Studies reveal that there has been a considerable increase in private equity activity in most EU states during the past two years. The Spanish market has been no exception to this trend of growth, but the figures are lower. The Spanish Venture Capital Firms' Association reported more than €2 billion-worth ($2.4 billion) of deals for the first nine months of 2005, which is 5% more than in the whole of 2004, as well as 140% more than the same period in 2004. This figure is experienced to increase significantly by the end of 2005 given several large transactions that may be closed, the final figure could be as high as €3.5 billion to €3.7 billion.

In general though the number of transactions carried out in the first nine months of 2005 has dropped slightly in comparison to those carried out in the same period in 2004 (about 2%) totalling about 349 transactions. The figure for the full year should be roughly equivalent to that of 2004 (about 483 transactions). Statistics show that the average size of deals has increased. Management buyouts (MBOs) represent 75.6% of the total volume of deals and about 55% of the investments were directed towards early stage financings. New funds raised in the first nine months of 2005 reached €1.5 billion, which is 188% more than the same period in 2004. But disinvestments have grown by a total of 254% reaching a volume of €777 million over the same period.

Although Spain is still far from being a mature market, 40 transactions in the first nine months of 2005 were capital investments ranging from €10 million of which two surpassed €100 million. These 40 transactions represent 68.5% of the total investments and clearly show that the Spanish mid-cap market is very active. It is also important to mention that although historically the market in Spain has been focused on mid-cap transactions, over the past year, due to the influence of domestic and foreign private equity investors, the volume and size of deals has risen. Notable big deals include those of Cortefiel, the increase in capital of ONO following the purchase of Auna, Amadeus Global and the investment by APAX in Panrico. Meanwhile, deal structures continue to evolve and the types of companies that investors target is changing also. As mentioned above, and until recently, the average size of private equity deals seldom exceeded €100 million in Spain. But transactions of €500 million or more are no longer unknown. Furthermore, and due to the higher capitalization of the ideal private equity target, private equity investors are drawing their attention towards publicly listed targets. This trend has led to an increased number of public-to-private transactions.

The past 12 months also saw a number of foreign funds attracted to the Spanish market, such as the US fund Giuliani-Sage Capital, the French fund L Capital and the British fund Doughty Hanson. These organizations have hired local staff to complete investments in the Iberian Peninsula. It is also important to note that although the private equity market in Spain is continuing to grow one should not lose sight of the M&A activity of strong industrial groups such as the recent acquisition of O2 by Telefonica and the hostile takeover bid launched by Gas Natural on Endesa.

Contributing to this evolution of the Spanish private equity market is a tax and legal framework rated by the European Private Equity and Venture Capital Association as favourable.

Legal framework

National member state regulations play an important part in the development of the private equity industry. And, although Spain is catching up with more legally advanced markets, foreign investors must bear in mind that Spanish regulations still need to evolve to allow for the sophisticated structures that private equity transactions require. One example is the Pension Plan and Fund Regulations (adopted in February 2004) that permit pension funds to invest, subject to certain restrictions, up to 30% of their assets in non-traded securities. These investments must however be disclosed and detailed in the prospectus of the pension or mutual fund.

The only provisions specifically relating to private equity are contained in Act 1/1999 which refers only to the formation requirements for and tax regime applying to venture capital (VC) corporations and VC funds, and in two circulars published by the National Securities Market Commission (Comisión Nacional del Mercado de Valores) laying down a series of standards implementing the general framework established by Act 1/1999, as well as the administrative procedures for fund formation, standards for accounting and reporting requirements.

In general most private equity transactions in Spain have been implemented within the general legal framework applicable to corporations and commercial contracts, namely, the Securities Market Act, the Stock Corporations Act, the Limited Liability Companies Act and the Commercial Code and the Civil Code.

In Spain most private equity deals have initially been structured as single layer equity deals where existing and new shareholders (including management) held ordinary shares. New investors were only privileged with rights of veto or casting votes at annual general meetings (AGMs) and board meetings, pre-emption rights on the transfer of shares and special step-out clauses (tag along, drag along). Senior financing by new investors was structured as subordinated or shareholders loans. Today, as investors seek more protection for their investment, especially in the event of restructuring or bankruptcy of the target company, preference is achieved through liquidation preference rights, preferential sale rights, blanket preference rights, anti-dilution rights and convertible preferred equity, among others.

Public takeovers

Financial assistance plays an important role in private equity as it directly affects the way in which leveraged buyouts (LBOs) and MBOs are structured. Spanish regulations, in line with the relevant EU directives prohibit and severely penalize the acquisition by a company of its own shares or the provision by the company of financial assistance or guaranties to a third party to buy its shares. Consequently in most cases a newly incorporated company whose sole purpose is to acquire the shares of the target is financed above its net equity to implement the purchase and is merged with the target immediately after the purchase. This allows the lenders who finance the purchase to have direct recourse to the assets of the target after the merger.

