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The corporate system is the main carrier of modern business civilization, and equity is the main cornerstone of the corporate system. With China's reform and opening up, a series of business laws and regulations centered around the Company Law have gradually improved, becoming one of the key elements for the success of the reform and opening up.

In this era, entrepreneurship has become a new path to change one's destiny, and the ways to gain personal wealth and career success are closely related to equity. In today's relatively well-developed legal environment, understanding the basic principles of business, such as equity and corporate systems, can help entrepreneurs avoid detours and increase their chances of success.

To understand equity, one must understand the corporate system, and to understand the corporate system, one needs to grasp the legal operational principles and accounting calculations at the ownership level. For most individuals from industrial backgrounds rather than legal or accounting professions, reading laws and regulations like the Company Law, CPA textbooks, and accounting standards can be as difficult as taking sleeping pills. This book attempts to provide a compilation of common knowledge and practical tools related to equity issues through examples, combined with simple conceptual explanations and numerical calculations. It aims to assist those who lack understanding of laws and regulations related to equity and financial accounting but are interested in the subject.

Limited Company#

Equity, or capital stock, shares, registered capital, and contribution amount, all refer to the same thing: the shares of a company. To clarify these concepts, one must first understand what a company is. Generally speaking, when the concept of a company is mentioned, the average person often thinks of roaring factories and busy machines, bankers in suits sitting in skyscrapers, countless servers, and busy websites presented on users' phones, or the fluctuating numbers on the stock exchange... However, all of these are merely the public's intuitive impressions of a business.

My understanding of a company is that it is an economic community where shareholders invest benefits into this community, expecting to gain greater benefits in the future from these investments, and equity serves as proof of shareholders' ownership stakes in the company.

The prototype of a company originated in the tax farming groups of ancient Rome, while the modern concept of a joint-stock company appeared in Europe during the Age of Exploration; the most famous examples are the Dutch and British East India Companies. The Dutch East India Company was the first joint-stock company, very close to the concept of a joint-stock company under today's Chinese Company Law. Its main principles can be summarized as follows:

(1) Contributions made to the company cannot be withdrawn; the company conducts business operations using the shareholders' contributions, and profits are distributed according to the proportion of shares held;

(2) Shareholders bear limited liability for the company's debts up to the amount of their contributions, meaning that if the company goes bankrupt, shareholders are not required to repay any shortfall after the company's assets are used to cover debts;

(3) There is a separation between shareholders and company management; shareholders elect the board of directors based on their voting rights, and the board is responsible for the company's development and strategy;

(4) The company's equity is non-nominative, allowing shareholders to transfer their shares without the consent of other shareholders. Therefore, whether shareholders disagree with the company's development direction or have temporary cash needs, they can freely sell their equity.

The basic principles of today's corporate system are merely adjustments and supplements to the above principles, explained as follows:

(1) In the continuous development of the economy and technology, distributing dividends strictly according to the number of shares no longer meets the needs of technology companies based on "people." By separating voting rights, dividend rights, and capital gains rights, a "dual-class share" system has emerged. World-class tech giants like Google, Apple, and Facebook adopt this special treatment, but China's capital market regulatory framework does not currently support it;

Additionally, there are derivatives such as "preferred shares," which, although contributions cannot be withdrawn, have a distribution and liquidation priority over common shares, often with fixed dividend rates;

(2) Before the emergence of limited liability, doing business was a very high-risk endeavor: when a business organization could not turn around due to poor management, all of its assets would be sold to repay debts, and any shortfall would need to be covered by the personal assets of the business's shareholders; it can be said that once a business fails, it often means ruin for the owners. The introduction of the limited liability system significantly reduced the risks for entrepreneurs and greatly promoted business prosperity; it is also the most widely used system for business organizations in today's society. However, with the implementation and continuous improvement of business taxation systems, companies, as independent legal entities, bear a heavy tax burden, leading to the emergence of modern unlimited liability business organization methods, primarily including sole proprietorships and partnerships within the framework of Chinese commercial law.

(3) As corporate governance structures are further refined, daily operational authority is delegated to a management team led by a general manager, while the board of directors is responsible for important personnel and strategic planning, and a supervisory board is established to oversee the actions of the management and the board. Meanwhile, the shareholders' meeting, as the highest decision-making body of the company, decides on the candidates for the board of directors and the supervisory board through regular and special meetings. The board of directors, having relatively distanced itself from direct operational roles, is responsible for strategic formulation and personnel decisions for the management team, which implements the strategies set by the board. However, in practice, especially in Chinese family businesses, the identities of directors and executives often overlap significantly, leading to confusion between the two roles.

Additionally, it is important to emphasize that the principles of corporate governance are based on the company's articles of association. A properly formulated and legally effective articles of association binds the company's shareholders, directors, supervisors, and senior management. If amendments to the articles are to be made, the procedures stipulated in the articles themselves must be followed. Therefore, some interesting business war cases involve battles over specific clauses or loopholes in the articles.

(4) In Chinese Company Law, there is another main organizational form of a company, namely the "limited liability company" (although joint-stock companies are also limited liability). Joint-stock companies are more suitable for companies with a large number of shareholders and larger operational scales, but they can easily lead to smaller companies falling into management chaos and shareholder disputes. Therefore, the "limited liability company" imposes restrictions on shareholders' transfer of shares, requiring the consent of other shareholders for the transfer of equity unless otherwise agreed in advance.

Equity occupies a dominant position in this corporate system. From the above explanations, it can be seen that mastering a company's equity means not only being able to receive traditional dividends and capital gains upon transfer but also being able to control the company's personnel, business, and strategic powers after meeting certain conditions. Moreover, the rights enjoyed by ordinary equity after lifting restrictions are, unless the company disappears, generally not infringed upon as long as shareholders do not agree to transfer their equity.

As the second most important form of human social organization after the state system, companies carry most of the social wealth and technological progress of modern industrial civilization; the success of personal careers and the rise and fall of nations are even closely linked to the rise and fall of companies. Understanding the role of equity is closely related to establishing a successful company.

Basic Concepts Related to Equity#

If you do not have a relatively comprehensive knowledge system regarding companies and equity, this section will explain basic concepts through a certain amount of quantitative examples to lay the groundwork for understanding equity value and some operational techniques in subsequent chapters. The content of this chapter may require some basic knowledge of accounting and law.

(1) Registered Capital

Registered capital refers to the scale of investment made by shareholders as reflected in the registration materials of neutral authoritative departments (such as the industrial and commercial bureau). When the corporate system was first implemented, registered capital reflected the company's "financial strength" and capability. However, in later actual business activities, the company's strength and creditworthiness have no necessary connection with the size of registered capital. Even with verified paid-in monetary contributions, there are countless ways to withdraw contributions. Nevertheless, a considerable number of the public still measure a company's strength by its registered capital. After the reform of the commercial registration system, it is now possible to subscribe for any amount, and measuring a company's strength by registered capital has become a misconception.

Additionally, the nominal value of registered capital in China is defaulted to 1 yuan/share, and the relationship with the stock price will be further explained below.

(2) Paid-in Capital

Paid-in capital refers to the actual benefits received by the company from shareholders as reflected in the registered capital. In contrast, registered capital is merely a "declaration" at the commercial level, while paid-in capital is something that needs to be seriously "proven" at the financial level. Therefore, in audit reports issued by accounting firms, concepts such as "capital stock" and "paid-in capital" refer to the concepts described in this section.

