Contributed By Linklaters
As recognised in the 2019 global private equity report prepared by Bain & Company, in the past year the private equity industry has continued to make deals, find exits and raise new capital at a historic pace. Despite the uncertain economic outlook for 2019, the private equity M&A market has remained relatively strong in the first half of 2019 and this trend is expected to continue for the second half of the year.
Some of the key trends for private equity M&A transactions in Belgium are detailed below.
The structural challenges of the private equity industry, fierce competition and high prices, combined with macro-uncertainty, force behaviour change with private equity funds. Private equity funds start adopting alternative strategies to be ahead of the competition. Next to speed of execution and pre-emptive offers being made, there has started to be a stronger focus on 'buy and build' where new businesses are added to existing portfolio companies to unlock synergies, or club deals whereby private equity funds are teaming up with trade buyers to compete on price in auction processes.
In the past six months, we have seen a primary focus on the following sectors for M&A activity involving private equity: IT (Combell, SecureLink), FIG (Banca Monte dei Paschi, Generali, Fidea), healthcare (Physiol) and infrastructure (Brussels Airport, Hansea, Verbraeken). Healthcare and IT are expected to remain highly attractive sectors for the second half of 2019, as well with some upcoming transactions (such as the sale of Agfa Healthcare). It is also anticipated that further action may be taken in respect of some portfolio companies active in the staffing/HR sector.
On 1 May 2019, a new companies and associations code entered into force (Wetboek van Vennootschappen en Verenigingen,Code des Sociétés et des Associations, dated 23 March 2019, as published in the Belgian State Gazette on 4 April 2019). This code levels the playing field between the NV/SA and BV/SRL for private equity vehicles, with certain additional advantages for BV/SRL.
In particular, the minimum share capital for the BV/SRL and the mandatory proportionality between voting and economic rights will be abolished. The new code also increases the possibility of making a contribution in labour, and interim dividend distributions are made more flexible, thereby providing additional opportunities for structuring acquisition vehicles and management incentive plans.
Notwithstanding the above, the new code also comes with certain points to note. For example, transfer restrictions set out in articles of association must now be included in the shareholders' register and, more importantly, transfer restrictions in a shareholders’ agreement must, upon request by a party to such shareholders’ agreement, also be included in the shareholders’ register. Further, certain company forms, most notably the Comm.VA., will no longer exist in the future and will have to be converted to another legal form.
In principle, (private) M&A transactions and foreign investments are not subject to any general restrictions or regulatory supervision in Belgium. However, Belgian and foreign investors (including private equity backed buyers) may be confronted with certain specific restrictions or requirements (eg, regulatory authorisations, prudential supervision or licensing requirements) when investing in certain sectors, including the banking and insurance sector, the transport and distribution sector, the television, radio and telecom sector or the energy production sector.
The primary regulators in Belgium are:
Recently, the Flemish legislator introduced a specific 'foreign investment control' instrument to protect the security of the Flemish Community and Flemish Region. Pursuant to the relevant Regional Law that entered into force on 1 January 2019, the Flemish Government can annul or declare without effect (ex posteriori) any legal act of certain public law entities (such as the Flemish Government, local authorities and other entities that are under decisive control of the aforementioned authorities), resulting in foreign natural or legal persons (including private equity backed buyers) acquiring control in such public law entities, if the strategic interests of the Flemish Community or the Flemish Region are threatened as a result thereof. It is expected that the Flemish Government will use this instrument only in very rare circumstances.
In terms of antitrust regulations, the EU Merger Regulation No 139/2004 sets out which transactions must be notified to the European Commission. In short, any 'concentration' with an 'EU dimension' must be notified to, and approved by, the European Commission before being implemented. A 'concentration' arises either (i) from a merger between previously independent undertakings, (ii) by an undertaking or person acquiring long-lasting control of (part of) another undertaking, or (iii) by two or more undertakings forming a 'full-function' joint venture.
Control is defined as “the possibility of exercising decisive influence on an undertaking”. Control can be obtained by the acquisition of a majority of voting rights in another undertaking or by veto rights over strategic business decisions such as the budget, business plan or the appointment and removal of senior management. The acquisition of such decisive influence can stem from the by-laws or a shareholders’ agreement, but in certain circumstances also on a contractual basis (eg, from asset management agreements). More exceptionally, control can be acquired on a de facto basis. Control should in any case be acquired on a long-lasting basis to qualify as a concentration.
