Private equity activity has been – cautiously – on the rise over the past year in Belgium, in terms of fundraising and most importantly in terms of buy-out volume. Looking at buy-out and exit sizes and deal counts as well as at the particulars of individual deals, however, it is obvious that the private equity investors have not yet completely shrugged off the effects of the business climate of 2007-2009. A more optimistic mood is dawning on private equity activity in the Benelux region, but, in the post-Lehman era, private equity houses have to be more creative than ever to extract value from their investments.
Buy-outs
The typical structures of buy-outs are, to a large extent, similar to those encountered in the UK and in continental European countries. The acquisition is usually completed through one or several vehicles incorporated for that purpose (Newcos), in which the private equity sponsors hold a majority stake (while the management team of the target is invited to invest in a minority stake). In more complex deals, several levels of Newcos are used often for tax-optimisation reasons and in order to achieve structural subordination. The use of (foreign) Newcos up the chain should be reviewed from a Belgian tax perspective to secure Belgian withholding tax exemptions on shareholder debt granted to the Belgian acquisition vehicle and in view of possible exit scenarios.
Debt push-down (shifting as much as possible of the debt from the parent company to the operational level) is usually sought for tax efficiency reasons and to strengthen the banks' direct claim against the operational assets, but is constrained by financial assistance rules and compliance with corporate interests.
Auction processes remain the norm, even for relatively small investments. After signing a confidentiality agreement, the potential bidders receive an information memorandum and, later on, are given access to a data room (usually an electronic one). Depending on the size of the company put up for sale, the auction is run by domestic financial advisers or by international investment banks, which influences also the level of detail in the teaser and in the information memorandum. As a consequence of debt being more difficult to raise in current market circumstances, private equity sponsors and banks tend to put more emphasis on robust due diligence reports, departing from the previously traditional exception-only approach to a more extensive one, knowing that the due diligence reports (and the reputation of the external advisers who prepared them) are an important element in the banks' credit committee approval process.
Legal documentation
The legal documentation for the acquisition typically consists of:
acquisition agreement or share purchase agreement (SPA) between the seller(s) and Newco, which includes warranties and indemnities;
shareholders' agreement relating to the management of and the transfer of shares in Newco, entered into between the private equity sponsor(s) and the management team;
articles of association of Newco; and
equity term sheet, which describes the conditions under which the management team will be asked to invest (ratchet, good leaver/bad leaver mechanisms affecting call and put options, and so on).
The structure of a Belgian-law governed SPA is in many respects similar to US- or UK-style SPAs. Current market practices are emerging in respect of SPAs in the context of buy-outs.
In the predominantly buyer-friendly environment of the first half of last decade, pricing mechanisms granting more certainty to sellers had developed. More specifically, so-called locked-box mechanisms were close to becoming the norm in buy-outs. It is a mechanism in corporate acquisitions through which the parties agree a price, on a cash-free, debt-free basis, payable for the target company at a certain point in time in advance of signing the SPA so that the target's price is essentially locked as at that agreed date. The buyer is protected by anti-leakage provisions, whereby the seller undertakes not to extract value from the business between the locked-box date and the completion date. Even during the lean years of 2007-2009, the locked-box mechanism did not disappear from acquisition agreements, and still remains a commonly encountered alternative to the more traditional mechanism whereby the price is adjusted on the basis of completion accounts, to reflect the variations of value up to the date of completion.
In order to reduce the size of the equity component of the investment and the burden of the debt, buyers are usually keen to defer a portion of the consideration, which can act as an incentive for the seller to contribute to the achievement of certain financial targets (earn-out) or as a protection against the seller's insolvency in case of a successful warranty claim. This usually does not apply to secondary buy-outs in view of the seller's need to repatriate value to its own investors.
In larger buy-outs, when the seller did not have the opportunity to gauge the market price of the target company through an auction process (for example, when the seller was rushed to sell the target within a tight time frame) and is concerned that it may have undersold the business, it sometimes seeks a so-called anti-embarrassment clause, which gives it the right to claim a proportion of the proceeds of any subsequent uplift in the value of the business within a specified period after completion.
When the period between signing of the acquisition agreement and completion of the transaction is expected to be a long one, buyers sometimes seek a material adverse change clause, which allows them to pull out of the transaction if particularly serious events occur to the business.
Shareholders' agreements usually set out (i) the contractual rules for the governance of Newco, and – indirectly – of the target company; (ii) the allocation of profits; and (iii) conditions affecting the transfer of the shares in Newco.
