This country-specific Q&A provides an overview to private equity laws and regulations that may occur in Austria.
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/practice-areas/private-equity/
What proportion of transactions have involved a financial sponsor as a buyer or seller in the jurisdiction over the last 24 months?
Transactions by financial investors remained the exception in 2017, with strategic investors accounting for 94% of all transactions according to the EY M&A-Index Austria 2017. Such high ratio comes as a surprise though since the interest of financial sponsors in the Austrian market is steadily increasing.
While private equity activity remained robust throughout the last 24 months, there were only a handful of completed larger buyouts, with the by far most prominent deal being the acquisition of Austria based Schweighofer Fiber by TowerBrook Capital Partners with a reported deal value north of 500 million Euros, followed by the acquisition of chemical manufacturer Esim Chemicals by Sun European Partners from Ardian with a reported deal value of almost 400 million Euros, the acquisition of CCC Holding GmbH by Ardian from Silverfleet Capital Partners and the acquisition of Vienna based software house Tricentis by Insight Ventures from Kenneth Partners with a reported deal value of Euro 154 million. In another high profile transaction, Capvis acquired a majority interest in Amann Girrbach, a leading full-service provider in digital dental prosthetics (transaction volume confidential). PE investments in the mid-market segment (comprising deals with values between 10 million and 100 million Euros) dropped compared to previous years as well with the drop, however, being less pronounced than at the top end. Examples mid-market deals include the control investment in Austria based inet-logistics GmbH by Castik Capital S.a.r.l., the acquisition of a majority stake in VSE listed Wiener Privatbank by Arca Capital, the acquisition of a majority interest in publicly listed lingerie company Wolford AG by Chinese financial investor Fosun (with a proposed bid by OpCapita), the acquisition of Leibnitz-based online car trading platform gebrauchtwagen.at by private equity-backed Scout 24 group, the acquisition of majority stake in Austria based ABC Marketing GmbH by Swiss Investnet AG, the acquisition of optical measurement systems producer Nextsense by Hexagon, the acquisition of payroll solution service provider Infoniqa by Elvaston from Cornerstone and the acquisition of a majority interest in pant engineer VTU group by DPE Deutsche Private Equity. In the growth capital segment, the most notable transactions were the investment by Germany based Hannover Finanz in Sportnahrung Mitteregger, the investment of Trumpf Venture in Vienna based tech company Xarion Laser Acoustics and the investment of IMCap Partners in software company Intact. In the distressed segment, financial investor GA Europe acquired the insolvent fashion retailer Charles Vögele. Interest of property funds remained stable. Closed transactions include Corestate Capital’s forward purchase of the third Vienna Triiiple tower or Accelerate Property’s acquisition of a portfolio of specialist DIY retail centres.
PE exits outnumbered PE investments. The vast majority of those exits were to strategic investors. However, the three biggest exits (i.e. the sales of CCC Holding GmbH, Esim Chemicals and Tricentis (already reported on above)) were to PE. Examples of exits to strategic investors include the sale of POOL4TOOL AG by aws-mittelstandsfond to US Jaggaer, the sale of mySugr GmbH by Roche Venture Fund, Austria Wirtschaftsservice, XLHEALTH AG and iSeed Ventures to Roche Holding AG, the sale of M&R Automation GmbH by Quadriga Capital to PIA Automation Holding GmbH, the sale of mechatonic Systemtechnik GmbH by FIDURA Private Equity and Danube Equity to Accuron Technologies Limited, the sale of Prescreen GmbH by Kizoo Technology Ventures to XING AG and the sale of nxtControl GmbH by TecNet Equity to Schneider Electric SA.
At the top end, there was no particular trend as deals were spread across different sectors. In the mid-market, on the other hand, technology and industrial products and services accounted for most of the deal flow and that trend is expected to continue. Real estate overall remained very hot with PE playing a lesser role, however. A not able deal was the acquisition of a pan-European portfolio, including the Vienna Florido tower by Ares from Amundi.
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?
Private equity sellers tend to prefer locked box structures (see question 5).
While well advised trade sellers usually prefer locked box structures as well, closing adjustments are more frequently agreed with trade sellers than with private equity sellers.
