This country-specific Q&A provides an overview of the legal framework and key issues surrounding private equity law in the Finland.
This Q&A is part of the global guide to Private Equity.
For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/private-equity-2nd-edition/
What proportion of transactions have involved a financial sponsor as a buyer or seller in the jurisdiction over the last 24 months?
Hannes Snellman: There has been a continued uptick in private equity activity in Finland over the last 24 months, an overall trend we expect to continue. According a recent study by the Finnish Venture Capital Association, the total value of investments made by Finnish financial sponsors grew over 60%, and the number of exits by financial sponsors from Finnish companies increased by more than 10%, when comparing 2018 to 2017. However, after a significant fundraising year in 2017, the fundraising for buyout funds slowed down by approximately 50% in 2018. Nonetheless, the current amount of dry powder waiting for deployment in the Finnish funds (over 1.7 billion in 2018), coupled with strong international private equity interest in the Finnish market, supports the growth outlook for private equity activity in Finland.
What are the main differences in M&A transaction terms between acquiring a business from a trade seller and financial sponsor backed company in your jurisdiction?
Hannes Snellman: Financial sponsors tend to prefer a locked-box pricing mechanism to closing accounts, particularly when on the sell-side. Moreover, deal certainty is a decisive factor for financial sponsors resulting in minimum conditions precedents. The typical closing conditions include merger clearance (if applicable), other sector-specific clearances and deal-by-deal negotiated requirements. Financial sponsors typically endeavour to achieve a ‘clean exit’ with only limited fundamental warranties given by the seller, especially as the use of (buyer-side) W&I insurance has become common in Finland. While the management may provide more extensive warranties than the financial sponsor seller, typically all sellers are treated equally in the sale and purchase agreement due to the drag-along provisions in the sellers’ shareholders’ agreement often requiring equal treatment of all sellers.
On an acquisition of shares, what is the process for effecting the transfer of the shares and are transfer taxes payable?
Hannes Snellman: Under Finnish law, the following steps are required to transfer title to shares in a private limited liability company: (i) corporate resolutions by the vendor and the acquirer to approve and enter into the relevant share transfer agreements; (ii) agreement between the vendor and the acquirer regarding the transfer of the shares; (iii) if share certificates have been issued, the share certificates must be physically transferred (duly endorsed) into the possession of the acquirer to perfect the relevant share transfer; and (iv) update of the shareholder register of the target company. There is no public register of shareholdings in private companies and, thus, there are not as such any related perfection requirements in Finland.
If at least one of the transaction parties is a Finnish resident for tax purposes, a transfer tax of 1.6% of the purchase price is levied on the purchase of shares in a Finnish limited liability company. If the target company is treated as a ‘real estate company’ for tax purposes, i.e. more than 50% of its business activity comprises owning and managing real estate, the transfer tax is 2% of the purchase price. The buyer customarily pays transfer taxes. According to recent case law from Supreme Administrative Court, an acquisition of shareholder loans is not captured in the transfer tax base. This has made it more common place that shareholder loans are acquired separately with the shares.
How do financial sponsors provide comfort to sellers where the purchasing entity is a special purpose vehicle?
Hannes Snellman: In transactions involving financial sponsor backed buyers, the purchasing entity is typically a special purpose vehicle incorporated as a Finnish limited liability company. It is customary that the purchasing financial sponsor issues an equity commitment letter whereby the investing fund commits to fund the SPV’s equity portion of the purchase price and damages for breach of agreement. Moreover, a commitment letter from the financial sponsor backed buyer’s debt financier is typically provided to the vendor’s knowledge e.g. in connection with auctions.
How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?
Hannes Snellman: Locked-box mechanisms are common in auctions and are particularly prevalent in transactions involving financial sponsor sellers, who generally prefer certainty concerning the purchase price and ability to distribute the purchase price promptly to their investors. Moreover, an interest component calculated from the locked-box date is commonly used and typically negotiated on case-by-case basis depending on the business under acquisition. Buyers, in such situations, spend significant time and resources on thorough due diligence, modelling and valuation in order to accurately assess the purchase price and likelihood of leakage etc.
What are the typical methods and constructs of how risk is allocated between a buyer and seller?
Hannes Snellman: In addition to tailored purchase price mechanisms (earn-outs etc.) designed to share risk regarding future performance or events, warranties and indemnities in purchase agreements are the main contractual means of risk allocation. The seller’s liability for unknown risks is covered by warranties, which are commonly subject to e.g. time and monetary limitations as well as the buyer’s knowledge based on the disclosure material in the data room. Financial sponsors typically endeavour to achieve a ‘clean exit’ with only limited fundamental warranties given by the seller, and operative warranties being covered by a W&I insurance policy paid for by the buyer. Risks related to known but contingent liabilities, such as pending litigations or environmental risks, are commonly dealt with by means of specific indemnities negotiated on a case-by-case basis depending on the bargaining power of the parties. In addition, post-closing covenants, such as confidentiality obligations, non-compete and non-solicitation and, in case of separate signing and closing, pre-closing covenants concerning e.g. seeking regulatory approvals or ordinary course of business, are generally agreed upon.
