Advisory Board

  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Peter Clarke
  • Barry Diller
  • IAC/InterActiveCorp
  • Fu Chengyu
  • China National Petrochemical Corporation (Sinopec Group)
  • Richard J. Gnodde
  • Goldman Sachs International
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V.
  • Jiang Jianqing
  • Industrial and Commercial Bank of China, Ltd. (ICBC)
  • Handel Lee
  • King & Wood Mallesons
  • Richard Li
  • PCCW Limited
  • Pacific Century Group
  • Liew Mun Leong
  • CapitaLand Limited
  • Martin Lipton
  • New York University
  • Wachtell, Lipton, Rosen & Katz
  • Liu Mingkang
  • China Banking Regulatory Commission (CBRC)
  • Dinesh C. Paliwal
  • Harman International Industries
  • Leon Pasternak
  • Bank of America Merrill Lynch
  • Tim Payne
  • Brunswick Group
  • Joseph R. Perella
  • Perella Weinberg Partners
  • Baron David de Rothschild
  • N M Rothschild & Sons Limited
  • Dilhan Pillay Sandrasegara
  • Temasek Holdings
  • Shao Ning
  • State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC)
  • John W. Snow
  • Cerberus Capital Management, L.P.
  • Former U.S. Secretary of Treasury
  • Bharat Vasani
  • Tata Group
  • Wang Junfeng
  • King & Wood Mallesons
  • Wang Kejin
  • China Banking Regulatory Commission (CBRC)
  • Wei Jiafu
  • China Ocean Shipping Group Company (COSCO)
  • Yang Chao
  • China Life Insurance Co. Ltd.
  • Zhu Min
  • International Monetary Fund

Legal Roundtable

  • Dimitry Afanasiev
  • Egorov Puginsky Afanasiev and Partners (Moscow)
  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Johan Aalto
  • Hannes Snellman Attorneys Ltd (Finland)
  • Nigel P. G. Boardman
  • Slaughter and May (London)
  • Willem J.L. Calkoen
  • NautaDutilh N.V. (Rotterdam)
  • Peter Callens
  • Loyens & Loeff (Brussels)
  • Bertrand Cardi
  • Darrois Villey Maillot & Brochier (Paris)
  • Santiago Carregal
  • Marval, O’Farrell & Mairal (Buenos Aires)
  • Martín Carrizosa
  • Philippi Prietocarrizosa & Uría (Bogotá)
  • Carlos G. Cordero G.
  • Aleman, Cordero, Galindo & Lee (Panama)
  • Ewen Crouch
  • Allens (Sydney)
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Rachel Eng
  • WongPartnership (Singapore)
  • Sergio Erede
  • BonelliErede (Milan)
  • Kenichi Fujinawa
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Manuel Galicia Romero
  • Galicia Abogados (Mexico City)
  • Danny Gilbert
  • Gilbert + Tobin (Sydney)
  • Vladimíra Glatzová
  • Glatzová & Co. (Prague)
  • Juan Miguel Goenechea
  • Uría Menéndez (Madrid)
  • Andrey A. Goltsblat
  • Goltsblat BLP (Moscow)
  • Juan Francisco Gutiérrez I.
  • Philippi Prietocarrizosa & Uría (Santiago)
  • Fang He
  • Jun He Law Offices (Beijing)
  • Christian Herbst
  • Schönherr (Vienna)
  • Lodewijk Hijmans van den Bergh
  • Royal Ahold (Amsterdam)
  • Hein Hooghoudt
  • NautaDutilh N.V. (Amsterdam)
  • Sameer Huda
  • Hadef & Partners (Dubai)
  • Masakazu Iwakura
  • Nishimura & Asahi (Tokyo)
  • Christof Jäckle
  • Hengeler Mueller (Frankfurt)
  • Michael Mervyn Katz
  • Edward Nathan Sonnenbergs (Johannesburg)
  • Handel Lee
  • King & Wood Mallesons (Beijing)
  • Martin Lipton
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Alain Maillot
  • Darrois Villey Maillot Brochier (Paris)
  • Antônio Corrêa Meyer
  • Machado, Meyer, Sendacz e Opice (São Paulo)
  • Sergio Michelsen Jaramillo
  • Brigard & Urrutia (Bogotá)
  • Zia Mody
  • AZB & Partners (Mumbai)
  • Christopher Murray
  • Osler (Toronto)
  • Francisco Antunes Maciel Müssnich
  • Barbosa, Müssnich & Aragão (Rio de Janeiro)
  • I. Berl Nadler
  • Davies Ward Phillips & Vineberg LLP (Toronto)
  • Umberto Nicodano
  • BonelliErede (Milan)
  • Brian O'Gorman
  • Arthur Cox (Dublin)
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Sang-Yeol Park
  • Park & Partners (Seoul)
  • José Antonio Payet Puccio
  • Payet Rey Cauvi (Lima)
  • Kees Peijster
  • COFRA Holding AG (Zug)
  • Juan Martín Perrotto
  • Uría & Menéndez (Madrid/Beijing)
  • Philip Podzebenko
  • Herbert Smith Freehills (Sydney)
  • Geert Potjewijd
  • De Brauw Blackstone Westbroek (Amsterdam/Beijing)
  • Qi Adam Li
  • Jun He Law Offices (Shanghai)
  • Biörn Riese
  • Mannheimer Swartling (Stockholm)
  • Mark Rigotti
  • Herbert Smith Freehills (Sydney)
  • Rafael Robles Miaja
  • Robles Miaja (Mexico City)
  • Alberto Saravalle
  • BonelliErede (Milan)
  • Maximilian Schiessl
  • Hengeler Mueller (Düsseldorf)
  • Cyril S. Shroff
  • Cyril Amarchand Mangaldas (Mumbai)
  • Shardul S. Shroff
  • Shardul Amarchand Mangaldas & Co.(New Delhi)
  • Klaus Søgaard
  • Gorrissen Federspiel (Denmark)
  • Ezekiel Solomon
  • Allens (Sydney)
  • Emanuel P. Strehle
  • Hengeler Mueller (Munich)
  • David E. Tadmor
  • Tadmor & Co. (Tel Aviv)
  • Kevin J. Thomson
  • Barrick Gold Corporation (Toronto)
  • Yu Wakae
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Wang Junfeng
  • King & Wood Mallesons (Beijing)
  • Tomasz Wardynski
  • Wardynski & Partners (Warsaw)
  • Rolf Watter
  • Bär & Karrer AG (Zürich)
  • Xiao Wei
  • Jun He Law Offices (Beijing)
  • Xu Ping
  • King & Wood Mallesons (Beijing)
  • Shuji Yanase
  • OK Corporation (Tokyo)
  • Alvin Yeo
  • WongPartnership LLP (Singapore)