Experienced private equity sellers will try to avoid business warranties and indemnities (and instead just provide warranties on title and capacity). In addition, experienced private equity sellers will be very keen to limit recourse for warranty claims (e.g. to an amount paid into escrow) as well as any other post-closing liability.
Where private equity sellers are forced to give business warranties, they will seek back-to-back warranties from management and underwrite a seller’s warranty and indemnity insurance policy or offer the buyer management warranties instead (which are usually linked to a buyer’s warranty and indemnity insurance policy). The latter structure has the benefit that the private equity seller will not have to concern himself with post-closing warranty litigation.
In contrast to this, it is fairly common for trade sellers to give business warranties without a warranty and indemnity insurance.
Private equity sellers will try to limit post-completion covenants to access books and records and sometimes assistance in relation to pre-completion affairs. Usually, all buyers will insist on non-compete and non-solicitation covenants (which private equity sellers will typically try to resist). Trade sellers are usually more likely to offer and accept post-completion covenants.
On an acquisition of shares, what is the process for effecting the transfer of the shares and are transfer taxes payable?
The transfer of, and every offer to transfer, title to shares in a limited liability company (GmbH) requires a purchase or other transfer agreement drawn up in the form of an Austrian (or German; for other jurisdictions a case-by-case analysis is required) notarial deed. The registration of the new shareholder in the companies register has only declaratory effect. The transfer of title to registered shares in a stock corporation (AG) requires handing over of the duly endorsed share certificates. Where no share certificates are issued, an assignment agreement is sufficient. To be recognised as a shareholder and be able to exercise shareholder rights in a stock corporation, registration in the share ledger (Aktienbuch) (which is effected by the management board on application of the purchaser) is required. Bearer shares can only be issued where the issuer is listed (or is to be listed pursuant to the articles of association). The transfer of title to bearer shares requires matching purchase and sell orders and book order entry. Consent requirements and transfer restrictions may apply.
There are no transfer taxes levied in Austria.
The transfer of shares is exempt from VAT.
Real estate transfer tax
Austrian real estate transfer tax is triggered if at least 95% of the shares of a company that directly holds Austrian real estate (or similar rights) are consolidated in the hands of one shareholder (Anteilsvereinigung), which could be the case by purchasing at least 95% of the shares or by purchasing a smaller stake that together with shares already held by the purchaser add up to 95% or more. Furthermore, if within a period of five years, 95% or more of the partnership interests of a partnership that directly holds real estate (or similar rights) are transferred, this triggers real estate transfer tax (this can include several transactions with different purchasers). In each case the real estate transfer tax amounts to 0.5% of the real estate value (Grundstückswert) of the real estate. Shares held by trustees are to be attributed to the trustor for purposes of calculating the 95% threshold. If Austrian real estate is transferred by way of a reorganisation (Umgründung) that qualifies for the benefits of the Reorganisation Tax Act (UmgrStG), the real estate transfer tax will likewise be 0.5% of the real estate value of the real estate. The real estate value has to be calculated either (i) under a certain formula taking into account the proportional ground and building value or (ii) in reference to an appropriate real estate price index.
Until a recent tax reform, real estate transfer tax could be avoided by transferring a minority interest to a third party to avoid consolidation of all shares. Austrian tax authorities sometimes challenged this structure as being abusive where the size of the minority interest was notional, trust or similar arrangements were in place or other comparable circumstances justifying a "look through" for tax purposes. Under the new regime, the minority interest must exceed 5% and it is not possible anymore to use a trustee for such purposes.
Reorganisation Tax Act
Certain share purchases can be structured as a merger, a spin-off or a contribution in kind, in which case the transaction may be eligible for the benefits available under the Reorganisation Tax Act (UmgrStG), in particular a roll-over treatment. In general, such roll-over treatment may be applied with retroactive effect for tax purposes of up to nine month (typically with respect to a balance sheet day in the past). If the transaction qualifies under the UmgrStG, transfer taxes can also under certain conditions be avoided or reduced. These conditions depend on the type of reorganisation. For domestic reorganisations, they include, among others:
• A proper documentation including the required balance sheets.
