1. Introduction
1.1 The Securities Commission of Malaysia enhanced the Guidelines on Unlisted Capital Market Products under the Lodge and Launch Framework (issued on 9 March 2015 and revised on 28 April 2020) (“LOLA Guidelines”) with effect from 28 April 2020. Under such initiative, business entities are now permitted to issue conventional convertible notes to venture capital firms and private equity firms registered with the Securities Commission under the Guidelines of Registration of Venture Capital and Private Equity Corporations and Management Corporation (“Specific Registered Persons”), without compliance of certain requirements set out under the LOLA Guidelines, making such fundraising process more administrative and cost efficient (“LOLA Framework Enhancement”).
1.2 The above remains subject to (i) the Specific Registered Persons satisfying the criteria under Part I of Schedule 6 and/or Part I of Schedule 7 of the Capital Markets Services Act 2007 (the “CMSA”); and (ii) the terms and conditions of the issuance of convertible notes being in compliance with certain prescribed criteria.
1.3 Please refer to our earlier article for further information.
1.4 Following the above, it is expected that venture capital firms and private equity firms will now have the option of investing via subscription of redeemable preference shares (which has been the conventional practice before the LOLA Framework Enhancement) or subscription of convertible notes. Given such development, investee companies or investor should consider which investment instrument can better serve the interest of the respective company or better achieve their commercial objectives.
1.5 Given the emergence of such options to business entities and Specific Registered Persons, this article aims at providing an overview over certain matters that an investee company or a venture capital firm / private equity firm may wish to consider in respect of its fundraising exercise or investments in Malaysia.
2. Overview of the relevant matters
2.1 Under the LOLA Framework Enhancement, the Securities Commission clarified in the FAQ on the Requirements of the LOLA Guidelines (click here) that currently only conventional convertible notes may be issued under the enhanced LOLA Guidelines, although the Securities Commission acknowledged that this may change subject to a revision to the LOLA Guidelines in the future.
2.2 We set out below a brief overview of the matters which a venture capital firm or private equity firm or investee company wish to consider when deciding between issuance of redeemable preference shares (“RPS”) or convertible notes (“CN”) as investment insturment:
No. |
Subject Matter |
Redeemable Preference Shares (RPS) |
Convertible Notes (CN) |
| 1. | Amendments to the constitution of the issuer to reflect the rights of the RPS holders or CN holders. | Required under section 90(4) of the Companies Act 2016. | Not Required |
| 2. | Priority on liquidation and return of capital |
Holders of RPS rank after the creditors of the issuer, whether secured or unsecured. Generally, the investment agreement would provide that the holders of RPS shall have priority over the ordinary shareholders of the issuer on liquidation or return of capital. |
Holders of CN rank pari passu with unsecured creditors of the issuer, and shall have priority over ordinary and preference shareholders of the issuer on liquidation or return of capital. |
| 3. | Conversion to ordinary shares |
Convertibility of the RPS into ordinary shares depends on the terms of the issuance. If permitted under the terms, RPS can be convertible into ordinary shares at such term and during such period as may be agreed between the parties. |
Yes, CN are convertible into ordinary shares of the issuer at such term and during such period as may be agreed between the parties.
|
| 4. | Redemption / Repayment |
Compulsory Redemption
Typically, in the event of default or upon occurrence of a prescribed event (if any), the RPS shall be redeemed by the issuer by paying the subscription amount of the outstanding RPS, computed at an agreed rate (together with any declared but unpaid dividend on a cumulative / non-cumulative basis).
Voluntary Redemption
If the terms of the issuance permit, the issuer may redeem the RPS at certain agreed rate by delivery of a written notice, subject to there being no event of default. Please refer to Paragraph 3 of this article concerning capital maintenance rules under the Companies Act 2016 which may impede the flexibility of redemption of RPS. |
Compulsory Redemption
Typically, in the event of default or upon occurrence of a prescribed event (if any), the CN shall be redeemed by the issuer by paying the subscription amount of the outstanding CN, computed at an agreed rate (together with any accrued and unpaid interest).
Voluntary Redemption
If the terms of the issuance permit, the issuer may redeem the CN prior to its maturity at an agreed rate by delivery of a written notice, subject to there being no event of default. Redemption of CN is not subject to capital maintenance rules.
|
| 5. | Dividend / Interest |
RPS generally carry preferential dividend (cumulative or non-cumulative). Issuer may only distribute dividends from its profits. |
CN generally bears interest at an agreed rate from the date of issuance until conversion of the CN into ordinary shares of the issuer or redemption, whichever is the earlier. Payment of interest constitutes a debt to the CN holder, the payment of which is not subject to the issuer having sufficient profits. |
| 6. | Rights to vote in meetings |
Generally, RPS holders have no right to vote on a resolution as that of ordinary shares at a general meeting of the issuer.
