With the gradual recovery of the global economy, private equity houses are once again looking towards emerging markets for value investments. In light of certain recent legislative reforms, it is hoped this will lead to an increase in the number of private equity deals in Russia in the coming months.

Co-investment model

International investors in Russia tend to co-invest with a strong local partner. This is true of both trade buyers and financial investors and applies equally in the case of new ventures or the purchase of existing operations.

The advantages of having a local partner for the international investor are usually clear to see. A strong local partner can assist the international investor in understanding the relevant market. In particular, a strong local partner will help navigate complex local regulatory issues (and, ideally, discourage predatory competition).

The success of foreign investments in Russia tends to hinge, therefore, on the quality of the local partner and the relationship between the two. The quality of the relationship inevitably rests to a considerable extent on the quality of the underlying documents. In this context, good documents tend to mean good friends.

A well negotiated deal will give the international investor a meaningful level of comfort at the operational level, while aligning the interests of the Russian co-investor with its own objectives and allowing for a managed investment exit for either or both parties.

Deal structuring

Corporate structures

The most common forms of onshore legal entities are the limited liability company ("LLC") and closed joint stock company. In many respects these are identical, with little difference in terms of their corporate capacity. The LLC is often preferred, however, because of its more flexible corporate governance regime and because it is not subject to Russian securities legislation.

To date, there has been a strong preference from international investors for offshore investment vehicles (usually Cypriot but sometimes Dutch) when investing into Russia. The onshore (i.e. Russian) vehicles in an acquisition structure act as wholly-owned subsidiaries of the offshore investment vehicle.

Offshore entities are preferred as the co-investment vehicle for a range of reasons, but specifically due to the inability to apply internationally standard joint venture terms to onshore entities (e.g., in relation to veto rights) this is because Russian law is not on the whole as flexible as English law.

Furthermore, Russian jurisprudence does not contemplate tag and drag rights and there is also legal debate about the status of put and call options. Being able to offer Cypriot (or Dutch shares), or offshore cash flow, as security to third party lenders may be seen as an attractive option from a funding perspective and may also reduce the tax burden on foreign investors.

Simply having an offshore co-investment structure will not, of itself, address the concerns of international investors about control over operational matters in Russia (and, in particular, the ownership of key assets and cash flows). These will need to be specifically provided for in the transaction documents and will need to be effective from both international and Russian law perspectives.

Unpredictability of tax system

Despite substantial and ongoing reform of the Russian tax system, difficulties remain in certain areas. For example, the tax administration process is very much focused on enforcement and collection. This tends to lead to a less co-operative approach between the tax payer and the tax authority than has developed in some other jurisdictions.

Problems can also be exacerbated by the different interpretations of the substantive provisions of tax legislation which persist between (and even within) government ministries and organisations. The net result is that tax payers may therefore be exposed to the risk of significant fines, penalties and enforcement measures, despite their best efforts at compliance.

Perhaps more so than in any other area, careful due diligence may be required in connection with the target's tax position. An international investor will also usually wish to consider at the outset different structuring options which may be appropriate to help reduce the risk from historic tax liabilities.

Deal structuring – majority investments

Macro protections

If the international investor is the majority investor in an existing operation, it will usually be looking for some deferral of the purchase price and to create appropriate incentives for the vendor and senior management to assist in the ongoing success of operations. As in other jurisdictions, common incentives may be both positive (for example earn-out arrangements) and negative (clawbacks of purchase price if there are problems with key permits or warranty breaches).

The overall goal is to encourage conditions in which the investment will not be vulnerable to operational collapse or hostile predation on exit by the Russian co-investor. The international investor may also wish to think about new management having share options, so that a new regime, loyal to the international investor, can take root. Overall, a successful strategy tends to involve aligning the Russian co-investor and management with the international investor's objectives by financially rewarding co-operation.

The international investor may also seek to negotiate provisions into the shareholders agreement allowing for a forced exit of the Russian co-investor in the event that problems arise.

Internal management controls

At the level of the Russian operating companies, the right to appoint and remove all of the management bodies of the relevant companies is essential to the international investor maintaining control over its investment. While Russian companies can have one or more of a supervisory board, management board and general director, most often the key control is the ability to appoint and remove the general director.

Russian companies have a general director (essentially, the company's CEO). The general director has the right to act on behalf of the company, conclude transactions on its behalf and, if not properly addressed in the charter, to sign agreements binding it without any additional authorisation. The general director will also be one of the signatories to the company's bank mandates.

It can therefore be a major problem if the general director favours the Russian co-investor, and the international investor does not have any rights in respect of his removal. Removal rights (to the extent they can be negotiated into the transaction documents) need to be rehearsed in the shareholders agreement at the offshore level and enshrined in the charter of the Russian operating companies (where they will be of practical value).

Deal structuring – minority investments

It is far less likely that an international investor acquiring a minority stake would be able to negotiate arrangements that could lead to a forced exit of either senior management or the Russian co-investor in the event that problems arise. Even if the international investor is able to negotiate such terms, it may have real difficulties enforcing those rights in practice in Russia.

In the case of the minority international investor, there are therefore two possibilities to deal with operational issues: either deadlock provisions or the agreements will provide for the exit of the international investor.

In the case of deadlock, the international investors will usually seek as many veto and co-signature rights as possible to ensure (as far as possible) that value is preserved and that money or assets are not being improperly diverted. Where deadlock arises in connection with the budget or business plan, ideally the parties will also agree that the status quo should prevail (subject to certain adjustments) until such time as matters are resolved.

In the case of an exit, the international investors will wish to protect against an artificially low purchase price (for example by having its deadlock exit option valued at an independent fair market value or, perhaps, a fixed IRR). Ideally, the international investor's rights would also be secured over assets in offshore jurisdictions.


As with cross-border investment in other jurisdictions, the key for the international investor in Russia is to identify an appropriate local investor with which to align its strategic and financial goals. Significant due diligence into potential partners and clearly articulated paths in respect of operational control and investment exit always makes sense and help avoid future problems. Despite recent high profile disputes which might suggest otherwise, Russia still remains a largely welcoming place for foreign investment. Investors should, however, look to protect themselves in the manner set out in this bulletin, particularly by forging strong and well-documented links with a local partner, ensuring an offshore holding structure and, if possible, looking for security against overseas assets, if appropriate.