This country-specific Q&A provides an overview of the legal framework and key issues surrounding Private Equity in France.
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?
As of November 2019, private equity firms buyouts amounts to €11.9bn, exits activity stood at €23.8bn with a total of €26.8bn over 275 operations.
In 2018, the private equity trend was still moving upwards both in terms of value and deal count. Buyout and exit deals reached €36.7 billion with over 390 deals. Activity was close to the pre-crisis levels. It should also be noted that 39% per cent of the deals involved domestic private equity firms.
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?
The representations and warranties provided by financial sponsors and management are generally limited to core warranties, i.e. title to shares, capacity, authority and insolvency, in a secondary LBO where the scope of the representations and warranties granted by trade sellers is substantially wider and will cover operational matters (e.g. compliance with laws, employment, taxes etc.).
Almost all transactions involving financial sponsors are based on locked box mechanisms whereas trade sellers continue to use completion accounts. However, the use of lock box mechanisms is more and more frequent in trade sales as well.
Financial sponsors, unlike trade sellers, will also refuse non-compete or non-solicit undertakings so as to avoid any constraints in their future acquisitions.
Finally, because they want to stream up the proceeds as soon as possible after completion of the transaction, financial sponsors tend to refuse to assume any residual liability vis-à-vis the purchasers. As a result, specific indemnities are quite rare. Financial sponsors will also be reluctant to put in place escrow accounts to guarantee the payment of any indemnification amount.
On an acquisition of shares, what is the process for effecting the transfer of the shares and are transfer taxes payable?
The process for effecting the transfer of the shares differs from one legal form of company to another. In the vast majority of cases, the transfer of the shares only requires an update of the share ledger and shareholders accounts of the target company. In such a case, the shares are recorded in the share register as owned by the purchaser. In other situations, which are very rare in practice, the transfer of the target’s shares will require an update of the articles of association of the company.
Any transfer of shares in a French company (or any transfer of shares evidenced by an instrument executed in France) will trigger registration or stamp duties the amount of which depends on (i) the business and the legal form of the target company and (ii) the value of the transaction.
The simplified joint stock company (société par actions simplifiée) is the most common vehicle on the French market. Subject to certain exceptions, the transfer of its shares should trigger a tax registration fee equal to 0.1% of the fair market value.
How do financial sponsors provide comfort to sellers where the purchasing entity is a special purpose vehicle?
In situations where the purchaser is a special purpose vehicle with no substance, the sellers will require the financial sponsors to provide, together with their binding offers, equity and debt commitment letters with certain funds commitments. Under the equity commitment letters, the financial sponsors irrevocably undertake to fund the bidding company if the bid is successful.
When reviewing the offers, the sellers will make sure that (i) the funding obligations of the financial sponsors and/or their debt providers are subject to no or very limited documentary conditions and (ii) the commitment letters can, upon closing, be enforced by the sellers themselves.
How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?
Almost all transactions involving financial sponsors are now based on a locked box mechanism. On the other hand, closing/adjustment accounts are still used in trade sales although the use of locked box mechanism is more and more frequent.
In certain – and rare – instances, hybrid mechanisms could be put in place. In those instances, the price is based on a set of historical accounts and there is a covenant that a certain amount of net debt or working capital is not exceeded at closing. This would be typically the case when revenues of the target group are highly seasonal and the cash flow forecast may not be relied upon.
What are the typical methods and constructs of how risk is allocated between a buyer and seller?
Under a customarily structured share purchase agreement, the risks attached to the business of the target company are mainly dealt with through interim covenants and leakages protection. Purchase price mechanism, closing conditions, representations and warranties and specific indemnities are also used to reduce the risks attached to the transaction.
For the past couple of years, due to the influence of private equity transactions, the French market has been more and more seller friendly. This is particularly tangible when it comes to closing conditions (that are limited to mandatory regulatory clearances) and warranties .
It should however be noted that recent evolutions in the French civil code impose to sellers a duty to provide to the purchaser all key information relating to the object of the sale. However, professional purchasers such as private equity sponsors are supposed to perform reasonable due diligence in the context of a transaction.
How prevalent is the use of W&I insurance in your transactions?
France remains a jurisdiction with significant M&A volumes that are not using insurance. This situation could be explained by the fact that financial sponsors generally do not provide representations and warranties. This situation is reinforced by the fact that managers of French companies under LBO are generally treated on a pari passu basis with the financial sponsor. However, managers may accept to provide representations and warranties to the extent a W&I insurance entirely covers their risk. Other exceptions may be seen in trade sales.
More generally, W&I insurance is still seen as making the process slower or burdensome. However, more and more clients are considering, at some point in a transaction, the opportunity to purchase a M&A insurance.