Notwithstanding, the preference shares may still carry certain voting rights which must be specified in the Constitution of the issuer. The RPS holders may be able to vote on matters relating to their respective class of shares provided that such rights are stated in the Constitution as required under section 90(4) of the Companies Act 2016. In addition, it should be noted that further control may be exercised by the RPS holders over the affairs of the issuer by inclusion into the subscription agreement certain protective provisions which may limit the issuer’s ability to carry out certain corporate exercises without the blessing of the RPS holders. |
Generally, CN holders have no right to vote on resolution as that of ordinary shares at a general meeting of the issuer.
However, the control exercised by the CN holders over the affairs of the issuer may be enshrined in the terms of the issuance, such as inclusion of certain protective provisions that may limit the issuer’s ability to carry out certain corporate exercises without the blessing of the CN holders. |
| 7. | Lodgement with the SC | Not required | Required |
| 8. | Requirement of a trustee | No | Yes, unless exempted under the CMSA |
| 9. | Limit on investment sum pursuant to the BNM Foreign Exchange Administration Rules |
No limit to the subscription amount.
Pursuant to the refinement of the foreign exchange policies which came into effect on 30 April 2020 (“Refined BNM Foreign Exchange Policies”), the Bank Negara Malaysia (BNM) clarified that a resident entity is allowed to borrow in Ringgit in any amount from a non-resident through issuance of RPS. |
No limit to the subscription amount.
Pursuant to the Refined BNM Foreign Exchange Policies, BNM clarified that a resident entity is allowed to borrow in Ringgit in any amount from a non-resident through issuance of unlisted Ringgit-denominated CN. However, this does not apply to issue of non-tradeable Ringgit denominated CN to a non-resident entity outside the issuer’s group or a non-resident financial institution). |
| 10. | Any concern which may arise from the Moneylenders Act 1950 | None | None (exempted under Section 2A(2) of the Moneylenders Act pursuant to P.U.(B) 219/2005). |
3. Key Matters to Note
3.1 Malaysia-incorporated companies are subject to capital maintenance rules which aim at protecting the companies’ creditors. Generally, companies are only able to distribute dividends to its shareholders from its profits. Subject to prescribed limitations and adherence to certain procedures under the Companies Act 2016, a company generally may not:
(a) purchase its own shares or redeem its preference shares;
(b) reduce its own capital; and
(c) provide financial assistance to a third party to purchase its shares.
3.2 Although the Companies Act 2016 provides that redemption of preference shares shall not be regarded as reduction of share capital of the company, redemption of RPS can only be effected if they are fully paid up and the redemption is made out of (i) profits (which would otherwise have been available for dividend); (ii) a fresh issue of shares; or (iii) capital of the company.
3.3 Pursuant to section 72(5) of the Companies Act 2016 amended pursuant to the Companies (Amendment) Act 2019, where RPS are redeemed out of profits of the issuer which would otherwise have been available for dividend, there shall be transferred into the share capital accounts of the issuer, a sum equal to the amount of shares redeemed. Further, in the case of redemption of preference shares out of capital, all directors must make a solvency statement forming an opinion that the company satisfies the solvency test for purposes of such redemption. A company is deemed to satisfy a solvency test if:
(a) immediately after the redemption the company will be able to pay its debts;
(b) the asset of the company is more than the liability of the company at the date of redemption; and
(c) either:
(i) it is intended to commence the winding up of the company within 12 months after the date of redemption, the company will be able to pay its debts in full within 12 months after the commencement of the winding up; or
(ii) in any other case, the company will be able to pay its debts as the debts become due during the period of 12 months immediately following the redemption.
3.4 Unlike RPS, payment of interest and redemption of CN by an issuer will not be impeded by the capital maintenance rules aforesaid. Having said that, as issuance of unlisted corporate bonds such as CN requires compliance of the LOLA Guidelines, it may only be commercially viable for the investors to subscribe for CN instead of RPS if the issuance of CN complies with the criteria set out under the enhanced LOLA Guidelines (such that certain procedural requirements and costs may be exempted) and the issuer agrees to effect the relevant lodgement with the Securities Commission. Please see our earlier article for more information.
4. Views
The LOLA Guidelines Enhancement is a very much welcomed initiative to the industry, as it has expanded the fundraising and investment options available to the emerging growth companies, venture capital firms and private equity firms. Be that as it may, as discussed in this article, each instrument carries with it different benefits and drawbacks. There is no hard and fast rule to determine which investment instrument better serves the interest of the investee and/or the investor. Before determining a fundraising or investment structure and the instrument to be used, the relevant stakeholders should consider the relevant factors, premised on the financial position, capabilities and commercial goals of the parties involved.
If you have any questions about fundraising by way of issuance of redeemable preference shares or convertible notes or the LOLA Guidelines in general, please do not hesitate to contact us.
This legal update is for general information only and is not a substitute for legal advice.
Published on: 12 June 2020