Although Switzerland is not a member of the EU, its strategic location in the middle of continental Europe is reflected in its private equity business, which is booming.

From the entrepreneurial side, Swiss academics and authorities have realized that Switzerland needs to develop new high-added-value industries to remain competitive and retain its special place in the worldwide economy. As a result, new business programmes and departments have cropped up both in the Polytechnic federal schools and in the universities, where more and more young Swiss graduates, especially in the biotechnology and life science industries, are developing new ideas and technologies, often in conjunction with their universities, into commercial products and creating new businesses.

From a domestic investors' standpoint, more Swiss private investors are today willing to diversify their investment portfolios through private equity and the number of business angels and venture capital firms are rapidly increasing.

From an international investors' viewpoint, recent years have seen a growing number of international consortiums of venture capital firms investing directly in Swiss companies or indirectly, through acquisitions of large groups of companies that often include Swiss subsidiaries.

The Swiss federal and cantonal authorities are also supporting the private equity and venture capital industry, either directly by creating new legislation tailored for private equity, or indirectly, by creating various departments or state-controlled entities whose primary purpose is to foster the creation of new businesses. This government help can take various forms, including seed money, management resources, networking or facilitated access to various professionals.

Lastly, a number of private non-profit organizations offering the same type of services complete the range of services and resources available for young entrepreneurs.

As a consequence, every day a greater number of new businesses private equity investments occur in Switzerland, which is recognized by all players as good news for the country.

This industry growth has not escaped the attention of the Swiss authorities, who are showing their support in what is considered in Switzerland to be record time, through numerous pieces of legislation aimed at correcting perceived deficits in the Swiss legal framework. These new laws substantially improve the legal environment for the private equity business, particularly from a tax perspective and in the creation of new vehicles tailor-made for private equity funds.

Private equity investment

Structure

In the absence of Swiss private equity funds, investors today have the choice of either participating in an investment through a foreign private equity fund, such as the ones existing in Luxemburg, often the favoured method, or, alternatively, to invest in Swiss companies directly or through a privately owned investment company.

Swiss law favours direct investment because investment through an investment company is subject to double taxation both at the corporate and the investor's level. Although an investment company may benefit from favourable tax treatment in limited circumstances, this situation is widely recognized as unsatisfactory and has prompted much of the recent legal developments detailed below.

Setting aside for the moment the limitations in the vehicles available for subscribing or acquiring companies' equity, depending on the stage of investment, the structure of the private equity investment itself is quite flexible in Switzerland. Swiss contract law is versatile enough to accommodate almost all specific needs or requirements of an investor, with only minor limitations in the context of enforcement issues.

From a contractual point of view, equity investment is generally formalized in an investment agreement, the contents of which depend upon the intent of the parties. However, as a general rule, most rights and/or protection mechanisms used by sophisticated investors blends in perfectly with an agreement governed by Swiss law.

The following rights and/or protection mechanisms, for example, can all be fine-tuned to meet an the investor's needs in the particular circumstances: (i) limitations on transferability; (ii) rights of appointment for board members, management and employees; (iii) preferential share rights for dividends, liquidation and/or voting; (iv) rights of veto of the board or of the investor for certain big decisions; (v) share-transfer restrictions (the whole range of pre-emption, right of first refusal and drag- and tag-along rights are available); (vi) various exit devices (trade sale, initial public offering) and related rights (piggy-back rights); (vii) anti-dilution rights; and (viii) information rights in favour of the investor.

As mentioned above, the only limitation on the creativity of the investor and counsel are the few mandatory provisions of Swiss company law.

Depending on the legal form of the target company, only selected rights and/or protection mechanisms referenced above can be inserted into the articles of association of the target company, making them enforceable erga omnes, that is, against all third parties. For instance, one may not include the limitation on the transferability of the shares of the founders in the articles of association of a joint stock company (société anonyme, SA or Aktiengesellschaft, AG), the most commonly used legal entity in Switzerland. Nevertheless, simple mechanisms allow one to achieve the same result in practice, so that this mismatch between contractual and company law does not, as a practical matter, raise major issues. Consider the example mentioned above, wherein Swiss company law allows registered shares with limited transferability, the transfer of which are subject to the board of directors' prior consent. Because an investor generally has a seat on the board, no transfer could occur without the investor's knowledge, and with such knowledge, they could, if necessary, seek specific enforcement of the limited transferability provisions before a court.