How active have financial sponsors been in acquiring publicly listed companies and/or buying infrastructure assets?
Regarding publicly listed companies, out of 36 public offers (other than share buyback) – which were declared compliant by the AMF – over the last 24 months, 3 tender offers were submitted by investment funds.
Although financial sponsors have expressed more interest for publicly listed companies, these figures can be explained, in part, by the fact that French market authority will reject any offer that is conditional on reaching the squeeze-out threshold. Early 2019, this threshold has been reduced from 95% of the share capital and voting rights of the listed target to 90%. This change may encourage bids from PE funds in the future, although the fact that activist funds may acquire blocking minorities is still perceived as a risk. This may be due to recent transactions where activist funds managed to block a squeeze-out.
In 2018, we also saw an increase of investments in infrastructure. €3.9bn have been invested in 111 companies with of predominance of the energy and transportation sectors, both in debt and capital (65% of the investments). 2019 has also been a very active year with a global trend in Europe regarding disposal of telecommunication infrastructures by the main operators.
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?
In France, investment is in principle unrestricted. However, by way of exception, foreign investments carried out in business sectors deemed to be sensitive are subject to prior authorization from the services of French Minister for the Economy (“DGT”).
In the beginning, foreign investment control was limited to a small number of specific activities, such as gambling, cryptology, weapons and warfare equipment. This list has grown considerably over time and the system has been profoundly overhauled, in particular by a Decree dated 14 May 2014 on foreign investments subject to prior authorization. This list has been further extended in 2018 to cover certain technologies including artificial intelligence, robotic or space activities.
Powers of the authorities and sanctions have also been strengthened through the Pacte Law. Since 2019, the DGT can for instance force a foreign investor to either file an application for authorization, restore the situation preceding its investment at its own expense, and/or modify the investment. The DGT is also subject to a higher scrutiny from the Parliament and will, by the end of 2020, be required to coordinate with other EU countries in the implementation of foreign investment controls. This may entail a stricter enforcement of the French rules.
As a result of the foregoing, sellers tend to see the foreign investment rules as a risk similar to merger controls risk. Purchasers are more and more requested to make hell or high water commitment in connection with the issuance of foreign investment clearances.
How is the risk of merger clearance normally dealt with where a financial sponsor is the acquirer?
In all medium or large sized transaction, the closing will be subject to the issuance of merger clearances by the relevant competition authorities. It is common for sellers to require financial sponsors to agree to a “hell or high-water obligation” pursuant to which the purchaser will carry out any action that is required by competition authorities to obtain the merger clearance.
However, given their fiduciary duties vis-à-vis their investors, financial sponsors will generally refuse any provisions pursuant to which they may be under the obligation to impose undertaking to portfolio company.
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?
We see more and more financial investor trying to make minority investments. However, the market is extremely competitive and the bargaining power lies on the seller and management side. To protect their investment, financial sponsors will seek a right to trigger and implement an exit after a certain period of time. Financial sponsors may also subscribe hybrid instruments with downside protection in case of under-performance of the business.
How are management incentive schemes typically structured?
The management incentive schemes aim at aligning the managers and the financial sponsor’s interests. To do so, the financial sponsor will request the key managers to make a significant investment in the target company. In practice, the amount to be invested by top managers could represent 6 to 12 months of the manager’s gross salary. For less senior managers, the investment will generally represent between 3 to 6 months of their salary. In a secondary LBO, the financial sponsor will request the top managers to reinvest around 50% of their net proceeds or 30% to 40% of their gross proceeds. The incentive plan is specific from one transaction to another and managers may subscribe a large variety of instruments.
It is now quite common for managers to benefit from free share programs that benefit from a specific tax and social regime (under certain conditions). The vesting of these shares will generally be subject to certain conditions including an obligation for the beneficiary to remain a manager/employee of the company during the vesting period that must be at least equal to one year.
Are there any specific tax rules which commonly feature in the structuring of management’s incentive schemes?
Gains realized by French resident managers investing in shares should in principle be eligible to the capital gain tax regime provided that they meet certain conditions. As highlighted by tax case law, the managers’ investment should notably be substantial, fully at risk (i.e. for instance without any form of guaranteed return) and priced at arm’s length in order to mitigate the risk of reclassification as salaries from a tax standpoint. Capital gain tax regime generally results in a 30% to 34% taxation (including social security contributions).
Other equity schemes can benefit from specific favorable regimes, such as free share plans, provided that they are granted in compliance with the conditions set forth by the French commercial code and the Tax Authorities guidelines.
