Switzerland: Switzerland unlocked

Author: | Published: 1 Oct 2010
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Two aspects of the Swiss private equity environment merit particular discussion: first, the question of whether the locked-box mechanism used in the sale of enterprises is just a (past) trend or more, and how the locked-box process works and what considerations are relevant from a (private equity) seller's side. Secondly, the leveraged recapitalisation which has not yet been broadly commented upon, at least in Switzerland, even though this form of transaction provides an adequate tool for entrepreneurs, family companies and private equity funds to increase the return from invested capital.

Locked-box process

In the context of a sale of a business, a purchaser is typically interested in ensuring that the assets of the target on which the determination of the purchase price is based will still exist at the completion of the transaction, or, in case those assets no longer exist, that the agreed purchase price will be adjusted accordingly after the completion of the transaction.

In view of this, different purchase price adjustment mechanisms have been developed in practice. Typically, the parties agree on a preliminary purchase price which is, as per completion date, adjusted based on interim financial statements drawn up as per such date. The parameters relevant for the adjustment are balance-oriented and encompass net cash/debt, net working capital or even the entire balance sheet (net equity). Other parameters such as the amount of assets under management are often seen in the sale of banks or asset managers.

Purchase price adjustment mechanisms are often disadvantageous for the seller. The purchaser most often controls the adjustment procedure since the interim financial statements that are decisive for the adjustment amounts are typically drawn up by the purchaser. The seller is therefore on the defence if it wants to challenge the adjustment amount proposed by the purchaser. Further, the seller cannot dispose of the entire purchase price in case the parties have agreed on a purchase price adjustment as it is the seller who may need to repay part of the purchase price after the completion of the transaction if the purchase price is reduced as a result of the adjustment. Finally, purchase price adjustment provisions often result in long and costly expert procedures to determine the adjustment amount.

In view of theses disadvantages, the so-called locked-box mechanism was developed predominantly in English M&A practice. This mechanism's use reached a real height in the distinctive sellers' market which preceded the current financial crisis. Locked-box clauses were particularly widespread in auctions and in transactions in which private equity sellers were involved; it should also be noted that such clauses are still quite common in the current economic environment.

The locked-box mechanism is a mechanism in corporate sales and acquisitions through which the parties agree a fixed purchase price payable for the target at a certain point in time before executing the sale and purchase agreement. Such fixed purchase price is normally based on the last audited financial accounts of the target, and the purchaser ensures that between the date of the financial accounts (locked-box date) and the completion date, no value flows from the target to the seller and/or persons/entities related to the seller. In other words, the box is locked until the completion date. In effect, the purchaser takes over "economic ownership" of the target as from the locked-box date. The profits and losses made by the target after the locked-box balance sheet date will be to the benefit or detriment of the purchaser. In addition to the fixed purchase price the parties often agree an interest charge on the purchase price until completion of the transaction.

General requirements

In Swiss M&A, practice private equity sellers often successfully negotiate that a locked-box mechanism be included in the sale and purchase agreements, in which case, however, a purchaser usually requests that certain conditions are met.

One of the most important requirements for a locked-box price is the availability of audited, up-to-date financial accounts of the target, which can serve both as locked-box accounts and the basis on which the parties can agree on a fixed purchase price. As a rule of thumb, a purchaser typically requires that such accounts are not older than three months at the date of execution of the sale and purchase agreement. If the last year-end or half-year balance sheets are older than three months, it is recommended that interim balance sheets are drawn up and audited.

Another important practical point is the time needed prior to the execution of the sale and purchase agreement. A sophisticated purchaser will usually request enough time to conduct a detailed financial due diligence since there is no possibility to bring up any items which are relevant for the determination of the purchase price or adjust the purchase price after completion. As a consequence, private equity sellers need to take into account the additional time required by purchasers, and should also be prepared to deliver current sales figures on a monthly or even weekly basis which permit the purchaser to verify the calculated purchase price.

Finally, a locked-box mechanism is rather difficult to accomplish in cases where the target being sold is not a stand-alone enterprise but where carve-out actions are required prior to the transaction. In particular in turnaround/restructuring situations, it is barely possible to agree on a locked-box mechanism since it is very difficult for a purchaser to anticipate the future development and profits of the target.

