Romanian law does not define the concept of private equity but, as in other jurisdictions, it is commonly used when referring to transactions involving risk capital under the form of acquisitions, subscriptions or disposals including related restructuring or refinancing. All such operations are separately regulated by the law.

The market

Since the beginning of the decade, the market has clearly shown an increasing appetite in foreign investors for placing money in Romanian private equity deals. The investment funds started to make acquisitions on the Romanian market at of the end of the nineties, mainly in the retail, pharma and telecom industries. In the past five years, the real estate, IT, construction, consumer products and some manufacturing industries have attracted new private equity investments. In 2005 and 2006 the market has experienced the largest exits of investment funds until date, both concerning drugs producers: (i) Advent International from Terapia ($324 million) and (ii) Global Finance from Sicomed (€200 million). Advent has reportedly gained from the sale of Terapia at ten times the initial investment. Perhaps such astonishing return rates are no longer feasible as the market becomes more mature, but there is still space for exceptionally high returns. Generally, exits have been made with strategic investors. However, in the next years analysts expect secondaries also (that is, fund-to-fund exits).

Most of the private equity transactions we have seen range between €10 million and €50 million. However, there are sophisticated investors looking at investments of over €100 million. The majority of deals were buy-outs, with an exit time between three and seven years. The private equity market has been dominated until now by average-sized regional investment funds such as Advent International, Global Finance, Ged Capital Investments and Enterprise Investors. According to recent market reports, Romania is being ranked number two after Poland in the CEE region in terms of funds' investment intentions on a short-term basis. According to a KPMG report, the total estimated value of private equity investments doubled from 2006 to 2007.

The benefits

Private equity means more than money infusing into a company. The private equity business culture is positively shaping managerial behaviour. The investors impose clearly defined financial targets and timeframes, business plans and strategies on management, incentivising this by the addition of benefits (including participation to profit). This know-how benefit of private equity transactions is even more valuable in emerging markets such as Romania where the business culture is not very well settled. Therefore, according to market reports, the value of Romanian companies taken over by private equity funds has at least doubled in the last four years. A company with private equity infusion is, on average, 30% more profitable than a company without.

Furthermore, a private equity investment may allow the local owner to remain in business within a joint-venture with a foreign investor, often maintaining a decisive role. This is the case in Romania, where many of the investors focusing on family businesses need to use the local experience of the target company's founders. In turn, the local founders need an infusion of private equity capital and know-how but are generally reluctant to sell to competitors and other strategic investors as they do not contemplate a total exit. Such success stories resulting from joint-ventures between foreign investors and local partners are quite common in Romania in areas such as the IT (for instance, TotalSoft) or medical services industries (for instance, Centrul Medical Unirea).

Role of investors' legal advisers

In this active business environment, lawyers play a key role in moving a transaction forward. The main task of the legal advisors, as elsewhere, is mainly to detect all potential issues that may affect the value of the transaction during the due diligence process and to prepare the transaction documents so as to better protect the client by way of contractual guarantees, indemnities, representations and warranties. Usually legal work is required after the signing of the term sheet for the transaction, but often the buyer will ask for legal assistance in the drafting of the term sheet as well. Furthermore, following signing, the buyer's lawyers would follow the process of fulfilment of the conditions precedent to completion.

Essentially, the legal advisors may (along with the tax advisors) have a major role in the structuring of the deal, especially when legal restrictions that make certain proposed options unfeasible apply. For example, a major obstacle in leveraged transactions is the legal prohibition of financial assistance. Under Companies Law No 31/1990, the target company is prohibited to grant a loan, advance or a guarantee for the subscription or acquisition of its shares by a third party. Such restriction is absolute and does not allow for a whitewash procedure. Moreover, it is usually interpreted by the legal doctrine as applicable to indirect financial assistance where the financial assistance is offered by an affiliate. How can this be overcome? There are a few options available, amongst which most suitable would be: (i) the buyer's SPV merges with the target company (in this way the security will be provided by the merged company and not by the target); or (ii) the seller contributes the shares in the target to an offshore company and then sells the buyer the offshore company (in this way the transaction escapes Romanian court jurisdiction).

Usual steps

Term sheet

As elsewhere, a private equity transaction starts with the signing of a term sheet designed to freeze the main terms of the transaction. Although the term sheet would normally be non-binding in order to allow flexibility, the investors would often want to make it binding for the seller in order to rule out any third party competitor from the deal (securing the transaction). There are two kinds of binding term sheets: (i) one which imposes an exclusivity period during which the seller is bound to refrain from negotiating with another potential buyer; and (ii) one which imposes on the seller the obligation to sell to the investor if certain conditions are met to the satisfaction of the investor. In this last case, the term sheet would become equivalent to a pre-contract. In both cases the enforceability is ensured by way of stipulating contractual penalties for the seller breaching its obligations.