Founding Directors

  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz
  • Nigel P.G. Boardman
  • Slaughter and May
  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz
  • Peter Williamson
  • Cambridge Judge Business School
  • Franny Yao
  • Ernst & Young

Private Equity

U.S. UPDATE – 2013 Private Equity Year in Review

Editor’s Note: Andrew J. Nussbaum is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton firm memorandum by Mr. Nussbaum, Steven A. Cohen, Amanda N. Persaud, and Joshua A. Feltman.

Main Article:

Private equity deal activity ebbed and flowed, often unexpectedly, in 2013. Despite some slow periods, strong debt and equity markets helped support first nine-months numbers that are well ahead of 2012, although Q4 2013 is unlikely to match Q4 2012, where activity was stimulated by anticipated changes in the tax laws. Successful sponsors again demonstrated their ability to perceive and exploit changing market conditions. Moreover, the private equity industry posted its best fundraising numbers in years. It was a year that showed that Semper Paratus may indeed be the industry’s new motto.

What Types of Deals Are Getting Done? Lots of deals got done in 2013, although only two topped $20 billion and barely a handful exceeded $5 billion. But the volume totals do not reflect the many challenges of getting a deal over the finish line. While deal activity was helped in some cases by announced or behind-the-scenes activism—which may motivate listed companies to exit certain areas of the portfolio or consider a public-to-private for the entire business—there is no question that deals are getting harder to do (e.g., Dell), and attractive assets have multiple suitors (e.g., BMC Software).

Perhaps not surprisingly, in an environment of rising stock prices, cheap financing and cautious economic optimism, private equity sponsors faced ample competition for attractive targets, including from strategics willing to borrow and pay all cash. The winning bidder needed an edge—speed of execution, deal philosophy or capital structure creativity, or all of the above. Sponsors who focused on a substantive investment theory as to how the deal makes sense (e.g., Neiman Marcus and Albertsons), or how to cleverly put it together (e.g., Heinz), achieved potentially hallmark transactions.

