Lexology GTDT Market Intelligence provides a unique perspective on evolving legal and regulatory landscapes. This interview is taken from the Private Equity volume featuring discussion and analysis of emerging trends and hot topics within key jurisdictions worldwide.
1 What trends are you seeing in overall activity levels for private equity buyouts and investments in your jurisdiction during the past year or so?
Regarding buyouts, we continue to see some highly competitive bids with aggressive buyers trying to pre-empt, and in some cases succeeding in pre-empting the process. By offering attractive management packages including significant leverage, investment funds are able to compete successfully with strategic buyers. In addition, the number of initial public offerings (IPOs) has declined significantly. Major IPOs have been postponed and large sales, which were initially structured as IPOs, such as SMCP, have been completed with private equity funds.
In large-scale transactions, bidders now enter into consortium agreements because of the size of the transactions. For mid-scale and small-scale transactions, private equity funds are looking for new investment opportunities, such as spin-offs from strategic buyers.
Another trend is the increase in the number of players financing leveraged buyouts (LBOs) thus entailing more competition between lenders, including unitranche funds. In addition, we are also seeing new players in the equity and LBO space, such as highly specialised US funds or family offices.
Stock market volatility and stock market valuations force public companies to be continuously reacting to markets turbulences and affect their ability to build mid- or long-term strategies, while the groups under LBO may implement their strategy over a four to five-year period. This may explain the growing attractiveness of private equity.
2 Looking at types of investments and transactions, are private equity firms primarily pursuing straight buyouts, or are other opportunities, such as minority-stake investments, partnerships or add-on acquisitions, also being explored?
We recently closed a LBO transaction for one of our clients. The week after the closing, we were already working on a build-up operation. External growth is still the privilege route to foster the growth of groups under LBO. As such, the ability of the investment fund to finance such growth is closely considered by management during the process.
In addition, owing to the competitive nature of the bidding process, some funds choose to take an alternative path and opt for a minority stake participation, which has proved successful on several occasions. This option is being increasingly considered by private equity funds that are seeking investment opportunities in fast-growing companies.
Newcomers and excess of cash result in highly competitive deals and leave numbers of bidders by the wayside. Making room for an unfortunate bidder in the final structuring is more often considered by funds.
3 What were the recent keynote deals? And what made them stand out?
The market has been very seller-friendly this year. Bidders have had to be flexible to meet sellers’ demands in terms of price and certainty of completion. In several recent bid processes, the bidders were successful because they managed to secure a fully financed offer in a short amount of time, with equity commitment and debt commitment letters that the sellers considered satisfactory. In this competitive environment, negotiating the management package to include reinforced governance rights and incentive instruments, has been a key aspect of the approach early in the process.
4 Does private equity M&A tend to be cross-border? What are some of the typical challenges legal advisers in your jurisdiction face in a multi-jurisdictional deal? How are those challenges evolving?
M&A targets generally have multi-jurisdictional operations. This requires close coordination with the local counsel at the due diligence and negotiation stage to understand and address local regulatory or tax issues. In competitive bid processes, it is crucial to have reliable local counsel to identify and understand the key concerns, and report and explain them to the client so as to take them into account the investment decision.
5 What are some of the current trends in financing for private equity transactions? Have there been any notable developments in the availability or the terms of debt financing for buyers over the past year or so?
In our view, the main trends can be summarised as follows:
- leveraged loans and high-yield bonds are in decline;
- bank lenders remain under story pressure from their regulatory environment;
- French and European debt funds have continued to develop strongly, benefiting from a favourable regulatory environment;
- there has been a convergence of terms between US and European term loans and high-yield bonds (ie, loosening of financial covenants and lender protection, and increase of flexibility for borrowers); in general, the US-style provisions appear more and more frequently in European credit agreements;
- covenant-lite terms have become available in European deals; and
- strong development of unitranche solutions and number of players.
6 How has the legal, regulatory and policy landscape changed during the past few years in your jurisdiction?
Further to the presidential elections in 2017, the new government introduced a series of reforms in favour of investment that led to, inter alia:
- a progressive reduction of the standard rate of corporate income tax from 33.33 per cent to 25 per cent by 2022;
- a significant change in the taxation of individuals with respect to capital gains, dividends and interest, which are now all taxed at a 30 per cent flat tax rate;
- a new reform of the tax and social security contributions regime of the free shares; and
- the implementation of a regime of a trust to enable monitoring security interests more efficiently in syndicated financings.
More recently, the French Finance Bill for 2019 has implemented a major reform of the French rules governing the deduction of financial charges, following the obligation to comply with the European standards set by the Anti-Tax Avoidance Directive. Therefore, for fiscal years opened as from 1 January 2019, the tax deduction of net financial charges (ie, excess of deductible of financial charges – after the application of certain limitations – over taxable financial income and other assimilated income) is essentially capped to the higher of €3 million or 30 per cent of a ‘tax EBITDA’.
7 What are the current attitudes towards private equity among policymakers and the public? Does shareholder activism play a significant role in your jurisdiction?
We believe the perception of private equity funds has improved among policymakers and the public. Large French companies have been sold to private equity funds over the past few years and these funds have been instrumental in initiating a new development strategy, including providing new money and leading the renegotiation of debt in distressed M&A deals.
Shareholder activism plays a growing role in the public equity space, for underperforming public companies and squeeze-out attempts. Under French securities law, in order to complete a squeeze out following a tender offer, minority shareholders must not hold more than 5 per cent of the share capital and voting rights following the offer. In several public-to-private deals, funds have acquired a minority shareholding participation following the announcement of the offer to impede the squeeze out and to force the bidder to offer a higher price.
