Related-Party Customer Risk Before a STAR Market IPO

A Nanjing technology company preparing for a STAR Market IPO earns a material portion of its revenue from a distributor connected to a founder's family. The sales are real, but the relationship raises questions about independence, pricing, revenue quality and disclosure. The issuer needs to decide whether to retain, restructure or reduce the relationship and how to build evidence showing that the customer exists for commercial reasons rather than to manufacture listing metrics.

The CSRC's IPO Registration Measures implement the registration-based framework and require issuers and intermediaries to satisfy issuance conditions and disclosure obligations. The Securities Law requires truthful, accurate and complete disclosure and prohibits false records, misleading statements and material omissions. The Company Law governs corporate approval and governance of related transactions. A material connected customer can therefore affect both business independence and disclosure quality.

The specific issue#

1. Identify the related-party connection completely rather than relying on formal share ownership#

Identify related-party connections through shareholding, family, former employment, side agreements and economic dependence—not only through the equity register. STAR Market disclosure and independence analysis fail when the company treats “not a registered shareholder” as the end of the inquiry.

2. Quantify revenue, margin, receivables and concentration#

Quantify revenue, gross margin, receivables, aging and customer concentration attributable to the related party across the track-record period. Without numbers, neither counsel nor sponsors can test materiality, disclosure thresholds or remediation options.

3. Test the underlying commercial substance through contracts, logistics and payment#

Test commercial substance with contracts, purchase orders, logistics, acceptance records and payment paths. Related-party revenue that cannot be tied to real delivery and payment is both a disclosure problem and an accounting integrity problem.

4. Benchmark pricing and explain commercially justified differences#

Benchmark pricing against independent customers or market references and document commercially justified differences. Unexplained preferential pricing is a classic exchange question. If differences exist, the file must show why they are arm’s-length or how they will be corrected.

5. Assess whether the issuer can operate independently without the related customer#

Assess whether the issuer can operate and grow without the related customer on realistic assumptions. If the business collapses when the related party is normalized or removed, independence and sustainability disclosures become the core listing risk.

6. Review board and shareholder approvals for related transactions#

Review whether related transactions received required board and shareholder approvals under law and the articles. Missing approvals are both governance defects and disclosure items; curing them may require ratifications before filing.

7. Build conflict declarations and approval thresholds into internal controls#

Install conflict declarations, related-party lists and approval thresholds that actually operate—not policies that exist only in the handbook. Sponsors will ask how the company identifies and clears conflicts in practice.

8. Prepare prospectus disclosure that explains both relationship and economics#

Draft prospectus disclosure that explains the relationship, transaction terms, pricing policy, amounts and risk factors in plain terms. Minimizing the relationship while metrics show concentration invites supplemental inquiries and credibility damage.

9. Avoid cosmetic termination of a genuine customer immediately before filing#

Avoid terminating a genuine related customer solely to cosmetically reduce concentration immediately before filing if the economic reality is that sales will resume or shift to a proxy. Exchange review looks through artificial discontinuities.

10. Develop a real diversification plan where concentration is strategically material#

Where concentration is strategically material, build a real diversification plan with named customers, product qualification timelines and revenue milestones. A paragraph promising to “expand the customer base” without an operating plan is not remediation.

11. Analyze receivable aging and collection from the related customer#

Analyze receivable aging and cash collection from the related customer. Persistent delays or circular settlements undermine the quality of earnings even when invoices exist. Align collection evidence with revenue recognized.

12. Align legal evidence with revenue-recognition accounting#

Reconcile legal evidence of delivery and acceptance with revenue-recognition accounting. Lawyers and auditors must tell the same factual story; discrepancies become listing-process defects.

13. Investigate relationships with former executives and family members#

Investigate counterparties linked to former executives and family members, including distributors inserted between the issuer and end users. Indirect channels are a frequent hiding place for related-party economics.

14. Conduct customer due diligence on end demand and business capacity#

Diligence the related customer’s end demand, capacity and payment ability. A thinly capitalized distributor that exists mainly to buy from the issuer is a substance red flag, not a diversification success.

15. Use a case study where 30 percent of revenue comes from a founder-connected distributor#

Work an explicit case: if roughly thirty percent of revenue flows through a founder-connected distributor, model disclosure, pricing cleanup, governance approvals and diversification options before fixing the filing timetable. Abstract debate underestimates the workstream.