Private equity sponsors also reacted to challenging market conditions by increasing the proportion of “add-on” acquisitions and minority investments. The latter types of investments can fly under the radar of other private equity firms, resulting in less competition, and typically require less time and fewer resources from the private equity sponsor after the investment is consummated.

Dry powder in the private equity industry remains high, the investment window is closing on funds raised in 2007 and 2008, and the Federal Reserve seems to be moving away from the policies that let the historically cheap financing of 2012 survive through 2013, all suggesting that sponsors will want to continue to put capital to work even in challenging market conditions.

What About Exits? The trend toward private equity sponsors selling to other private equity sponsors continued in 2013, but for the first time in 4 years the volume of sponsor-to-sponsor activity declined. The public equity markets were solid for much of the year, which permitted certain very large deals (e.g., Seaworld and Hilton) to launch. In the first half of the year there appeared to be more dual track processes than in the second half, perhaps a result of the buoyant public equity markets and sponsors becoming less interested in chasing them. These trends should continue as long as stock market valuations remain strong.

Fundraising and Limited Partners. After a prolonged period of contraction, private equity achieved in the first three quarters alone the highest fundraising totals since 2009. Particularly noteworthy is that a number of sponsors raising multi-billion dollar funds hit their target much quicker than anticipated, and in some cases high investor demand has resulted in sponsors increasing fund sizes.

Sponsors successfully raising capital have adapted to the balance of power having tilted in favor of limited partners. Not uncommon these days are customized arrangements for significant investors, various discounts to the 2 and 20 model, sector specific funds and co-investment and direct investment platforms. While the numbers are still small, some sponsors are raising capital through the public markets by employing novel structures to manage the complicated retail regulatory regimes. Others are managing platforms that invest in small cap managers who often have the ability to post higher returns than larger funds. Regardless of the amount of assets under management, sponsors are working harder to maintain investor relationships in the hopes of maximizing commitments to future capital raises.

Consolidation Ahead? The alternative asset management industry is highly fragmented, with the top 25 sponsors controlling less than one-third of assets. We expect that institutional investors, in particular, will continue to direct most of their capital to sponsors with top brand names and diverse product offerings. These sponsors often have stronger internal governance and controls to effectively manage the myriad of US and foreign regulations affecting their business. They also tend to be more adept at handling complex fund structuring arrangements. The ever-increasing regulatory burden also drives consolidation, as costs and the need for sophisticated risk management personnel raise challenges for smaller managers.

* * *

We have predicted since 2007 that the post-recession private equity industry would reward focused endeavors and distinctive strategies. 2013 was a case in point. Successful fundraising required clear articulation of specific strategies, and, ideally, the track record to prove the thesis; the M&A and IPO markets rewarded “bespoke” dealmakers and those nimble enough to move quickly in response to markets. We see reason for optimism for the well-prepared in the coming year.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

SOUTH AFRICAN UPDATE – The Private Equity Review (2013 Edition)

Editors’ Note: This article was contributed by Michael Katz, chairman and senior partner of Edward Nathan Sonnenbergs and a member of XBMA’s Legal Roundtable. It was authored by Edward Nathan Sonnenbergs directors Johan Loubser, Jan Viviers and Andrea Minnaar.

Executive Summary:

This article provides an update on the legal framework and regulatory developments for fundraising by fund managers from third parties who invest into closed-ended funds domiciled in South Africa.  While private equity fundraising activity and the success rate thereof has not returned to 2006–2007 levels, the relatively expensive level of equities on the Johannesburg Stock Exchange, regulatory acceptance of investment by South African pension funds in private equity funds, the South African government’s renewable energy programme and the remarkable economic growth enjoyed by some sub-Saharan African countries are fuelling renewed interest in private equity investment.  Although South African private equity funds are likely to have increased exposure to sub-Saharan African countries other than South Africa, the current trend is for most South African private equity funds to maintain a primary focus on investment in South Africa.  The full review is posted here

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

GERMAN UPDATE – Private Equity Reacting Flexibly

Editors’ Note: Dr. Christof Jäckle and Dr. Emanuel Strehle are members of XBMA’s Legal Roundtable and Partners at Hengeler Mueller—a leading German firm in the M&A and corporate arena. This article is co-authored by Hengeler Mueller partners Dr. Emanuel P. Strehle and Dr. Hans-Jörg Ziegenhain.

