A private equity fund contemplating an investment in a listed company has to face a different environment from its “sweet spot” consisting of transactions in privately-held companies. It does not have the same flexibility to negotiate the terms and conditions of its investment with the target particularly in regards to fixing the issue price of the securities independently from the market price, determining in advance the percentage of the target it will hold after completing its investment if the offer has to be made to the other shareholders, or choosing the timetable for preparing and completing its investment. This article will describe the constraints applying to equity investments in French, German and English listed companies and analyze some solutions to deal with these constraints.
The investments subject to the most constraints are those that fall within the scope of the public offers regulations and require the drafting of a prospectus and its approval by the competent stock market authority. Given the time required to prepare a prospectus and have it approved, it is clear that avoiding the scope of public offers regulations will give more flexibility when investing in public companies.
The European Directive on prospectuses, dated November 3, 2003 (the “Prospectus Directive”), harmonizes the EU member states’ regulations on public offers and the circumstances in which it is necessary to publish a prospectus approved by the competent stock market authority.
The Prospectus Directive also defines a limited number of cases in which each member state may exonerate a company from publishing a prospectus when offering securities to the public. There are three main types of exemptions, relating to: the aggregate amount of the fundraising; the individual amount invested by each investor; and private placements.
To understand fully the constraints applying to such investments, it is also necessary to assess the rights issues regulations from a corporate perspective.
Prospectus Exemption Related to the Amount of the Fundraising or the Investment
In France, pursuant to the Monetary and Financial Code and the General Regulation of the Autorité des Marchés Financiers (“RGAMF”), regardless of the means used to offer the securities to the public (including advertising) and the qualification of the investors, rights issues do not constitute a public offer if the total consideration of the offer is less than €2.5 million and the issued securities represent less than 50% of the share capital of the company.
Nonetheless, such rights issues may only be implemented if the existing shareholders benefit from subscription rights. Consequently, the maximum number of securities available to a third-party private equity investor will be limited by the above mentioned caps and also by the subscription rights that will be eventually retained by the existing shareholders. As such, this exemption will only be useful if one or several significant shareholders agree to transfer their subscription rights to the third-party private equity investor to ensure it has sufficient rights to reach its expected amount of investment and level of financial interest in the target company. In such a rights issue, the issue price of the new securities may be freely determined by a shareholders’ general meeting or by the board within the limit of the authorization granted by the shareholders’ general meeting.
Under the German Securities Prospectus Act (“WpPG”), the exemption relating to the amount of the rights issue is very limited as it only applies if the total consideration of all securities offered is less than €100,000 calculated over a period of 12 months. Due to its low cap, this prospectus exemption is not really useful in Germany.
In the United Kingdom, under the Financial Services and Markets Act 2000 (“FSMA”), the exemption relating to the amount of fundraising states that a prospectus is not required if the total consideration for the transferable securities being offered does not exceed €100,000. As in Germany, it is necessary to look back at all offers that were made in the 12-month period preceding the relevant offer to see if this exemption is available. Nonetheless, if the total consideration for the offer is less than €2.5 million (aggregated with all other offers for shares of the same class within the preceding 12 months), then no prospectus is required in respect of such an offer.
In addition, in France, Germany and the United Kingdom, rights issues where each minimum individual subscription amount exceeds €50,000 do not fall into the scope of public offer regulations as the persons subscribing to such amount are deemed to be qualified enough to assess the risks of their investment.
The private placement is the most commonly used means to invest in listed companies while bypassing the public offer regulations.
In France, Germany and the United Kingdom, there are two alternative criteria to qualify as private placement— either the offer of securities is addressed solely to qualified investors or securities are offered to less than 100 natural or legal persons per member state (even if they are not qualified investors)—and in the UK, the total consideration for the offer is less than €2.5 million (aggregated with all other offers for shares of the same class within the preceding 12 months).
The definition of qualified investor slightly differs in each of these three jurisdictions, but it mainly covers institutions that conduct banking and investment business, insurance companies, national or foreign investment companies or funds, pension funds and other legal entities that are deemed to be qualified due to their size. Small or medium-sized companies (i.e., that meet at least two of the following three criteria: less than 250 employees, a total balance sheet not exceeding €43 million and an annual net turnover not exceeding €50 million) and natural persons may also be qualified investors provided they are registered in a national register. Such register is held by the Autorité des Marches Financiers (“AMF”) in France, the Bundesanstalt für Finanzdienstleistungsaufsicht (“BaFin”) in Germany and the Financial Services Authority (“FSA”) in the United Kingdom. Pursuant to the Prospectus Directive, the member states have agreed on a policy of mutual recognition of persons or entities who are qualified investors in another member state.