Contractual provisions

The main element of the locked-box mechanism is a fixed purchase price which is not subject to any adjustment. If the transaction is not completed immediately after execution of the sale and purchase agreement it is common – although, of course, not mandatory – that an additional compensation element is agreed between the parties which reflects the anticipated future operating profits (less interest, taxes, depreciations and capital expenditures) of the target between the locked-box and the completion date. In the seller's view such element is compensation for the fact that the purchase price is not paid until completion (time value of money), and in the purchaser's view, it reflects the actual operating profits generated as from the locked-box date.

Such additional compensation element is often stipulated as a linear interest charge of the purchase price as from the locked-box until the completion date. Alternatively, it is possible to agree that the purchaser has to pay a fixed amount (eg per day) in the form of a so-called daily profit rate charge.

Anti-Leakage Provisions; Indemnification

In order to insulate the target and the purchaser against mismanagement, a purchaser will typically negotiate protections in the sale and purchase agreement in the form of so-called anti-leakage provisions, which prevent the seller from siphoning or extracting value from the target company in the run-up to completion. The only exceptions to such anti-leakage provisions are the limited permitted leakages, ie, certain actions that are explicitly allowed to be taken by the target. The realm of interests with respect to the anti-leakage provisions is similar to the one relating to conduct of business clauses, where the seller has the duty to ensure that the operations of the target company are conducted in the ordinary course of business and consistent with past practice, and that certain important actions are taken with prior written consultation or consent of the purchaser only.

The main difference between conduct of business clauses and anti-leakage clauses is that the latter are already applicable as from the locked-box date and not only as from the date of execution of the sale and purchase agreement. Anti-leakage clauses may include or prohibit the following:

  • any dividends or other distributions of profits or assets or any bonus or other payment of any nature paid or declared;
  • any payments made or agreed to be made by the target to the seller in respect of any share capital or other securities of the target being issued, redeemed, purchased or repaid, or any other return of capital;
  • any management fees, professional advisers' fees, consulting fees, monitoring fees, service fees, to be made by the target to or for the benefit of the seller;
  • waiver by the target of any debt owed to it by the seller;
  • any lien granted over the target's assets in favour of the seller; and
  • any payments made or agreed to be made by the target to the seller which payments are not at arm's length.

As an exception to the above anti-leakage clauses, the seller is likely to request that certain actions (repayment of loans, payment of transaction costs) shall be permitted (so-called permitted leakage).

If any leakage which is not a permitted leakage occurs before the completion date, the seller has to indemnify the purchaser, typically on a franc-for-franc basis.

Advantages for the seller

The main advantage for the seller is clearly the price certainty. This makes the locked-box process attractive for private equity sellers as it permits the seller to distribute the purchase price to its investors immediately after completion of the transaction without making any holdbacks.

Further, the locked-box mechanism facilitates the comparability of different offers in an auction process. The seller is in particular not requested to verify the various definitions of net debt and/or net working capital as would be the case in a purchase price adjustment scenario.

An additional advantage is that long and costly expert procedures relating to the determination of the adjustment amount can be avoided. The parties will, however, nevertheless discuss and negotiate the accuracy of specific balance sheet items since they form part of the basis for determining the fixed purchase price. The fact that such negotiations take place prior to the execution of the sale and purchase agreement fosters compromise since the parties are generally optimistic about the transaction.

The locked-box mechanism is a seller-friendly alternative to customary purchase price adjustment provisions. This locked-box mechanism is mainly used in auction processes or if the seller is a financial investor for which price certainty is key. The mechanism may be considered in sales of stand-alone targets which are structured as share deals. In order for the mechanism to be acceptable to a purchaser, up-to-date financial statements must be available and the purchaser must be permitted to conduct a detailed financial due diligence.

In any transaction, the sale and purchase agreement is the result of key commercial and pricing negotiations. The financial aspects of such sale and purchase agreement are key to ensure that the purchaser is buying, and the seller is selling, what they expect, for the price they expect and without undue residual risks. All this can be reached not only through traditional purchase price adjustments, but also through a locked-box, if well-considered by the seller and the purchaser. Hence, even if the locked-box mechanism was created during the times of a sellers' market, such mechanism will, in our view, also persist in a changed business environment due to its advantages and because of its simplicity.

Leveraged recapitalisation

The second part of this article will discuss some issues relating to leveraged recapitalisations.