Highlights:

  • The private equity business it has recovered to a constant level.  In 2012, private equity transactions related to Germany reached a total volume of approx. EUR 5.8B. Other than in the United States, volumes and conditions have not returned to their levels of before 2007, but there is development in this direction.
  • Following 2007, leverage decreased significantly and most recently settled between 50% and a maximum of 70%. At present, a return to pre-2007 leverage ratios is not to be expected in the short term, also in view of the increasing capital requirements for banks. Leveraging transactions by a combination of bank financing and (in some cases, structurally junior) bond financing via the capital market is clearly on the rise.
  • The current uncertainties in the debt and [capital/equity] markets and the resulting requirement of being able to react to changes on short notice are often reflected in flexible sales schemes or exit strategies
  • Multiple-track processes are currently standard practice, especially in larger transactions, and are also used outside the private equity business by industrial companies in carving-out  or selling sub-groups.
  • Deals are increasingly structured to include management participation in the profit or losses

Main Article:

Multi-track transactions, club deals and direct investments by pension funds: currently wide-spread development in transactions.

Börsen-Zeitung, 15 June 2013

Although the private equity business in Germany has yet to reach pre-Lehman Brothers volumes again, it has recovered to a constant level. In 2012, private equity transactions related to Germany reached a total volume of approx. EUR 5.8 billion according to the industry association BVK. Other than in the United States, volumes and conditions have not returned to their levels of before 2007, but there is development in this direction. The trend has been confirmed within the first five months of the current year, when CVC funds bought Ista in the first billion-volume deal.

It’s all about the right mix

If one takes a closer look at the M&A transactions with a private equity component, however, it becomes evident that there are major differences as compared to the years until 2007.

Leverage. Until 2007, the share of non-equity financing (leverage) was as high as 90%. In the years that followed, this share decreased significantly and most recently settled between 50% and a maximum of 70%. The decline is not surprising, given the consequences that the financial crisis had also for the banking system. At present, a return to pre-2007 ratios is not to be expected in the short term, also in view of the increasing capital requirements for banks. Against this background – and also in view of the trend towards corporate bonds – leveraging transactions by a combination of bank financing and (in some cases, structurally junior) bond financing via the capital market is clearly on the rise. A current example is the bond financing in connection with the Ista transaction.

Multiple-track transactions. The current uncertainties in the debt and [capital/equity] markets and the resulting requirement of being able to react to changes on short notice are often reflected in flexible sales schemes or exit strategies. This is especially the case where the sell side also involves a private equity firm (secondary or tertiary transactions).

Including recapitalisation

The sale of Kabel BW by EQT to Liberty in 2011, which served as a role model for other transactions, is a prominent example. In parallel to the auction process, the former owners – funds advised by EQT –prepared for an IPO as well as for a refinancing through the placement of a bond on the capital market. By simultaneously preparing multiple alternatives for a partial or complete exit from the investment, they intended to achieve the highest degree of transaction security that was possible in those uncertain times. In the end, the deal comprised a sale to a strategic bidder (Liberty) and the placement of a bond in the period between signing and closing of the transaction, allowing for part of the proceeds to be distributed prior to the closing date by way of recapitalisation.

Multiple-track processes are currently standard practice, especially in larger transactions, and are also used outside the private equity business by industrial companies in carving-out  or selling sub-groups (such as the spin-off of Osram from Siemens or ThyssenKrupp’s sale of its stainless steel business in 2012). Due to their high complexity, multiple-track transactions make very high demands.

Management rollover. One of the material success factors of private equity is the participation of the management and of key employees in the company with the aim of synchronizing their interests and the Company’s interests to the highest degree possible. In most cases, the participation is structured in such a way that if the company’s development is normal or negative, management participates less, and if the targets are overachieved, management participates more.

New challenges arise due to the increase in transactions in which private equity funds are involved both on the seller’s and on the purchaser’s side. Upon initial participation in the target company, management is often in an inferior economic position due to the limited funds it can invest and frequently needs financial support (such as a loan) to fund the participation. Accordingly, their position when it came to negotiating the conditions of the management participation programme has been weak.

The past years, however, have shown that the balance of power can shift quickly, at the latest after the first successful exit in which management participated to a large degree in the resulting profit. If the sold company is again acquired by a private equity company, the latter is then dealing with a party that is considerably more self-confident when negotiating th next management participation in the target company. Management then – at least partly – sees itself more as a co-investor. From a legal perspective, the transfer of the existing participation to the transferee is a particular challenge, if the parties seek to avoid unnecessary back and forth payments.

