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Alibaba's business structure: Does it involve risks?

Alibaba (BABA), China’s largest tech corporation, prides itself on having the third largest IPO in history. However, China’s Internet sector is quite a contradiction– it reaps benefits from foreign equity investments, without letting the foreigners own a single share.

VIE – A Peculiar Regulatory Loophole

According to the laws of China, it is illegal for foreigners to own stocks in a few industries such as Internet commerce and finance.

Alibaba is an Internet company and thus cannot have foreigners as stockholders. This raises an important question as to how Alibaba could have managed to float an IPO on an American stock exchange. The answer to this is VIE or variable interest entity. 

The structure entails the setting up of two entities, one in China and one abroad. The China based entity – the VIE— holds the essential permits and licenses, which are mandatory to do business in China.

The second entity is an offshore holding company. This is the company in which foreigners are allowed to buy shares.

The Chinese subsidiary is controlled by the holding company’s top executives – it pays fees and royalties to the offshore company according to contracts between the two.

Therefore, investors who bought shares of Alibaba on the NYSE actually purchased stocks of the holding company called Alibaba Group Holding Ltd registered in the Cayman Islands with a claim on some of Alibaba’s profits but no real ownership stake.

This means that investors do not own shares of the actual Alibaba and therefore no voting rights in the company.  They also therefore have no rights against any of its assets, including Taobao and Tmall. All they get is a share in Alibaba’s profits.

Who Owns Alibaba then?

According to a post on the New York Times Deal book blog, Alibaba co-founders Jack Ma and Simon Xie actually own Alibaba.

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