When Belgian law governs the shareholders' agreement, which is usually the case when Newco is a Belgian company, it is important to bear in mind the following:
Groups of shareholders can agree on a representation on the board of directors of Newco but, in this case, in order to ensure that the shareholders' meeting is still in a position to choose the directors, each group of shareholders must present more than one candidate for each position of director.
More generally, voting arrangements (namely, the undertaking to vote in a certain way, such as the undertaking to elect the directors from among the candidates presented by a group of shareholders) must be limited in time – in the absence of further precision in the law, 10 to 20 years is usually deemed acceptable, depending on the circumstances – and justified by the corporate interest of the company.
Put and call options feature prominently in shareholders' agreements, but should not conflict with the prohibition of agreements whereby one shareholder is excluded from participating in the company's losses (so-called leonine agreements). Case-law helps interpret this general principle and points to the true purpose and intentions of the parties at the time of signing of the agreement.
Lock-up clauses must be limited in time (five to 10 years is usually deemed acceptable, depending on the circumstances) and justified by the corporate interest of the company.
Debt push-down, corporate interest and financial assistance
The acquirer of the company usually seeks to move the debt from the acquisition vehicle to the operational subsidiaries in order to create more robust direct claims for the banks and to allow those subsidiaries to offset their taxable profits against the interest paid, which constitutes tax-deductible expenses. Debt push-downs thus address some of the issues raised by limitations on upstream guarantees from operational group entities. While such upstream guarantees are generally regarded as being valid and enforceable, it is common practice to provide for certain forms of guarantee limitation in the financing documentation as directors of the relevant subsidiaries will generally want to satisfy themselves of a certain balance between the guarantee obligations and the benefit derived by the relevant subsidiary.
More specifically, the main legal constraints to be considered are:
from the perspective of the subsidiary that becomes a borrower, such borrowing and any guarantee obligations should pass the corporate benefits test: more particularly, the board should be able to justify that the borrowing is in the interest of the company (taking into account the benefit that the company can draw from being a member of the buyer's group) and that the burden of the debt service or guarantee obligations should be manageable for the company, in view of its forecasted cash-flows and the overall risk of the guarantees ever being called upon;
the debt push-down should not breach the prohibition of financial assistance, that is the granting of a loan or of a security by the target company with a view to (facilitating) the acquisition of its shares by the buyer; this prohibition affects the acquisition of shares in the most common types of Belgian company, such as the limited company (société anonyme/naamloze vennootschap or SA/NV) and the private limited company (société à responsabilité limitée/besloten vennootschap met beperkte aansprakelijkheid or SPRL/BVBA).
Since January 1 2009, financial assistance has been permitted provided that certain conditions are met, which are to a large extent comparable to the former English whitewash procedure (Article 629, §2, Companies Code):
the board of director takes responsibility for the granting of financial assistance, which must be at fair market conditions (including as regards interest paid to the company and securities granted to it) and after due consideration of the financial situation of each party;
the shareholders' meeting must have given its prior approval to the granting of financial assistance with a special majority, on the basis of a report prepared by the board of directors. (This report includes sensitive information, such as the price of the acquisition, the risks attached to the financial assistance for the liquidity and solvency of the target, and must be published in the Belgian State Gazette.);
the financial assistance must be paid out of distributable profits. When such assistance consists in a security, then the amount taken into account is the principal amount of the loan secured by the target company; and
a non-distributable reserve must be created on the liabilities side of the balance sheet for the amount of the financial assistance for as long as the assistance remains in place.
In practice, however, the new Belgian whitewash procedure is used only in exceptional circumstances, given in particular the disclosure obligations and the requirement to have distributable profits and to create a non-distributable reserve in an amount equal to that of the financial assistance. For this reason, it seems that parties are more inclined to use one of the techniques set out below.
A rather radical debt push-down can be achieved through a tax-free merger of the acquisition vehicle which took the acquisition financing and the (operational) target company.
Due to uncertainties on the tax consequences of such operation, however, debt push-down mergers have become infrequent on the Belgian market, except in specific circumstances requiring heavy structuring.
Other, more commonly encountered ways of performing the debt push-down include:
under the credit facility agreement, a clear distinction is drawn between two tranches of the loan;
debt-funded distribution of equity out of the target company and its subsidiaries through dividends, share capital reductions or a share buyback by the target to the buyer once it has become its parent company;
payment by the target company of management fees and/or profit distribution to directors;
the transfer of functions by the target company or its subsidiaries to the acquisition vehicle;
the transfer of income generating assets or activities by the target company or its subsidiaries to the acquisition vehicle, which can be supported by financial assistance from the target company;
financial assistance by a subsidiary of the target company; and
acquisition of the most profitable target subsidiary by Newco and draw-down of debt by such subsidiary, whereupon the newly-acquired subsidiary acquires the target group's top holding company.