• Timely filing of the reorganisation (in some cases with the companies register, in others with the competent tax office).
• In case of a contribution in kind or a spin-off also the transfer of qualified assets (for example a business unit or a qualified stake of shares representing at least 25% of the share capital or ensuring together with shares already held by the acquiring company a majority in the share capital of the company that shares of which are being transferred).
• Minimum holding periods for certain items.
• Various other formal requirements.
For cross-border or foreign reorganisations further requirements apply, for example, the comparability of the foreign corporation and of the foreign reorganisation.
Capital gains resulting from a sale of shares in a corporation generally are subject to tax in Austria. The rate of applicable income tax is 25% if the seller is a corporate entity and 27.5% if the seller is an individual. Capital gains from a sale of shares in a company that is not resident in Austria for tax purposes do not increase the tax base for corporate income tax purposes if the shareholding qualifies for the Austrian international participation exemption and the seller has not opted out of tax neutral treatment of capital gains. There is no comparable exemption for capital gains from a sale of shares in a corporation that is resident in Austria. On the other hand, dividends distributed by the Austrian target will be tax exempt for the recipient in the legal form of a corporation. Accordingly, it is common to distribute any accrued profits before the sale.
At the shareholder level capital gains taxation will depend on whether the sellers are domestic or foreign residents. In case of foreign resident shareholders such capital gains taxation only applies if their participation in the Austrian target amounted to at least 1% in the last five years. However, tax treaties usually restrict the right of Austria to tax such capital gains, as Article 13(5) of the OECD Model Tax Convention, which is followed by most treaties concluded by Austria, assigns the right to tax such capital gains to the state of residence of the shareholder (unless a special provision for real estate companies applies).
The exemption from corporate income tax is denied if a structure is considered generally abusive, or certain criteria under statutory tests indicating that they are abusive are met.
Austria levies stamp duty on certain transactions, including:
• Leases (at a rate of 1%);
• Assignments (at a rate of 0.8%);
• Settlements (at a rate of 1% or 2%);
• Easements (at a rate of 2%);
• Sureties (at a rate of 1%);
• Mortgages (at a rate of 1%).
Stamp duty is generally only triggered if a written deed (Urkunde) on the transaction or referring to the transaction is signed in Austria. Under certain limited circumstances stamp duty is also triggered if the deed is signed outside of Austria. If stamp duty was avoided by signing a written deed outside of Austria, the later import of that deed (or a certified copy) into Austria as well as any documentary proof (rechtsbezeugende Urkunde) like correspondence from an to Austria referring to the transaction (including emails) may trigger stamp duty. The Austrian tax authorities take a broad view of what constitutes a "deed" and accordingly triggers stamp duty and therefore avoidance schemes must be carefully structured.
How do financial sponsors provide comfort to sellers where the purchasing entity is a special purpose vehicle?
Private equity buyers will typically be willing to provide a copy of the executed equity commitment letter from the fund and copies of the definitive financing agreements together with documents evidencing that all conditions precedent (other than those within the private equity investor’s sole control) have been satisfied, to provide comfort that the necessary funds will be available at closing. If those financing commitments are not complied with, sellers are typically limited to claims for damages. Equity underwriting of debt funding is the exception but, in situations where definitive financing agreements are not in place at signing, experienced sellers will insist on an equity underwrite, particularly in auctions (to limit execution risks).
How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?
In Austria, locked box pricing mechanisms are more frequently seen than closing accounts. Private equity investors tend to prefer locked box structures, particularly when they are on the sell-side. Likewise, experienced trade sellers usually prefer locked box structures. Where the gap between signing and the anticipated date of closing is long (e.g. because of antitrust or other clearance requirements), closing adjustments are the norm. Which parameters are included in a closing adjustment depends on the target business, with the most common combination being adjustments for net debt, working capital, and (sometimes) capex. Equity adjustments are relatively rare.
What are the typical methods and constructs of how risk is allocated between a buyer and seller?
With locked box mechanisms being very frequent, the business risk between the last account date and closing is usually borne by the purchaser, who will have limited protection by way of ordinary course of business and no-leakage warranties and covenants.