(3) Contribution

Contribution refers to the process by which shareholders invest their resources into the company in exchange for equity. Contributions can be made in cash or non-cash forms. Cash contributions refer to direct monetary investments, where banks directly transfer cash into the company. The process for non-cash contributions is more complex: first, non-cash contributions usually only accept "physical assets, intellectual property rights, and land use rights that can be valued in monetary terms and legally transferred." In terms of the contribution process, assessments are usually required to determine their value. Although management of certain types of assets (such as intellectual property and trademarks) is relatively lax, using these assets without fair value for contributions can cause problems for companies that need to enter the capital market, requiring impairment and tax adjustments. It is worth mentioning that these assets used for contributions must also undergo ownership transfer to be considered as truly contributed.

(4) Premium Capital Increase

The reason why paid-in capital is not the entirety of shareholders' contributions is that the commercial status among shareholders is not the same: the cost per share for founders is the lowest, requiring only 1 yuan per share, while subsequent financial investors generally must pay more than 1 yuan to acquire 1 yuan of registered capital (1 share), and the excess amount is considered a gratuitous contribution by shareholders to the company, recorded under "capital reserve - capital premium"; this is a frequently confused area.

For example, in the phrase "new investors subscribe for the company's newly issued shares at 3 yuan/share," the 3 yuan is the price the investor pays to obtain 1 yuan of registered capital (1 share). After the capital increase is completed, the number of registered capital for this investor in the registered capital is actually the number of shares they subscribed for, while the additional 2 yuan per share premium enters the company's capital reserve - capital premium.

(5) IPO

A company's IPO is the issuance price determined through inquiries and other methods, publicly issuing shares to the public. The number of shares subscribed by the public is a certain proportion after the increase (mainly divided into 10% and 25%). For example, if the company's capital before issuance is 75 million yuan, the issuance price is 10 yuan/share, and the capital after issuance is 100 million yuan, not considering underwriting fees and other factors, the company receives cash of 2,500×10=25 million yuan, increasing capital by 25 million yuan and increasing capital reserve - capital premium by 22.5 million yuan.

(6) Relationship Between Secondary Market Prices and Companies

Changes in secondary market prices do not directly affect a company's financial statements, as trading in the secondary market occurs between shareholders, and the company does not receive any funds. However, fluctuations in secondary market prices can influence the pricing of a listed company's refinancing, as according to Chinese laws and regulations, the refinancing price must be based on the weighted average price of trading over a certain number of past days. When a listed company conducts refinancing, the accounting treatment is similar to that of an IPO, increasing capital and capital reserve - capital premium.

(7) Equity Transfer

The equity transfer behavior of a company does not affect the company's balance sheet; it merely changes the ownership of the capital stock due to the transfer between shareholders. That is, the buyer pays the transfer consideration for the company's equity in a form accepted by the seller; upon completion, the seller obtains the company's equity while the buyer receives the consideration paid by the seller.

The above statement may sound convoluted—mainly because the consideration for equity transfer is not necessarily a straightforward exchange of money for goods; it may also involve equity with market value as consideration. For example, a listed company may use its equity (the acquirer) to fully acquire the equity held by shareholders of a non-listed company (the target). After the transaction is completed, the shareholders of the target become shareholders of the acquirer, and the target becomes a wholly-owned subsidiary of the acquirer. This leads to the concepts discussed below.

(8) Mergers and Acquisitions

Mergers and acquisitions aim to achieve a change in control through increasing shareholding. The vast majority of mergers and acquisitions are implemented through cash or equity acquisitions. Cash acquisitions are relatively straightforward, involving a direct exchange of cash for shares. However, equity acquisitions are more complex, as the acquirer seeks to inflate its own valuation while depressing that of the target; the target does the same. After both parties reach a compromise through negotiation, an agreement is signed at a determined price. This is commonly referred to as "issuing shares to purchase assets," equivalent to the target using its equity as consideration to invest in the acquirer and subscribe for its shares.

(9) Consolidation

The primary goal of mergers and acquisitions is to achieve "consolidation." Consolidation refers to the ability of the consolidating party to include the assets and liabilities of the consolidated party in its consolidated financial statements after certain processing, significantly increasing the financial strength of the consolidating party.

The condition for consolidation is achieving "actual control," with the core goal being the ability to control the board of directors. Therefore, in common scenarios, holding more than 50% of shares is usually considered sufficient to meet the consolidation criteria; in some cases, holding less than 50% but being the largest shareholder with a significant gap from the second-largest shareholder (for example, 40% vs. 5%) often occurs in companies with relatively dispersed equity. We believe that the latter can also meet the consolidation standard.

(10) Valuation

The equity of listed companies has a dynamic price formed by market participants. Generally speaking, this price is closest to fair value in the long-term trend (though not necessarily in the short term). In practical applications, we also calculate the total market value of a company by multiplying the reference stock price of the listed company by the total number of shares. Total market value does not mean selling all of the company's stock on the market—if that were done, the stock price would plummet to near zero—but rather indicates the price that others would need to pay to acquire the company.

For non-listed companies, there is no price reference, so the company's value actually depends on the amount and proportion of financing in each round of private equity financing. For example, if a startup raises 10 million yuan for a 10% stake post-investment, it can be roughly estimated that the post-investment valuation of the company is 10 million ÷ 10% = 100 million yuan. Meanwhile, subtracting the investment amount gives a pre-investment valuation of 90 million yuan.

(11) Price-to-Earnings Ratio Valuation Method

The price-to-earnings (P/E) ratio method is the most commonly used valuation method. The commonly referred "×× times" P/E ratio can be simply understood as how many years it would take to recover the initial investment based on the current level of net profit remaining unchanged. Suppose we purchase shares of a company at 10 yuan per share, and the net profit per share is 0.2 yuan; based on the above definition, the P/E ratio = stock price ÷ net profit per share, i.e., 10 ÷ 0.2 = 50 times. If we multiply both sides of the above formula by the total number of shares, the rewritten formula is: P/E ratio = total valuation ÷ net profit.

What does the P/E ratio signify? For companies with profits greater than 0, it is positively correlated with investors' confidence in the company's future profit growth.

According to the above formula, net profit is a relatively static indicator because financial reports are released periodically, and even forecasts of future performance are based on year-end or quarter-end figures. Total valuation, on the other hand, depends on the performance of stock price and total shares. Since total shares are also a relatively static indicator, the P/E ratio typically depends on stock price, which in turn depends on the balance of supply and demand for the stock. Investors will sell stocks they believe are overvalued and buy those they believe are undervalued. Therefore, when investors are more confident in the company's profit growth prospects, they are willing to accept a higher P/E ratio; conversely, if their confidence decreases, they will only accept a lower P/E ratio.

Thus, the trading price of a stock is merely a surface phenomenon; the main representation of the market's recognition of a company is actually the P/E ratio. Of course, with the emergence of new business models and new formats, valuation methods are no longer limited to the P/E ratio. However, the P/E ratio, as the simplest and most direct valuation method, remains widely used as the basic language of the investment industry.

(12) Betting

Some sensational headlines may read, "×× bets with capital tycoon ×× that performance will reach ×× billion in 20××." In reality, betting is a very common technique in investment. Due to early investors being relatively disadvantaged by information asymmetry and having little influence on the board due to their small shareholding, they use betting to protect their rights. The main method of betting is through so-called valuation adjustments. We can illustrate this using the simplest P/E ratio method:

Company A is performing well, with a net profit of 10 million yuan in year T, and it is expected to double each year for the next two years with sufficient funding. The actual controller of Company A, A, needs to supplement cash to achieve the aforementioned rapid development and market capture, and investor B agrees with the company's growth prospects, willing to invest 30 million yuan at a post-investment P/E ratio of 15 times corresponding to the projected net profit of 20 million yuan in year T+1, acquiring 10% of the company post-investment. However, for B, a P/E ratio of 15 times is not low, and the investment amount is also substantial. To protect their rights, they propose a betting clause: "A promises that Company A's net profit will not be less than 20 million yuan in year T+1." If we disregard some more detailed conditions, if the audited report for Company A in year T+1 shows that the target was not met, the investor will adjust their shareholding based on the unchanged valuation corresponding to their shareholding in the company. Note that the adjustment of equity is a matter between shareholders A and B and does not involve the company; betting between the company and shareholders is invalid.

