Private Equity Fund formation and transactions in 34 jurisdictions worldwide
2008
Contributing editor: Casey Cogut Published by Getting the Deal Through in association with: Blake Cassels & Graydon LLP Bowman Gilfillan Carey Olsen CHSH Cerha Hempel Spiegelfeld Hlawati De Brauw Blackstone Westbroek NV Dillon Eustace EsinIsmen G Breuer Gessel Attorneys at Law Golovan and Partners Homburger Kronbergs & Cukste Latournerie Wolfrom & Associés Lepik & Luhaäär LAWIN Loyens & Loeff, Luxembourg Lydian Maples and Calder Moussas & Tsibris Mulla & Mulla & Craigie Blunt & Caroe P+P Pöllath + Partners Proskauer Rose LLP Regoli Merani & Associati Rodés & Sala Roschier, Attorneys Ltd SAI Consultores, SC Sarka, Sabaliauskas, Jankauskas Simpson Thacher & Bartlett LLP Stoica & Asociatii Veirano Advogados Vinge Wiesner & Asociados Ltda Abogados WongPartnership LLP Yangming Partners
Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through – Private Equity - 2008, (published in March 2008 - contributing editor: Casey Cogut). For further information please visit www.GettingTheDealThrough.com
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Roschier, Attorneys Ltd
Finland Ulf-Henrik Kull and Mika Paavilainen Roschier, Attorneys Ltd
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What different types of private equity transactions occur in your jurisdiction?
Private equity, in its broad sense, includes both private equity (or buyouts) and venture capital transactions. In this chapter, private equity refers to both types of transaction, unless otherwise specified. Private equity, or buyouts, usually means majority investments into relatively mature companies with established operations. Buyout transactions are most often implemented as private business or share purchases, or, if the target company is publicly traded, as public tender offers. As discussed in question 13, there have been few public tender offers by private equity buyers in Finland. Venture capital transactions usually involve minority investments into seed or growth-stage companies that need external financing to grow fast enough. For this reason, such transactions are usually made by issuing new shares or other equity-linked securities such as convertible bonds, and are implemented basically as private placements. 2
What are the implications of corporate governance reforms for private equity transactions? Are there any advantages to going private in leveraged buyout or similar transactions? What are the effects of reforms on companies that, following a private equity transaction, remain public companies or become public companies?
The Finnish corporate governance reforms have not been as dramatic as the Sarbanes-Oxley legislation in the US. The Helsinki Stock Exchange did publish its corporate governance recommendation for listed companies, effective as of 1 July 2004, but the changes were rather aimed at clarifying the relatively loose Finnish legislation on the matter and unifying corporate governance standards between different listed companies. The recommendation is based on a ‘comply or explain’ principle, ie, a listed company should comply with the entire recommendation, or if it wishes to deviate from the provisions thereof, it should publicly explain the reasons for such deviations. A general benefit of going private is obviously the fact that the target company will no longer be subject to the securities market laws, notably the duty to disclose any price-sensitive information. Another important benefit is strategic freedom, enabling the development of the company in the long term (ie, over the investment horizon of the private equity fund) without the need to consider the reactions of the stock markets in the meantime. The fact that portfolio companies seldom remain publicly traded or become publicly traded subsequent to the private equity investment would indicate that these benefits are significant for private equity funds. Getting the Deal Through – private equity 2008
3
How can management of the target company participate in a going-private transaction? What are the principal executive compensation issues in such transactions?
A decisive factor in this context is whether the manager is a member of the board and the related fiduciary duty to the current shareholders. Participation by members of the board of directors (whether they are managers of the company or external board members) in a going-private transaction should generally be excluded, or kept to a minimum. This is because the board members have an obligation to act in the best interests of the company and its current shareholder collective. Board members need to carefully maintain equality between all shareholders and may not take any action that is likely to confer an unjustified benefit on any shareholder or any other person (eg, the private equity investor or a management member) at the expense of the company or another shareholder. Participation by board members in the investment could cause conflicts of interest between the board members and the current shareholders of the target company. Should board members participate in the investment, they would generally be prevented from taking part in the preparation of the transaction (and related decisions) in the target company. On the other hand, managers who are not members of the board may be entitled to participate in a going-private transaction. This is often also necessary as it is essential for the private equity investor to retain and provide an incentive to key management in the target company. In connection with the transaction, such managers can enter into agreements concerning, for example, different incentive schemes (through share ownership, options or synthetic options), redundancy packages and direct success fees related to the transaction. 4
What are the issues facing boards of directors of public companies considering entering into a going-private or private equity transaction? What is the role of a special committee in such a transaction where management members of the board are participating in the transaction?