Due diligence

After the signing of the term sheet, the investor engages due diligence on the target company. The term sheet usually provides for a timing of the entire transaction, including the duration of the due diligence phase. Very often, a separate confidentiality agreement is signed with the seller and/or the target company for gaining access to the documents. In general, the preference of private equity funds is for an issues-only report rather than a descriptive one, as it would normally be required by a strategic investor. A due diligence focuses on identifying legal issues to be resolved by the seller until completion in a manner satisfactory to the buyer or, alternatively, issues to be priced by the buyer, if not solved before completion. Also, a due diligence exercise should determine all regulatory approvals (for instance, merger control) and consents needed (for instance, change of control clauses in material contracts) for the completion of the transaction.

Negotiation and signing

After the due diligence phase is finalised, the share-purchase agreement (SPA) and the other ancillary documents are negotiated. Usually, alongside the SPA, there will be at least: (i) a separate investment or subscription agreement that details the commitments of the shareholders to invest in the target; and (ii) the management agreements with the directors/managers of the target. Also, the parties often prefer to conclude a separate shareholders' agreement that will set out the rights of the parties to the target's equity and the agreed corporate governance rules. Under Romanian law, such provisions are included in the target's articles of association, which is a public document registered with the Trade Registry. A separate shareholders' agreement may be subject to foreign law and contain other clauses in addition to the articles of association, but it could not contravene the articles of association.

The transaction documents do not necessarily need to be governed by Romanian law, though often required by Romanian sellers. In any case, if governed by a foreign law, the SPA must not contravene certain imperative rules of Romanian law (rules pertaining to public order of international private law). Such rules are usually not expressly identified in the law, being subject to a case-by-case basis assessment by the courts of law in a potential litigation; therefore all imperative rules potentially applicable to the subject contracts should be considered as part of the legal analysis.

Completion

The SPA may provide for a closing mechanism whereby the price is paid subject to fulfilment of certain conditions precedents (CP). Usually such CP refer, among other things, to regulatory approvals and other consents, spin-off of assets unrelated to the main business and conclusion of contracts valuable to the business. The investors will not agree to commit money until completion. Also, completion should occur before an agreed back-stop date beyond which the agreement will terminate if the CP are not fulfilled.

Equity acquisition and disposal

The investors may acquire shares in the target either by purchase from the current owner or by share capital increase. In both cases, the acquisition of shares must be registered with the Trade Registry for opposability purposes.

Acquisition by purchase of existing shares

The price of a buyout is usually calculated as a multiple of Ebitda subject to certain adjustments. Also, in certain cases a deferred consideration is applied under several forms, such as key events provisions, earn-out provisions or subscription rights to the benefit of the seller. Under Romanian law, any price mechanism is acceptable provided the price in a sale may be determined according to established criteria.

Acquisition by subscription of new shares

When the seller remains in partnership with the private equity investor, the parties usually commit to invest certain amounts of money in the form of equity or convertible loans resulting in agreed equity participation for each of them. Usually such equity infusion is linked to specific milestone expenditures (for instance, the acquisition of valuable assets or contracts). Also, the investor would usually require to be protected against dilution resulting from the subscription of new shares at a price less than the initial price paid by the investor (down round). Frequently, such protection against dilution is achieved either by way of giving the protected investor a right of veto for any share capital increase or by way of the issue of as many additional shares as are necessary to ensure the protected investor a number of shares corresponding to the reduced down round price. These mechanisms must be incorporated in the articles of association of the target.

It sometimes happens in the case of a young business that the investor and the local partner agree on a special premium payable to the local partner for its contribution to the business development (for instance, for obtaining all permits required for a heavy regulated activity). Such additional benefits may be obtained by the partner through a consultancy/management agreement with the target. However, it is more tax efficient to recognise such value as equity in the target. In order to preserve the agreed participation, the excess equity contractually recognised to the partner is provided in the form of an appropriate share premium payable only by the investor. In this way, the local partner benefits from the share premium injected in the target by the investor pro rata with its stake.

Rights in relation to shares

The investor generally requires several rights to acquire or dispose of shares depending on whether it intends to hold the majority or 100% in the target and/or to make a successful exit. Such rights may be preferred subscription, preferred sale, pre-emption call/put options, drag/tag along rights, and so on. All of these types of agreements to acquire/dispose of shares are valid under Romanian law although not expressly regulated. However, the Romanian courts may not grant specific performance for breach of these arrangements. Contractual penalties may be stipulated to secure efficiency.

