This country-specific Q&A provides an overview of the legal framework and key issues surrounding Private Equity in Sweden.
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?
Financial sponsors are very active in Sweden which has been the case for many years. Our statistics show that the involvement of financial sponsors has been steady for the past two years and they were involved in approximately 35% of all transactions. Financial sponsors continued to drive M&A activity in the Nordics. Comparing 2017 and 2018, both the number and value of buy-outs and exits in Sweden significantly increased.
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?
A financial sponsor more often uses a controlled auction and has a more strict view on terms such as that: (i) the buyer must assume the merger clearance risk; (ii) there will be no conditions precedent to completion (except for mandatory merger control clearance) ; (iii) the sponsor backed company will not offer any representations and warranties unless the buyer takes out a warranties and indemnities insurance policy (“W&I insurance”). Almost all PE backed exits will require the buyer to take out W&I insurance.
On an acquisition of shares, what is the process for effecting the transfer of the shares and are transfer taxes payable?
The transfer is effective (i.e. the buyer obtains the right in rem in relation to the shares and is able to exercise all rights pertaining to the shares) when the buyer is entered in the target company’s share register as owner of the shares. In those cases where share certificates representing the shares have been issued, the transfer is fully effected when the certificates have been endorsed and transferred to the buyer.
There are no Swedish transfer taxes applicable to a transfer of shares.
How do financial sponsors provide comfort to sellers where the purchasing entity is a special purpose vehicle?
Most commonly, with an equity commitment letter from the fund. Sometimes (but rarely) the fund guarantees the payment obligation of the special purpose vehicle.
How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?
Locked box pricing mechanisms are commonly used in Sweden. In our experience, the last few years, locked box mechanisms were chosen in approximately 50% of all the transactions and in 2018 the number increased significantly to 70%. Locked box mechanisms are still more predominant but during recent years (prior to 2018) the use of other purchase price adjustment mechanisms (i.e. closing balance sheet mechanisms and other forms of true-ups) have increased again, and on average, the last few years have been on par with the locked box structure. We believe the increased use of purchase price adjustment mechanisms is partly due to the increased number of carve-outs on the Swedish market lately. However, locked box pricing mechanisms are still particularly favoured by financial sponsors. In transactions where there is a financial sponsor on the sell-side, the locked box pricing mechanism is chosen in approximately 80% of the transactions, in 2018 the number was even higher at 90%.
What are the typical methods and constructs of how risk is allocated between a buyer and seller?
It varies, but it is more common that warranties are given both at signing and completion so that the risk actually remains with the seller until completion. Swedish law and market practice puts a lot of responsibility on the buyer to perform proper due diligence and everything that is fairly disclosed in the data room will be considered disclosed against all warranties (normally) and any specific diligence findings will need to be negotiated as specific indemnities.
How prevalent is the use of W&I insurance in your transactions?
The activity level has been quite steady over the last few years and in particular in large cap transactions where the deal value exceeds SEK 500 million, and in transactions where the seller is a financial sponsor, W&I insurance is very frequently used. As brokers and underwriters active on the Swedish market have recruited M&A specialists and developed the product and the underwriting process, W&I insurance has become a more flexible and thus viable part of transactions.
How active have financial sponsors been in acquiring publicly listed companies and/or buying infrastructure assets?
Recently, public to private deals by financial sponsors have been rather uncommon, with only one or two transactions per year. Similarly, in 2018 only around 7% of the transactions involved infrastructure assets, although we have seen a significant increase transactions involving renewable energy assets.
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?
Outside of heavily regulated sectors (for example the financial sector), Sweden has no foreign investment controls or other governmental consents that are specifically required for financial sponsors. Swedish investment funds, or their managers (as applicable), may however be subject to the Alternative Investment Fund Managers Directive and therefore required to register with, or seek a permit from, the Swedish Financial Supervisory Authority. The same applies to foreign investment funds, or their managers (as applicable), that intend to market their funds in Sweden.
How is the risk of merger clearance normally dealt with where a financial sponsor is the acquirer?
It is fairly common, regardless of the parties involved, that it is the buyer who will be required to assume the merger clearance risk. It is often less difficult for a financial sponsor to agree to this (if the fund does not already own competing businesses). However, often an industrial buyer acquires a competitor to create synergies in one aspect or another and the issue of who should bear the merger clearance risk then often becomes more complicated.
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 have definitely seen an increase in the number of minority investments made by financial sponsors, although the most conclusive trend is that the size of the financing rounds / investments is growing. The recent uptick in both number and size of investments may, at least partly, stem from the fact that the number of financial sponsors focusing on venture capital has increased in Sweden over the last few years, as has the size of the funds. Established venture capital firms continue to actively invest in Sweden, there are several new players on the market, and traditional buy-out funds have also started to dedicate resources and raise capital specifically for minority investments.
Although debt-like investments occur, the vast majority of deals are structured as equity investments.
How are management incentive schemes typically structured?
Typically, management will invest into a “TopCo” (as individuals or via a wholly owned company or via a jointly owned ManCo with the rest of management) in which the lead investor also invests. The TopCo usually owns a MidCo and the MidCo owns a BidCo. It is the BidCo which takes up the external financing so most sponsors want the management incentive scheme to be in a company outside the banking group. Most commonly, management invest via a mix between preference shares and ordinary shares with a mix which is substantially heavier on the ordinary shares compared to the mix of the lead investor.
Are there any specific tax rules which commonly feature in the structuring of management’s incentive schemes?