Assuming Company A fails to meet the commitment in year T+1, for example, only achieving a net profit of 15 million yuan, the total valuation of the company adjusts to 15 million × 15 = 225 million yuan, and 30 million ÷ 225 million = 13.33%. Generally speaking, A will transfer 3.33% of the equity to B as compensation at a symbolic price. Betting may also be agreed to be compensated in cash, equivalent to A compensating the investor for the shortfall in cash, but this is quite difficult to execute and has a low probability of occurrence.

(13) Buyback and Liquidation

Buyback and liquidation are relatively routine clauses in investment agreements, typically triggered when investors cannot exit for a long time or when significant risks arise, such as financial fraud, misappropriation of funds, or severe business underperformance. The obligor in the buyback clause is usually the major shareholder, who, after raising funds, buys back equity from investors at an agreed price; liquidation occurs when the company can no longer operate, selling off remaining assets for distribution—generally, investors will require priority in liquidation. The so-called priority in liquidation means that the remaining assets of the company will first be returned to investors, and any remaining will be distributed to the founders. Of course, in most cases, if it reaches the point of liquidation, investors will hardly recover anything, let alone the founders. To put it another way, if any project reaches liquidation or buyback, even if performance does not meet expectations, it is a loss for both parties.

(14) Limited Partnership

A limited partnership is a form of enterprise that differs from limited liability companies and joint-stock companies, governed by the Partnership Enterprise Law. A general partnership consists of general partners, all of whom bear unlimited liability. This has been mentioned earlier; unlimited liability business entities are very rare today. However, partnerships have a significant tax advantage compared to corporate entities, as they only incur a single layer of income tax on partners' earnings rather than corporate income tax. Thus, a compromise solution has been introduced, namely the limited partnership.

The characteristics of a limited partnership are that partners are divided into general partners (GP) and limited partners (LP): general partners bear unlimited liability and are responsible for the actual operations of the limited partnership, while limited partners only bear limited liability but can enjoy lower tax rates. Therefore, this business form is most commonly used in private equity investment funds.

(15) Financing Rounds

The name is not important; it's just a habit. Perhaps one day, when Chinese VC dominates global startup projects, it may be renamed A, B, C, D rounds. The popular full set of financing rounds is as follows:

① Seed Round

The company has not yet been established, but the team is in place and full of energy, just lacking funds. Introducing an investor to inject the first capital into the company is called the "seed round," which typically has a nominal value of 1 yuan per share. Generally, this stage involves family, wealthy friends, or personal savings accumulated from work. Very few investors get involved at this early stage; they must have a strong belief in the business model or the team.

② Angel Round

Angel investors, as a category of investment, have become deeply ingrained with the rapid rise of the internet industry. Extremely rare cases of thousands of times returns have driven many funds to invest in such early-stage projects. A classic angel investment usually ranges from 2 to 5 million yuan, accounting for 10% to 20% of equity, corresponding to a company valuation in the range of 10 to 50 million yuan.

However, angel investment is extremely high-risk. If all angel investments in the market were packaged into a fund, the overall return of that fund would be negative in most cases, even during better market conditions. In other words, the invested funds often exceed the returns produced, making this return structure akin to winning the lottery.

Therefore, investors in this round focus on whether the company has the potential to become a "unicorn" (a startup valued at over 1 billion USD). If there is a clear market ceiling or if the company cannot demonstrate the potential for exponential growth, it is challenging to secure angel investment during poor market conditions or more rational times.

③ Pre-A Round, A Round

After the angel round, most unreliable ideas are eliminated, entering the Pre-A or A round. In my opinion, investors in this round need to confirm the existence of genuine market demand externally and ensure that the team can collaborate stably internally. The Pre-A round is an extension of the angel round, where investors may be willing to take a chance on companies that have not yet met the above standards but have an attractive business model.

After an A round of financing, the company's post-investment valuation typically reaches the billion yuan level, with financing amounts in the tens of millions, which may vary significantly by industry. However, regardless, after completing the A round, a considerable amount of funds will be received, allowing the company to promote the business model validated in the angel round or invest in mass production of product prototypes.

④ B Round and C Round

Most companies that secured angel rounds are eliminated in the A round, leaving those that reach the B and C rounds, which are relatively later-stage financing rounds. At this stage, the company's operational results will be primarily tested. Achieving profits or even reaching preliminary breakeven is ideal, but typically, they still focus on business revenue and other indicators. Losses are not a concern; what matters is whether market share can be gained. For some "burning money" O2O startups, each round of financing must be carefully timed, as failure to secure financing often means defeat in competition due to running out of resources, hence the term "C round death."

At this stage, the market begins to concentrate on a few companies, and competition becomes fierce. Companies in this stage often attract the attention of BAT (Baidu, Alibaba, Tencent); whoever can first gain the support of the three giants often wins in competition.

⑤ Pre-IPO Round

Companies that survive to the C round typically begin to approach the milestone of an IPO. However, whether in the Chinese or American market, IPOs are very stringent for unprofitable companies. Only the most outstanding and high-profile star companies (like JD.com) can smoothly IPO while in a loss state. The market's attitude towards IPOs is quite realistic, which is why funding similar to Pre-A is needed to allow companies to prove their value and ultimately achieve an IPO. Unfortunately, during poor market conditions, many so-called "unicorns" experience price inversions between IPO and private financing. More companies ultimately get acquired by giants or merge under capital arrangements, completing their exit.

How Equity Realizes Value

Because equity can yield future benefits, it undoubtedly has value. But how should one identify the value of equity? Here, I will provide references from three perspectives: control rights, income rights, and liquidity premiums.

1. Control Rights

First, using a metaphor, this economic community is like a parliamentary-style small country, with a head of state, government, legislative body, and judiciary. Our equity serves as the votes in this small government; based on the amount of equity held, we can vote to obtain board seats at the shareholders' meeting, and the board of directors, composed of directors, serves as the permanent decision-making body of this small country, determining its strategy and important matters. The board can decide on the management team, including the general manager and executive team, who are the prime minister and cabinet of this small country, responsible for daily affairs and operational decisions. Based on the amount of equity held, we can also vote to obtain supervisory seats at the shareholders' meeting, and the supervisory board can oversee the daily operations, major decision-making, and financial status of the board and management. Therefore, holding equity in a company means having a portion of control over that company.

When equity is traded on secondary markets like exchanges, it is often referred to as "stocks." Due to the large scale of listed companies, the equity held by small and medium investors—often referred to as "retail investors"—has very little control over the company, let alone appoint directors or control personnel decisions. However, in extreme cases, such as hostile takeovers, the fragmented control rights of small and medium investors can become crucial for the attacking party, leading to significant premiums on stock prices during such special events. This value was previously only discussed in economics or finance textbooks, far removed from the experiences of most retail investors. Hostile takeovers signify the maturity of the capital market, and the value of control rights will be rediscovered and excavated.