The rights and duties of directors in connection with a goingprivate transaction are not addressed by any specific Finnish legal provisions but are governed by the general principles of Finnish company law. In general, the board must maintain equality between all shareholders and may not take any action which is likely to confer any unjustified benefit on any shareholder or any other person (such as the private equity investor or a management member) at the expense of the company or another shareholder. In case of a public tender offer, the duties of the board are driven by the interest of the company’s shareholder collective, which means in practice that the board must pursue the best possible end result for the company’s shareholders.
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Roschier, Attorneys Ltd If approached by a private equity investor, the board of a public company may allow the prospective investor to conduct a due diligence review of the company and its operations, provided such a review is in the interest of the company’s shareholder collective (eg, if the due diligence review is a precondition for making a good offer to the company’s shareholders). It is common market practice to allow such a review. Even in an unsolicited takeover, the board may allow a review because of its fiduciary duty (described above), provided that the above preconditions are met. Similarly, the right of the board of directors to take defensive action is limited by its obligation to act in accordance with good business practice and in all other respects in the best interests of the company and its shareholder collective. There are no Finnish legal provisions on special committees for situations in which certain management members of the board of the target company are participating in the transaction on the bidder’s side, but such committees have been used in practice. Under the general principles of Finnish company law and the recommendations (the so-called Helsinki Takeover Code) issued by the Finnish ‘takeover panel’, members of the board who are participating in the transaction on the bidder’s side should disqualify themselves in matters related to the contemplated transaction (see also question 3).
finland from the Finnish tax authorities allowing such utilisation despite the change in ownership. Using a Finnish special-purpose vehicle to acquire a Finnish company will not automatically allow the deduction of interest expenses of the acquisition debt from the income of the target company. Interest expenses are generally deductible in the taxation of the borrower, provided that the interest rate is at arm’s length and the loan is taken for business purposes. Interest paid on loans taken from abroad is normally exempt from Finnish withholding tax, although the exemption does not apply to interest paid on loans that represent investments comparable to equity. Private equity transactions do not automatically trigger any immediate tax consequences related to executive compensation. However, possible social security contribution obligations by the target company and golden parachute-related tax consequences for executives should be determined on a case-by-case basis. In Finland, share acquisitions cannot be classified as asset acquisitions and, consequently, the acquisition cost of the shares may not be deducted in taxation, except in certain limited situations. 7
What are the timing considerations for a going-private transaction or other private equity transaction?
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Are there heightened disclosure issues in connection with going-private transactions or other private equity transactions?
The main provisions governing the acquisition of shares through public tender offers are set out in the Securities Market Act (SMA). These provisions do not make any distinction based on the identity of the offeror. The SMA sets out rules regarding, inter alia, information to be disclosed in connection with a public tender offer (in the form of a tender offer document and stock exchange releases), the main principles to be complied with when conducting the offer (including the length of the offer period and pricing matters), and the obligation to launch a mandatory offer upon exceeding certain ownership thresholds. The SMA also imposes certain disclosure obligations relating to the employees (or employee representatives) of the bidder and the target company, respectively. Further guidance on such matters may be sought in the standards issued by the Financial Supervision Authority (FSA) and the Helsinki Takeover Code issued by the ‘takeover panel’, which was established on 1 September 2006 and operates in connection with the Finnish Central Chamber of Commerce. There are no heightened disclosure issues related to private share or business purchases by private equity investors. 6
What are the basic tax issues involved in private equity transactions? Can share acquisitions be classified as asset acquisitions for tax purposes?