As regards pre-emption rights, Companies Law No 31/1990 regulates a mandatory pre-emption right for the existing shareholder in case of share capital increase in joint-stock companies. Nevertheless, this pre-emption right can be waived by the beneficiary shareholders on a case-by-case basis, but not in advance, for any future share capital increase. Also, under the law, the shareholders' meeting deciding the share capital increase may decide the withdrawal of the pre-emption right for a specific share capital increase.

Corporate governance

Corporate bodies

Many rules of corporate governance provided by Companies Law No 31/1990 are imperative, such as that governing types of corporate bodies and their core competences. Therefore, only a joint-stock company may have a two-tier management system with a surveillance board and an executive board. A limited liability company may only have one or several directors with distinct levels of competence. Most of the targets that attract private equity investments are limited liability companies because they are the preferred corporate vehicles for small and medium – sized companies. In such a case, where the investors prefer to have a two-tier management system, the solution is to differentiate competences at the level of the target's directors.

Swamping or step-in rights

The investor would usually want to control management body decisions by appointing the appropriate number of directors or by having a right of veto for certain matters irrespective of whether it is just a minority shareholder (swamping rights). Hence, the task for the lawyers is to find legal solutions for the granting of actual control over the target company to a minority shareholder. This can be achieved by: (i) dilution of the local partner by issuance, to its benefit, of preferred shares deprived of voting rights; or (ii) by allowing the investor to appoint the decision-making majority of members in the board of directors. In the first case, the local partners will accrue the majority of dividends, but the majority of votes in the shareholders' meeting will be held by the investor (preferred shares may be issued only for joint-stock companies). In the second case, the investor and the local partner may agree that the local partner will vote in the shareholders' meeting in favour of the nominees for management positions designated by the investor (pact on vote). We have also seen cases where the minority investors wanted to take control of the target only in limited situations where a negative deviation of the financial results against the agreed target Ebitda occurred (step in rights). In such situations, the investor requires the right to dismiss the directors appointed by the local partner and to decide the company's strategy, as well as to receive additional shares in the target calculated against a negative deviation threshold (for instance, 0.5% of the share capital for a €500,000 negative deviation against agreed Ebitda).

In the situations described above, the investor and the local partner decide on the manner in which they will vote at the target shareholders' meeting approving the appointment/dismissal of directors, business strategy, and so on. Pursuant to a recent amendment of the Companies Law, this pact on vote is allowed to the extent that the voting is not influenced by a target company's representative.

Tax matters

The sale of shares of non-listed companies is subject to 16% capital gains tax. The capital gain is calculated as the margin between the acquisition price and the disposal price. Problems in calculating the capital gain may arise when the payment price is deferred or subject to adjustments. If the seller is a legal entity, the profit made on the sale of shares in a Romanian company will be subject to the global profit tax in the reference period. If the seller is an individual, the buyer is obliged to withhold and pay the tax from the purchase price of the shares prior to registration of the share transfer with the Trade Registry.

A practical difficulty arises when the buyer is not a company fiscally registered in Romania. In this case, the fiscal authorities require the buyer to register in Romania in order to be able to pay the withholding tax on capital gains on behalf of the seller (a quite lengthy procedure). Therefore, the registration with the Trade Registry will be delayed accordingly.

The subscription of new shares (including the share premium) is not taxable as a rule.

Other fiscal implications of a private equity transaction may relate to management incentives. In this case, the most tax efficient solution seems to be a stock option plan as the margin between the market value and the issuance value of the shares issued under the stock option plan is not taxable. However, a stock option plan requires that its beneficiaries be employees of the target.

Market expectations

The Romanian private equity market already has about 10 years of experience. The first generation of private equity investments is completed, but the second-generation investments are not yet mature enough to be sold: the market is now offering more opportunities for acquisitions than for exits. Therefore, we expect to see in the following months and years new significant acquisitions by investment funds in a thriving market that does not seem much affected by the international credit crunch.

Author biographies

Cosmin Stavaru Bulboaca & Asociatii SCA Cosmin Stavaru is a senior associate at Bulboaca & Asociatii. Before joining Bulboaca & Asociatii, Stavaru was an associate with the corporate practice of the Bucharest office of a Magic Circle law firm. Stavaru advised a broad range of clients such as major international energy companies, investment funds and banks in both private and public M&A transactions (including several key privatisation deals), energy and natural resources as well as corporate and commercial. His corporate expertise includes structuring share/asset deals and renewable energy projects, advising on corporate restructuring matters, joint ventures and drafting and negotiating complex commercial contracts. He has also been extensively involved in large real estate transactions and project finance, advising both developers and banks. Other areas in which he has extensive knowledge are public-private partnerships, insurance and pensions. Stavaru graduated from the law school of Bucharest University and is a member of the Romanian Bar Association. He also holds an LLB in EU Law from the Sorbonne, Paris and a degree in International and Human Rights Law from Robert Schuman University, Strasbourg. He is fluent in English and French.