Representations and warranties are usually qualified by matters that have been disclosed (in a certain manner) or are deemed disclosed by operation of the provisions of the acquisition agreement or the disclosure letter (e.g. information which can be obtained from publicly accessible registers). The seller will always push for general disclosure (i.e. everything disclosed to the purchaser and its advisors at whatever occasion qualifies all warranties) while the purchaser will push for specific disclosure (i.e. separate disclosure for each warranty) and try to introduce a disclosure threshold requiring that a matter must be “fully and fairly” disclosed. This is usually heavily negotiated. Disclosure letters are relatively rare.
Purchasers who have identified a risk as part of their due diligence which would be excluded due to the disclosure need to negotiate an exclusion or indemnity to have protection. Indemnities are generally not qualified by disclosure or knowledge. The tax indemnity is usually only subject to a specific tax conduct provision, a direct loss limitation and the overall cap. Other limitations are a matter of negotiation. If other indemnities (e.g. for contamination and environmental compliance or specific due diligence findings) are accepted, limitations are usually heavily negotiated.
Common limitations on warranties include:
Time limitation for bringing claims:
- title and capacity warranties usually survive 10 years at the minimum;
- business warranties between 12 and 24 months;
- tax warranties typically around seven years; and
- environmental warranties five to 10 years.
Financial limits, including:
- a cap on the total liability (where there are multiple sellers, each may seek to limit its liability pro rata);
- a minimum aggregate claims threshold (“basket”); and
- an exclusion of de minimis claims.
Limitation to direct loss (as opposed to indirect and consequential loss).
Exclusion of claims to the extent caused by:
- agreed matters;
- acts of the purchaser (outside of the ordinary course of business);
- change of law or interpretation of law; or
- change of tax or accounting policies.
No liability for contingent liabilities.
No liability if the purchaser knew or could have known.
No liability for mere timing differences (e.g. if tax authorities request longer tax depreciation periods).
Obligation to mitigate loss.
No double recovery under warranties, indemnities and insurance policies.
A conduct of claims provision.
MAC clauses are sometimes agreed, usually after heavy negotiations. Private equity sellers tend to avoid MAC clauses in order to have transaction security.
Bring-down due diligence is relatively rare.
The risk of regulatory approvals, such as merger clearance, is usually borne by both parties. While it is common for purchasers to agree on covenants with regard to prompt filings and reporting to and consulting with the seller, purchasers very rarely accept hell or high water clauses. In transactions which appear to be difficult from a merger clearance point of view, break fees are sometimes discussed, but only rarely agreed.
How prevalent is the use of W&I insurance in your transactions?
Warranty and indemnity insurance is more frequently discussed in private equity exits, but still not as common as what we see in other jurisdictions, such as the UK and Germany.
Private equity sellers sometimes use warranty and indemnity insurance to “bridge the gap”. Seller policies are usually not discussed in the course of the sales process unless the buyer is expected to bear all or part of the costs. Conversely, if a buyer’s policy is proposed, this is usually addressed early in the process. The typical retention (also known as an excess), which is the uninsured amount of the loss to be borne by the insured, is around 1% of the consideration. Policy limits vary between seller policies (usually they match the agreed maximum liability under the purchase agreement) and buyer policies (usually they start at around 20% of the enterprise value but can also cover the full enterprise value). Typical carve-outs and exclusions include fraud, and matters the insured was aware of at the time of taking insurance, forward looking warranties (e.g. the ability to collect accounts receivables). Indemnities for risks identified in the course of the due diligence can sometimes be insured as part of the policy, if the contingent risk is identifiable and quantum and likelihood assessable.
How active have financial sponsors been in acquiring publicly listed companies and/or buying infrastructure assets?
With regard to publicly listed companies, financial sponsors have not been very active, in part due to the fact that there are few Austrian publicly listed companies with a considerable free float. The only takeover completed in 2018 we are aware of was the acquisition of a majority interest in Wolford AG by Chinese financial investor Fosun.
As for infrastructure assets, while financial sponsors were looking at potential targets, we are not aware of any transaction having been completed recently.
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?