A private equity transaction is generally accomplished as a purchase of shares for cash. Therefore, the transaction realises capital gains taxation to a seller, unless the Finnish participation exemption is applicable. A tax-neutral exchange of shares is not practically feasible in the case of private equity transactions. When the shares in a Finnish company are sold, a transfer tax of 1.6 per cent is levied on the sales price. However, if both parties to the transaction are non-residents, no transfer tax is payable. A direct or indirect change in the ownership of the target company’s shares that exceeds 50 per cent will cause the target company to forfeit its carry-forward losses and any unused imputation credits. However, a special clearance can be obtained
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Under current legislation, the entire delisting process in a goingprivate transaction will typically take approximately six to 12 months. First, a decision to launch a public tender offer must be made public and disclosed to the target company, the FSA and the Helsinki Stock Exchange. Second, the tender offer document needs to be filed with the FSA for approval, subject to a review period of five business days. The length of the offer period must be a minimum of three weeks and a maximum of 10 weeks. However, the period may be extended on special grounds (eg, pending merger control clearance), provided that this does not impede the operations of the target company for an unreasonably long period. Following a successful voluntary public tender offer, with the bidder having received at least 90 per cent of the shares and votes in the target company, the bidder will be entitled to squeeze out minority shareholders under the Companies Act. The bidder can typically obtain advance title to the squeezed out shares in three to four months from the commencement of the squeeze-out proceedings, with the entire process taking some six to nine months. The target company can be delisted upon the bidder having gained advance title to 100 per cent of the shares in the target company. The Finnish provisions on public tender offers have been recently amended as a result of the implementation of the EC Directive on Takeover Bids. The implementation of the directive did not result in an extensive reform of the Finnish takeover regime, although certain amendments of a material nature were introduced, in particular the simplification of the previous partly parallel redemption procedures by abolishing the obligation to launch a mandatory offer under the SMA in cases where the threshold triggering the mandatory offer has been exceeded by means of a voluntary offer made for all shares and securities that are entitled to shares in the respective target company. This has significantly affected the timing considerations relating to a going-private transaction. The second major timing consideration relates to merger control. Should the transaction not fall within the jurisdiction of the European Commission, the Finnish Competition Authority (FCA) has a period of one month from notification to either clear Getting the Deal Through – private equity 2008
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the transaction or decide to initiate a further investigation. If an in-depth investigation is carried out, the FCA must, within three months from the decision to initiate such an investigation, either clear the transaction or request the Market Court to block it. This second-stage procedure may result in a maximum aggregate investigation period of nine months. 8
What purchase agreement issues are specific to private equity transactions?
In the case of a financing condition, the seller typically requires the private equity bidder to submit a term sheet from the financing bank upon signing the purchase agreement. Covenants to assist in raising financing are not market practice in Finland and we have not seen reverse break-up fees. An increasingly common phenomenon has been that finance walkaways have not been accepted by sellers, which private equity bidders were required to accommodate in the recent, very competitive bidding climate by providing evidence of a certain fund solutions. Private equity investors are typically focused on the purchase price mechanisms and try to avoid any unexpected cash-out elements. A common example is a provision on normal levels of working capital to the effect that the private equity investor requires the working capital of the target to be within a normalised range, and any deficit to be deducted from the purchase price. Also, any other identified issues with an effect on the purchase price are frequently taken into account in the purchase price mechanisms. Private equity funds as sellers tend to issue very limited representations and warranties. On the other hand, when a private equity fund (as against a trade buyer) is acting as the purchaser, the scope of representations and warranties may be broader owing to the private equity investor’s less detailed knowledge of the industry compared with trade buyers. 9
What issues are raised by existing indebtedness at a potential target of a
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11 What are the key provisions in shareholder agreements covering minority investments or investments made by two or more private equity firms?
Private equity investors making minority investments are likely to focus on exit and transfer clauses while total control over governance will not be possible. Key exit provisions typically cover drag-along and forced exit. Key transfer provisions are typically tag-along clauses, first right of refusal and other tailor-made transfer restrictions. Common governance provisions include clauses on board representation by different parties, qualified majority requirements in certain decisions by the board or shareholders’ meetings, and different veto rights. 12 Do private equity transactions involving leverage raise ‘fraudulent conveyance’ issues? How are these issues typically handled in a goingprivate transaction?