Management incentive/investment schemes are subject to increasing scrutiny and reassessments from the French tax administration. In case of reassessment of the gains realized by the managers as salaries, such gains would be subject to the progressive income tax scale (i.e. up to 45% % to 49%), plus social security charges, late payment interest and, as the case may be, penalties (it being specified that under certain conditions, tax penalties may go up to 80% and may also trigger the automatic transfer of the file to the public prosecutor). From a French social security standpoint, the French Supreme Court has recently considered that gains realized by managers should be considered as salaries because the instruments at stake (warrants) only benefited to the managers and were closely linked with their employment contracts (it being specified that warrants do not benefit from a specific tax or social regime).
Are senior managers subject to non-competes and if so what is the general duration?
It is market practice for senior managers to be subject to exclusivity and non-compete obligations. The length of such obligations varies from 12 to 24 months it being specified that managers shall receive a compensation in exchange for their non-compete undertaking unless they only had a corporate office and no employee position. However, in the latter case, these managers will request to be granted such compensation.
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?
Upon closing, a supervisory board is generally set up comprising a majority of members appointed by the financial sponsor. Certain material decisions, including the decisions affecting the business of the group, shall be approved by the supervisory board before they are implemented by the managers.
The list of decisions that requires the prior approval of the supervisory board is set out in a shareholders’ agreement entered into between the financial sponsors and the managers of the target group. This agreement will contain further details on the governance of the portfolio company and will also describe, among others, the liquidity rights of the shareholders. In order to ensure that the provisions of the shareholders’ agreement will be enforceable under French laws, its main terms will generally be reflected in the articles of association of the holding companies.
Is it common to use management pooling vehicles where there are a large number of employee shareholders?
It is fairly common to use specific entities in order to regroup the manager / employee shareholders within one investment vehicle usually referred to as “Manco”. This structure aims at simplifying the implementation of an exit. The financial sponsor will generally hold a preferred share in the share capital of Manco. By using this preferred share, the financial sponsor will be entitled to force Manco to sell its interest in the target group in the event a manager / employee shareholder opposes the sale or is unable to consent to the sale.
A Manco cannot receive free shares. As a result, the structure of the management package may have an impact on the holding structure.
What are the most commonly used debt finance capital structures across small, medium and large capital financings?
Bank loans remain the most prevalent source of financing for French acquisitions, either through syndication or club deals. Such financing is often combined with a refinancing of the target company's existing debt, typically with a term loan (usually a term loan B) and a revolving credit facility.
As an alternative source of funding, acquisition financing has been carried out through private placements and high yield issuances (associated with a bridge financing) thus allowing them to access institutional investors and diversify their financing sources. Certain borrowers also finance acquisitions by unitranche structures.
The French finance market in relation to small cap transactions mainly consists of bank loans.
Is financial assistance legislation applicable to debt financing arrangements? If so, how is that normally dealt with?
Under the French Commercial Code, it is prohibited for acquired French limited liability companies and for their subsidiaries, , to provide any financing to acquire the shares of the target or to give any guarantees or grant security interests over their assets to secure the amounts used to acquire them. Financial assistance issues must also be considered when merging the acquisition vehicle and the target or when implementing debt pushdowns.
Hence, the acquiring entity will typically provide security only over its own assets, the shares of the acquired company and downstream guarantees.
In addition, the target group may provide upstream guarantees to secure a revolving credit facility and/or a CAPEX line but provisions limiting the amount of such upstream guarantees must be provided with corporate benefit rules.
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?
For large and mid cap transactions involving syndicated loans, the most widely used standard form is based on the French law Loan Market Association’s template, with adjustments for leveraged acquisition finance transactions. The resulting documents is subject to negotiations.
For large and mid cap transactions, in-house precedents from private equity funds are widely used.
What have been the key areas of negotiation between borrowers and lenders in the last two years?
For large and mid cap transactions, there is a general trend in the acquisition finance market to only put in place a Term Loan B to take into account the weakening of banking monopoly prohibitions and covenant lite documentation. In addition, sponsors often obtain provisions of a springing covenant whereby the financial ratios are tested only when a certain percentage of the revolving credit facility is drawn.
However, for small and mid cap transactions, acquisition amortizable term loansrobert are still widely used.
For all type of financings, there also has been an increase in negotiations relating to the following items:
- sanctions and anti-money laundering provisions;
- transfer provisions, with negotiations resulting in restrictions as to (i) any free transfer by a lender of its participation under a facility, such free transfer being now usually limited to the occurrence of limited events of default (i.e. payment default, insolvency and breach of covenants) and (ii) an express prohibition of transfer to “Loan to own” distressed funds; and
- due to the recent changes with respect to the reference rates transition, the insertion of replacement screen rate provisions.
Have you seen an increase or use of private equity credit funds as sources of debt capital?
The weakening of banking monopoly prohibitions has led to more and more private equity funds creating a lending entity in France.