Club deals. In particular in transactions involving infrastructure entities (airports, power grids, gas grids etc.), the number of club deals, i.e., transactions involving a consortium of bidders, has lately increased. Current examples are the acquisition of Open Grid Europe by a consortium consisting of Macquarie, Adia, Meag and BCIMC as well as the acquisition of Net4Gas by Allianz Capital Partners and Borealis Infrastructure (a subsidiary of the Canadian Omers pension fund).

But also in traditional private equity transactions, bidders have teamed up on numerous occasions, for example the mid cap funds Bregal and Quadriga for the acquisition of LR Health, or Aea Investors and the Teachers Private Capital pension fund for the acquisition of Dematic.

Besides risk sharing considerations and the increase of the potential transaction volume, regulatory requirements play a role. The acquisition of a majority holding, for example, would regularly not be permitted for pension funds, or would not be desirable, for example for insurance companies or banks, for consolidation or capitalisation aspects.

Club deals do not show any special characteristics on the sell side, as the parties involved normally pool their assets to form an acquisition vehicle; at most, the procedure for obtaining the necessary antitrust clearance may become more complicated due to the larger number of parties involved. On the bidder side, however, the transaction will definitely be more complex, as, in addition to the acquisition documentation, a consortium agreement is needed. In such agreement, in addition to provisions governing capitalisation, the rules on corporate governance and a later exit must be stipulated. In this context, problems may arise in particular where different investment horizons are involved.

Direct investments. The trend towards mega funds and the significant management fees associated therewith have led some investors to consider engaging in the private equity business themselves. This is especially true for the major Canadian pension funds, which play a trendsetting role in this regard (e.g. Ontario Teachers, Canada Pension Plan or Omers) and which have established their own private equity departments or subsidiaries. These pension funds usually refrain from taking the lead in the acquisition of companies, mainly due to regulatory constraints, but direct investments are on the upswing.

A firm position

These are direct participations in the (topmost) holding company through which the target company is acquired. In the past, the typical clients of private equity funds were pension funds that invested in them and thus participated in the fund’s total return only. Direct investments allow for a more targeted risk allocation when investing, and also give the private equity company greater flexibility in structuring its fees.

It becomes clear that private equity continues to hold a firm position in the German M&A market. In the long-run, only those equity investors will remain successful that are able to react flexibly and quickly to changes in the markets will remain successful. And, the market leaves room for dynamics.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

GERMAN UPDATE – What Managers of Private Equity Funds should know about the new German Investment Law

 

Editors’ Note:  Christof Jäckle and Emanuel Strehle are partners at Hengeler Mueller and members of XBMA’s Legal Roundtable.  Hengeler Mueller partner Christian Schmies authored this article.  Hengeler Mueller is the leading German firm in the M&A and corporate arena.

Executive Summary

  • New notification and disclosure requirements will apply to managers of private equity funds under the German AIFMD implementing legislation.
  • Managers of private equity funds will also be subject to asset stripping restrictions regarding European target companies.
  • The new rules will apply not only to German domiciled funds, but also to EU and non-EU funds and their EU and non-EU fund managers as long as the fund is marketed in Germany and the target company is domiciled in the EU.
  • Marketing on a private placement basis will no longer be possible under this new regime.

Main Article:

I.          The new German Capital Investment Act

On 21 July 2011, the European Directive 2011/61/EC on Alternative Investment Fund Managers (“AIFMD” or the “Directive”) entered into force which introduced the first comprehensive regulatory framework for managers of alternative investment funds (“AIF”) in Europe.  The Directive does not only affect European managers but also third country managers (e.g. managers domiciled in the United States) if they manage or market alternative investment funds in the European Economic Area (“EEA”).

All EU Member States must implement the Directive no later than 22 July 2013.  The German legislator will implement the Directive by creating an entirely new statute, the Capital Investment Act (Kapitalanlagegesetzbuch – “KAGB”). The KAGB will become effective on 22 July 2013.

While the Draft KAGB focuses on the regulation of German fund managers, in particular their licensing and passporting into other Member States, as well as on the passporting for non-German fund managers and their funds, it also contains some frequently overlooked provisions for foreign private equity funds which are marketed in Germany by way of public or, more commonly, private placement.

II.         Specific Requirements for Managers of Private Equity Funds

Private equity funds domiciled in Germany or, in the case of non-German funds, marketed in Germany (see under A), whose investment objective is to gain control of an unlisted company or an issuer (see under B), must fulfil certain notification requirements (see under C), must meet certain disclosure requirements (see under D) and are subject to certain rules prohibiting so-called “asset stripping” (see under E).