The acquisition of ownership and certain lease interests in real estate by non-EEA nationals, or the acquisition of control over companies owning such interests, is subject to notification or approval by the local Real Estate Transfer Commission (Grundverkehrsbehörde). What interests are covered and whether notification or approval is required varies from state (Bundesland) to state. Where the real estate is used for commercial rather than residential purposes approvals are usually granted.
Foreign Trade Act
The acquisition of an interest of 25% or more or a controlling interest in an Austrian business by a foreign investor (that is, an investor domiciled outside of the EEA and Switzerland) is subject to advance approval by the Austrian Minister of Economic Affairs under the Foreign Trade Act (Außenwirtschaftsgesetz) where that business is involved in:
• Inner and outer security (Innere und Äußere Sicherheit), for example, defence and security services.
• Public order and security, including public and emergency services (öffentliche Ordnung und Sicherheit einschließlich der Daseins- und Krisenvorsorge), for example, defence, security services, hospitals, emergency and rescue services, energy and water supply, telecommunications, traffic and universities.
Within one month of submitting the application, the Minister of Economic Affairs must either approve the transaction or initiate phase two investigations. If phase two investigations are initiated, the decision is due within two months following the application. If no decision is adopted within those time limits, the transaction is deemed approved by law. The application for approval must be filed prior to signing. Transactions subject to approval cannot be completed pending approval. Failure to obtain approval is subject to criminal penalties.
While the acquisition of an interest of 25% or more or a controlling interest in an Austrian business by an investor that is domiciled in the EEA or Switzerland is not subject to advance approval under the Foreign Trade Act, ex officio investigations may be initiated at any time (that is, there is no time limit to start that procedure). These investigations can be initiated, for example, to counter abusive structures.
How is the risk of merger clearance normally dealt with where a financial sponsor is the acquirer?
The risk of merger clearance is usually borne by both parties. While it is common also for financial sponsor purchasers to agree on covenants with regard to prompt filings, reporting and consulting, they find it even more difficult than institutional investors to agree on hell or high water clauses. Likewise, financial investors are very reluctant 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?
As far as we are aware, there has not been an increase in the number of minority investments undertaken by financial sponsors. Usually, it is larger funds which make minority investments. These are mostly structured as equity investments. Debt investments with equity kicker were extremely rare, but interest seems to slightly increase. Nevertheless, convertible loans are a usual structure, but usually only for venture capital investors or business angels.
Private equity investors taking a minority position typically insist on new governance documents. Where that request is rejected, the investor must carefully analyse what rights are available to him following completion under the existing governance documents and, where necessary, request amendments. In that process, it is important to familiarize oneself with which minority protections are already available under the law, which of them are mandatory, which of them can be amended to the benefit of minority shareholders only, and which of them can be amended without restriction. Which protections are available differs depending on the type of company but, generally, minority shareholder protection includes information rights, rights to call a shareholders’ meeting, quorum, and voting requirements for major corporate actions (such as corporate restructurings, a change of the company’s purpose, changes to the articles of association, dealings involving all or substantially all of the business or assets, and squeeze-outs of shareholders).
The governance documents will typically include veto rights of the fund (and/or a sponsor representative in a supervisory board) over major corporate actions and strategic decisions (such as acquisitions and disposals, major litigation, indebtedness, changing the nature of the business, business plans and strategy) although the specific requirements vary widely from fund to fund and deal to deal.
Usually, such veto rights are structured to fall away if the relevant fund’s interest is reduced below a certain quota. Where multiple funds invest, they will generally insist that all investors vote on the veto matters, with quorum and majority voting requirements varying widely from deal to deal.
Most mezzanine transactions involve an equity kicker in the form of shares, options or warrants. Under stock corporation law, a specific part of the share capital can be reserved for future issues of shares which can be used by management for convertible instruments, such as warrants. That feature is not available for limited liability companies where any future issue of shares must be approved by the shareholders' assembly. Where there is a concern that the required majority will vote in favour of the share issue, trust structures can be put in place (that is, shares are issued to a vehicle at the time the warrant is issued, and the vehicle is then required to sell those shares to the warrant holder on exercise of the warrant).
How are management incentive schemes typically structured?