When acquiring listed companies' investors should also be aware of several issues. Due diligence investigation is possible, although frequently limited, provided that the seller has a controlling interest in the target company. Disclosure and discretion rules must be respected before, during and after the process. Otherwise due diligence is usually limited to information in the public domain.

In takeovers of publicly traded companies where investors buy a "significant share" in a company they must launch a public bid in one of the following ways:

• If the shares acquired are equal or greater to 25% of the capital, a bid must be launched for a minimum of 10% of the share capital.
• If the investor holds more than 25% but less that 50% of the capital and intends to increase this percentage by at least 6% in a 12-month period, the bid must be launched for a minimum of 10% of the capital.
• If the acquisition is less than 25% of the capital a bid must be launched for 10% of the capital as long as the following circumstances arise: i) the stake acquired is equal to or greater than 5% of the capital (or the shares acquired would permit the appointment of more than one-third and less than half plus one of the board of directors of the company), and ii) the intention exists of naming the board members.
• A bid must be launched for 100% of the capital when the following occurs: i) investors acquire a share holding equal to or greater than 50% of the capital, or ii) less than 50% of the capital is acquired but: a) the share holding is equal to or greater than 5% of the capital or would permit the appointment of more than half of the board of directors of the company, and b) the intention exists of naming the board members.

Arrangements with existing shareholders to secure the purchase of their stakes are customary as well as shareholders agreements with existing shareholders. These agreements must be disclosed to the National Securities Commission immediately after they are signed.

Competing bids

Competing bids have also been the object of legislative changes during 2005. In the event of a takeover of a listed company, third parties can present competing bids within 30 days from the date the National Securities Market Commission has approved the initial bid presented. The most important step to follow when presenting a competing bid is that the price must be higher than that of the initial bid, and competing bidders will be prohibited from setting a minimum acceptance requirement lower than the one fixed by the initial bidder.

Spanish regulations on takeovers set out that, if there is more than one bidder for a company, the bidders are permitted to increase their offers. Having said that, a bidder can still succeed in a takeover even if its bid is not the highest by agreeing with a significant amount of shareholders that they will only sell their shares to that bidder in particular. The sole condition would be that the bidder could not offer a better price for their shares than the price offered to all the shareholders in general.

Public-to-private transactions

Given the higher capitalization of buyout targets, investors have turned their attention to the stock market to choose and identify potential targets. This has of course led to an increase in public-to-private buyouts sponsored by private equity investors. As in other jurisdictions the fact that the target is a listed company has led to considerable changes to the structure of deals especially compared with the acquisition of a privately held company. On the other hand, many publicly traded companies in Spain are owned by family groups, which simplifies negotiations. Also, because of the limited number of shareholders in these companies, they are often more eager to enter into deals with private equity investors.

Public-to-private transactions are subject to two important limitations. Firstly, if the bidder does not achieve the purchase of 100% of the stock capital but comes close (depending on how the bid has been launched, the percentage stake achieved in the target, and the position of the National Securities Commission) the investor is more than likely to be required to cause the target company to launch a de-listing bid after the takeover. The National Securities Commission must approve the price of the de-listing bid, and in no way can it be an amount lower than the price in the takeover bid by the investor.

Secondly, in Spanish law there is no specific squeeze-out provision and therefore no compulsory squeeze-out of minority shareholders who are not obligated to sell their shares either in the takeover or the de-listing bid process. Due to this unsatisfactory legal situation it is important to deal with this matter at the inception of the transaction. The law is expected to change in the near future with the implementation of the EU takeover directive but at present investors in public-to-private transactions must consider having to live with minority shareholders in the target company.

Legislation

Due to recent modifications in Spanish legislation, several changes have been adopted that work in favour of private equity investors in Spain.

The yields obtained by foreign investors (not resident in a tax haven and without a permanent establishment in Spain) from their investment in Spanish venture capital and private equity funds benefit from a 100% tax credit on dividends and on the part of the capital gains corresponding to retained profits generated through permanent establishments.

Furthermore, recently the Spanish thin capitalization rules have been modified and will no longer be applicable to loans granted by EU resident lenders to Spanish related companies.

Meanwhile, the new Spanish insolvency law, in force since September 1 2004, provides that the filing of insolvency proceedings is no longer considered an event for early termination of agreements in general, including bank loans and other credit facilities, although the accrual of interests is suspended provided that the accrued sums are not secured. Secured creditors are not entitled to enforce their collateral for a period of 12 months unless the borrower goes into liquidation or a creditors' arrangement is approved. Mezzanine financings are now considered ordinary credits (subordinated to senior debt is still possible by agreement), and loans granted by shareholders holding a 10% stake in the company, and 5% for listed companies, and inter-company loans are now considered subordinated debt. It is also important to note that the new insolvency law has introduced liabilities for statutory and shadow directors that were in their posts when proceedings started or have occupied the post in the preceding two years.