16. Choose remediation among repricing, governance, independent benchmarking and contract changes#

Choose remediation deliberately among repricing, independent benchmarking, contract restatement, governance upgrades, escrowed related-party sales or staged reduction of concentration. Different tools fit different facts; using all buzzwords without a chosen path wastes pre-filing time.

17. Prepare the sponsor and lawyers' evidence file before exchange questions arrive#

Assemble the sponsor and counsel evidence binder—contracts, pricing benchmarks, approvals, logistics samples and customer confirmations—before exchange questions arrive. Speed of response is part of credibility in the registration process.

18. Ensure prospectus, audit report and legal opinion use the same facts#

Ensure the prospectus, audit report and legal opinion use the same related-party perimeter and figures. Inconsistent definitions of “related” across workstreams are a self-inflicted comment letter.

19. Design post-listing controls for continuing related transactions#

Design post-listing controls for continuing related transactions: approval matrices, periodic reporting and independent director oversight. Listing does not end the issue if the commercial relationship continues.

20. Do not file until the company can show that revenue exists for business reasons, not listing optics#

Do not file until the company can demonstrate that related-party revenue exists for ordinary business reasons capable of independent explanation—not merely for group allocation or listing optics. If that demonstration fails, fix the business or the perimeter before filing.

Worked scenario: a founder-connected distributor represents 30 percent of IPO revenue#

Assume a semiconductor-equipment company preparing for the STAR Market derives 30 percent of annual revenue from a distributor controlled by the founder's brother. The distributor is a genuine business with real customers, but it has few employees, pays the issuer more slowly than unrelated distributors and receives somewhat higher gross-margin products. The relationship has existed for years and cannot realistically disappear overnight.

The issuer should first identify and disclose the relationship accurately. The legal, audit and sponsor teams should use the same ownership facts and the same definition of the relevant period. Next, they should test commercial substance through purchase orders, logistics, end-customer evidence, acceptance and cash collection. If the distributor is merely a channel with no independent business function, the issuer needs to understand what that means for revenue quality.

Pricing requires a separate file. The company should compare comparable products, volume, credit terms, after-sales service and geographic coverage. If the connected distributor pays a different price, management should be able to explain the commercial reason with data. A board resolution stating that pricing is fair is not enough.

The issuer should then assess independence. Could it reach the underlying customers directly or through alternative channels? Is the distributor responsible for market access the issuer cannot replicate? Would losing the distributor materially reduce sales? A diversification plan should reflect business reality rather than be created only for the prospectus.

A cosmetic pre-filing termination can make the situation worse if the issuer remains dependent on the same end customers or replaces the distributor with another connected channel. A better approach may be to retain the relationship under strengthened governance, independent pricing benchmarks, conflict approvals and complete disclosure while gradually building unrelated channels.

The sponsor and lawyers should have the evidence assembled before exchange questions arrive. Prospectus language, legal opinions and accounting workpapers should tell one consistent story about why the relationship exists and how the issuer controls the conflict.

Action checklist before implementation#

1. Confirm who has authority to delay filing until related-party remediation is complete.
2. Assemble the core evidence set: related-party perimeter, revenue metrics, contracts, logistics, pricing benchmarks, approvals and disclosure drafts.
3. Identify the one concentration or substance fact most likely to draw exchange questions.
4. Quantify revenue that would remain after normalization or diversification.
5. List third parties needed—distributor confirmations, independent customers, sponsors and auditors.
6. Define the fallback if cosmetic fixes are rejected in review.
7. Reconcile prospectus, audit and legal-opinion definitions of related parties.
8. Assign owners for remediation tools actually selected.
9. Ensure post-listing controls are designed before filing.
10. Retain the evidence binder for rapid comment response.

Quality-control questions#

Before the matter is closed, an independent reviewer should be able to reconstruct the related-party perimeter, economics and remediation path. The reviewer should explain why the team avoided cosmetic termination of a real customer relationship without fixing substance, pricing and disclosure. If that explanation depends on recollection rather than the file, the work is not complete.

Decision tree for the issuer#

The issuer should first determine whether the connected customer is genuinely related under applicable law and disclosure standards and whether any informal family or management relationship needs to be treated as relevant. The ownership analysis should be completed before the revenue analysis so the legal, audit and sponsor teams use one consistent factual premise.

