Author: | Published: 4 Jan 2001
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In the last 10 years, the phenomenon of private equity has assumed previously unknown dimensions and importance for the Italian economy. According to this trend, the use of structures other than the pure and simple acquisition of the target's share capital has become more widespread. The most commonly employed of these other structures is a merger with the target company, the acquisition of the target company's business as a going concern, the capital increase reserved to third parties and the contribution in kind of a branch of the business.

The legislator has also followed a similar trend first with D.Lgs 544/92, which implemented the directive 90/434/Cee on mergers and demergers, and later with reorganization of the regulations on taxes applicable to company restructuring operations.

The question of how the most fitting route is chosen for the acquisition of a target company is twofold. Firstly, we will examine the general legal outlines of the main structures, highlighting the principal advantages and disadvantages of each, and secondly, alongside such considerations, we will examine the way in which the choice is made in relation to the characteristics of the purchaser and of the target company.

The options

The choice of instrument for an acquisition takes into account legal, fiscal and financial profiles. From such a perspective, the most significant and problematic aspects, in order to sketch the principal advantages and disadvantages of each option, have to be evaluated from the purchaser's and the vendor's respective viewpoints.

The acquisition of company interests

The acquisition of the target company capital stock has been the most customary legal instrument in private equity transactions in Italy so far, and presents a series of advantages and disadvantages to the purchaser and the vendor.

There is an advantage common to both the vendor and the purchaser in its simplicity of form: as the acquisition of company interests is realized essentially through the conclusion of a deed of sale and through its relevant executive formalities, the procedural fulfilments required by other operations (such as the merger, or transfer of a business in its various forms) are not necessary.

Advantages and disadvantages to the financial investor

Other than the absence of time-consuming processes and fulfilments, the acquisition of shares presents the purchaser with the advantage of a simpler and more precise identification of what is being acquired, without having to provide its description. However, the use of this instrument also entails the purchaser taking over all the liabilities of the acquired company; a disadvantage which can be eased with preliminary due diligence. This allows an enquiry into the risks connected to the operation, and the subsequent drafting of clauses of guarantee, aiming at protecting the purchaser from any hidden, and supervening liabilities.

The acquisition of interests presents disadvantages for financial investors both of a fiscal and financial nature.

From a financial point of view, if the purchaser is the customary holding company who resorts to debt, there is no consistency between negative cashflow for interests and capital reimbursement, which remain under the charge of the holding company, and the positive cashflow normally generated by the target company business.

From a fiscal point of view, this operation would not have an optimum result, since it is not possible to compensate the financial charges for interests with the profits of the typical activity. In addition, the goodwill, or rather the difference between the price paid for the acquisition and the net asset value of the target company, does not represent an amortization asset from a tax viewpoint.

All of these disadvantages could be overcome by opting for a later merger between the purchasing company and the target company.

Yet a successive merger, which would allow the leveraged buyout (LBO) financial technique to be used in the acquisition of the interest, would not detract from the problem recently brought back to general attention, by the decision of Section V of the Italian Supreme Court. It concerns the problem of the legality of such an outline.

It must be borne in mind that this case stated the possibility of illegality of the leveraged buyout, in light of the financial assistance prohibition of article 2358 c.c., motivating a criminal decision related to a different subject (specifically, fraudulent bankruptcy), and therefore not suitable to build a binding precedent as regards civil matters. This means that it is necessary to continue referring to the previous doctrine and jurisprudence (particularly Milan Tribunal of May 13 1999) which does not consider the LBO to be in fraud of article 2358c.c. in se, but illicit only when it is used to get round the prohibition of financial assistance.

Given this margin of uncertainty as to the legality of the LBO, the adviser who verifies the legitimacy of the operation would have to put all suitable precautions into it, and emphasize the observance of article 2358 c.c. even in the knowledge that, until an unambiguous legal direction has been decided, the technique might be censored by the Italian Courts.

Advantages and disadvantages for the vendor

Taken from the vendor's point of view, which is, normally, fundamental in order to succeed in the acquisition, it must be observed that acquisition is comparatively more advantageous, as the sum of money obtained would be immediately available.