For capital tycoons, controlling a company in various ways (reaching a level where financial consolidation is possible, including several standards: being the largest shareholder, absolute control, controlling the board, etc.) brings benefits not only from the company's financial statements but also from using relatively small equity to drive the entire company to implement their greater interests and higher will. For instance, consolidating significantly expands the group's financial strength, allowing for more credit, or acquiring similar assets under the same control. At the very least, the company's business jet, luxury cars, and ocean-view offices would belong to the actual controller. As the capital market matures further, events like hostile takeovers will become more common, and investors will increasingly understand the value of control rights attached to the stocks they hold.

2. Income Rights

Secondly, holding equity serves as a certificate for distributing profits generated by this economic community. Classic equity distribution is based on the proportion of shares held relative to the total number of shares. Suppose a company has 1,000 shares, and someone holds 1 share; if the company decides to distribute 1,000 yuan in dividends that year, that individual will receive 1 yuan for their share.

Next comes the content from political science classes. As a certificate for company dividends, the expected future dividends discounted over time and summed up constitute the intrinsic value of the stock. But is it that simple? Clearly not; companies are not static, deterministic machines but rather living organisms that grow, age, become ill, and die. A company that can continuously adapt to market demands and make changes will see its profits grow in line with the overall growth of the human economy over the long term. For instance, some companies that have been listed for over 50 years have seen their equity appreciation far exceed the original estimation methods mentioned earlier. Although countless companies have failed and disappeared throughout history, if we examine the entire securities market as a whole, the probability of equity outpacing inflation is the highest.

Therefore, when considering the factors influencing stock prices, growth potential must also be taken into account—not just the company itself but also the industry in which it operates and even the growth potential of the country in which the company is located. In emerging markets like China, listed companies are often limited in number, and more often than not, they carry a premium for horizontal integration within the industry: through mergers and acquisitions of non-listed companies, they expand the scale of net assets and net profits per share.

3. Liquidity Premium

Finally, to facilitate the trading and exchange of the aforementioned control rights and income rights, companies generally need to be public or listed. Non-listed companies, except for those in certain specialized industries, find it challenging to survive in fierce competition over a decade, especially after the departure of their founding figures. This is because the capital market provides listed companies with convenient financing channels, social recognition, and helps attract talented individuals—resources that are scarce for most enterprises, making it difficult for non-listed companies to compete for these resources efficiently.

The term "listing" encompasses not only IPOs but also the option of being acquired by a listed company, converting the equity of the acquired company into equity of the listed company through a share exchange. In this process, the company's equity becomes a standardized product with no differences between them, which we refer to as capitalization.

The most important characteristic of capitalized equity is its liquidity, meaning many people want to trade the stock. We know that the price of any commodity depends on supply and demand—in China, due to issuance system constraints on supply, new stocks often face excessive demand upon listing, leading to significant appreciation in stock prices before and after issuance. Of course, star startups in the U.S. also experience similar "treatment" upon listing, but comparatively, the average quality of IPOs in China remains lower.

Thus, obtaining liquidity premiums is a value that entrepreneurial teams in Chinese companies can relatively easily acquire. In industries like machinery manufacturing, chemicals, and metallurgy, companies can only seek to be acquired by giants for securitization in developed capital markets; however, in China, as long as there is a certain scale of net profit, independent IPOs are still entirely possible.

Equity Incentives#

Equity incentives refer to the additional rewards provided by company shareholders and managers to key talents to encourage them to work better, linking these rewards to company equity, maximizing the interests of both parties.

The primary purpose of establishing equity incentives is to resolve the conflict of interest between key talents needed by the company and the company's shareholders. In simple terms, it is to ensure that when shareholders receive returns, these key talents also receive corresponding returns, prompting them to consider shareholder returns more while working. The simplest method is to make these key talents shareholders of the company and grant equity conditionally based on set indicators.

Although the principle seems uncomplicated, implementing options is not so easy. For employees, if the conditions are too harsh or the consideration too high, the attractiveness of equity incentives diminishes, making cash more practical; conversely, if the conditions are too lenient or the consideration too low, it effectively means giving away equity for free to the founders. Of course, this book does not aim to propose a universally applicable method for setting up equity incentives; a mutually agreed equity incentive plan is not a conclusion derived from mathematical formulas or financial economic models but rather a consensus reached through continuous exchanges of interests and negotiations between both parties. The intention of this book is to provide some references for the negotiation between employees and companies by introducing different methods of equity incentives and their corresponding pros and cons.

1. Classification of Equity Incentive Plans

(1) By legal form, it can be divided into actual shares, options, restricted stocks, virtual stocks, etc.;

Actual shares refer to direct equity granted through capital increases or transfers from existing shareholders; options refer to contracts that allow obtaining company equity at an agreed price at a future time with additional conditions; restricted stocks refer to initially acquiring shares at a low price, then undergoing performance assessments at a future time, with unqualified portions being canceled and qualified portions becoming actual shares; virtual stocks do not involve signing equity agreements or being reflected in business registration materials, but rather distribute company profits according to certain rules.

(2) By grant recipients, it can be divided into partners, key personnel, and all employees;

Partners are those who can bring unique resources to the company or can independently handle various aspects of the company's business departments, designing the company's business development direction and strategy; key personnel are experts who can lead teams to achieve business goals, obtain orders, or complete research and development.

(3) By income method, it can be divided into common stock, indirect holdings, and cash income rights;

Common stock refers to the equity directly held by shareholders as reflected in business registration and shareholder registers, in contrast to indirect holdings; indirect holdings refer to holding equity through a specialized holding platform for equity incentive plans, then indirectly holding company equity by becoming a shareholder of the equity incentive platform; cash income rights refer to cash distributed according to certain rules.

(4) By entrepreneurial stage, it can be divided into startup, growth, and maturity stages;

The stages are relatively defined and do not have particularly strict divisions. Even in the commonly understood maturity stage marked by an IPO, there may still be significant growth potential after the company becomes a listed entity. Therefore, we simply assume here: the startup stage is when the company is in the early investment phase promoting exploration and validation of the business model; the growth stage is when the company finds its business model and generally determines its direction, gaining market recognition and beginning to see increasing market share; the maturity stage is when the company starts generating profits or occupies a significant market share, influencing the market itself.

2. Differentiated Considerations for Equity Incentives Based on Different Classifications

The above classification methods are not isolated; there are correspondences between these methods. For example, for different levels of grant recipients, appropriate granting methods and approaches should be considered in conjunction with actual circumstances. Next, I will briefly elaborate according to the classifications mentioned above.

(1) Different grant recipients have different characteristics and demands

In my opinion, the characteristics and demands of different grant recipients can refer to the following table:

For partners, their participation in entrepreneurship is driven by the expectation of becoming part of future BAT and leaving a mark in Chinese business history; offering money or minimal equity or options may not be appealing, as they might have stable positions in large companies with decent income.

For mid-level key personnel, they hope to achieve financial freedom through the appreciation of equity while not wanting their current standard of living to be significantly impacted by entrepreneurship. Therefore, they are usually offered options with performance conditions. No cash investment is required, but if they perform well, they can receive a promising return.

For ordinary employees, I personally believe it is not advisable to use full employee equity incentives in the early stages of development: on one hand, the probability of company failure is still high, and the value of equity incentives is low, which employees may not appreciate; on the other hand, if the company succeeds, excessive early equity incentives may result in overly generous compensation for some early employees with limited contributions. This perspective may differ from that of other practitioners and is for reference only.