There are no specific tax rules other than the tax rules for capital gains. Management incentive schemes based on shares or options set up for Swedish resident managers by Swedish companies generally allow for capital gains taxation at a tax rate of 30%. Management incentive schemes taxed at the progressive tax rates for employment income, e.g. traditional employee share option schemes, are unusual due to high marginal tax rates (up to ~58%) and the cost of employer social security charges (the general uncapped rate is 31.42%).
The terms and conditions governing the management incentive scheme have to be structured in such way that the instruments are deemed to be actual securities. Far-reaching transfer restrictions and lockups or terms such as that the managers are not allowed to vote for their shares or they are not allowed to be registered as owners in the share register, may determine at which rate any gain is taxed.
Are senior managers subject to non-competes and if so what is the general duration?
Yes, most commonly during their holding of shares and for twenty-four months thereafter.
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?
The financial sponsor regularly holds the majority of the shares and voting power in the portfolio company (often the lead investor ‘s shares carry 10 votes and management’s shares carry 1 vote) and as a result thereof controls the appointment of board members and CEO in the portfolio company. In addition thereto, in case there are other shareholders, the ownership of the portfolio company is normally regulated by a shareholders agreement according to which the financial sponsor and/or its representatives on the board may have veto rights in relation to certain material business decisions. Further, the board in a Swedish company regularly adopts governance documents to establish structures for the decision-making process in the company. Common documents include rules of procedures for the board, instructions to the CEO and instructions for financial reporting. Since the financial sponsor normally has the power to appoint the board (or a majority thereof), it may indirectly dictate the content of such governance documents and thereby ensure control.
Is it common to use management pooling vehicles where there are a large number of employee shareholders?
It is not uncommon but it is still more common that managers own individually. The latter is less complex when there are leaver and joiner situations and some management teams prefer the sense of having a transparent and clear investment. However, some sponsors feel that they have better control of one party (a management pooling vehicle) and thus require that.
What are the most commonly used debt finance capital structures across small, medium and large capital financings?
Typically, private equity transactions are financed by a combination of debt and equity. The portions of debt and equity vary depending on various factors such as relevant sector, geography, size of the deal, market conditions and availability of debt and thus it will differ from case to case.
The type of debt varies but bank loans remain the most common form of financing although there has been increasing competition between traditional bank lenders and non-bank, or alternative, lenders and funds which has resulted in a wider array of debt products being offered on the Swedish market. The form of bank debt is generally a combination of: (i) term debt used to finance the acquisition and refinance the target companies’ existing indebtedness; and (ii) working capital (typically structured as a revolving facility) to fund the working capital requirements of the target companies.
Traditionally, “Swedish” (initially founded by Swedish individuals and with a strong foothold on the Swedish market) private equity funds have enjoyed a strong banking relationship with designated Nordic “house banks” supplying funding to them on attractive terms.
Small and mid-cap transactions
The Swedish finance market is highly relationship-driven and the large Nordic commercial banks have been, and indeed still are, the biggest lenders for small and mid-cap transactions. However, there has been a funding gap and as a result thereof the Swedish market has experienced a growing direct lending market where debt funds and other alternative capital providers are increasingly active.
During the past decade, the Swedish market has seen an increase in corporate bonds (high-yield and investment grade) as well as other alternatives to bank financing such as alternative debt providers and financing through preference shares. However, bond debt is not yet customary in private equity transactions in Sweden and bank loans thus remain the main source of financing also for large-cap transactions.
Is financial assistance legislation applicable to debt financing arrangements? If so, how is that normally dealt with?
Swedish law contains rules regarding financial assistance that prohibit the granting of loans, security and guarantees for the purpose of financing the acquisition of shares in such lender (or its parent/sister company). These rules apply to both private and public companies.
As most private equity transactions are financed by bank loans, the lending banks will usually require that the target company and its subsidiaries (as applicable) accede to the loan agreement as guarantors and also provide security over certain assets. The issue is usually dealt with by the target (and its subsidiaries) providing security and guarantees after a time period of approximately 90 days have passed since closing of the relevant acquisition. To our knowledge, the time period has never been adjudicated by a Swedish court but it is standard on the Swedish market and something that both lenders and borrowers/guarantors are comfortable with and expect to see in the loan documentation.
In addition to the above, the granting of security and guarantees by Swedish companies is subject to certain company law restrictions on distributions, prohibited loans and the object(s) of the target’s business. These issues are usually dealt with by including a Swedish law limitation language provision in the relevant accession, security and guarantee documents.
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?
The loan documentation with regard to large-cap transactions is typically drafted in English and based on the Loan Market Association’s (“LMA”) template. In-house precedents from both law firms and banks are often based on the LMA template as well with only certain transaction-specific items being subject to negotiations between the parties.
With regard to small and mid-cap transactions, the loan documents, which are typically on a bilateral basis, are often individually tailored to the practices on the Swedish market and based on precedent documentation previously entered into between the relevant bank and private equity fund (if such precedent exists). These loan documents are often similar to the documents used for large-cap transactions and can be seen as a shorter and less detailed version of the LMA template.
What have been the key areas of negotiation between borrowers and lenders in the last two years?
We have seen an increase in negotiations relating to extension options in loan agreements (primarily a three year option with an optional one plus one year extension). We have also seen somewhat of an increase in negotiations relating to sanctions in the past couple of years which has led to a new, more borrower friendly, market standard.
Have you seen an increase or use of private equity credit funds as sources of debt capital?
Yes, an increased level of competition between both available lenders and debt has given rise to a range of new products on the market and we have seen an increase and use of private equity credit funds and debt funds which have not previously been present on the Swedish market.