8 What levels of exit activity have you been seeing? Which exit route is the most common? Which exits have caught your eye recently, and why?
There is a strong appetite for acquisitions through LBOs. Private equity funds have raised significant amounts of capital to be invested and, as a result, secondary and tertiary LBOs are very frequent. This is particularly the case for mid- and small-cap companies as private equity funds have the financial capacity to conduct the deal alone, and the company’s management tends to have a strong preference for a new private investor to enhance the development of the company and generate significant value over a four- to five-year period.
9 Looking at funds and fundraising, does the market currently favour investors or sponsors? What are fundraising levels like now relative to the past few years?
Fundraising activity in France has been very dynamic over the past two years. In our experience, successful asset managers (ie, managers with a good track record) do not have any difficulty when raising capital and their funds are usually oversubscribed. The process for such managers is quick and certain funds are now able to finalise their fundraising with a single closing instead of having a one- or two-year subscription period. In this respect, managers are currently favoured on the French market (it being understood that new managers, or managers with a poor track record, may have trouble successfully raising a new fund). However, limited partners have more leverage nowadays with respect to the fees charged by the managers. Most institutional investors have now formalised their investment process and call upon legal advisers to negotiate their investment.
10 Talk us through a typical fundraising. What are the timelines, structures and the key contractual points? What are the most significant legal issues specific to your jurisdiction?
The timeline of fundraising in France depends on the manager. French private equity funds with total commitments in excess of €1 billion have recently been raised in less than four months over a single closing. However, some fundraisings can last for up to 12 or 18 months, even in the current favourable market conditions. In the past, private equity funds have been structured as professional private equity funds or as specialised professional funds, which are two forms of French regulated funds. Now, more funds are structured as free partnership companies, a form of limited partnership established in 2015 with legal personality and the objective, among others, to attract foreign investors and offer the same tax advantages as the professional private equity funds.
The key contractual points discussed in France are linked to fault or no-fault divorce clauses, key man clauses, fees, costs and expenses, and transparency-related clauses (eg, reporting and valuation).
11 How closely are private equity sponsors supervised in your jurisdiction? Does this supervision impact the day-to-day business?
Private equity sponsors are rare in France, with the exception of banking or insurance companies that invest in management companies or historic shareholders in management companies. These entities are not supervised as sponsors of private equity funds, but are usually subject to their own sets of regulations. As a result, French regulations (eg, the Law on the Separation and Regulation of Banking Activities), European regulations (eg, Solvency II and Capital Requirements Directive IV) and US regulations (eg, the Dodd–Frank Act or Bank Holding Company Act) may have an impact on the day-to-day business of managers.
12 What effect has the AIFMD had on fundraising in your jurisdiction?
The AIFMD has not had a material effect on fundraising in France, as private equity funds are usually set up as regulated funds.
13 What are the major tax issues that private equity faces in your jurisdiction? How is carried interest taxed? Do you see the current treatment potentially changing in the near future?
The main tax issue within the framework of a private equity structuring relates to the tax deductibility of interest charges, particularly regarding the tax deductibility of the interest under related-party loans, which is currently aggressively challenged by the French tax authorities. Furthermore, it should be noted that the tax structuring of the private equity deals must now be determined taking into account that most of the private equity funds finance part or all of their investment at closing through an equity bridge financing.
Regarding the carried interest, it is in principle taxed as employment income, but a favourable tax regime exists in France if certain conditions are met. In this case, carried interest is taxed as capital gains (ie, at a 30 per cent flat tax rate). In addition, further to the Brexit vote, the Prime Minister announced that the taxation of carried interest as capital gains may become ‘systematic’ for individuals who relocate in France. We have no additional information at this point but are following this subject closely.
14 Looking ahead, what can we expect? What might be the main themes in the next 12 months for both private equity deal activity and fundraising?
Two major trends may have an impact over the next 12 months. The first is the strong appetite of private equity funds to make acquisitions, with competition from new players such as foreign private equity funds and family offices; and the second is the growing role of debt funds pursuant to the reform that entered into force in January 2018 (as of 2016, since French funds have been authorised to directly originate loans this has resulted in an increase in the offer of debt funds on the French market).
The Inside Track
What factors make private equity practice in your jurisdiction unique?
- Management’s expectations in terms of financial incentives.
- Several tax reforms have been implemented since 2012 and now 2018, which have significantly changed the taxation of capital gains under management package schemes.
- The expectations of the sellers that are not ready to grant operational representations and warranties other than capacity and ownership of the transferred securities.
- The impact of insolvency legal provisions in the structuring of financings.
What should a client consider when choosing counsel for a complex private equity transaction in your jurisdiction?
- The experience and track record of the legal counsel. Our lawyers are ‘solution-oriented’ when addressing clients’ concerns arising from due diligence or in the negotiation.
- The responsiveness and involvement of the counsel. Our team is fully dedicated to our clients’ requests, in order to be able to offer a high-value service to ensure the success of the transaction.
- The various practices and the international network of the law firm.Regulatory and antitrust matters are increasingly complex, and potential concerns must be identified and addressed very quickly in the deal. The counsel should also be familiar with the complex regulations of regulated sectors, such as life sciences and antitrust. Financing structures have also become more and more elaborate over the years and need to be manoeuvred by true experts.
What interesting or unusual issues have you come across in recent matters?
We recently advised Caravelle, a family office, in the acquisition, alongside with the management team, of Luneau group, a global leader in the manufacturing and distributing of ophthalmic equipment. The LBO-unfriendly policy of the residing country of certain key managers significantly complicated the structuring of the transaction. Our finance, tax and corporate teams had to compose with the numerous constraints imposed by the local tax administration to authorise the management’s roll-over and make them compatible with the implementation of a banking loan facility.