The next question is economic dependence. Revenue percentage alone is not enough. The team should examine margin, receivable days, end-customer concentration, channel exclusivity and whether the issuer could reach the market without the distributor. A 30 percent channel with unique regional coverage can be commercially different from a 30 percent entity that simply resells to customers already controlled by the issuer.

Pricing should be tested using comparable third-party transactions. Differences in product mix, volume, service, credit terms and geographic responsibility should be documented. If the connected distributor receives unusually favorable terms, the issuer should either justify them commercially or remediate them before filing.

Finally, management should decide whether the relationship should continue. Immediate termination is not automatically the best answer. If the business is genuine, strengthened governance and transparent disclosure may be more credible than a cosmetic pre-filing exit followed by indirect continuation through another channel.

Evidence file for sponsor and exchange review#

The file should contain ownership and relationship evidence, contracts, order history, logistics and acceptance records, bank collections, pricing comparisons, receivable aging, end-customer information and board approvals. The accounting workpapers and legal analysis should use the same revenue periods and counterparty definitions.

Where customer concentration is material, management should document the diversification strategy and actual progress. New direct customers, alternative distributors and changes in sales personnel can demonstrate that the issuer is reducing dependence for business reasons, not simply to satisfy a listing narrative.

Prospectus drafting should explain the relationship, the commercial rationale, pricing controls, historical trend and risk. Boilerplate statements that transactions are “fair and reasonable” are weak unless supported by evidence. If the relationship remains significant, the risk factor and related-party disclosure should be consistent with the financial statements and legal opinion.

Post-listing governance matters too. Continuing related transactions should operate under approval, recusal, pricing and disclosure controls. The issuer should build those controls before filing so it can show they are functioning rather than merely promised.

How the issuer should respond to regulator questions about the connected customer#

The response should begin with a factual ownership and relationship chart, followed by the commercial history of the relationship. The issuer should explain when the distributor was established, why it became a channel, what services it performs and how end customers are sourced. This is more persuasive than simply stating that the transaction is “necessary and fair.”

Pricing questions should be answered with data. The company should provide comparable products, volumes, credit periods, logistics responsibilities and after-sales obligations. If no perfect comparator exists, management should explain the commercial adjustments rather than invent an artificial benchmark.

Revenue-quality questions require evidence of end demand. The issuer should be able to show orders, delivery, acceptance and cash collection and, where appropriate, information about the distributor's onward sales. A distributor with little operational substance and unusually slow collections will require deeper explanation.

If the company has begun diversification, the response should show concrete progress rather than forecasts. New customer contracts, sales-team expansion and changing concentration ratios can support the argument that the issuer is reducing dependency in the ordinary course of business. The legal, sponsor and accounting teams should agree on the same factual narrative before any response is submitted.

Pre-filing governance test#

Before filing, the issuer should run a mock related-party review through its actual approval process. The transaction should be identified, conflict disclosed, interested decision makers recused where required, pricing evidence reviewed and the approval recorded. If the company cannot operate the control in practice, the prospectus should not claim that the mechanism is already effective. Demonstrated operation is more persuasive than newly drafted policy language.

Disclosure consistency check#

The final pre-filing review should compare the legal opinion, audit workpapers, related-party register, prospectus and sponsor responses side by side. Any difference in ownership, revenue percentage, pricing explanation or customer history should be resolved before submission. Inconsistent factual descriptions can generate avoidable regulator questions even where the underlying transactions are genuine.

Conclusion#

This issue should be managed as a specific legal-control problem. The legal framework must be applied to verified facts and converted into an executable sequence. The central lesson from this scenario is to avoid trying to solve the issue cosmetically by terminating the relationship immediately before filing without addressing economic dependence or historic disclosure. A strong file shows the legal rule, the commercial decision, the supporting evidence and the fallback if the preferred route fails.

Legal and regulatory sources#

^[1] CSRC Measures for the Administration of Initial Public Offering Stock Registration: https://www.csrc.gov.cn/csrc/c101953/c7121923/content.shtml ^[2] Securities Law of the PRC — official NPC legal database: https://flk.npc.gov.cn/ ^[3] Company Law of the PRC: https://www.npc.gov.cn/npc/c2/c30834/202312/t20231229_433999.html

This article is general legal information and is not legal advice for a specific matter.