This country-specific Q&A provides an overview of the legal framework and key issues surrounding Private Equity in Vietnam.
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 continue to remain active in Vietnam. According to Grant Thornton’s 2019 report on Private Equity in Vietnam, the aggregate deal value of private equity investments in Vietnam in 2018 was US$1,609 million, with onshore PE funds taking the lead with approximately 36% of the total number of PE deals. Offshore financial sponsors have also consistently been involved in PE deals in the past few years. As a recent example, in 2018, Techcombank raised US$370 million in a pre-IPO funding round from Warburg Pincus and US$922 million in its IPO from financial sponsors (including Dragon Capital Group Ltd.) and GIC, a Singaporean sovereign wealth fund.
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?
Financial sponsors need to achieve a clean exit which allows them to distribute a clearly defined amount of sale proceeds to their investors. This approach influences purchase price mechanics as well as indemnity and warranty coverage given by sellers.
Transactions involving financial sponsor sellers commonly results in limited warranties. However, where financial sponsors are on the buy side, it is not unusual that they insist on full warranties and indemnity protections (save, in our experience, where the potential sale is to another financial sponsor and in which case the terms are more relaxed). To fill the “warranties gap” arising from a sale by financial sponsor seller, the seller may be willing to agree to a retention or escrow of the purchase price pending the outcome of a particular event (e.g., obtainment of regulatory approvals for the sale).
Unlike trade sellers, financial sponsor backed sellers resist terms that subject disposal proceeds to any risk and therefore negotiate against clawback provisions under warranties and indemnities. It would not be uncommon for a financial sponsor seller to provide an indemnity subject to caps and with minimal survival periods. When given, fundamental warranties can be expected to have a survival period of 5 – 7 years and tax warranties of up to 10 years.
On an acquisition of shares, what is the process for effecting the transfer of the shares and are transfer taxes payable?
When acquiring an equity interest in a Vietnamese company, a foreign investor is required to obtain an approval of the local Department of Planning and Investment (DPI) where the target operates in certain sectors having conditions applicable to foreign investors or where the foreign investor acquires a controlling stake in the target. The target will need to apply for an amendment to its “enterprise registration certificate” from the DPI to record changes in its charter capital arising from the foreign invested capital. To the extent that the target company is issued with an “investment registration certificate” for an investment project, then it will often be necessary for it to amend this certificate to reflect the change of investors and capital, among other information it conveys. After completion, the target will also need to file a report to the DPI regarding the change in the foreign shareholders resulting from the acquisition by the foreign investor.
If the target is a Vietnamese company with foreign invested capital (FDI enterprise) then for the purposes of the State Bank of Vietnam’s regulations on exchange control of foreign direct investments, payment of the purchase price by a foreign buyer to a local seller must be made through a “direct investment capital account” (DICA), which is a bank account that the target company must open in Vietnam to process the payment to the local seller. Where the acquisition is between non-residents, the purchase price can be denominated and paid in foreign currency and will not be required to go through the DICA. If the target is not a FDI enterprise, the foreign buyer is required to effect payment through, instead of the DICA, an “indirect investment capital account” (IICA), which is a bank account that the foreign investor must open in Vietnam in order to effect payment to the local seller.
Gains arising from any sale of an interest in a Vietnamese private company are generally subject to a standard CIT rate of 20%. Gains earned by a foreign investor from the sale of an interest in a public company are subject to a deemed rate of 0.1% of the total sales proceeds.
How do financial sponsors provide comfort to sellers where the purchasing entity is a special purpose vehicle?
In small size transactions, sellers with limited bargaining leverage often agree to contract with a special purpose vehicle (SPV) without recourse to a fund entity of any substance. In larger transactions, financial sponsors often provide comfort to the seller by way of an equity commitment letter, committing the fund to invest certain funds in the SPV for the purpose of the acquisition by the SPV as the purchasing entity, and where the transaction is to be partly financed with debt, debt commitment letters prior to signing.
How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?
Locked box pricing structures are the most common pricing structure for small-sized or less complex transactions that do not include any pre-deal restructuring of the target business. The buyer assumes the economic risk of the target’s business performance as from the locked box date and, therefore, prior to the signing of the share purchase agreement. The share purchase agreement usually restricts leakage as from the locked box date up to and until the closing date (except for any permitted leakage that has been expressly agreed upon).