A concentration will have an 'EU dimension' and be subject to the European Commission’s jurisdiction if the parties concerned achieve an aggregate worldwide turnover exceeding EUR5 billion and each of at least two parties achieve EU-wide turnover exceeding EUR250 million (unless all the parties concerned achieve two thirds of their EU-wide turnover in one and the same Member State). A concentration can also have an EU dimension at a lower threshold, if the parties concerned generate an aggregate worldwide turnover exceeding EUR2.5 billion, each of at least two parties has an EU-wide turnover exceeding EUR100 million, and other criteria as to in which Member States the turnover is achieved, are met. Turnover should be understood as the turnover of the economic group and would generally include the turnover of portfolio companies controlled by the undertaking.
If the concentration has an EU dimension, it will exclude filing requirements to national competition authorities in the European Economic Area (ie, the EU Member States, Iceland, Liechtenstein and Norway). If the concentration does not have an EU dimension, it may require notification to, and prior approval by, the BCA if the parties concerned achieve aggregate Belgian turnover exceeding EUR100 million and at least two parties concerned achieve turnover in Belgium exceeding EUR40 million.
Under both European and Belgian merger control rules, a transaction with no nexus to the EU (or Belgium) can still be notifiable. Conversely, transactions with an exclusive focus on Belgium may nevertheless trigger merger control filing obligations in other jurisdictions, including major jurisdictions such as China. In practice, private equity transactions are, therefore, often subject to prior multi-jurisdictional merger control analysis.
Finally, if a transaction is not considered as a 'concentration', it nevertheless remains subject to general Belgian and EU antitrust rules prohibiting anticompetitive agreements and the abuse of a (collective) dominant position.
The level of legal due diligence conducted by private equity (and strategic) buyers on Belgian target companies depends on the nature of the transaction and of the target. Usually, it includes a review of, among other things, the target’s corporate, financial, IP/IT, real estate and employment law matters, as well as its commercial agreements and pending and threatened litigation. The target group’s compliance with regulatory, data protection, sanctions and anti-corruption laws and environmental, social and governance (ESG) matters is becoming an increasingly important area of focus. The review of tax matters is typically conducted by a separate tax adviser. While overall similar to the due diligence exercise carried out by strategic buyers, private equity backed buyers tend to be more focused on commercial and financial matters and on whether the investment will generate a sufficient return.
As to the format of the legal due diligence report, both private equity sellers and buyers will typically request an exceptions-only ('red-flag') report covering only material issues above a certain financial threshold.
It is worth noting that private equity sellers do not typically give warranties (except for basic warranties on title and capacity), which implies that a purchaser will generally need to put more emphasis on its due diligence when buying a company from such sellers.
It is increasingly common, particularly in auction sales, for a seller’s advisers to conduct a due diligence review and prepare a vendor due diligence report for financial, commercial, legal and tax matters. Depending on the nature of the transaction, other areas such as environmental or IP/IT may also be relevant to conduct a due diligence review. An internal review prior to the sale may be particularly useful for private equity sellers, as they typically are not familiar with the day-to-day operations of their portfolio companies. This goes hand-in-hand with private equity sellers’ significant appetite for a stapled warranty & indemnity (W&I) insurance. Indeed, as insurers will require a considerable amount of due diligence in order to assess the risks, it is much easier to (timely) secure W&I insurance if vendor due diligence reports exist.
Vendor due diligence reports are usually made available to potential purchasers on a non-reliance basis, provided they sign a release letter acknowledging that they do not rely on the report and agree to indemnify the seller’s advisers for any loss arising from any breach by the directors, officers and advisers of the potential purchasers of terms set out in the letter. Typically, the ultimate buyer will be given a final copy of the VDD reports at the time it enters into the definitive acquisition agreement. The providers of the reports and the ultimate buyer will, at that point in time, enter into an agreement permitting the buyer to rely on the final reports, subject to the terms and limitations contained in such agreement (in particular, a cap on liability).
Reports prepared by the buyer’s advisers will usually contain language stating that no party other than the buyer may rely on their contents, except with prior written approval of the concerned adviser (which, for example, will be provided on a non-reliance basis to the buyer’s banks and W&I insurer).
Acquisitions by private equity funds of Belgian companies or assets are typically carried out by a private sale and purchase agreement, with share deals being more common than asset deals. Under Belgian law, there is no need for the involvement of a notary public for a transfer of shares. In some circumstances, a notary involvement may nevertheless be required, for instance, if assets are being transferred which are subject to such notary involvement or if a pre-transaction carve-out needs to be organised.
In recent years, we have seen an increase in acquisitions being structured through a short put option agreement (with the agreed form sale and purchase agreement attached as an annex thereto) for reasons which are mainly related to applicable information and consultation requirements in certain jurisdictions that are involved in the transaction, or in situations where the buyer wants to have certain conditions fulfilled before entering into the definitive acquisition agreement.