How prevalent is the use of W&I insurance in your transactions?
Hannes Snellman: The use of W&I insurance has become increasingly common in Finland over the last few years and particularly in auctions and other sponsor-led sales processes. Especially in auctions, it is common that the seller initiates the insurance processes, which is then “flipped” over to the buyer in the final round of the auction. Standard W&I insurance provides coverage for breaches of representations and warranties with general exclusions, which include for instance known/identified issues, criminal liability, penalties (e.g. GDPR fines), secondary tax liabilities and forward-looking statements.
How active have financial sponsors been in acquiring publicly listed companies and/or buying infrastructure assets?
Hannes Snellman: There has been a limited but increasing number of sponsor backed public-to-private transactions in the Finnish market. Financial sponsors have also been very active in transactions involving infrastructure assets – energy (including transmission grids), telecommunication infrastructure assets, and highways/roads – and the trend appears to continue growing in the near future. In addition, the public sector has exhibited increasing willingness to enter into public-private partnerships with financial investors in order to finance and construct significant infrastructure projects such as highways and schools.
Outside of anti-trust and heavily regulated sectors, are there any foreign investment controls or other governmental consents which are typically required to be made by financial sponsors?
Hannes Snellman: There are no foreign investment controls or other governmental consents, which apply to financial sponsors in particular. However, on rarer occasions and more sector-specifically, the Act on Monitoring Foreign Corporate Acquisitions in Finland may become applicable if a foreign buyer acquires a controlling stake of 10% or more in a target company, which operates in a sector considered critical to the functioning of the society.
In the defence material industry, monitoring covers all foreign owners, whereas in other sectors, such as pharmaceuticals, monitoring only applies to foreign owners residing or domiciled outside the EU or EFTA. Acquisitions in the defence or dual-use sectors are subject to prior approval from the Ministry of Economic Affairs and Employment. In other sectors, an advance notification is voluntary, but the Ministry of Economic Affairs and Employment may subsequently examine the acquisition if no advance notification is made. The Act is rather open-ended giving the Ministry leeway in determining which companies are vital to the functioning of the society.
How is the risk of merger clearance normally dealt with where a financial sponsor is the acquirer?
Hannes Snellman: In Finnish sale and purchase agreements, the liability for obtaining competition authority approvals is typically allocated to the buyer whereas the seller customarily provides the buyer information required for the merger clearance process. In cases of no apparent overlaps, the buyer often bears the risk of authority requirements. If there are any overlaps (e.g. portfolio companies of the buyer operating in the same sector), the risk allocation is negotiated on case-by-case basis. Financial sponsors acquiring businesses in Finland sometimes accept hell-or-high-water clauses but seem to be less prepared to accept break fees.
Have you seen an increase in the number of minority investments undertaken by financial sponsors and are they typically structured as equity investments with certain minority protections or as debt-like investments with rights to participate in the equity upside?
Hannes Snellman: Yes, there has been an increase in minority investments undertaken by financial sponsors, also beyond traditional financing rounds by VC sponsors in start-ups. While we have seen debt-/mezzanine-like investment structures with equity kickers and other types of equity upside, minority investments by PE/buyout sponsors are also increasingly structured as equity investments coupled with minority protection in the shareholder agreement (e.g. exit control, board participation, veto rights, anti-dilution, drag- and tags-along rights etc.).
How are management incentive schemes typically structured?
Hannes Snellman: Management incentives are usually structured through share ownership, either by issuing new equity or through rollover arrangements. Both common and preferred shares classes are usually used. Preferred shares are typically paid a fixed interest ranging from 5 to 10% of the subscription price. Management shares are sometimes subject to vesting schedules, typically up to 4-6 years from the investment. Options and warrants are more uncommon in financial sponsor backed companies in Finland, save for startups backed by VC sponsors. At the other end of the spectrum, managements’ investment agreements typically include leaver clauses. In case a leaver event occurs, the management member in question is customarily obliged to sell their unvested shares to the private equity investor at a price, which depends on the leaver event at hand.
Are there any specific tax rules which commonly feature in the structuring of management’s incentive schemes?
Hannes Snellman: Main structures available are management share investments and stock options. Share investments are as a main rule taxed with capital income rates 30-34% and require that the shares are acquired at fair value. An underpriced share issue would result into salary taxation with progressive rates up to approx. 55% and employer’s pension and social security charges of roughly 25%. Stock options can be structured as actual or synthetic options (settled with cash). Stock option benefit is tax as salary (tax rates up to approx. 55%) but can be exempt from employer’s pension and social security charges. Payments made under synthetic stock options are tax deductible for the employer.