Post-closing price adjustments based on the target’s financial statements as at the closing date (i.e., completion accounts) are increasingly common for large or complex transactions (that may or may not include pre-deal restructuring of the target’s business). The parties will agree on methods and principles of calculation in order to determine the valuation of the target company, though this is typically achieved by use of net asset value and/or earnings. It is customary for the valuation to be finally determined by an independent expert jointly appointed by the parties.
What are the typical methods and constructs of how risk is allocated between a buyer and seller?
In respect of transactions with separate signing and closing dates, it is common for the buyer’s obligation to close to be conditional upon (a) compliance with pre-closing covenants in all material respects and (b) the accuracy of the target’s representations and warranties as at signing and closing dates. If any pre-closing covenant is not materially complied with or if any representation or warranty is materially breached, the buyer may generally refuse to close the transaction, alternatively exercise an indemnification claim against the seller following closing. The buyer also usually seeks to allocate pre-closing adverse change risk to the seller in the form of a closing condition and/or a seller representation that there is no material adverse change to the business of the target between locked box date and closing date.
In competitive auctions, sellers are increasingly able to obtain more favorable terms including that there is no conditionality to the transaction (except for required regulatory approvals), limited recourse against the seller (for example, with caps/limitations and minimal survival periods) or even no recourse against the seller (save for certain limited exceptions, such as breach of fundamental warranties and tax liabilities) following closing.
How prevalent is the use of W&I insurance in your transactions?
W&I insurance has not been commonly used in private equity transactions in Vietnam.
How active have financial sponsors been in acquiring publicly listed companies and/or buying infrastructure assets?
Sponsor backed going private transactions are not common in Vietnam due to their complexity (i.e., public tender offer rules will be triggered when acquiring at least 25% of the outstanding shares of a public company and waiver of the trading band from the State Securities Commission if the purchase price falls outside the trading band) as well as that it is time-consuming to deregister a public company status and delist a listed company.
The infrastructure market has been active in Vietnam as a result of the government prioritizing infrastructure development, though state-owned companies and strategic investors remain dominant players in the infrastructure market.
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?
Foreign investors and Vietnamese companies that have a majority foreign investment are subject to certain investment conditions and restrictions that do not apply to domestic investors. When acquiring an equity interest in a Vietnamese company, foreign financial sponsors are subject to conditions applicable to all foreign investors including DPI approval where the target operates in certain sectors having conditions applicable to foreign investors or where the foreign investor acquires a controlling stake in the target (see the response to question 3 above). Further, Vietnam has foreign exchange control relating to the use of DICAs and IICAs to remit capital contributions, lawful profits, and other legal investment activity revenues.
All monetary transactions in Vietnam must be made in Vietnamese Dong (VND). There are no restrictions on foreign investors converting earnings and other lawful profits denominated in VND into foreign currency for remittance abroad. However, outward foreign currency remittance requires supporting documents such as proof of tax obligation fulfillment. In addition, foreign investors are also required to submit to tax authorities a prior notification of profit remittance abroad (at least seven days prior to the remittance).
How is the risk of merger clearance normally dealt with where a financial sponsor is the acquirer?
In Vietnam, recent changes have been made to competition law, including in the respect of merger control clearance. Under the (previous) 2004 Law on Competition, where the parties’ combined market shares are between 30%-50% of the relevant market, a notification to the competition authority is required. The statutory timelines for clearance review will start to run from the date the parties have submitted a complete notification that has been accepted by the authority, and the transaction may proceed only after a supportive written response is received from the competition authority. Under the (new) 2018 Law on Competition, the notification triggers have been expanded to also include combined assets, combined revenue, and the value of the transaction. Although the precise values or thresholds of these notification triggers are yet to be determined, it is undoubtful that the new law calls for a significant shift in merger control rules in Vietnam.
The risk associated with this is usually dealt with by making the transaction subject to a condition precedent that merger clearance under the 2004 Law on Competition is obtained and to place a primary obligation on the Vietnamese seller to procure such approval, which may include that specific reports are compiled. Given the limited number of notifications received by the competition authority to date, the use of a termination fee where the parties cannot close the transaction as a result of a failure to obtain merger clearance from the competition authority is not common. While it is expected that the number of notifications will increase as a result of the introduction of new criteria thresholds under the 2018 Law on Competition, it remains to be seen how the risk of merger control is dealt with between the parties to the transaction.