Management equity is typically subject to vesting over a period of three to five years. Compulsory transfer provisions apply upon termination of the management function, with the consideration varying depending on the reason for termination (a “good” or a “bad” leaver), although structures have become less aggressive in that regard due to recent developments in Austrian labour law. In addition, the private equity fund will require a right to drag-along the management upon an exit and typically will insist on the pooling of the management equity in a pooling vehicle (often a partnership).
In buyout transactions, a private equity firm often involves future management in the due diligence process and the financial modelling. Typically, management is offered the opportunity (and is sometimes even required) to acquire an interest in the target to ensure their commitment. Senior management is sometimes also given the opportunity to invest in the same instruments (‘institutional strip’) acquired by the private equity firm to ensure that their interests are fully aligned. In the latter case, structuring options are by definition limited. Where management is asked (or given the opportunity) to participate on a target level, share options (in the case of stock corporations), restricted shares (for a description of the typical restrictions, see below), profit participation rights (a contractual arrangement that can be structured as equity or debt and, by contrast to shares, never confers voting rights), virtual shares (that is, a contractual arrangement giving the member a stock like return) and phantom stock (that is, a contractual arrangement giving the member a bonus depending on operational performance) are the most common structures.
The detailed structuring of incentive packages is usually driven by the tax treatment of the benefits in the jurisdictions of residence. For example, management will have a strong interest in ensuring that any gains in relation to interests acquired are taxed as capital gains (and not as employment income unless a preferred tax rate applies). Management will typically also have an interest in limiting taxation at the time of the grant. It should be noted that where the investor provides financing to the management, tax authorities may be more inclined to question whether economic ownership has passed for arm’s-length consideration. Since the tax treatment of incentive programmes is often somewhat unclear, it is advisable to seek a tax ruling on the related tax issues before deciding on a particular incentive structure.
Are there any specific tax rules which commonly feature in the structuring of management’s incentive schemes?
From a tax perspective, it is important whether, upon the investment by the management members, economic ownership in the shares (or other instruments) actually transfers. In relation to shares this mainly depends on the management members’ entitlement to dividends (if any), voting rights and the applicability of transfer restrictions. Management incentive packages are typically structured to ensure such transfer. Otherwise, the full return received at exit may be subject to taxation as (employment) income.
Where economic ownership of the benefit concerned passes for arm’s-length consideration (usually management is asked to invest up to one year’s salary), there is no taxation of the grant (for Austrian tax residents). If there is no arm’s-length consideration, the grant is taxed as employment income.
In the case of stock options, non-transferable stock options are not taxed at the time of the grant, but upon exercise of the option based on the difference between the (discounted) acquisition cost and the fair market value of the shares received based on the option. In contrast, transferable stock options are considered an asset for tax purposes and, consequently, are already taxed at the time of the grant.
Income from shares received by individuals resident in Austria is taxed at 27.5 per cent. Such income includes dividends as well as capital gains. Former models that granted shares to the management relied on an exemption for capital gains (if the percentage of the shareholding in the Austrian company was below 1 per cent and was held for more than one year) are no longer applicable as realised capital gains are generally subject to tax. However, in the case of non-resident individuals, capital gains are only subject to tax in Austria at a rate of 27.5 per cent if the percentage of the employee’s (weighted) shareholding in the Austrian company amounts to at least 1 per cent during the previous five years. Double taxation treaties, however, usually restrict Austria’s right to tax such capital gains (article 13, paragraph 5 of the OECD Model Tax Convention on Income and on Capital), whereas dividends are subject to withholding tax at a rate of 27.5 per cent (which is usually reduced by double taxation treaty).
Recurring income from profit participation rights that classify as equity at the level of the company is taxed similar to income from dividends, at a rate of 27.5 per cent. If, owing to its features, profit participation rights qualify as debt at the level of the company, income is taxed similar to interest at a rate of 27.5 per cent. Regarding the exit, profit participation rights generally give more room for a tax-optimised structuring than other incentives, such as stock options or restricted stock.
Income from phantom stock (not qualifying as profit participation rights) is generally taxed similar to ordinary income from employment at the progressive income tax rate.
Are senior managers subject to non-competes and if so what is the general duration?