As mentioned above, auction activity is still high in Belgium. Transactions which are run as an auction sale process will typically be more seller-friendly than privately negotiated transactions (for example, in an auction sale, one will typically see a locked box purchase price mechanism, no deferred payments, limited conditions precedent, etc). Also, it is demonstrable that there is a clear link between deal value and the use of competitive auctions.
The private equity backed buyer will typically be structured by means of several SPVs (with one SPV being exclusively controlled by the other) which are specifically set up for the transaction. The preferred overall acquisition structure and involvement of an intermediate special purpose vehicle is primarily driven by tax considerations and the requirements of finance providers.
Depending on the nature of the private equity fund and the jurisdiction of the target company, for Belgian transactions the ultimate SPV (Bidco) will most likely be a Belgian legal entity, but the intermediate SPVs (Midco and Holdco) are often legal entities governed by English, Luxembourg or Dutch law.
Typically, the private equity fund will not be a direct party to the acquisition (or sale) documentation, only the acquisition SPV (Bidco) will be party.
Private equity deals are typically financed with a mix of debt and equity. The ratio of debt to equity will depend on market circumstances, but we typically see in Belgian transactions a ratio of 65% debt financing and 35% equity. The most common financing structures being used are term loans, either bank club deals or syndicated loans.
Typically, an equity commitment letter will be provided by the private equity fund upon signing of the sale and purchase agreement, whereby the fund commits to its acquisition vehicle that the equity portion will be unconditionally available upon closing.
Most of the private equity deals in Belgium are majority-owned by the private equity investor. Some smaller private equity funds may only take a minority stake, but this should not be seen as a typical feature for the Belgian market.
Deals requiring a consortium of private equity sponsors are not often seen in the Belgian market.
Depending on the nature and size of the private equity fund, other co-investors may invest alongside the private equity fund. Such co-investors will typically take a passive stake alongside the private equity backed SPV without any governance or controlling rights. Such silent co-investors can either be limited partners of the fund or other external co-investors. The possibility of co-investments will, however, be mainly driven by how the private equity fund operates and not by the Belgian market and/or its transactions.
A private equity fund (whether buy-side or sell-side) will want to obtain as much certainty on price as possible. A locked box structure where there is no post-closing price adjustment is therefore the predominant form of consideration structure used in Belgian M&A transactions when a private equity fund is involved. Most commonly, the locked box is based on audited accounts, on which full warranties are given. A private equity house selling on a locked box basis will usually insist that an equity ticker is applied from the locked box date to closing. We have also seen variable ticking fees, where the ticking fee increases after a certain period of time (typically the time which is reasonably needed to satisfy the conditions precedent) or upon fulfilment of (certain of) the conditions precedent.
Deferred consideration mechanics such as earn-outs are not common in a Belgian private equity context. This is particularly the case once the deal value exceeds EUR100 million. In smaller transactions, it is sometimes used to bridge valuation expectations or to incentivise individuals remaining with the target business (often seen, for example, in the technology sector).
As indicated above, a private equity fund will commonly provide an equity commitment letter upon signing of the acquisition documentation to give the sellers comfort that the equity portion will be available upon closing at the level of the Bidco. Further protection offered by the private equity fund in relation to the consideration mechanisms is rare. In the case of a corporate buyer, additional protection is sometimes negotiated by the private equity fund (eg, escrow, bank guarantee or parent guarantee).
As indicated above, the predominant form of consideration structure used in Belgian private equity transactions is the locked box structure.
In terms of protection for a buyer, leakage indemnity will be crucial as it prevents the seller extracting value from the business from the locked box date onwards. It is not common in a Belgian context to apply interest on leakage, which is typically reimbursed on a euro-for-euro basis.
Although the acquisition documentation in the event of completion accounts consideration structures usually provides for a structured process to determine the price adjustment post-closing, the parties often provide for subsidiary dispute resolution mechanisms (eg, intervention of a third-party expert). Since, for locked box consideration structures, the calculations are more straightforward, such separate dispute resolution mechanisms are less common.
Private equity funds are keen on deal certainty. Transactions are therefore only subject to those conditions that are required by law when a private equity fund is involved. This entails, in particular, antitrust clearance, but could also include approvals from other regulatory authorities when the target belongs to a specific regulated industry (eg, banks and insurance, energy, etc).
Material adverse effect clauses are reasonably rare throughout Europe, including Belgium. Only in very limited circumstances (mainly when a US buyer is involved) are material adverse effect clauses included in the acquisition documentation.