However, it is certain that it is inappropriate for entrepreneurial companies to distribute equity to all employees like crowdfunding; the issue is not merely cost but rather the governance costs of the company will become unprecedentedly high—holding a shareholders' meeting may require signatures from a dozen or twenty people, and if there are differing opinions, it may lead to disputes and lengthy legal processes. Moreover, if the number of shareholders exceeds 50, it may violate regulations. Additionally, ordinary employees do not inherently seek control rights over the company; even if granted, they may not utilize them effectively.

(2) Different legal forms of equity incentives have different applicable scopes

Actual share incentives are the simplest to grant but have significant costs for recovery. As previously mentioned, equity obtained without accompanying restrictions is difficult to recover except through buybacks, and for a promising company that is favored by investors, the cost of buyback is also substantial. Furthermore, changes to actual shares require going through business registration procedures, which vary by region; it also requires various shareholders' signatures, leading to enormous time and energy costs. If a company is preparing for an A-share IPO, shareholders generally cannot change.

Options are the most flexible, as they can be fully effective, partially effective, or completely voided, requiring no initial investment. If the company fails, there is no risk, making the initial costs for both parties the lowest. However, if an individual signs an options contract with the company, there may be tax issues. Exercising options will reduce the company's net profit, affecting performance against investors; individuals must also pay taxes, and crucially, startup companies may not be listed, making it difficult to liquidate the equity while still needing to pay a significant income tax upfront. Of course, in actual entrepreneurship, most companies do not take such risks, and relying on professional guidance incurs additional expenses.

In restricted stock plans, employees initially acquire shares at a relatively low price, and if they meet the conditions of the incentive plan, the shares are unlocked in stages; if they fail to meet the targets, the corresponding portions or all shares will be forcibly repurchased and canceled. This method often appears in A-share listed companies and new third board companies, but entrepreneurial companies generally do not use it, as it is less convenient and risk-averse compared to options.

Virtual stocks are even less common, resembling a fundraising mechanism where the company collects funds from employees and distributes cash rewards based on agreed amounts or proportions when the company generates profits in the future. However, this system carries considerable legal risks, and ordinary enterprises should avoid it, as it can easily lead to illegal fundraising pitfalls, harming both the company and its employees.

(3) The convenience of cashing out benefits from different equity incentive methods varies

Cashing out common stock is relatively straightforward, whether through actual shares, options, restricted stocks, or other methods, obtaining equity in a listed company or one most likely to go public is undoubtedly the most convenient, as it not only allows for easy sale and simple value assessment but also provides full autonomy.

However, indirect holdings are relatively more complicated. Indirect holdings are achieved through a holding platform, typically in the form of a limited partnership. The advantage of indirect holdings through a limited partnership is that it allows for unified management of small amounts of equity, and for companies preparing to go public, it is crucial as it avoids the hassle of frequent business registration changes when personnel changes occur. For incentive recipients, limited partners in a limited partnership generally do not have voting or management rights, so the voting rights of the company equity held by the limited partnership are actually in the hands of the general partner. When conditions are met and liquidation is needed, the limited partnership must first reduce its holdings before distributing the proceeds to the incentive recipients.

Cash income rights are essentially a special bonus linked to stock price performance, with a straightforward implementation method that directly distributes cash based on calculated results. However, non-listed companies find it challenging to assess the price of equity, making it difficult to distribute this bonus. Moreover, I believe that designing cash income rights is not very necessary; it would be more scientific to directly offer bonuses based on performance commissions or other performance assessments.

(4) The tax burden and timing of tax payments differ for various equity incentive methods

The equity incentive process involves many personal income tax matters; understanding the tax burden and timing of tax payments is beneficial for assessing whether an equity incentive plan is worthwhile:

① Market Price Benchmark Capital Increase

Commonly seen in some listed companies' private placement plans. Generally, the cost of entry for this method is high, but the tax burden is low; there is no tax burden at the time of capital increase, only a 20% tax on the difference between the selling price and cost when sold. However, due to significant information asymmetry in Chinese listed companies, private placements for insiders often establish positions at a low point in a phase. Of course, this approach carries considerable market risk and requires careful consideration.

② Options

The advantage of options is that no upfront investment is required, and they can be settled in stages based on final outcomes. The amount obtained is calculated based on the fair price (usually the market price) on the exercise date, then included in the total salary income; personal income tax is calculated based on different tiers, with the highest tier reaching 45%. Since the exercise price is often symbolic, even if the stock has not been sold, cash outflows may occur at the time of exercise. For the actual controller of the company, the only downside of options is that IPO companies do not support them.

③ Restricted Stocks

Restricted stocks are a widely used structure in listed companies, primarily involving the incentivized party increasing capital at a relatively low price, and then after assessments, the unqualified portions are canceled, and the qualified portions are unlocked as common equity. The tax burden is similar to that of options, but it requires upfront capital investment, creating significant financial pressure. Additionally, the funds for the unqualified portions must undergo share cancellation procedures after being returned, which typically only listed companies can do.

④ Cash Income Rights

Using cash settlements linked to performance assessments or stock price performance as rewards is generally included in salary income. For the same reasons as previously mentioned, this will be briefly covered.

(5) Different equity incentive methods and recipients should be considered based on the company's development stage

In the early stages of a company's establishment, partners should be allowed to contribute, but the number of partners should not be too large. As entrepreneurship becomes increasingly youthful and diversified, many startups recruit numerous partners at the outset, but by the time the company has gone through two or three rounds of funding, the value of the stock has risen significantly, often leading to "partners" who are part-time or do nothing. Since actual shares can only be repurchased and have no other means of recovery, various troubles may arise, so it is advisable to grant actual shares only to partners who are fully committed to entrepreneurship.

Once partners are determined, it is best not to change them lightly. Consider setting a certain work tenure with partners, allowing for the buyback of shares at a certain price if they leave before the term expires, to avoid situations where "people leave but equity remains occupied." However, if such clauses are included, they will inevitably reduce the attractiveness to partners; the balance between these considerations is what entrepreneurs must contemplate.

In the startup phase, as teams are usually small, it is difficult to distinguish between "key personnel" and ordinary employees; therefore, we recommend establishing a certain option pool, with the founder holding shares on behalf of the team. As the company grows, the team expands, and the previously flat company structure begins to show some hierarchy, options should be recognized and rewarded for key positions such as technical talents, sales experts, and administrative managers, rather than being a "universal" benefit. Additionally, it is advisable to set the exercise price based on the most recent round of investors' pricing and tie it to continued employment with the company, so that when it comes time to reduce holdings, employees can accumulate a considerable floating profit without needing to invest upfront, effectively reducing turnover rates for key positions.

I personally believe that only after the company reaches maturity should it consider full employee equity incentives or employee stock ownership; by then, the company's equity will have a relatively fair price reference, and employees will have clearer expectations for their future exits. Therefore, establishing plans such as employee stock ownership programs, allowing employees to purchase shares at a certain discount based on market prices, is a common practice among A-share listed companies.

3. Different financing rounds have different values and cash-out methods

Equity incentives exchange future equity for employees' hard work, so to make a rough judgment on the value of equity incentives, one must first have a concept of the approximate price of equity.

In the seed round, equity pools or a small number of options are typically set, as the team is still in the process of adjustment and trial and error; if conflicts arise, both the company and employees can try to be more open-minded and bravely adjust their initial choices.

By the A round, the team usually grows rapidly as the business is officially commercialized, and veteran employees who have successfully navigated the business begin to take on small leadership roles—if in some highly competitive industry categories, mutual poaching may occur. Therefore, after completing the A round of financing, providing options to these veteran employees with strong business qualifications is a good opportunity; on one hand, the company's prospects become more optimistic with the influx of A round funds, making employees more willing to participate in equity incentives at the expense of some cash compensation; on the other hand, if the company can successfully exit in the future, the consideration for the A round will be appropriate for those who have contributed to the company since its inception. After the A round is completed, significant personnel changes at the partner level should generally come to an end.