Another advantage to the vendor is the more favourable fiscal treatment with respect to the transfer of the business, if subject to capital gains tax.

One disadvantage for the vendor is the uncertainty as to the net amount of the consideration obtained, as it is common practice to reimburse the purchaser for any hidden or supervening liabilities in the company's assets, based on the usual guarantee clauses.

The purchase of a business

The idea of purchasing a business as a going concern offers its simplicity as an advantage, since no particular fulfilment obligations are provided for, with the exception of article 47 of law 428/90, which provides for a mandatory notice of the transfer to the union representation.

One further burden could be the preparation of the sworn expertise, according to article 2343, if the vendor decides to reinvest part of the sum obtained through the transfer of the business, or if the acquisition takes place through a newly established company.

Advantages and disadvantages to the financial investor

Among the advantages offered to the financial investor by the acquisition of a business, compared with the acquisition of interests in a target company, is the optimisation of the financial and fiscal aspects of the operation. There is also the possibility of realizing the leveraged buyout without exposing oneself to the risks of illegality of the instrument. In fact, in the case in point, there is not the inconvenience of the discrepancy between the party suffering the costs, and the party benefiting from the revenues, or the party who bears the financial charges compared with the one enjoying profits. Furthermore, in this type of transaction, goodwill is an amortizable cost from a tax viewpoint.

Another advantage to the purchaser is the limited liability of a civil nature in purchasing a business, because it is limited to that which expressly results from the accounts, according to article 2560 c.c.

Equally limited is the fiscal liability, because if the purchaser has the same responsibility as the vendor for tax debts of the concern, with the effect that the tax authority could act against the purchaser, the responsibility concerns only tax charges due by the concern for the financial year in which the transfer took place and for the two years before. It is also limited to the debt resulting from the records of the competent revenue office, at the date of the transfer. The tax authority is then obliged to release a certificate to whoever requests it, describing any tax issue still pending: this certificate would limit the purchaser's liability to its content.

A further advantage lies in the fact that the purchaser has the chance to limit the acquisition to a single branch of the company if the company has business activities, or if there are assets (like properties) which are not strategic for the financial investor. This does not happen in the case of the acquisition of total interests or controlling interests.

Finally, the purchaser's position as regards working relationships is dealt with by article 2112 c.c, as modified by law 428/90, which establishes that the responsibility for all the worker's credits lies jointly with the purchaser and seller.

Advantages and disadvantages to the vendor

In general practice, the vendor does not so much enjoy the option of transferring the business, as there is no chance to optimise the fiscal aspects of the operation. Despite the fiscal discipline being equal to the transfer of interests through the forecast of substitutive taxes, and despite the benefit derived from the deferred taxation of the capital gain, compared with the immediate tax on the profits realized through the sale of interests, the business transfer presents too little flexibility. This turns into a higher price if the financial investor insists in pursuing this option, since it realizes an LBO which cannot be censored under a legal viewpoint.

The capital increase

Capital increase, with exclusion of the optional right provided for by article 2441 c.c, is another of the legal outlines by which the acquisition of a company is approached by a financial investor. In this case, the purchaser will subscribe to the capital increase resolved by the target company, in this way assuming the capacity of a shareholder, and thus – depending upon the percentage of its ownership - a degree of control.

Advantages and disadvantages to the purchaser

Among the main reasons why a financial investor may prefer to invest through a capital increase, is the use of financial disbursement to capitalize the target company, rather than to liquidate the members who thin down their involvement. From an economic point of view, this method of acquiring the target company is extremely efficient for the purchaser, who, in his capacity as a member, and in proportional relation to his shareholding, takes advantage of the amount paid under subscription.

On the other hand, a disadvantage connected to this type of operation is the need to negotiate and stipulate very detailed shareholders' agreements, which customarily encompass the following: the relinquishment of the option right to a capital increase and the obligation to rule on capital increase with the exclusion of the same option right, the governance of the company, the circulation of the interests, and – last but not least – a way out for the financial investor.