Fraudulent conveyance issues cannot be entirely excluded in private equity transactions involving leverage, but in almost all cases security is provided by the financing institutions. The financing institutions, which are the largest creditors, usually require a robust security package covering virtually all the major assets of the target company. Private equity investors are also very keen to ensure that there are no unclear issues that may affect their reputation, which is a prerequisite for arranging financing in any future transactions, and therefore rely on comprehensive corporate governance policies. 13 What types of companies or industries have typically been the targets of goingprivate transactions? Has there been any change in focus in recent years?
The Finnish market has seen a limited number of going-private transactions by private equity investors during recent years as there has been a scarcity of suitable investment targets. Recent investments have typically been in the retail and consumer goods industry and in infrastructure such as hospitals and roads.
private equity transaction? How are these issues resolved?
Typically, a private equity investor would completely refinance the target in connection with the transaction, therefore potential issues are related mainly to early amortisation of the existing indebtedness. In cases where the existing indebtedness is particularly inexpensive (such as a subsidised loan from public authorities) and the private equity investor would like to retain the indebtedness, the transferability or change of control provisions, or both, related to the indebtedness may become relevant. 10 What types of debt are used to finance going-private or private equity transactions? Do margin loan restrictions affect the debt financing of these
14 Do private equity firms have limitations on the size of transactions they may engage in?
Most private equity funds have limitations on the minimum and maximum size of transactions, as described in the investment agreements with the limited partners. Most funds domiciled in Finland are fairly small, with maximum equity investments into buyout targets of about e50 million and technology investments up to e20 million. However, there are many international private equity funds that operate actively in the Finnish market and are capable of larger transactions (eg, CVC, Bank of America, Industri Kapital, Nordic Capital, EQT and Altor Equity Partners).
transactions?
Typically, the majority of the debt will be senior bank loans. In addition to senior loans, frequently used forms of debt financing include mezzanine, vendor loans (from the seller of the target) and shareholder loans. The rights and inter-relationships of the different lenders are often agreed upon in an inter-creditor agreement. Senior debt typically consists of term loans (fixed-term loans for financing of the acquisition), and revolving or overdraft facilities, or both (for financing of working capital). There are no margin loan restrictions in Finland limiting the possibilities of financing private equity transactions. However, margin loans are used relatively rarely in Finland.
Getting the Deal Through – private equity 2008
15 How do the exit strategies and investment horizons of private equity firms affect the structuring and negotiation of leveraged buyout transactions?
The expected investment horizon and type of exit have an effect on tax planning. Key issues include the allocation of the purchase price between different assets and the resulting amortisation of goodwill. Another important issue is a cost-efficient financing structure that fits into the investment period and exit strategy, and combines sufficient leverage with inexpensive debt financing without excessive covenants. A third important structural issue is a suitable incentive system for the management. A current trend seems to be to build increased flexibility into the equity and incentive structures, realising that not all investments will develop as planned when the investment is made.
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Roschier, Attorneys Ltd Update and trends The M&A market has somewhat slowed down recently and become less seller-friendly. It is likely that in comparison to big auction processes the number of one-
finland companies and businesses within the defence sector require clearance by the Ministry of Defence, where the acquisition would be cleared by the authorities unless it might endanger important national interests. Furthermore, specific legislation applies to foreign acquisitions of companies that hold real property located on the border zone or other areas protected for defence purposes.
to-one off-market transactions will increase. In addition the risk allocation provisions in the purchase agreements will presumably become more balanced with respect to, eg, conditions precedent, indemnity and seller’s warranties. The tightening of credit terms may also improve the market position of trade buyers who are typically less dependent on external debt financing.
16 What are some of the principal accounting considerations for private equity transactions?
The main accounting considerations going forward are the new goodwill impairment tests, established by the introduction of International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS). The IAS 36 provision concerning the goodwill impairment test is complicated and has a high degree of detail. The major areas affected by its introduction include: the frequency of impairment testing; measuring value in use; the allocation of goodwill to cash-generating units; the timing of the impairment test for goodwill; reversals of impairment losses for goodwill; and disclosure. The rule may have a significant effect on new and current private equity investments, especially if they result in breaches of loan covenants, inter alia, through increased debt-to-equity ratio. 17 What provisions relating to debt and equity financing are typically found in a going-private transaction? What other documents set out the expected financing?