For all of the above, the particularities of the proposed transaction should be carefully examined in order to assess its compatibility with the law.
There is a clear tendency within the Belgian tax authorities to challenge tax-aggressive (intra-group) operations including debt push-down techniques especially where they consist of arrangements without valid business motives. Contemplated debt push-downs should be tested against possible attempts to reject tax-deductibility of interest payments or other tax benefits. The way in which (contemplated) debt push-downs are translated into the transaction documents and how they are subsequently implemented, including their timing, may prove paramount in this respect.
Leveraged financing
Financing largely follows the evolution in the London and continental European markets. LMA-type financing documents have become the norm, rather than the exception. Depending on the quantum of the bank debt and the size of the syndicate, the finance documents will be governed by English or Belgian law. The differences between the two are small.
Since the crisis, there has been an increased focus on lending from relationship banks, and syndicates have often been formed on a club-deal basis. Given the more uncertain and jittery markets, sponsors and banks are increasingly focusing on mandate letters and long-form term sheets early on in the process, as well as on the possible syndication to other key relationships. Bank documentation increasingly contains so-called certain funds provisions, and sponsors will be keen to satisfy as many of the conditions precedent to funding on signing in order to ensure the attractiveness of their bid.
Generally, leverage has come down, and security as well as intercreditor arrangements have received more attention. This has also been influenced by recent experience in certain restructurings and the new so-called Belgian Chapter 11 law on continuity of enterprises.
In terms of documentation, some of the currently most debated issues are transferability, Basel III costs and structural adjustments.
The ability to amend documentation (and to re-tranche and increase or restructure existing facilities) without having to resort to an all lenders' consent is also on the rise. These structural adjustment clauses are often heavily negotiated and tailor-made. Likewise, change-of-control provisions and definitions have become more structured in view of potential exits.
Whereas borrower consent to transfers was prevalent before the financial crisis, lenders and their credit committees are increasingly requiring (unfettered) ability to transfer loan participations.
This calls for a debt funding structure that offers a Belgian interest withholding tax exemption not only to the initial lending syndicate but also to investors stepping in after syndication, such as hedge funds and CLO vehicles. This can sometimes be achieved by routing (senior) debt through a Belgian, Luxembourg or Dutch finance vehicle, which will often be a target group company. In such case the lenders will have to accept the consequences of indirect lending including in terms of security package. This requires careful drafting and should remain an attention point throughout implementation.
Adequate intra-group debt structuring (between the finance company and the ultimate borrower) will further reduce the risk that the Belgian tax authorities can disregard the intermediary structure to deny the applicable Belgian withholding tax exemption.
As an alternative to loan facilities, issuances of X/N Bonds (bonds settled through the book-entry clearance and settlement system operated by the National Bank of Belgium) have also been seen, the terms of which can be geared to traditional LMA clauses to accommodate traditional lenders.
Though tax efficient, direct X/N Bond issuances remain rather exceptional; for many secondary market dealers X/N Bonds (especially the trading mechanism) remain non-standard and are therefore considered less liquid than LMA-type facility agreements.
The future: partnering with industrial players?
In order to deal with the difficult economic environment and the scarcity of external means of financing, many industrial and financial groups have had to restructure their debt and sometimes dispose of non-key assets in order to recreate liquidity. As a result, many corporates are refocusing on their core business or core geographies and are looking to sell some of their non-essential assets at the best possible price.
Private equity investors have taken advantage of this environment to invest in the assets sold by corporates. Such opportunities can take the shape of a straightforward spin-off followed by a primary buy-out sponsored by the private equity house. It can also involve long-term cooperation between the industrial group and the private equity investor, such as an investment by the private equity house in a (majority or minority) stake in the spun-off division, while the industrial group still holds the remainder of the equity. The two parties create a sort of joint venture through this partial divestment. In that type of configuration, the key concern of the private equity house, irrespective of the size of its stake, is often to be put in the driving seat in order to be able to turn around the company and exit over time.
Shareholders' agreements between the industrial player and the private equity investor tend to be more complex, since the interests of both parties are aligned only to a certain extent.