Another inconvenience of this operation concerns the method for adjusting the consideration (i.e. the share premium), which cannot be postponed, as is usually the case when buying company interests, under the so-called adjustment clauses.

Disadvantages to the vendor

It is obvious that this way of dismissing interests is not particularly advantageous to the vendor who, based on the prospective of larger future gain, does not obtain the immediate amount which would be realized through the sale of company interests.

Contribution in kind

The contribution in kind of a target business (or of the target branch of a business) into an existing or newly established company owned by a financial investor, implies the capital increase of the receiving company, and the emission of shares to be attributed to the conferring company.

Each time one opts to transfer a business, one must evaluate which is more convenient. With the purchase, or receiving the contribution of that business, it is necessary to bear in mind that, as regards legal fulfilment obligations, the contribution of the business and the relevant capital increase is more cumbersome with respect to the purchase, most of all because of the need to compile the expertise according to article 2343 c.c.

However, as regards labour law aspects, the burdens are exactly the same, in as much as the in-company conferral of a separate branch of the business is officially regarded as the transfer of a business, according to article 2112 c.c. As a consequence, the communication procedure to the union representatives must be carried out.

The fiscal cost of the operation will be lower in the case of a contribution, where there is less concern over the registration tax (levied at 1%), and where the operation can be rendered fiscally neutral, so long as the receiver registers the business with the same values as the conferring party's accounts.

Advantages and disadvantages to the receiving purchaser

As regards the liability for hidden or supervening liabilities, the receiving company's responsibility is limited to that indicated in the contribution act. Furthermore, the receiving company could benefit, by analogy, from the limits of responsibility provided for by the transfer of the business.

The selection of an acquisition instrument

Considerations as to the nature of the purchaser

Very often, the choice of the instrument to realize an acquisition varies according to the activity of the purchasing company; whether it is of an industrial (or operational), commercial or financial investment nature.

Where the purchaser is a financial investor, operations allowing the use of leveraged buyout techniques are generally preferred, since they reduce the chance of capital being permanently tied up, and so produce the largest I.R.R. on the investment. Therefore, the financial purchaser, as a rule, will opt for share purchase, and subsequent merger, or the acquisition of the business, or the creation of a newco through the contribution in kind of the target's business as a going concern.

The use of an LBO forces the legal adviser to confront the problem of its legality, and to try to structure operations which do not work against the financial assistance prohibition of article 2358 c.c.

Equally as acceptable to the financial purchaser are operations of capital increase, which allow acquisition through financial disbursement. This enriches the capital of the acquired company, and the financial disbursement therefore remains 'within the business'.

The so-called industrial purchaser, who will for the large part aim to enlarge and/ or diversify its own productive activities, or assume control of a certain activity, will prefer 'sheet versus sheet' operations. These allow for the avoidance of financial disbursement and therefore debt, making a merger preferable, or the contribution in kind of the target business into its own company.

Considerations on the nature of the target

The nature of the target suggests a series of considerations which, combined with what has gone before, and relevant to the nature of the purchaser, should direct the advisers in defining the structure of the operation.

And in fact, the financial side of the target must be taken into account. If, for example, the company was heavily in debt and its revenues were insufficient to allow it to confront this, it would be necessary to choose the structure which would re-establish balance, introducing liquidity where there was debt. In this case, the following options would be equally as valid: the increase of capital, the purchase of a business or the incorporation of an adequately capitalized vehicle and the contribution of the indebted business into the liquid receiving party.

Conversely, if the target company experiences major positive cashflows, it can be useful to adopt a structure that exploits the financial leverage. In this case the following options are practical: the purchase of a business, merger, and every other type of operation that allows the assets and liabilities of the target company and those of the purchaser to be unified.

Final considerations

The result is that the key points for selecting the best course of action are: the analysis of the target company by the financial investor, the identification of the legal options available for the realization of the investor's objectives under the guidance of a legal adviser, and the evaluation of the fiscal implications for each option, with the aim of optimising the chosen course of action.

Negri-Clementi, Toffoletto, Montironi & Soci

Via Monte Napoleone 12

Tel: 39 02 541641
Fax: 39 02 54 164500