Corporate governance and directors' liability have recently been strengthened and extended to shadow directors in insolvencies and in relation to tax obligations. These principles may reasonably apply to private equity funds holding substantial stakes and influencing the management of their portfolio companies.

Meanwhile, in late 2005 Spain also approved two pieces of legislation affecting private equity investment: the new Venture Capital Entities Act and the new Regulations on Collective Investment Institutions.

The new Regulations on Collective Investment Institutions (CII) implement Law 35/2003 on CIIs. This legislation in turn implements changes adopted in the EU under Directives 2001/107/CE and 2001/108/CE.

The Regulations aim to eliminate obstacles to collective investment in Spain, and cover the creation of certain types of shares or participations within a CII, the regulation of hedge funds, the elimination of the obligation for the shares of CIIs to be traded on the stock market, and the creation of alternative methods to authorize liquidity of their shares. Furthermore the Regulations subject management companies, trustees, traders and investment companies to the fulfilment of a series of norms of conduct with the objective of preventing conflicts of interest.

The Regulation permits CIIs to invest in bank deposits, investment institutions, derivatives and non-traded monetary assets. At the same time, the legal regime is defined for management companies by detailing, among other matters, the requirements for the delegation of activities or equity rules. The new trans-border trading rules allow shares of Spanish CIIs to be traded in foreign markets through the mediation of foreign companies.

The Regulations provide for different types of CIIs and further implement the regulation on financial institutions. In particular investment policies are further developed through rules on eligible assets, the use of derivatives of private shares and risk diversification. One important change is that CIIs can now invest up to 10% of their assets in venture capital and hedge funds.

Author biographies

Alberto Echarri Mullerat Alberto Echarri is co-head of the M&A and Capital Markets Group at Mullerat, of which he was a founding partner. He has been practising law since 1985. He is listed in the International Who's Who of Mergers and Acquisition Lawyers 2005 as a leading M&A lawyer. He concentrates on acquisition, structuring and disposal of private and listed companies, project and corporate finance, takeover bids, shareholders' agreements and disputes, restructurings, PPP, private equity, joint ventures, corporate law and corporate governance. He has recently advised on some of the largest private equity deals and public bids in the Spanish market and holds office as director in several public companies. His practice group has been involved in large cross-border and national transactions in very diverse sectors such as automotive, financial services, paper, packaging, power and renewable energies, real estate, telecommunications, IT, environmental services and construction, franchising, chemical, food, healthcare, textile, retail, transportation, aerospace and private equity. He co-authored International Contracts (1988), The Spanish Limited Liability Company (2000), and Joint Ventures (2002). Jorge Adell Mullerat Jorge Adell is a partner and co-head of the M&A and Capital Markets Group at Mullerat. He has a Law Degree from the University of Barcelona and a Master of Law, from the University of Chicago. From 1993 to 1994, he was a lawyer at Mayer Brown Rowe & Maw in Chicago; from 1990 to 1992, lawyer of the Barcelona '92 Olympic Organizing Committee; and from 1987 to 1988 lawyer at Glaisyers Solicitors in the UK. He specializes in M&A, including business start-ups; acquisitions (assets and share deals); MBOs, LBOs, MBLs; joint ventures and alliances, including partnerships and European economic interest groupings; venture capital; securities public and private placements; reorganizations and restructurings, and acquisitions financing. He is a member of the Barcelona Bar Association, the International Association of Lawyers, the International Bar Association and the ESADE (Escuela Superior de Administración de Empresas) Real Estate Club. He is a lecturer at the Law School of ESADE, and author of several articles on mergers and acquisitions and corporate finance. Angel Pendás Mullerat Angel Pendás is a partner of the Private Equity Group at Mullerat. He has a law degree from the University of San Pablo CEU and a Master in Business Law from the Instituto de Empresa in Madrid. He concentrates on acquisition, structuring and disposal of private and listed companies, project and corporate finance, takeover bids, shareholders' agreements, restructurings, private equity, joint ventures, corporate law and corporate governance. He has recently advised on some of the largest private equity deals and public bids in the Spanish market. He is a lecturer on mergers and acquisitions in the Master of Business Law programme at the Instituto de Empresa as well as lecturer on acquisitions in the Master of International Law at the European Studies Institute of the San Pablo CEU University in Madrid. He co-authored Technology Transfer (1999), The Spanish Limited Liability Company (2000), and Joint Ventures (2002).