(A)       Affected Private Equity Funds

(i)        The new rules apply to alternative investment funds whose objective is to acquire control over unlisted companies or certain issuers.  Alternative investment funds are defined as collective investment schemes which raise capital from investors in order to invest such capital according to a defined investment policy for the benefit of the investors and which are not UCITS. The new rules do not apply where a fund manager domiciled in Germany and its group companies only manage alternative investment funds with an aggregate volume of no more than €100 million or, in the case of unleveraged alternative investment funds with no redemption rights during the first 5 years, with an aggregate volume of no more than €500 million.

(ii)       These rules do not only apply to private equity funds domiciled in Germany but also apply to private equity funds domiciled outside of Germany if one or more of the following conditions are met:

–      the fund manager is domiciled in Germany,
–      the fund manager is domiciled outside the EEA but has (i) Germany as a reference state or (ii) manages a private equity fund which is marketed in Germany.

(iii)      “Marketing” is any sales activity of the fund manager or of third parties on the fund manager’s behalf, including private placement, except where the sale of a fund unit occurs upon the exclusive initiative of the investor.  Please note that there is no private placement regime under the KAGB.

(iv)      As far as the target investments of the aforementioned private equity funds are concerned, the following rules apply only with respect to unlisted companies having their registered seat in the European Union with the exception of SMEs, i.e. small and medium-sized enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding €50 million, and/or an annual balance sheet total not exceeding €43 million.  Special purpose vehicles for the acquisition, the holding and the management of real estate do not qualify as unlisted company in this context.  Certain of the following rules also apply with respect to issuers of securities admitted to trading on a regulated market provided the issuer has a registered seat in the European Union (in the following the “Issuer”).

(B)      When is a private equity fund deemed to gain control of a target company or an Issuer?

(i)        “Control” is defined as the holding of 50% or more of the voting rights of a target company, either alone or acting in concert with others.  Voting rights held by companies controlled by the private equity fund and voting rights held by individuals or legal entities acting on behalf of the private equity fund or on behalf of a company controlled by the private equity fund are attributed for this purpose to the private equity fund.

(ii)       In the case of issuers, and exclusively for purposes of the disclosure obligations and prohibitions on asset stripping set out below, control is defined with reference to the European Takeover Directive as the percentage of voting rights which confers control for purposes of establishing the takeover obligation as determined by the rules of the EU Member State in which the Issuer has its registered office.

(C)      Which notification requirements apply in connection with the ACQUISITION OF INTERESTS IN AN UNLISTED COMPANY?

(i)        The fund manager must notify the German Federal Financial Services Supervisory Authority (“BaFin”) of the proportion of the voting rights held by the private equity fund if the percentage shareholding in an unlisted target company reaches, exceeds or falls below the thresholds of 10%, 20%, 30%, 50% and 75%.
(ii)       Where the private equity fund, alone or jointly, gains control over an unlisted company, the fund manager will have to inform the following of the acquisition of control:

(a)       the unlisted company,
(b)       the target’s shareholders whose identities and addresses are available to the fund manager, can be made available by the unlisted company or are available through a register to which the fund has or can obtain access, and
(c)        BaFin.

(iii)      The aforementioned notification must contain the following additional information:
(a)       the resulting situation in terms of voting rights,
(b)       the conditions under which control was acquired, including information about the identity of the different shareholders involved, any private individual or legal entity authorized to exercise voting rights on their behalf and, where applicable, the chain of undertakings through which voting rights are actually held, and
(c)        the date on which control was obtained.

(iv)      All of the aforementioned notifications must be made as soon as possible, but no later than 10 working days after the private equity fund has reached or passed the relevant threshold or gained control.

(v)       When informing the target company, the fund manager must request the target’s management board to inform the employees’ representatives, or where there is no such employees’ representation, the employees themselves of the acquisition of control by the private equity fund and of the further information listed above.  The fund manager must use its best efforts to ensure that the target’s management board properly fulfils the aforementioned information requirements.

(D)      What are the disclosure requirements when a private equity fund acquires control of an unlisted company or an issuer?

(i)        Where the private equity fund has acquired control over an unlisted company or an Issuer, it must provide the recipients listed in C (ii) above with the following information:

(a)       the identity of the private equity fund(s) involved,

(b)       the policy for preventing and managing conflicts of interest, in particular between the fund manager, the private equity fund and the target, including information about the specific safeguards established to ensure that any agreement between any of them is concluded at arm’s length and

(c)        the policy for external and internal communication relating to the target in particular as regards employees.