Other conditions to which the transaction would be subject (such as financing or third-party consents) are also not common in a Belgian M&A context involving private equity.
'Hell or high water' clauses are often negotiated in Belgian M&A deals to allocate the antitrust risk. If a buyer accepts such a clause, he/she agrees to take on all of the antitrust risk in the transaction, including making any divestitures required to obtain antitrust clearance. A private equity fund or a private equity backed buyer will be reluctant to accept such a clause due to its structure.
In a worst-case scenario, accepting such a 'hell or high water' undertaking could result in an obligation for the private equity fund to divest portfolio companies held by other funds of the private equity house. Exceptionally, in a subsidiary order, a private equity fund may accept a diluted 'hell or high water' clause which only covers the acquisition vehicle or which includes thresholds indicating the extent to which the private equity fund is required to divest assets to obtain antitrust clearance.
Break fees or reverse break fees are sometimes negotiated to prevent the seller or the purchaser, respectively, to back out of the transaction. However, such fees are, not common in Belgian M&A deals. Break fees are more common in public-to-private transactions.
Under Belgian law, break fees may be reduced if, and to the extent, they are deemed to constitute a penalty. This is the case when the amount manifestly exceeds the damages which, at the time of signing of the sale and purchase agreement containing the break fee, could have been foreseen by the parties as a result of breaking off the negotiations or transaction. Such damages include accrued transaction costs (including adviser fees), but it can also cover a loss of profit.
Except for termination by mutual consent, a private equity seller or buyer can usually terminate the acquisition agreement if the conditions precedent have not been satisfied on the long-stop date. In addition, parties sometimes negotiate the right to terminate the acquisition agreement prior to the long-stop date if it becomes clear that the conditions precedent will not be satisfied (or waived) on or before the long-stop date.
Other termination rights are rare but have been negotiated in the event of a material adverse effect prior to closing or a breach of representations and warranties or closing obligations.
A sale and purchase agreement typically includes a waiver stating that, except for the termination rights as expressly set out in the agreement and except in the case of fraud or dishonest misconduct, there is no possibility for either party to terminate the agreement in accordance with applicable law or otherwise.
A private equity seller wants to distribute the proceeds of the sale as quickly as possible to its limited partners. It will thus be reluctant to accept any residual liability (eg, escrow or specific indemnities), as this may prevent or delay such distribution. On the contrary, a private equity seller will negotiate for a general liability cap, a de minimis amount for claims and for a basket (where only the excess amount is due) to reduce its residual liability as much as possible. If the seller is a corporate seller, customary liability protection (including specific indemnities) is more often included in the acquisition documentation.
When W&I insurance is used, this is slightly different. The limitations on liability will be aligned with the de minimis and retention amount as set out in the insurance policy. In recent years, we have often seen liability caps in the acquisition documentation being reduced to zero if W&I insurance is taken out by the buyer.
Where a corporate seller will usually provide broader business warranties, private equity sellers are reluctant to give warranties that go beyond title and capacity and a locked box indemnity. In mid-market private equity transactions, greater comfort was sometimes given by the private equity seller (but always subject to data room disclosure and actual awareness). In buy-out transactions, the management sellers will be requested to provide business warranties, often subject to their actual awareness and with liability capped at a certain percentage of their net cash proceeds from the sale (typically between 25% and 50%), as they are more familiar with the target group.
The warranties are subject to customary financial and time limitations, with a difference to be made between the core warranties provided by the private equity seller (which will have a higher cap and a longer claim period) and the business warranties provided by management. In addition, business warranties will typically be qualified by appropriate knowledge and materiality qualifiers.
Data room disclosure is a common feature of Belgian M&A transactions, regardless of whether private equity is involved. When items are fairly disclosed in the virtual data room, a purchaser can no longer claim for damages for breach of representations and warranties. Disclosure schedules are only used on an exceptional basis (mainly when US buyers are involved).
In general, very little protection is offered by private equity sellers. In particular, escrow or price retention mechanisms are rarely seen in private equity transactions. However, as indicated above, W&I is becoming increasingly popular in Belgium and is often requested by private equity sellers.
The provisions that are by far the most commonly litigated are representations and warranties – in particular, those in relation to either tax (tax claims relating to the period prior to closing but initiated by the tax authorities post-closing) or financial statements (misrepresentation of the financial situation of the company). Such claims are sometimes lodged together with a claim for fraud to maximise recovery by the buyer.
In post-acquisition litigation, the question regularly arises what constitutes fair disclosure and whether fair disclosure applies in the case at hand. In addition, the degree of construed knowledge of the seller and buyer as professionals is also often debated.