In public tender offers, the provisions relating to debt and equity financing typically found in a going-private transaction originate from the Securities Market Act (the SMA). The SMA sets forth provisions to ensure sufficient financing is in place. Before the announcement of the offer, the offeror must ensure that it will have sufficient financing available to pay any cash consideration offered in the tender offer or take other reasonable action to secure the payment of any other type of consideration. It is important to ensure that the debt and equity provider has met the necessary formal requirements, eg, through a credit committee, but this could also be conditional through a material adverse change clause. The manner of financing the offer (and related conditions) must be disclosed in connection with the announcement of the offer and in the tender offer document, but additional documentation is usually not required to set out the expected financing. 18 Do industry-specific regulatory schemes limit the potential targets of private equity firms?
There are no industry-specific regulatory schemes that would limit investments by private equity firms in particular. Even in general, there are very few regulations limiting the ownership of companies in Finland. A few industries are subject to various licences and permits by the authorities, such as certain financial services, pharmacies and taxis. In addition, foreign investments in
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19 What are the issues unique to structuring and financing a cross-border going-private or private equity transaction?
In a private equity transaction, shares in the target company are typically acquired by a newly incorporated special-purpose vehicle using a combination of debt and equity financing. Normally, the bank providing debt financing will also insist that the existing indebtedness of the target group is refinanced at the same time. Thus, the bank will provide financing both for the acquisition and for general corporate or working capital purposes, including the refinancing of existing debt. Under Finnish financial assistance rules, a Finnish limited liability company cannot provide, or grant security for, the financing of the acquisition of its own shares or shares in an upstream member of the same group of companies. To mitigate the negative consequences of this prohibition, the available equity financing is generally to the maximum extent possible allocated to the financing of the actual acquisition. The debt financing is then divided into separate facilities, one (typically a term loan facility) being used to finance the balance of the purchase price for the target shares and secured only by a pledge over those shares and the rest (typically revolving or overdraft facilities) used for refinancing or general corporate purposes and secured by the assets of the target company or its subsidiaries (in each case subject to further restrictions set out in the following paragraph). The granting of loans or security by a Finnish limited liability company for the benefit of related parties is restricted unless certain express exemptions apply. In practice, the most important such exemptions are loans granted for the benefit of qualifying group companies and loans with qualifying commercial justification granted for the benefit of non-group companies. In addition to this (and regardless of the applicability of any such exemption), loans and security may only be granted where this is genuinely held to be in the best commercial interests of the granting company. Sufficient commercial benefit must in other words exist on a company level. The concept of ‘group benefit’ is not recognised. Following a merger between the acquirer and the target company, security can be granted over the target assets also for the acquisition financing facility, as the security will then be granted for the target’s own debt. 20 What are the special considerations when more than one private equity firm is participating in a club or group deal?
The most significant matters in such a situation are related to the shareholders’ agreement, in which the club deal participants agree on the division of their rights and obligations, especially related to governance of the target company and the exit-related provisions. Also of importance are the limitations imposed by confidentiality agreements to restrict private equity firms from combining influence. Therefore special consideration is given to the confidentiality agreements entered into by each party when implementing a club deal.
Getting the Deal Through – private equity 2008
Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through – Private Equity - 2008, (published in March 2008 - contributing editor: Casey Cogut). For further information please visit www.GettingTheDealThrough.com
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Roschier, Attorneys Ltd 21 How have recent disruptions in the credit markets affected dealmaking? What specific changes to transaction terms do you expect?
The M&A market has somewhat slowed down recently and become less seller-friendly. It is likely that in comparison to big auction processes the number of one-to-one off-market transactions will increase. In addition the risk allocation provisions in the purchase agreements will presumably become more balanced with respect to, eg, conditions precedent, indemnity and seller’s warranties. The tightening of credit terms may also improve the market position of trade buyers who are typically less dependent on external debt financing.
Ulf-Henrik Kull
[email protected]
Keskuskatu 7 A 00100 Helsinki Finland
Tel: +358 20 506 6000 Fax: +358 20 506 6100 www.roschier.com
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