Senior managers participating in management incentive schemes are usually subject to non-competes. By law, managing directors of stock corporations and limited liability companies are subject to non-compete obligations for as long as they hold their position. Exemptions are rarely agreed.
Contractual non-compete obligations usually cover one year after termination of the position and are usually limited to the company's line of business and Austria.
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?
Financial sponsors typically ensure their control over material business decisions by negotiating important rights in the portfolio company's governance documents. The governance documents for private equity portfolio companies typically include:
• a shareholders’ agreement;
• new articles of association; and
• by-laws for the management board and supervisory board (if any).
The main areas of concern in the governance documents are the private equity fund’s rights to appoint sponsor representatives (and/or observers) to the supervisory board (if any) or advisory board (if any), sponsor representative liability, veto rights of the fund (and/or the sponsor representative), dilution protection for the fund, a liquidation preference for the fund, restrictions on dealings with shares (typically including a lock-up, rights of first refusal, tag-along, and drag-along rights), exit rights for the fund (via a trade sale, an IPO or a shotgun mechanism) as well as reporting, information and access rights.
In most cases, the fund will also insist that senior management signs up to an incentive scheme and that all of the management team (and sometimes also certain other key personnel) enter into new employment agreements at terms agreed with the fund.
To the extent the above arrangements are included in the articles of association (which have some benefits for some (but not all) of them from an enforcement perspective), they are publicly accessible through the companies register. In addition, certain arrangements may have to be disclosed if the target is a listed JSC and Securities Law disclosure requirements are triggered.
The governance documents will typically include veto rights of the fund (and/or a sponsor representative in a supervisory board) over major corporate actions and strategic decisions (such as acquisitions and disposals, major litigation, indebtedness, changing the nature of the business, business plans and strategy) although the specific requirements vary widely from fund to fund and deal to deal. Usually such veto rights are structured to fall away if the relevant fund’s interest is reduced below a certain quota. Where multiple funds invest, they will generally insist that all investors vote on the veto matters, with quorum and majority voting requirements varying widely from deal to deal.
Is it common to use management pooling vehicles where there are a large number of employee shareholders?
Where actual shares are held by management, they are usually pooled (e.g., through a partnership) so that the investor technically only has one co-investor. Furthermore, a financial sponsor will usually ensure full control of the exit through such vehicle.
What are the most commonly used debt finance capital structures across small, medium and large financings?
Available debt mainly depends on the size and type of the business, the track record of the private equity fund, its relationships with the financing banks and the quality of the due diligence material. Sources of debt finance for private equity transactions differ substantially for domestic private equity buyers, who typically finance all equity or seek debt finance from domestic banks, and international private equity buyers, who are able to tap international markets. On mid- and small-cap transactions there is usually just senior and institutional debt as the additional transaction costs associated with mezzanine debt are often not supported by the limited transaction size. On large-cap transactions it is a matter of pricing whether mezzanine debt is applied. High-yield is usually only considered for post-completion refinancing but not for the financing of the (original) purchase price.
Leverage levels for large-cap buyouts have gone up to around five to six times EBITDA and relative debt to equity ratios of 50% to 70%. Mid- and small-cap transactions are sometimes financed through equity only. Leverage levels and debt to equity ratios for mid- and small-cap transactions tend to be lower than for large-cap buyouts (40% to 60%).
Debt financing can take the following forms:
Senior debt. Senior debt typically includes:
- a term loan (to finance the acquisition and the costs of the acquisition); and
- a working capital facility (to fund the working capital requirements of the target).
The term loan is sometimes divided into "alphabet loans", a term loan "A" repayable in annual instalments and a term loan "B" repayable by a single bullet repayment (that is, a lump sum payment for the entire loan amount at maturity). Given the different risk profile, interest on each tranche of the alphabet loans is different.
Mezzanine debt. Mezzanine debt may be used to fill the gap between senior debt and equity invested. Mezzanine debt carries higher interest, ranks after senior debt but before institutional debt (if any) and has the benefit of second ranking security and usually an equity kicker (that is, shares, options or conversion rights in the debt issuer).