For the purpose of this chapter, assume that the target company is a joint stock company, as most businesses in Switzerland are incorporated in this form, although this might soon change.

One of the most critical mechanisms to implement under Swiss law is voting rights which, in some jurisdictions, may be calculated not on the actual holding of an investor but on its holding on a converted basis, that is, taking into account anti-dilution rights that have not resulted in an increase of the actual holding of their beneficiaries. For example, an investor holding X shares in a joint stock company would be entitled in some circumstances to exercise voting rights related to X + Y shares, Y being the number of new shares the investor would be entitled to purchase according to anti-dilution rights, but that are not yet issued. Under Swiss company law, however, voting rights are always subject to either the number of shares held (one share, one vote), or subject to their nominal value (one Swiss franc, one vote). All other voting mechanisms are null and void. As a result, a dissenting shareholder could challenge a resolution adopted according to this mechanism before a Swiss court. In practice, investors and counsel have tried to circumvent this Swiss rule with various mechanisms, for example by holding a pre-meeting in which the investor is granted the preferred voting rights through the appointment of a single representative for all shareholders who, in turn, casts their vote during the real shareholders meeting pursuant to the result of the votes during the pre-meeting. Aside from the obvious impracticalities this solution poses, that is, holding a pre-meeting before each real meeting, and in some cases calculating the preferred voting rights, case law has confirmed that if a shareholder were to refuse to comply with the result of the pre-meeting and voted differently during the shareholders' meeting, the dissenting vote would nonetheless be valid. Other solutions exist, although their implementation might not be enforceable under Swiss law.

So, apart from the preferred voting right on a converted basis, which is quite often requested by non-Swiss venture capital firms, Swiss law generally can accommodate any specific requirement of an investor in a satisfactory manner.

Effective as of July 1 2004, a new Swiss Federal Act on Merger, Demerger and Transfer of Companies came into force in Switzerland. The Merger Act is generally perceived as a powerful tool for private equity investment because is allows fast and efficient (re)-structuring opportunities of target companies before an investment, if required.

Involving management

Management, especially in private equity deals, is a crucial factor for investors, and Swiss law offers a number of tools that give management a performance-based participation package.

The most traditional tool permitted is a link to a large or small part of the management salaries to its performance. This standard bonus scheme, while effective in established companies, can be in some instances impractical depending on the stage the company is in and its cash flow availability. Also, although it is cost effective for the company, which can deduct the bonus as part of its personnel charges, it is a rather expensive solution for management, which is taxed at the full personal rate on any bonus.

Another available tool frequently used is the employee stock option plan (ESOP), which grants management participation rights in the company at preferred prices. Although quite popular initially, largely due to a favourable tax treatment, the ESOP is increasingly considered to result in a disproportionately costly administrative burden for the company, rendering this tool impractical depending upon the size and stage of the company. The tax treatment of stock options in Switzerland is also less favourable due to the practices of local tax authorities.

The share plan, that is the distribution of treasury shares as part of the performance-based salary, is becoming increasingly popular because, depending on the value of the shares, distribution of shares can in some instances be more tax efficient in comparison to distribution and exercise of stock options. As a rule, a company seeks a tax ruling regarding the value of the treasury shares before implementing a plan. Assuming that the treasury shares have been planned from the companies' inception, this could be an attractive participation package. However, treasury shares cannot exceed a defined percentage of the share capital of the company and might be subject to adverse tax consequences if not distributed within a defined period of time.

Lastly, companies are increasingly using phantom shares, that is, implementing a purely contractual bonus scheme indexed on the value of the shares, this value being distributed upon defined occurrences. Although this tool is more widespread with listed companies, it is becoming more and more popular with private companies because it is usually cost effective, in that it is linked to the intrinsic value of the company and not subject to the same hurdles as the share plan.