By the B and C rounds, the company has grown into a well-known entity, and the options gradually become exercisable. After exercising options, the company's equity in later financing rounds often allows for a small amount to be sold to subsequent investors. The price of this batch of equity is based on the pricing of subsequent rounds of financing, but it is important to note that exercising options theoretically requires paying personal income tax, and exercising them to become actual shares also requires a sum of exercise funds. B and C rounds typically continue to issue options, but the consideration will inevitably be higher.

As for companies nearing an IPO, the value of the options held also rises significantly; holding company equity becomes a form of wealth, provided the company can successfully go public. Employees need to fully understand the company's future prospects—how much annualized return can be obtained is secondary; the most important thing is whether an exit can be realized. At this stage, the issuance of options will become more cautious, as the likelihood of cashing out increases, making them more attractive than cash compensation.

Entrepreneurs and Equity#

The content of this section reflects my observations and thoughts from my not-so-senior experience in the primary market. It merely provides a perspective and should not be taken as a standard answer.

1. The initial equity distribution at the start of entrepreneurship is crucial for success or failure

To put it further: successful startups often have a reasonably designed equity structure, while conversely, if the equity structure is poorly designed, the probability of failure increases significantly.

Here are a few unfavorable situations:

(1) Excessively dispersed equity

Everyone has their own ideas, especially when there are many shareholders, each hoping the company operates according to their vision. If the company's shareholders are very dispersed from the outset, the limited resources of the company will be consumed in endless disagreements and disputes. There may be seven or eight ways to handle a particular issue, of which two or three may be correct; generally, it suffices to choose one approach. While choosing the right direction is certainly important, quick decision-making and implementation are equally critical for startups.

Even if the company manages to navigate through disputes over operational direction, when most shareholders unconditionally support a particular leader in decision-making, they often find that their equity is insufficient when the company needs financing. Losing absolute control is not the end for founders, but if the founders' equity is too low, it may lead investors to worry that the founders lack motivation to strive, resulting in them not investing in the company from the outset.

Equity is a long-term resource; using it to exchange for easily replaceable and short-term resources is highly unwise. Of course, in a sense, equity financing is also unwise, but there are no other options.

(2) Partners who contribute labor but not effort

Many startups initially attract enthusiastic partners who eagerly draft resignation letters, invest money, and wait for year-end bonuses to resign and embark on a grand venture. When the promised time arrives, some individuals find themselves unable to participate for various reasons—yet they promise to handle company matters in their spare time until the company secures angel funding. Out of respect for their friendships, others may hesitate to speak up, and they push through to keep the company afloat. However, when the company begins to seek A round funding, they discover that this individual’s equity has skyrocketed from tens of thousands to millions, and when it comes time to contribute, their full-time job is too demanding. When asked to come out and work full-time, they demand a salary far beyond what the startup team can comprehend. What began as a brotherly relationship turns sour, but actual shares cannot be expelled. Ultimately, they had to be removed during the A round, incurring significant costs.

Such stories are not uncommon, and the lesson for entrepreneurs is: partners who do not commit full-time should only be granted equity if they are truly exceptional and indispensable; otherwise, those who will do the work should hold shares on behalf of the partners until they come on board. It is advisable to impose certain constraints on partners during the startup phase to minimize such free-riding situations—remaining in the company while those who contribute are unfairly burdened and occupying valuable equity space.

(3) Coal bosses as financial backers

There is no intention to demean all coal mine owners; this merely illustrates a scenario for readers: individuals over 40, from traditional industries, with low educational backgrounds, but who are quick to fund and can bear losses. For some traditional industries, finding a financial backer is a good thing.

However, for some emerging industries, having such a financial backer may not be beneficial. Due to their past business experiences, financial backers may instinctively propose many "suggestions" and "ideas," even intervening in company operations. Simultaneously, due to their concerns about the safety of their investments, they often demand a significant shareholding or even control. If both of these situations arise, it essentially signals the end of that entrepreneurial endeavor.

For professional investors, holding control of the company in the early stages is not a good idea. On one hand, the entrepreneurial team’s stance will gradually change after losing control, as legally, the company no longer belongs to the entrepreneurs, leading to a loss of motivation and morale. On the other hand, while investors may have researched the industry, they generally cannot truly operate a company. If investors cannot deploy a management team while holding a majority stake, they must rely on the entrepreneurial team with minority stakes, which may lead to moral hazards for the entrepreneurial team. Therefore, investors obtaining control of the company too early is something both the entrepreneurial team and investors want to avoid.

However, for companies in later rounds, why is the dilution of founders' equity not an issue? Because when the company is larger (after the B round), financing cannot come from a single investor, and the founding team typically retains significant decision-making power. Additionally, the interests of the founding team are already substantial; even a 20% to 30% stake remains considerable, ensuring sufficient motivation.

2. Establishing a reasonably planned equity usage strategy is crucial for the long-term development of the company

We often hear the term "financing rhythm." Financing rhythm not only includes the timing of financing but also considerations regarding financing proportions. Below are some considerations regarding financing rhythm:

(1) Financing time windows

Generally, financing is based on the company's cash usage, calculating the time until funds run out in the coming months and allowing for a buffer of several months. Additionally, the company must consider whether its business can achieve breakthroughs during the financing window or whether certain technologies or products can be developed during this period, as this significantly aids the success rate of financing.

(2) Financing efficiency

Equity is a limited resource, and each financing round incurs substantial costs, including the time required for communication between founders and multiple potential investors, various discussions and negotiations, travel expenses, and the time and costs associated with due diligence. These all contribute to significant fixed expenses. Moreover, the monetary costs are only a small part; the most important aspect is the valuable energy and intelligence of the founders spent in outsmarting investors.

Therefore, generally speaking, apart from the relatively short interval between the seed round and the A round, subsequent financing rounds are typically recommended to be spaced at least one year apart. Consequently, entrepreneurs should conduct detailed calculations of their cash usage and the cash flow generated by their business. Ultimately, entrepreneurs should consider the balance between efficiency and consideration; the more mature the company, the higher the financing consideration; the earlier the company finances, the lower the consideration, but it allows the company to mature more quickly.

(3) Reasonable equity distribution planning

In traditional industries, a company often requires a long time to accumulate before becoming a listed company, and usually, after reaching a basic level of maturity, it will push for performance before attracting investment. Therefore, in such companies, investors' shares are often minimal, and it is not uncommon for actual controllers to hold over 50% of equity even years after going public. In some extreme cases, companies may accumulate rapidly without ever bringing in investors before going public.

However, it is challenging for emerging industries to achieve this, primarily because the entire society's venture capital strength has significantly increased, meaning that the priority of achieving profits is overshadowed by the priority of capturing market share, leading to unprecedented competition, and even causing first movers to be outpaced by later entrants through financing. Therefore, mastering the financing rhythm requires not only considering the current round but also planning for the next round in advance.

An ideal rhythm from an investor's perspective is to release 10% to 15% in each round, allowing for overall exits after about three rounds of financing, with founders retaining approximately 30% to 40% and employees receiving around 10% to 15%, resulting in a win-win situation. Of course, entrepreneurship is brutal; each round of financing is a hurdle, and each round filters out most companies, so there is no need to make equity planning overly meticulous.