(ii)       As in the case of the aforementioned notification requirements, the fund manager must use its best efforts to ensure that the employees or their representatives are properly informed of the information listed in (i) above by the target’s management board (cf. C (v) above).

(iii)      The fund manager must ensure that the private equity fund’s intentions concerning the future business of the unlisted company and the likely repercussions on employment, including any material change in the conditions of employment are disclosed to the target and its shareholders.  Furthermore, the fund manager must ensure that the target’s management board will disclose this aforementioned information to the target’s employees or employee representatives, as the case may be.

(iv)      As soon as a private equity fund acquires control over an unlisted company, its manager must provide BaFin and the investors in the private equity fund with information concerning the financing of the acquisition.

(v)       The following information must be included in the private equity fund’s financial reports or in the target’s financial reports, which should be timely prepared and made available to the target’s employees or employee representation:

(a)       a fair view of the development of the target’s business,
(b)       any important events since of the end of the financial year,
(c)        the target’s likely future development, and
(d)       the information required in the case of the acquisition of own shares.

(vi)      The fund manager must ensure that the private equity fund’s financial information is either (x) timely provided by the target’s management board to the employees or employee representation or (y) timely provided by the fund manager to the investors in the private equity fund.

(E)       What are the rules prohibiting asset stripping where a private equity fund acquires control over an unlisted company or an issuer?

(i)        For a period of 24 months following acquisition of control over the target, the fund manager is obliged
(a)       not to allow, facilitate, support or instruct any distribution, capital reduction, share redemption and/or acquisition of own shares by the target as set out in (ii) below,
(b)       where the fund manager is authorized to vote on behalf of the private equity fund in the meetings of the target’s governing bodies, not to vote in favour of any of the aforementioned measures,
(c)        to use its best efforts to prevent the target from effecting any of the aforementioned measures.

(ii)       Independent from the specific legal structure of the corporation (e.g. stock corporation or limited liability company), the amounts available for distribution must always be determined on the basis of the annual accounts of the immediately preceding financial year.  This wording of the new rule resembles the wording of the existing Second Corporate Directive (Directive 77/91/EEC) which has been implemented in Germany in the Stock Corporation Act, but not in the Limited Liability Company Act.  As a consequence, where the target company is a German limited liability company which may at present make interim dividend distribution, the new rules of the KAGB would, arguably, constitute a limitation of the applicable corporate laws.  With respect to the determination which amounts are available for distribution, the AIFMD and the KAGB are not quite clear.  One interpretation would be that the strict rules applying to stock corporations, in particular as regards the prohibition to resolve and distribute certain reserves, apply to all target companies regardless of their specific legal structure, e.g. also to German limited liability companies.  The interpretation more consistent with the purpose and spirit of the AIFMD, however, appears to be that the applicable provisions of the target’s national corporate law statutes determine which amounts are free for distribution, in particular which reserves can be resolved and distributed.  Please note that distributions are defined as the payments of dividends or interests relating to shares.  The latter includes interest payments convertible bonds and other forms of hybrid instruments but may also extend to acquisition finance loans.

(iii)      The purchase of own shares is only permissible (a) if it does not lead to an annual loss, (b) where it serves to offset losses or (c) where it serves the purpose to include sums of money in a non-distributable reserve provided that such reserve is not greater than 10% of the reduced subscribed capital.  Furthermore, the prohibition to purchase own shares does not apply in certain circumstances set out in Art. 20 (1) lit. (b) – (h) of Directive 77/91/EEC. The restrictions for the purchase of own shares and the aforementioned general prohibition of capital reductions go beyond the restrictions imposed by German corporate law.

III.        Grandfathering provisions

(A)       While fund managers managing exclusively German domiciled private equity funds which are fully invested on 21 July 2013 and do not make any further acquisitions after this date do not have to comply with the aforementioned rules, there is no corresponding grandfathering provision for private equity funds domiciled in other countries, be they EEA Member States or third countries.
(B)       The private placement rules for private equity funds established prior to 22 July 2013 continue to apply until 21 July 2014.  After this date public or private placement of a private equity fund requires a notification to BaFin as Germany, unlike other European jurisdictions, will not enact private placement rules for alternative investment funds.  A European passport for such funds will not be available before 2015.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

CHINESE UPDATE – Chinese Court Ruled Valuation Adjustment Mechanisms Invalid

Editors’ Note:  Contributed by Fang He and authored by Ying Zhang and Qiushuang Zou.  Ms. Zhang, a partner at Jun He, has more than 10 years of experience practicing Chinese law, focusing on M&A, private equity, joint ventures and general corporate matters.  Ms. He, a partner at Jun He and a member of XBMA’s Legal Roundtable, has broad experience in M&A, outbound investment, foreign direct investment, private equity and intellectual property.  Ms. Zou, an associate at Jun He, has more than 4 years of experience practicing PRC law, specializing in foreign direct investment and M&A. 