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?
Minority investments by financial sponsors have been very common in Vietnam for many years. These investments are typically in the range of between US$10 million and US$50 million and are made by regional PE firms and Vietnamese specific PE firms. Investments made by global PE firms such as KKR, Warburg Pincus, TPG and Goldman Sachs have tended to be US$100 million or more, though there are not many investments of this size.
We have seen many different capital structures, including common equity investments with certain governance-related rights, preferred equity instruments with a priority return on invested capital, or debt-like instruments (typically convertible loans or convertible bonds) with limited governance-related rights but with the ability to participate in equity returns (e.g., through detachable warrants).
How are management incentive schemes typically structured?
Most management incentive programs are structured on an equity basis granting the managers direct equity interests (such as shares or share options) in the portfolio company. An employee stock option plan (ESOP) is usually employed to incentivize the managers in a variety of ways. The financial sponsor will generally work with the managers to structure the ESOP in a tax-efficient manner in which the managers can buy shares directly, be allocated shares as bonus or receive shares options. ESOPs commonly account for between 3% and 10% of the fully diluted equity, depending on the size of the transaction.
Are there any specific tax rules which commonly feature in the structuring of management’s incentive schemes?
In Vietnam, generally gains from stock option exercises are taxed at the point of sale and are subject to personal income tax. Non-equity incentive awards such as bonus are typically treated as ordinary income which are also subject to personal income tax at the time of payment.
Are senior managers subject to non-competes and if so what is the general duration?
Yes. The senior managers of the target company are often subject to non-competes for a period between 1 and 2 years after termination of employment. Vietnamese law does not require the employer to pay the employee compensation in order to enforce the non-compete provision, though this largely remains untested before Vietnamese courts.
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?
As minority stake investments are common in financial sponsor transactions in Vietnam, financial sponsors often negotiate several governance-related rights and protections such as voting rights, consent/veto rights, and quorum requirements. They also seek to obtain board representation or observer rights in order to have greater involvement in the portfolio company’s management and direction. These rights are typically documented both in a shareholders’ agreement (or joint venture agreement) and the charter of the company.
Is it common to use management pooling vehicles where there are a large number of employee shareholders?
The use of management pooling vehicles is not common in Vietnam. This is because management are often the controlling shareholders of the company and only certain key employees are granted equity interests (e.g., ESOPs).
What are the most commonly used debt finance capital structures across small, medium and large capital financings?
Financial sponsors often finance their acquisition of shares in Vietnamese companies with equity only, and a few large transactions are financed with debt borrowed by offshore acquisition vehicles from offshore lenders. This is partly because most financial sponsor transactions are minority investments with small or medium deal sizes. Further, loans extended by offshore lenders to local companies are subject to satisfaction of certain requirements such as permitted purpose of the loan, and in case the term of such loan is greater than 12 months, is subject to registration of the foreign loan with the State Bank of Vietnam. The cost of onshore debt financing in many cases is not lower than offshore debt financing, resulting in the use of local banks for acquisition finance being uncommon (with the exception for acquisition finance transactions secured by real estate assets where offshore lenders are generally not permitted to take mortgage of land use rights and immovable assets located on land).
Is financial assistance legislation applicable to debt financing arrangements? If so, how is that normally dealt with?
The offshore acquisition financing is typically secured by the offshore borrower’s assets (including shares in its offshore subsidiaries) in favor of the offshore lenders. In such financing structure, the Vietnamese target company does not generally have the ability to provide guarantees in favor of offshore lenders to secure the repayment obligations of the offshore borrower. Guarantees by a Vietnamese entity in favor of an offshore lender are only available in the context of a foreign loan granted by the offshore lender to the Vietnamese borrower (i.e., the guarantees must be registered with the State Bank of Vietnam together with the registration of the foreign loan that is secured by the guarantee).
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?
Traditionally, the lenders make use of their in-house templates with minimal negotiation. Foreign lenders are generally base their credit agreements on the Asia Pacific Loan Market Association’s template facility agreements. Each financing is negotiated individually based on the commercial terms agreed between the parties.
What have been the key areas of negotiation between borrowers and lenders in the last two years?
Negotiations tend to be around financial covenants, event of defaults, security packages and other business-related terms.
Have you seen an increase or use of private equity credit funds as sources of debt capital?
Private equity credits funds are not currently common in Vietnam.