3. Some small common knowledge about corporate governance and equity

(1) Joint-stock companies must adhere to the principle of "same share, same right," meaning that every vote's rights and obligations must be identical. When extended to equity-related transactions, shares issued in the same capital increase must be at the same price. However, limited liability companies do not necessarily need to comply, so investment agreements for limited liability companies can be highly diverse—if it is a VIE structure with dollar funds, the terms can be even more varied, with investors writing all favorable terms for themselves into the investment agreement.

(2) The articles of association of limited liability companies can be highly customized, as long as they comply with the Company Law and other legal regulations, allowing for many stipulations in the articles. However, customized articles may lead to complications during due diligence when financing. Joint-stock companies have less freedom; if they are listed on the New Third Board or other exchanges, their articles are regulated by guidelines issued by the exchanges.

(3) Supervisors may seem to hold a trivial position, but they also possess the power to convene temporary shareholders' meetings, attend board meetings, and submit proposals to the board. However, directors can also serve as company executives, while supervisors cannot.

(4) Entrepreneurs, especially those in startups, should not use company funds for personal matters, as investors are extremely wary of such situations; this may even lead investors to demand early buybacks.

(5) If a shareholder exits, it is generally done through transfer, meaning that the funds are provided by the shareholder to the exiting party, and the company typically does not return funds to shareholders. The primary reason is that exiting shareholders must notify all creditors and obtain their consent. Additionally, if there is more than one investor, there are often binding exit clauses in the investment agreement, meaning that if one party proposes to exit, they can also request to exit under the same conditions. For example, if the company has only 3 million yuan in cash, and investors A and B each invested 5 million yuan, if one party wants to exit, the other may demand equal treatment, meaning each can only receive 1.5 million yuan, which is insufficient. Therefore, once a company faces issues, it is very difficult for investors to recover their funds.

(6) In extreme cases, when investors demand liquidation of the company, their investment terms often include priority liquidation rights, meaning that in the unfortunate event of bankruptcy, the remaining assets will first be used to repay the investors' contributions.

(7) It is best to avoid situations where there is a single natural person shareholder, as this may lead to problems in cases of poor management, such as "piercing the corporate veil" and pursuing unlimited liability.

(8) The so-called "preemptive right" means that if a limited liability company shareholder transfers equity externally, existing shareholders have the right to purchase it at the same price; if they are unwilling to pay the same price, this right becomes invalid—this restriction does not apply to joint-stock companies.

(9) Anti-dilution clauses refer to investors' unwillingness to see their equity devalued, requiring that the entry price for later investors cannot be lower than theirs; otherwise, compensation is required (ratchet clauses). Of course, in some extreme cases, to ensure the survival of the company or to achieve an exit with minimal losses, existing investors may also make certain concessions. As of the completion of this book, some "unicorns" experienced price inversions between IPO and previous rounds of private financing, triggering the aforementioned compensation clauses. Such clauses cannot exist in the mainland A-share market.

New Third Board Companies and Equity#

The New Third Board has evolved from being relatively unknown in 2012 to gaining prominence in 2013, and now frequently appearing in the media. What exactly is it? How is it related to listing? As a practitioner, I will discuss the New Third Board comprehensively.

1. Origin of the New Third Board

The New Third Board originated in Beijing's Zhongguancun, primarily involving relatively high-tech enterprises. It is called the "New" Third Board because there is also an "Old" Third Board, which mainly facilitated the transfer of shares for delisted companies and included the STAQ and NET transfer systems. The Old Third Board has essentially died out, and due to the limited number of companies in Zhongguancun, the New Third Board had little trading activity and was extremely illiquid at that time.

In 2012, the New Third Board expanded to four national-level high-tech parks, greatly increasing the sources of projects. At this point, it is necessary to mention Shenwan Hongyuan. The investment banking department of Shenwan was relatively low-profile, but while other brokerages were busy with IPOs and large deals, Shenwan quietly engaged in a substantial amount of New Third Board work that others overlooked.

At the end of 2013, the China Securities Regulatory Commission announced the nationwide expansion of the New Third Board, opening it to all companies. On January 24, 2014, the New Third Board listed 285 companies at once, reaching a total of 621 listed companies, marking the official establishment of the New Third Board market as a national securities trading market.

By March 6, 2015, a total of 2,026 companies had been listed on the New Third Board, making it quite substantial in terms of both quantity and total market value.

2. Requirements for Opening a New Third Board Account

First, the threshold for opening a New Third Board account is relatively high, with the following conditions:

(1) Individual New Third Board account opening conditions

① Requires more than 2 years of securities investment experience (the starting point for investment experience is the date of the first stock transaction in the investor's name in the National SME Share Transfer System, Shanghai Stock Exchange, or Shenzhen Stock Exchange), or a background in accounting, finance, investment, or related fields.

② The market value of the investor's securities assets on the previous trading day must exceed 5 million yuan. Securities assets include customer trading settlement funds, stocks, funds, bonds, and collective financial products from brokerages, excluding credit securities account assets.

(2) Institutional New Third Board account opening conditions

① Legal entities with a registered capital of over 5 million yuan;

② Partnerships with a total paid-in capital of over 5 million yuan.

Compared to the main board, small and medium board, and growth enterprise board, the threshold is significantly higher. This also determines that under the current threshold, generally only professional investors participate in this market, resulting in relatively low activity.

3. Trading Methods on the New Third Board

The trading methods on the New Third Board mainly include the following two, plus one that is planned for launch:

(1) Agreement Transfer

This method is relatively informal; one can place orders for others to click and complete transactions or set a secret code for the transfer, requiring that the transaction amount, code, and price must be identical, with opposite buy and sell directions for the transaction to occur. Additionally, there are no limits on price fluctuations, leading to significant price volatility. Generally speaking, liquidity for agreement transfers on the New Third Board is poor, and most companies listed have not seen any transactions.

(2) Market Maker Transfer

A brief introduction to the concept of "market makers." Market makers are essentially like wholesalers, obtaining inventory shares from market-making companies. When investors need to buy or sell stocks, transactions do not occur directly between investors but rather through market makers as counterparties, who have an obligation to transact within the quoted price range. Therefore, market makers provide liquidity to the New Third Board, making equity more liquid compared to agreement transfers.

(3) Auction Trading

This method has not yet been launched; it is tentatively planned to use the same auction trading method as the main board and growth enterprise board markets. Apart from some thresholds such as investor access, it will generally be similar to the main board market. We also anticipate that companies in the auction trading tier will have a dedicated trading level, with thresholds being more relaxed than the above two methods; of course, correspondingly, companies in the auction trading tier will also be the most outstanding.

4. Conditions for Listing on the New Third Board

(1) Must have a clear main business and a record of sustainable operations;

(2) The governance structure of New Third Board listed companies must be sound and operate in a standardized manner;

(3) The conditions for listing on the New Third Board must ensure that share issuance and transfer behaviors are legal and compliant;

(4) Recommendation by a sponsoring brokerage;

(5) Must have been in continuous operation for 2 accounting years;

Compared to IPOs, the above requirements are not problematic; the key is whether the enterprise has long-term development potential and the entrepreneur's determination to operate in a standardized manner. From the entrepreneur's perspective, the requirements for the New Third Board are essentially as follows:

(1) It is inconvenient; the company's money belongs to the company, and one cannot use it freely; external small wallets must be closed or merged. Although the company's decisions are still ultimately made by the major shareholder, there must be decision-making procedures, and everything must be done according to procedures;

(2) Taxes must be paid in a standardized manner; some companies have not paid income tax, and past dues must be settled, which involves real cash outflows;

(3) The company's financial statements and operational conditions are publicly displayed, which may lead to awkward situations or even disputes with competitors, customers, and suppliers.