Management share investments continue to be the most often used ways to incentivize management. An important pitfall to keep an eye on is that share investments cannot be made via holding companies financed by a loan taken from the employer, which could lead into re-characterization of the share investment into a stock option. Stock options have become more frequent especially in all equity deals. From 1 January 2021 onwards, stock options qualify for the employer’s pension and social security charge exemption even when the strike price for the options is below fair value of shares at grant.
Are senior managers subject to non-competes and if so what is the general duration?
Hannes Snellman: Senior managers of portfolio companies are almost without exception subject to non-competes. A typical duration of a non-compete in a shareholders’ agreement for management with an equity stake in the company is around 12 to 24 months (and sometimes up to 36 months in connection with significant manager investments), while employment (or director) agreements customarily include non-compete undertakings for a period of 6 to 12 months from the end of the employment (and sometimes up to 24 months in connection with significant manager investments). Non-competes exceeding three years are generally not deemed enforceable in Finland.
How does a financial sponsor typically ensure it has control over material business decisions made by the portfolio company and what are the typical documents used to regulate the governance of the portfolio company?
Hannes Snellman: Financial sponsors typically exert controlling influence by securing the right to nominate a majority of the members of the board of directors (and, by extension, the CEO). This control is typically further strengthened by the provisions in the shareholders’ agreement, which is the key document regulating the governance of the company, relationships between the shareholders, ownership and exit. While there are a number of provisions in the Finnish Companies Act concerning, e.g. the governance of the company and the protection of the rights of minority shareholders, it is common for the parties to a shareholders’ agreement to replace these provisions with more detailed provisions. In sponsor backed companies, the minority shareholders commonly waive most of minority protection mechanisms of the Companies Act. Financial sponsors sometimes – especially in situations where they do not hold an outright majority of the shares and votes – require veto rights in shareholders’ agreements.
Is it common to use management pooling vehicles where there are a large number of employee shareholders?
Hannes Snellman: Using management pooling vehicles is fairly uncommon. The common practice is that management and employees hold shares in their own names or through individually controlled companies.
What are the most commonly used debt finance capital structures across small, medium and large capital financings?
Hannes Snellman: Secured bank loans on senior terms are the most common source of debt across companies of all sizes. The main difference across small, medium and large capital financings is the provider of debt; small and medium-sized deals rely on one or a consortium of Nordic banks while international commercial banks provide debt financing for larger deals. Alternatively, mezzanine financing is occasionally used in larger deals and medium financings. Debt capital market alternatives in forms of public offerings or private placements are also used in larger private equity deals, in infrastructure deals involving sponsors, and for refinancing. More recently, some Nordic and Finnish financial sponsors have raised credit funds to fund deals and to lend directly to small- and medium-sized companies.
Is financial assistance legislation applicable to debt financing arrangements? If so, how is that normally dealt with?
Hannes Snellman: The Finnish Companies Act includes an explicit financial assistance prohibition preventing a limited liability company from granting any kind of loan, other assets or security for the purpose of a third party acquiring shares in the company or its parent company (save for employee share option plans). The prohibition, coupled with the corporate benefit rule, limit the use of certain financing structures involving upstream security or other arrangements, which is commonly accounted for in structuring debt financing arrangements.
For a typical financing, is there a standard form of credit agreement used which is then negotiated and typically how material is the level of negotiation?
Hannes Snellman: Credit agreements negotiated in Finland and with Nordic and international lenders are generally based on the Loan Market Association’s (LMA) template facility agreements, but occasionally somewhat “lighter” Nordic template versions are preferred. The overall structure of the LMA’s facilities agreements is typically not negotiated, but, as in all transactions, relevant matters to the parties and transaction at hand are reflected in the degree of negotiations and in the credit agreement. The negotiations of the term sheet prior to the actual credit agreement negotiations are typically more thorough, and scope of the term sheet and the degree of detail to which it has been negotiated tend to correspond inversely with the materiality of the level of credit agreement negotiations.
What have been the key areas of negotiation between borrowers and lenders in the last two years?
Hannes Snellman: Referring to Question 19, the key areas of negotiation in credit agreement negotiations depend on the outcome of the term sheet negotiations. Overall, borrowers and lenders have had detailed discussions of thresholds for covenant trigger events and on covenants as a whole, as well as on collateral and security packages. Reflecting general trends in other markets, the number and strictness of covenants, permitted-clauses and grower baskets as well as the required collateral and the extent of security packages demanded have been decreasing in Finnish transactions as well. Further, it has become customary over the last few years in private equity deals for financial sponsors, as lessees, instead of lessor banks (which overwhelmingly provide debt financing in Finland) to draft the credit agreement.
Have you seen an increase or use of private equity credit funds as sources of debt capital?
Hannes Snellman: Over the last few years, there has been a trend of some Nordic and Finnish financial sponsors raising credit funds to fund deals and to lend directly to small- and medium-sized businesses. Nonetheless, the Nordic relationship banking based financing of transactions and companies of all sizes remains strong and banks continue to be the principal providers of credit in Finland.