Despite the similarities between the jurisdictions, the corporate regulations render private placements very different in the three jurisdictions.
In France, pursuant to article L. 225-136 of the Commercial Code, a private placement requires that the shareholders’ general meeting resolve to cancel the shareholders’ subscription rights and empower the board of directors to implement a placement. Such a placement will be limited to 20% of the share capital of the company over a period of 12 months.
In such a case, the rights of the board of directors to determine freely the issue price will depend on the type of market (regulated or organized) and the percentage of dilution. For companies listed on a regulated market (for example, Eurolist of NYSE Euronext), the issue price of the new securities must be at least equal to the weighted average market price of the last three trading days prior to the issue of the securities reduced by a maximum discount of 5%. However, the shareholders general meeting may authorize the board to issue new securities in respect of which the issue price is disconnected from the market price up to a maximum of 10% of the share capital of the company over a period of 12 months. In such a case, the issue price or the conditions for determining that price are determined by the extraordinary general meeting. The flexibility on the issue price will consequently depend on the percentage of dilution that is acceptable for the target company and its shareholders (less than 10% or between 10% and 20%). For companies listed on an organized market (such as the Alternext market of NYSE Euronext), the issue price or the conditions for determining that price are determined by the extraordinary general meeting and can therefore be disconnected from the market price.
In Germany, the exclusion of the subscription right of the shareholders may be either a simplified or a regular exclusion. In case of a simplified exclusion, no exclusion justification will be required but the dilution resulting from such issue will be limited to 10% of the registered capital. On the other hand, if the company decides to use a regular exclusion, such exclusion will have to be in the best interests of the company, and adequate and fair to serve its corporate purpose (which is very difficult to justify) and the issue will only be limited by the general cap of the authorized capital, which may not represent more than 50% of the registered capital.
In both cases of exclusion of the subscription rights of the current shareholders, the issue price must not be significantly below the current market price, i.e., the issue price must not be less than 3% to 5% of the weighted average market price of the securities in the last five days prior to the issue of the new securities.
In the United Kingdom, pre-emption rights exist under section 561 of the Companies Act 2006 and the Listing Rules (contained in the FSA Handbook). Due to these pre-emption rights, a company proposing to allot equity securities wholly for cash must first offer these securities to existing shareholders pro rata. Companies are able to disapply these rights, either on a case-by-case basis or generally. In addition, the directors of the company must be granted authority to allot the shares that can again be given generally or on a case-by-case basis.
In order to disapply the pre-emption rights, a special resolution of the shareholders of the company is required. For a special resolution to be passed, at least 75% of votes cast by shareholders will need to be in favor of the resolution. The grant of general authority to allot only requires the approval of a simple majority. In theory, a general disapplication of these rights can be as wide as the company wants, but the Investor Protection Committee (“IPC”) guidelines state that a general disapplication of pre-emption rights must not apply to more than 5% (7.5% in a three-year rolling period) of the existing issued ordinary share capital. The general authority to allot should not extend to an amount exceeding one third of the existing issued ordinary share capital. Whilst the IPC guidelines are not binding, the IPCs are powerful investor bodies and so listed companies endeavour to abide by their guidelines. Most companies seek limited authorities annually at their annual general meeting. Larger transactions will always require resolutions to be presented to shareholders at a specially convened general meeting.
In the Listing Rules, there is a restriction on the issue price for companies listed on the Main Market of the London Stock Exchange. The issue price cannot be at a discount in excess of 10% to the middle market price without shareholder approval. However, IPC guidance states that where the issue is under a specific disapplication of preemption rights, a discount of more than 5% should not be used.
The French Legislation Gap Opportunity
The French Commercial Code provides for a specific regime for rights issues where the subscription right is cancelled by the shareholders’ general meeting in favor of a category of investors.
Such regime is primarily aimed at private companies, but it may also be implemented by listed companies. As such issues do not fall within the scope of public offers, they offer much more flexibility to listed companies that do not need to meet the above mentioned criteria for exemption to avoid the publishing of the prospectus or requiring the approval of the issue price by the AMF.
The shareholders’ general meeting will have to define the category which may consequently include non-qualified investors as well as qualified investors depending on its criteria, the cap of the share capital increase and the issue price or the conditions for determining that price. Such price or criteria may be disconnected from the market price.
The amount of such rights issues is solely limited by the shareholders’ meeting resolution and can consequently represent more than 20% of the share capital over a period of 12 months.