Therefore, the cost of entering the New Third Board is not just the direct fees for intermediary institutions but also the above-mentioned requirements. We hope that companies can genuinely consider whether they can meet these three requirements.

5. What is the process and time frame for the New Third Board?

The main process is as follows:

(1) Due Diligence and Plan Design

Brokerages, accountants, lawyers, and the enterprise reach a preliminary cooperation intention, spending 1 to 2 weeks conducting initial due diligence to identify important issues, then the four parties discuss the following questions:

① Is it feasible? Are there any insurmountable obstacles in the current situation?

② What major issues can be resolved over time, and how long will it take?

③ What are the estimated compliance costs, and how do they relate to point ②, often needing to balance time and money?

④ Specific rectification and implementation plans, briefly skipped;

If the initial due diligence results are favorable, they will be submitted to their respective risk control departments for internal approval. Once the internal approval is granted, the cooperation relationship is formally established, and work begins.

(2) The three institutions enter to conduct comprehensive due diligence and write the public transfer statement

The workload for accountants is the largest, as they provide the foundational data needed for subsequent decision-making and declaration documents, establishing the company's accounting system to meet the basic requirements of the New Third Board.

Lawyers and brokerages collaborate to review the company's history, checking for any equity-related issues, related transactions, and competition; if any exist, they must be resolved. They also ensure that all regulatory departments are operating legally; if issues arise, they assist in resolving them.

Once the company has undergone sufficient rectification, it will convert from a limited liability company to a joint-stock company based on the timing of the audit report. If a few companies were initially established as joint-stock companies, this step can be skipped.

(3) Formal Application

First, the three institutions submit internal approvals again to their risk control departments; once approved, they can submit applications to the National SME Share Transfer Company.

After the materials are submitted, the share transfer company will inquire about certain issues from the project team and the enterprise. If there are no problems after feedback, they will receive a "no objection letter" from the share transfer company, allowing them to handle equity registration and allocation of abbreviations and codes.

(4) Listing

After listing, stocks can begin trading, but generally, it is quiet and not as lively as an IPO with ringing bells. Most companies in agreement transfers still have low visibility, and the public's threshold is high; more importantly, compared to IPOs, the New Third Board lacks a public issuance phase, meaning external investors have no chips, resulting in little trading...

This is a brief overview of the listing process. If a company has a relatively simple history and well-organized finances, it can be completed in as little as six months.

6. The Significance of the New Third Board

The value of the New Third Board lies in:

(1) Standardizing company equity

The reform process of the New Third Board effectively transforms companies into enterprises that meet the most basic requirements of the capital market. Therefore, compared to non-listed companies, if a listed company seeks to acquire a New Third Board company, the financial data of the New Third Board company is authentic, and the foundational work is generally well done, significantly reducing the risk of information asymmetry.

(2) Certain financing capabilities

Many institutions tell companies that listing on the New Third Board enables equity financing and allows for equity pledge financing, but the reality is often less rosy. Indeed, there are many financing cases on the New Third Board, including large-scale financing in the billions, but the financing capability ultimately depends on the company's operational status rather than merely being listed on the New Third Board. The New Third Board undoubtedly aids in financing limits and costs, but it does not mean that poorly performing companies will definitely secure financing after listing under relaxed conditions.

If a company is in good condition, it can raise funds through private placements, and some relatively advanced concept companies with good operational conditions receive attention comparable to that of the main board and growth enterprise board markets, but this is still rare.

(3) Providing price discovery

Certainly, for those companies that have essentially met the legal requirements for the growth enterprise board or even higher, the valuation premiums provided by the New Third Board are undoubtedly valuable. The consideration for mergers and acquisitions of non-New Third Board companies generally falls below 15 times, with a few better industries being slightly higher, while the consideration for New Third Board companies is significantly higher than that of non-listed companies in the same industry.

The role of market makers in enhancing overall company valuations is more pronounced; on one hand, market making requires brokerages to invest real money in enterprises, which involves strict screening and implies a reputation guarantee from the brokerages; on the other hand, market making provides the New Third Board with the liquidity that is scarce: buying and selling is straightforward. Liquidity undoubtedly carries a price.

Thus, the aforementioned valuation increases significantly enhance the acquisition value of shareholders' holdings. To reiterate, wealth measured by market value does not mean shareholders will sell all their stocks—if they did, the stock price would plummet to rock bottom—but rather indicates the price that external investors would need to pay to acquire the company.

Consequently, the overall acquisition consideration for the company also increases. For some small, refined companies looking to "sell themselves," the New Third Board is undoubtedly valuable.

(4) Enhancing visibility and investor recognition

When a company lists on the New Third Board, it gains hidden credibility guarantees from brokerages, accountants, lawyers, and the share transfer company, making it easier for investors to find them. Since the company's information is displayed on a national platform, it undoubtedly has advantages in seeking investors, especially when the company is performing well. Additionally, as far as I know, many brokerage asset management subsidiaries or funds have begun raising New Third Board investment funds, targeting selective investments in New Third Board companies. In the future, the financing functions of New Third Board companies may indeed be enhanced.

Moreover, as the company showcases itself on a national market, it benefits its corporate image and employee recognition.

(5) Serving as a test for IPOs

The entire process of the New Third Board can serve as a test for the company team, the service level of intermediary institutions, and the market's understanding of the company. Companies listed on the New Third Board will certainly face different levels of scrutiny compared to non-listed companies, especially as future reviews are delegated to exchanges.

As for the transition to other boards, I advise non-internet companies not to take this too seriously, as it is quite challenging.

7. The Future of the New Third Board

Before the New Third Board, China's private enterprises were mainly divided into two types: listed companies and non-listed companies. The financing convenience of listed companies, the equity payment value (equity incentives and mergers), and the recognition of talent are all significantly higher under equal operational conditions compared to non-listed companies. This gap is also a significant inducement for fraudulent listings.

The New Third Board provides a diversified, multi-tiered capital market path, allowing companies to gradually upgrade through the New Third Board, from agreement transfers to market maker transfers, and eventually to future auction trading. Each step will yield progressive improvements and developments. Optimistically, if the investor access threshold for the auction trading segment is lowered to the level of 50,000 to 100,000 yuan, the distinction from the growth enterprise board may become negligible.

Since the New Third Board's access threshold is based solely on regulatory requirements without performance indicators, any company can list at the agreement transfer level, while relatively outstanding companies will rise to market maker transfers and eventually to auction trading. In this process, relatively professional investors will vote with their feet, creating a healthy mechanism of survival of the fittest, which is of significant importance for promoting the prosperity of the entire business system.

8. Conclusion

Debt financing has a limit on borrowing (debt-to-asset ratio) and must be repaid in cash. This also determines that companies capable of using debt financing require stable cash flow, which is challenging for startups and small to medium enterprises. This inherent contradiction leads to high loan risks for small and medium enterprises, and high risks necessitate high-interest rates to cover them. In reality, those who default on loans and run away cannot repay, leaving normal operating small and medium enterprises to bear high-interest rates to compensate for the losses caused by those who abscond. This mechanism leads to adverse selection among entrepreneurs, fostering a culture of wrongdoing.

However, equity investment is different. By participating in investing in companies, investors can achieve high returns from investing in good companies while facing penalties for poor investments. This mechanism encourages investors to discover better enterprises and compensate for other investment losses with substantial equity returns. Here, the adverse selection mentioned earlier is eliminated; if there are no significant systemic errors, it will promote the development of both investors and small and medium enterprises.