The following examples shall show some situations where a leveraged recapitalisation transaction can be used to offer a suitable solution for the involved parties:

An entrepreneur owns 100% of a company that generates an EBITDA of CHF5 million. The company does not have any debt or liquid funds. The entrepreneur is 55 years old and his entire estate is invested in the company. He now wants to slow down the pace of his life; however, he feels that he is too young to step down completely and sell the company. The company has a value of CHF30 million (6x EBITDA). The entrepreneur sells the company to an acquisition vehicle, which is funded by an investor and the entrepreneur himself. This special purpose vehicle borrows CHF20 million from a bank, while CHF10 million are own funds, of which CHF6 million are from the investor and CHF4 million from the entrepreneur himself (so-called roll-over). At the end of the recap, the entrepreneur has CHF26 million in his bank account after this transaction while still holding 40% of the share capital indirectly through the acquisition vehicle.

A company is owned by 5 shareholders, who each own 20% of the share capital. Two of the shareholders are already over 70 years old and would like to leave the company. The company generates a gross profit of CHF80 million with an EBITDA of CHF12 million. The company has only one long-term bank debt of CHF5 million. The value of the company is CHF70 million. The stock of the two withdrawing shareholders is therefore worth CHF13 million each (70 million minus 5 million times 20%). With external funds of CHF36 million, the withdrawing shareholders are bought out by the remaining shareholders via a new acquisition vehicle while simultaneously funding the new company with an additional CHF10 million.

A company held by a private equity investor bought a target company for 70 million. The external debt accumulated from the LBO of CHF45 million was completely amortised over the years; however, the current market situation does not allow for an exit. The private equity investor, together with management, founded a new acquisition company with CHF40 million of equity. The company in turn borrows CHF60 million to pay the purchase price of CHF100 million. Therefore, the private equity investors receive more than the originally invested amount of equity before the final exit, without the company being sold to a third party.

The above mentioned examples evidence that a leveraged recapitalisation can be used for different purposes. However, a common point in the above examples is that the balance sheet of the respective companies shows a high equity amount on the one hand and a low debt amount on the other hand.

The interesting question is how the invested equity can be profitably returned to the investors without selling the target company definitively.

Advantages and disadvantages

The most evident advantage of a leveraged recapitalisation for the equity shareholders is the fact that they get a return on investment for their invested equity, without having to definitively sell the company.

From a strategic point of view, another advantage of the leveraged recapitalisation for equity shareholders is the possibility to realise a profit on the invested equity without having to rely on an exit. This can be very helpful, especially in the current economically challenging times.

A disadvantage may be that the company will possibly face a downgrading of its credit rating or a deterioration of credit conditions. The recap also often leads to a contractual obligation on the company to get an approval from banks for certain legal transactions or a reorganisation of the company, which might create an impediment to future transactions.

Return of investment

There are various ways of returning equity to investors under Swiss law. In practice, only the sale to an acquisition vehicle is used as (within the context of a recap) the distribution of an extraordinary, substantial dividend, the share capital reduction as well as a share buy-back are either not suitable for the intended purpose or they have negative tax consequences.

The sale of all shares to a newly incorporated acquisition vehicle, founded by all or part of the selling shareholders, is the most frequently chosen procedure within the context of a recap and in essence corresponds to a leveraged buyout with in many cases identical shareholders.

The main advantage of the sale of shares of the company compared to a dividend payment is that individuals as equity shareholders have the possibility under certain circumstances to realise a tax-free capital gain.

That being said, the tax structuring is of utmost importance in such circumstances and various tax issues have to be carefully considered as set forth below.

Risks for creditors of the company and the company itself

The decision for a recap is within the discretionary power of the executives of a company and part of financial and strategic planning. Creditors have no say as regards the raising of debt. Indeed, Swiss law does not provide any means for creditors to influence a company's decision-making process and creditors do not benefit from any legal protection as long as the company is in a healthy financial condition (ie no bankruptcy).

That being said, a recent draft amendment proposed to Swiss Company law provides that creditors are put on the same level as shareholders, ie they may be allowed to make claims against the company (even before bankruptcy) in order to obtain a repayment of undue distributions made to persons close to board members (this term may include financing banks). This may present an issue with respect to up-stream guarantees granted within the context of a sale of the company to a Newco.

This new proposed amendment clearly goes too far as it puts creditors on the same level as the shareholders and executives of a company and provides for a direct possibility for creditors to influence the company's business. As in the past, financial and strategic decision making should exclusively remain with shareholders and company's executives, and creditors should be restricted to being allowed to make only ordinary debt claims.