While the industrial partner may be concerned to be seen by the market as the company that sold at the worst moment at a low price, the private equity investor wishes to realise a profit at exit and may not mind sharing this profit with the corporate if it is a condition to doing the deal. Tag-along and drag-along mechanisms ensure that the industrial partner will participate in the upside generated by the private equity investor at the time of exit.
The two partners will also usually contemplate the possibility of an IPO exit and will agree on the process and on the proportion of equity sold at the time of the IPO.
Another possibility is a buy-back right granted to the corporate: the corporate has a call option to buy back the shares of its private equity partner, for example to cater for the future situation where the corporate has solved its temporary liquidity issues.
The balance of powers between the industrial partner and the private equity investor is usually a focal point in negotiations. Both parties are keen to secure representation on the board, and the minority shareholder usually insists on defining certain reserved matters, which must be submitted either to the shareholders' meeting or to the board, and on which the minority shareholder benefits from a specific protection. An example of such sensitive issues is the brand of the corporate group. In order to capitalise on the existing goodwill of the target, the private equity investor will often insist on keeping the brand previously used by the spun-off division. The industrial partner, on the other hand, will be wary of reputational damage. Since it is in both parties' interest not to jeopardise the brand, this is often resolved through reserved matters, where neither partner can impose a decision that would be detrimental to the value of the brand.
There may be differences in the respective expectations of appropriate funding and indebtedness between the two partners which need to be addressed as early as possible in the shareholders' agreement.
Exits
The reduced availability of debt financing led to depressed valuations of portfolio companies, and prompted private equity investors to grow their portfolio companies through add-on acquisitions and to restructure their debt, rather than attempt trade sales and secondary buy-outs. A surge in negotiated exits occurred in 2010 and 2011.
Given the instability of the capital markets since 2008, IPO exits have been virtually non-existent. IPOs should, however, not be discounted as they constitute one of the preferred exit routes for many private equity players. Some peculiarities should be considered by the portfolio company and the private equity sponsor in the drafting of the listing prospectus. The Belgian Financial Services and Markets Authority has shown a willingness to impose a high standard of disclosure in the prospectus on sensitive topics such as the use of proceeds by the financial sponsor and the debt structure of the issuer. In the interest of the credibility of the IPO, the private equity sponsor and the management often keep a minority stake in the listed company. Such stake is affected by a lock-up agreement entered into with the underwriters that extends for a given period (perhaps six months) after flotation.
When private equity houses have invested in a listed company, their profit-maximisation strategy may dictate that they take the company private before turning it around and selling it through a trade sale or a secondary buy-out.
The authors thank Nikolaas Van Robbroeck, managing associate in the Brussels tax practice for his contribution to this article.
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About the author Arnaud Coibion specialises primarily in M&A, private equity and corporate finance transactions. He has been practising at Linklaters since 1999 (in Brussels and in London) and became a partner in 2009. He has had a lead role in many buy-outs and other M&A transactions, including joint ventures, mostly with a cross-border dimension. Coibion is a member of the Brussels bar and a solicitor of the Senior Courts of England and Wales. He graduated from the University of Louvain and holds an LLM from Cambridge University. He is the author of several contributions on company law and financial law, including a book on shareholders’ agreements in a private equity context, and is also a lecturer in company law and M&A at the Louvain School of Management, University of Louvain. |
Contact information Arnaud Coibion Linklaters Rue Brederode 13 Brussels 1000 Belgium T: +32 2 501 94 11 F: +32 2 501 94 94 |
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About the author David Ballegeer has been a partner in the capital markets and banking practice of Linklaters in Brussels since 2009. He specialises in bank financing, as well as equity and debt capital markets transactions. Ballegeer is a member of the Brussels bar and a solicitor of the Senior Courts of England and Wales. He graduated from the University of Ghent and holds degrees from the University of Louvain in economic sciences and tax law and an LLM from Harvard Law School. He is the author of several contributions on financial law and a regular speaker on those topics. |
Contact information David Ballegeer Linklaters Rue Brederode 13 Brussels 1000 Belgium T: +32 2 501 94 11 F: +32 2 501 94 94 |
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About the author Henk Vanhulle has been a partner since 1995 and is currently Linklaters’ global tax practice head. He specialises in domestic and international corporate tax, tax litigation and employee share schemes. Vanhulle graduated from the University of Louvain and holds an LLM from the University of Illinois. |
Contact information Henk Vanhulle Linklaters Rue Brederode 13 Brussels 1000 Belgium T: +32 2 501 94 11 F: +32 2 501 94 94 |