Institutional debt. The private equity fund's financing is typically split into an equity component and a debt component. The reason for that is that the funds will usually try to maximise interest deduction against the acquisition vehicle's taxable profit. There is no statutory thin cap rule or court rulings on the subject providing guidance on what that maximum is, but practice of the tax authorities suggests debt-to-equity ratios of 3:1 to 4:1.
High yield bonds. High yield bonds have been used in pan-European deals. We are not aware that they have been used in Austrian deals so far.
Is financial assistance legislation applicable to debt financing arrangements? If so, how is that normally dealt with?
Sections 82 of the Austrian Limited Liability Company Act (GmbHG) and 52 of the Austrian Stock Corporation Act (AktG) generally prohibit the return of equity (Verbot der Einlagenrückgewähr) to shareholders. Based on this principle Austrian courts have established that a company may not make any payments to its shareholders, except for:
• distributable balance sheet profit;
• a formal reduction of the stated share capital (Kapitalherabsetzung);
• surplus following liquidation.
The prohibition on return of equity covers payments and other transactions benefitting a shareholder where no adequate arms' length consideration is received in return. To the extent a transaction qualifies as a prohibited return on equity, it is null and void between the shareholder and the subsidiary (and any involved third party if it knew or should have known of the violation). It may result in liability for damages. Most of the above principles are also applied by the Austrian courts by analogy to limited partnerships having a limited liability company or stock corporation as unlimited partner (that is, GmbH & Co KG and AG & Co KG). In addition, section 66a of the Austrian Stock Corporation Act prohibits a target company from financing, or providing assistance in the financing of, the acquisition of its own shares or the shares of its parent company (irrespective of whether or not the transaction constitutes a return of capital). It is debated if section 66a of the Austrian Stock Corporation Act should be applied by analogy to limited liability companies . Transactions violating section 66a of the Austrian Stock Corporation Act are valid but may result in liability for damages.
With regard to the prohibition on return of equity Austrian courts have developed case law suggesting that a subsidiary may lend to a shareholder, or guarantee, or provide a security interest for a shareholder's loan if:
• It receives adequate consideration in return.
• It has determined (with due care) that the shareholder is unlikely to default with its payment obligations and that even if the shareholder defaults with its payment obligations, such default would not put the subsidiary at risk.
There are no exceptions to section 66a of the Austrian Stock Corporation Act . Given that a violation does not render the transaction void, section 66a of the Austrian Stock Corporation Act is usually of lesser concern.
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?
With the exception of low-volume transactions, the Loan Market Association (LMA) standard is frequently used, mostly in downscaled form. Usually, the negotiations focus mostly on the financial terms, while the legal terms are not negotiated in their entirety. In general, only certain legal provisions are materially negotiated (please see question 20 below).
What have been the key areas of negotiation between borrowers and lenders in the last two years?
The key areas of negotiations between borrowers and lenders have been:
These are usually heavily negotiated at principal level.
Debt providers typically request security interests not only in the assets of the acquisition vehicle but also in the assets of the target and all operating subsidiaries. For the acquisition vehicle, this typically includes security interests in:
• the target's shares;
• the rights and claims under the acquisition documents.
For the target and the operating subsidiaries, this typically includes security interests in:
• bank accounts;
• intellectual property;
• real estate;
In light of the financial assistance legislation (please see question 18 above), all upstream (or sidestream) securities given by an Austrian corporation need to be given subject to limitation language referring to the mandatory legal provisions. This limitation language is usually subject to negotiations between the parties.
Security realization principles
Borrowers usually try to agree on realization processes which make higher sales proceeds more likely.
Events of default
Events of default are usually negotiated in detail between lenders and borrowers.
The loan agreement typically provides for positive and negative covenants to ensure a certain conduct of business by the target group. In addition, the loan agreement usually provides for regular financial testing, reporting and information covenants. Exclusive lender clauses and intercreditor arrangements are entered into to address structural subordination of debt, priority and rights upon the occurrence of an enforcement event.
Have you seen an increase or use of private equity credit funds as sources of debt capital?
Private equity credit funds only rarely invest in Austrian targets. In light of the high costs compared to a regular bank financing, this source of debt capital is only considered in bridge financing and financial workout contexts. While we have seen a few private equity credit funds who have investigated transaction opportunities, we are only aware of very few completed transactions.