In the context of a leveraged recapitalisation, a company is increasingly exposed to the risk of possible excessive indebtedness, or even bankruptcy, as the company now has a lower equity and a higher debt amount in its balance sheet.

Aside from the pure financial effects, one should also bear in mind the strategic implications of a leveraged recapitalisation, since the company may lose flexibility to, for example, adjust to a quickly changing economic environment or implement a needed reorganisation of the corporate structure. The company is safe from the danger of getting in a situation of over indebtedness, only as long as the return on capital exceeds interests on debt.


As already mentioned, the tax structuring of a recap is of utmost importance. A tax-optimized option generally leads to a greater profit and benefit for equity shareholders. That being said, there are fundamental differences in tax treatments of individuals (holding shares in their private assets) and legal entities.

The following remarks are only a small part of the fiscal hurdles and are only rudimentary as there are multitude of tax options and problems to be considered.

Indirect partial liquidation

For the most part, the sale of shares of a company results in a tax-free capital gain for individuals (typically managers of the company in the case at hand), as long as the investment is part of their private assets. An indirect partial liquidation, and thus a tax payment, may result in the case where the vendor sells more than 20% of the shares out of his private capital to an acquirer who holds the shares as business assets. In case less than 20% of the shares are sold by an individual, (which is usually the case in leveraged buyout or management buyout situations as management most often has a stake of less than 20%), there are no taxes due.


The transposition theory applies if an individual sells his or her shares for a higher price than the nominal value to an acquisition vehicle that is controlled by the same individual.

Therefore it is in the interest of the individual selling its shares not to be considered as being in (shared) control of the acquisition vehicle. This may be realised by keeping the shareholding of the individual low or by contractually limiting the power of the individual shareholder (eg by virtue of a shareholders' agreement).

Participation deduction

The set of problems relating to an indirect partial liquidation or the transposition do not exist for a legal entity as equity shareholder and vendor. Consequently, a merger or a substantial dividend distribution may be performed immediately after the acquisition of the company by the acquisition vehicle.

The profits generated through selling equity are however subject to income taxes. Holding companies and mixed companies which hold a qualifying participation in another company are entitled to a proportional reduction of corporate income tax in respect of such capital gains, provided certain conditions are satisfied (some of which will actually be amended with effect as of January 1 2011).

Tax ruling

As long as individuals as well as legal entities act together as equity shareholders and vendors, there is no way around obtaining a tax ruling (which is actually common practice in Switzerland). The ruling allows an exact computation of all tax consequences and will also allow one to include such consequences in the planning process with the aim that potential additional financial burdens for individuals may be compensated by, for example, other advantages or payments or that certain tax theories such as the aforementioned transposition may be completely excluded.

As seen above, there are various reasons for a leveraged recapitalisation transaction. Subject to careful financial, legal and tax planning, and structuring, such a transaction may be very beneficial to both the shareholders and, to some extent, also the company. That being said, the consequences may also be disastrous for both creditors and employees (and the investors) if it is done in an overly aggressive manner.

About the author

Andreas Rötheli is an expert in corporate, M&A, corporate finance, and transactional real estate matters. He leads the corporate and M&A group of Lenz & Staehelin in Geneva.

Andreas Rötheli joined the firm in 1996, having studied law at the University of Geneva and New York University, and was made a partner in 2002. He is a member of the Geneva, Swiss, American and International Bar Associations, and lectures on the Masters of business law course at the University of Geneva. He is also a founding member and regular speaker at a yearly M&A conference entitled “Journée Fusions & Acquisitions”.

He speaks English, French and German.

Contact information

Andreas Rötheli
Lenz & Staehelin

Route de Chêne 30
CH-1211 Geneva 17

Tel: +41 58 450 70 00
Fax: +41 58 450 70 01

About the author

Stephan Erni is a senior associate in Lenz & Staehelin’s Zurich office. He regularly advises clients on domestic and international transactions and on corporate and commercial matters. Erni specialises in domestic and international M&A transactions, including public tender offers, and one of the main focuses of his practice is advising private equity firms in auction processes, both buy-side and sell-side.

Stephan Erni joined the firm in 2002, and has studied at the Universities of Zurich and Fribourg, and at the University of Virginia School of Law. He speaks English, German and French.

Contact information

Stephan Erni
Lenz & Staehelin

Bleicherweg 58
CH-8027 Zurich

Tel: +41 58 450 80 00
Fax: +41 58 450 80 01