Auctions

Auctions are increasingly being used in Switzerland as an effective tool in the buyout market as a means for value a company.

Typically, a company would organize auctions after due diligence proceedings have taken place and several potential buyers have expressed their firm interest. Swiss law does not contain extensive provisions governing auctions, so companies and their counsel are free to organize the auctions as they wish. Generally, a guiding principle is to provide the same level of information to all potential buyers, although for private companies this principle is not compulsory, except if the potential buyer already owns a holding in the company.

A particularly effective way to maximize the value of a company consists of organizing secret auctions, wherein the potential buyers must present their offers simultaneously and without disclosing the price offered to the other auctioneers. Such proceedings are, however, only effective when the potential buyers are deemed to be serious buyers by the company. Additional precautions in such instances may be useful, such as maintaining the identity of the auctioneer's secrets, or conversely acting with full transparency.

Finance

Financing and security

The financing aspects of private equity in Switzerland do not, as a rule, differ from practice in other jurisdictions, but certain security aspects are quite specific to Switzerland. For example, although the usual forms of security described below are common practice, Swiss law does not, as a matter of principle, know the security known as floating charge (except for global assignment of claims).

When a Swiss company is involved, lenders generally request a pledge of the shares (or parts) of the target company as security. Swiss law requires however that should such shares (or parts) be materialized into share certificates, the certificates no longer rest at the sole disposal of the pledgor. The pledgor must transfer the certificates either to the pledgee or to a third party acting as an escrow agent on behalf of the parties, who holds the certificates on behalf both of the pledgor and the pledgee.

Another security device commonly used by Swiss banks is the assignment of the receivables of the operating company, and, of course, this is not necessarily the borrower. Such an assignment merely requires the written form to be valid. Generally, the lender will also request a notice of assignment form signed by the operating company as security in the event the borrower defaults. Upon an event of default, the lender is authorized to inform the debtors of the operating company and, once informed, the debtors can only validly discharge their obligations by paying the lender.

The concept of trust does not exist under Swiss law, so more sophisticated versions of the assignment of receivables used in Switzerland generally include the opening of a defined bank account with a defined bank added as a party to the agreements upon which all the receivables must be paid. The specific bank accounts are pledged in favour of the lender who, upon occurrence of an event of default, can immediately take control of the accounts by simply notifying the bank.

What Swiss law proscribes is the floating security device given over the assets of a target company. Under Swiss law, and similarly as described above for the pledge of share (or parts) certificates, any pledge given over movable assets is valid only if the movable assets are no longer at the sole disposal of the pledgor. Accordingly, a floating charge is theoretically possible provided the assets are under the control of both the pledgor and the pledgee. This requirement raises obvious practical problems, including but not limited to the difficulty for a company to be operational when it can no longer dispose of its assets. So this pledge given on the assets of a company is never used in Switzerland.

Companies and their counsel have developed various solutions to circumvent this restriction in Swiss law. The most obvious is a stipulation that a foreign law under which a charge is permissible governs the floating charge. Although this solution achieves the objectives of the parties to some extent, its effectiveness is limited because, under the Swiss Federal Act on International Private Law, any choice of law regarding a charge may not be valid towards third parties. As a result, and although the assets of a Swiss company could be pledged under a foreign law in favour of the lender, the pledge would not deny third parties, acting in good faith preferential rights in Switzerland.

Conversion tools

Under Swiss law, conversion tools are possible and frequently used in favour of investors.

The most common conversion tool is the convertible loan, which is converted into equity upon the occurrence of defined events. Again, the loan agreement is essentially of a contractual nature. As a rule, however, lenders of convertible loans require securitization by the issuance of conditional capital, that is, new equity issued in favour of specific investors, which is referenced in the articles of association of the company. In this event, existing shareholders must waive the preferential subscription rights that they otherwise have by operation of mandatory Swiss law and the equity is automatically issued upon occurrence of the defined events.

