plan can be counted as one shareholder, and there is no need to do a penetrative calculation of the number of all the employees.

Furthermore, as the free circulation of the incentive plan shares held by the employees among qualified employees is realized, the employees’ demand for the liquidity of their shares is satisfied, and the company can also effectively satisfy the regulators’ requirement for the number of shareholders a company can have, and the requirement for stability of a company’s equity structure during the review period, achieving a win-win situation.

Currently, among the enterprises that have filed for listing on the Star Market, some have put the closed loop principle into practice. Company J has four employee shareholding platforms organized as partnerships, with a total of 122 employees holding shares. The employee shareholding platforms provide in their partnership agreements that when capital contribution shares in the partnership are transferred, the transferee must be the executive partner or a third party designated by it.

Until the partnership’s lockup period has expired, the transferees of such capital contribution shares are required to be regular employees of the issuer or its subsidiaries at the time in question; and after the expiration of the lockup period, the transferees of such capital contribution shares are required to be regular employees of the issuer or its subsidiaries at the time in question, or third parties consented to in writing by the executive partner.
As the four employee shareholding platforms have undertaken to lock up the shares for a period of 36 months from the date of listing and adhere to the closed loop principle, when Company J calculates the number of its shareholders, each shareholding platform counts as just one shareholder.

In short, the closed loop principle is a system innovation for employee shareholding plans created by Star Market, which contributes to companies that have a relatively large number of employees enrolled in their equity incentive plans to effectively avoid exceeding the limit on the number of beneficial shareholders and is conducive to stabilizing employee shareholding plans, thereby stabilizing companies’ equity structures.

Zhang Di is a partner at AnJie Law Firm. He can be contacted on +86 10 8567 5988 or by e-mail at Cai Hang is a partner at AnJie Law Firm. He can be contacted on +86 21 2422 4866 or by e-mail at