Highlights:

Valuation adjustment mechanisms have been often used by private equity firms in their portfolio investments in China, which had never been tested until recently ruled invalid by a Chinese local court.  It remains to be seen if and how this decision will impact the investment practice of private equity firms in China.

Main Article:

Recently, the People’s Court of Gansu Province of China reversed a lower court judgment and held that the valuation adjustment mechanisms (“VAM”) typically adopted by private equity firms were invalid.

Background of the Case

In 2007, Hai Fu Investment Company Ltd., a private equity firm (the “PE Firm”), subscribed 3.85% of the equity interests in Shiheng Non-ferrous Resources Company Ltd. (the “JV”), an equity joint venture formed under Chinese law, with a premium of RMB 18,852,283. 

In the subscription agreement, the JV, the PE Firm, and the majority shareholder of the JV (the “Majority Shareholder”) agreed to a VAM which provides that, should the net profits of the JV for 2008 be less than RMB 30 million, the PE Firm will be entitled to receive, from the JV or the Majority Shareholder, compensation equal to a certain sum as determined according to an agreed formula.  This provision was triggered in 2009, as the JV failed to reach the targeted performance for 2008 and  the PE Firm sued the JV in the local court to seek to exercise its right to the compensation. 

The decision

The post-closing VAM provision (which helps bridge the gap of different projections for the target company) has been widely adopted in private equity investment in China, but had never been tested before a Chinese court. 

The first instance court ruled that, the VAM is an arrangement for the sharing of the JV’s profits rather than a future adjustment to the valuation of the JV, and thus the compensation arrangement violates the Chinese legal principle that the shareholders should share the profits of the JV in accordance with their respective shareholding ratios. 

The second instance court reversed the lower court ruling and held that, the whole purpose of the compensation arrangement (together with the buy-back right of the PE Firm under the agreement) is to safely recoup the PE Firm’s investment regardless of the JV’s performance, which is against the legal principle that investors should bear the risks of their investment and essentially makes the “investment” a loan instead.  Based on this conclusion, the court ruled that the JV and the Majority Shareholder should jointly repay to the PE Firm the funds equal to the sum of the premium together with the interests accrued thereon (while the PE firm continues to own the 3.85% equity interest in the JV).

Some observations

Chinese company law does not allow the issuance of preferred shares, and still insists on the principle that shareholders share risks of their investment in accordance with their respective shareholding ratios.  We think the second instance court is correct in reversing the first instance court ruling by pointing out that the compensation arrangement is not a profit-sharing provision, but the court incorrectly understood the nature of the VAM and wrongly concluded that the “premium” is a loan, ignoring the facts that making/receiving a loan was clearly not the intent of the parties and Chinese law does not prohibit the Majority Shareholder from compensating the PE Firm, the minority shareholder.

As China is not a case law jurisdiction, it remains to be seen if and how this decision will impact other courts in the country and the practice of private equity industry in China.  Nevertheless, before the Supreme Court of China issues any guidance to specifically uphold the validity of the VAM, there exists a risk and an uncertainty that the VAM may have its validity be challenged in courts.    

This decision also reflects the fact that, mainly due to the concerns of taxation and foreign exchange administration, Chinese law currently still does not leave much room for parties to freely negotiate their transaction terms, and subject provisions of a cross-border M&A or investment agreement to various legal and regulatory restrictions (including, among other things, the general requirement that a deal price be fixed rather than adjustable, which makes the legality of such contingent pricing as an earn-out arrangement questionable under Chinese law). 

Investors in China need to be aware of these risks and uncertainties, and understand that the VAM and other terms of their legal documents must be carefully planned and crafted to manage and allocate the risks in a structured manner.  This sometimes requires creativity to address the risks and uncertainties.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

Subscribe to Newsletter

Enter your Email

Preview Newsletter