Share warrants, that is additional subscription rights attached, for instance, to part of a convertible loan agreement or to specific investors, also exist in Switzerland on a contractual basis. Depending on the structure of these share warrants it might, however, be difficult to reflect the contractual obligations in the articles of association of the company. There is therefore always a risk that, in the future, upon exercise of the share warrant, shareholders will refuse the appropriate capital increase. Generally, share warrants do not pose any a problem in Switzerland provided that all the shareholders are informed of the issue and are granted an opportunity to participate in the warrants.

Exit strategies

Switzerland offers exit strategies substantially similar to the ones usually available worldwide.

In sum, the main exit strategies include: (i) the trade sale, by which the investors are given specific rights if management decides to sell the company to another business; and (ii) initial public offerings, when a company decides to go public and list its shares on a stock exchange.

In Switzerland, from a contractual point of view, the parties are free to structure exit strategies according to their needs and these clauses may be on par with those required by international venture capital firms, including piggy-back rights.

Developments under Swiss law

Swiss authorities are acutely aware of the need for incentive innovation and the creation of new businesses and have accordingly undertaken a review of a variety of laws particularly relevant to the private equity arena.

Firstly, regarding the creation of new businesses, a new law pertaining to the Swiss limited liability companies (société à responsabilité limitiée, Sàrl, or Geselschaft mit beschränkter Haftung, GmbH) has recently been adopted and will probably come into force in January 2007.

The legal form of the limited liability company is an alternative to the Swiss joint stock company and is intended to suit the needs of small businesses, typically small family businesses or start-ups. Its main features include its lower capital requirement (SFr20,000 ($15,500) instead of SFr100,000 for a joint stock company), its simpler corporate structure (there is no board of directors and simply one manager), and the absence of mandatory statutory auditors. Moreover, the Swiss limited liability company may qualify as a check-the-box company under US law and so be fully transparent from a US tax perspective.

In practice, however, the legal form of the limited liability company has not been as successful with new businesses as it should have been because of several drawbacks of the current law. For example, any transfer of part needs to be formalized before a notary public, the minimal nominal value of one part is SFr1,000, the maximal nominal capital is SFr2 million and a partner may not hold more than one part.

The new law on the Swiss limited liability companies removes these drawbacks while simultaneously improving the legal framework in a substantial manner. Once this law enters into force, the limited liability company will once again become the most viable legal vehicle for creation of new businesses, at least at an early stage. Indeed, the limited liability company under the new Swiss law offers flexibility in its articles of association that is simply not available to the joint stock company. For example, tag- or drag-along clauses can be incorporated in the articles of association of a limited liability company, as well as specific limitations on transferability as respects founders. In a nutshell, the wide array of contractual clauses that may be included in an investment agreement can easily be incorporated into the articles of association, rendering any rights and/or protection mechanisms valid erga omnes.

The new limited liability company may further be a recommendable choice not only for new businesses but also for existing businesses. Since the entry into force of the new Merger Act, the conversion of a joint stock company into a limited liability company is a standard proceeding.

This new law is therefore a big advance in the private equity industry because it allows more flexibility in favour of investors.

Secondly, and also regarding the creation of new businesses, a new law pertaining to the auditors will enter into force together with the new law on limited liability companies.

The obligation to appoint statutory auditors will, under this new law, be dependent on the size of the company and not just on the legal form. Whereas all joint stock companies, but not limited liability companies, must appoint statutory auditors today, the criteria that will trigger this obligation in the future will be thresholds under which there will be an obligation to appoint a limited auditor only or, in some instances, no auditor at all.

This new law is significant for the private equity industry, because many new businesses or start-ups are today obliged to appoint statutory auditors, with the attendant costs.

Thirdly, there is a new law, which should also enter into force beginning 2007, that creates new legal vehicles tailored for private equity funds, especially the société en commandite de placements collectifs, which compares to the limited partnership existing in most other western jurisdictions.

The société en commandite de placements collectifs will have one partner with unlimited liability, the manager of the company, and as many limited partners as requested, whose liability will be fully limited to the amount of their investment.

Unlike the société d'investissement à capital fixe, or SICAF, which is the other new category of funds introduced by this new law, the société en commandite de placements collectifs will be transparent from a tax perspective, and should therefore be a much appreciated legal vehicle for private equity funds.

Lastly, the Swiss government has recently decided to amend the Swiss law on the joint stock company to improve its flexibility and, at the same time, the corporate governance rules. The process is new and it is difficult to assess the exact impact of this project at this stage, although the draft presented by the Swiss government is promising.

Author biographies

Lionel Aeschlimann Schellenberg Wittmer Lionel Aeschlimann heads Schellenberg Wittmer's corporate, finance and banking group in Geneva. His main areas of practice include banking and finance, investment funds and structured products, capital markets and stock exchange law, as well as corporate law and mergers and acquisitions. He regularly advises Swiss and international banks, brokers, investment managers, fund managers (including hedge fund managers), and financial advisors. Aeschlimann graduated from the University of Berne, School of Law, and was admitted to the Bar in Switzerland, in 1992. In 1993, he obtained a post-graduate diploma in EU law from the University of Seville, Spain. In 1994, he also graduated from the College of Europe, in Bruges, Belgium, with a master of laws (LLM). He joined Schellenberg Wittmer in 1994 and became a partner of the firm in 2000. Aeschlimann speaks French, English, German and Spanish. Jean Jacques Ah Choon Schellenberg Wittmer Jean Jacques Ah Choon is an associate in Schellenberg Wittmer's corporate, finance and banking group. He was admitted to the Bar in Switzerland in 1999 after having graduated from the University of Geneva School of Law in 1997. He joined Schellenberg Wittmer in 1997. His main areas of practice are mergers and acquisitions, corporate law, private equity and stock exchange law, and banking and finance law. He regularly advises Swiss and international clients on all types of mergers and acquisitions, private equity transactions, takeovers, joint ventures and general corporate matters. He also advises clients on banking and capital market issues. Before joining the Geneva corporate, finance and banking group, he practised in Schellenberg Wittmer's M&A and corporate group in Zurich. He speaks French, English and German. Martin Weber Schellenberg Wittmer Martin Weber heads Schellenberg Wittmer's corporate/M&A group in Zurich. He was admitted to the Bar in Switzerland in 1986 and graduated as a doctor of law from the University of Zurich in 1993. He also obtained a master of laws from the University of Chicago Law School. Weber joined Schellenberg Wittmer in 1988 and became a partner in 1993. His main areas of practice are mergers and acquisitions, stock exchange law, corporate law, competition law and international business transactions. Weber is an authorized representative at the SWX Swiss Exchange. He advises clients in all types of mergers and acquisitions transactions, public takeovers and going privates, initial public offerings, rights offerings and a in a variety of other international business transactions, such as in the implementation of business outsourcings and commissionaire structures. Weber has authored publications in the fields of mergers and acquisitions, private equity and corporate law. He speaks German, English and French. Oliver Triebold Schellenberg Wittmer Oliver Triebold is a partner in Schellenberg Wittmer's corporate and M&A group in Zurich. His main areas of practice are mergers and acquisitions, private equity and venture capital, corporate law, as well as capital markets and stock exchange law. Triebold regularly advises clients on domestic and cross-border M&A transactions, private equity and venture capital investments, public takeovers and going privates, initial public offerings and rights offerings, as well as on a variety of other international business transactions, such as joint ventures, (re-)structurings of groups of companies and business outsourcings. Triebold was admitted to the Swiss Bar in 1994 and the New York Bar in 1997. He studied law at the University of Basel (first degree 1990; doctorate 1993) and graduated with a master of comparative jurisprudence from New York University School of Law (MCJ 1996). Before joining Schellenberg Wittmer in 1997, he worked as a foreign associate with an international business law firm in New York and as a research and teaching assistant at the University of Basel. He became a partner of the firm in 2003. Triebold has authored several publications on mergers and acquisitions, corporate law and tax law. He speaks German, English and French.