Public-to-privates are not very common in private equity transactions in Belgium. By contrast, they have most typically been used by majority shareholders (eg, founders, strategic investors) to reduce administrative costs and restructure the company without the constraints of public disclosures and the pressure of a listing.
Shareholding disclosure requirements are mainly set out in the Law of 2 May 2007 and the Royal Decree of 14 February 2008, implementing the EU Transparency Directive, and in the Companies Code.
Any (natural or legal) person acquiring, directly or indirectly, securities and certain other reportable interests (see below) in a Belgian listed company representing at least 5% or multiples of 5% (10%, 15%, 20%, etc) of the total voting rights on the acquisition date must notify their shareholding to the FSMA and the relevant target company.
A disclosure notification duty also applies when securities are transferred and the transferor’s direct or indirect participation drops below one of the thresholds. Entering into, modifying or terminating an agreement to act in concert also triggers a notification requirement if the reportable interests held in concert by the parties to that agreement reach, exceed or drop below any reporting threshold.
In certain cases, a disclosure notification is required even when there is no acquisition or transfer of reportable interests, including:
Notification is required with respect to the following interests:
The disclosure notification must be sent to the FSMA and the relevant target company as soon as reasonably possible and, in principle, no later than the fourth Euronext Brussels trading day after the date of the circumstance or event giving rise to the notification requirement. The target company must publish the notification via a press release within three trading days following its receipt.
Non-compliance with the disclosure requirements is criminally sanctioned, and administrative and civil sanctions may also apply, including the suspension of the voting rights attached to the relevant reportable interest.
During the period of a (voluntary/mandatory) public takeover bid, the bidder, its directors and natural or legal persons acting in concert with them must notify the FSMA of any acquisition/sale conclusion/early settlement of a stock loan relating to voting securities of the bidder or the target company or of securities giving access to voting rights issued by the bidder or the target company (eg, warrants, options, convertibles). The same notification obligation applies to any person who holds, directly or indirectly, at least 1% of voting securities of the bidder or the target. This notification must take place on the business day on which the transaction occurred.
In accordance with Article 5 of the Takeover Law, any persons who acquire, alone or acting in concert, more than 30% of the shares in a listed company with its registered office in Belgium are required to launch a mandatory public takeover bid on the remainder of the shares in that company.
This means that if a potential bidder acquires the shares held by reference shareholders pursuant to a prior share purchase agreement – and thereby acquires, and afterwards holds, more than 30% of its shares – it will subsequently have to launch a mandatory takeover bid on the remaining shares in the target company.
Some exceptions exist to the obligation to launch a mandatory takeover bid. For example, in the event that the 30% threshold is surpassed following a voluntary takeover bid or as a result of subscribing for new shares issued pursuant to a capital increase with a preferential subscription right for the existing shareholders – a so-called 'rights issue'.
It is possible to use both shares and cash as consideration in Belgium, but cash consideration is more common.
As a general rule, conditions must not make the achievement of the intended result impossible.
Often, a voluntary offer is subject to the condition precedent of a minimum level of acceptance. Common levels set for minimum acceptance conditions are:
The implementation of such a condition can thus be motivated by the intention of the potential bidder to delist the target company after termination of the takeover bid, especially in the light of the limitations that apply on further acquisitions after termination of the offer period.
A voluntary offer can also be made, subject to the absence of a material adverse change, as long as the criteria on which this is based are unambiguously financial and not discretionary.
The takeover bid of a potential bidder on a target company may result in a change of control which requires approval by one or more competition authorities. If a bid falls within the scope of a competition law regime relating to concentration control, the bidder may only, as far as concentration control is concerned, make its bid subject to the condition precedent that the European Commission or the competent national competition authority decides that the concentration which was notified does not fall within the scope of the relevant legislation, or declares that the concentration is compatible with the common market or admissible from a competition law point of view in so-called 'phase 1' proceedings. In other words, the only admissible condition precedent in relation to competition clearance is the condition outlined above; the bid cannot be subject to the condition precedent of a positive outcome in so-called 'phase 2' proceedings, nor to the condition subsequent that the bid be rescinded in the event that the relevant competition authority renders a negative decision.
If the conditions set are not fulfilled, the bid is not automatically withdrawn. The FSMA demands an explicit notification of withdrawal by the bidder.
A business combination may not be conditional on a bidder obtaining financing. In the case of a cash offer, the required funds must be available in a blocked bank account at a Belgian financial institution or under an irrevocable and unconditional credit facility issued by a Belgian financial institution (it may also be a Belgian branch of a foreign financial institution). This is the so-called 'certain funds' requirement.
A bidder must always seek to obtain a 100% ownership of a target, but it may not succeed (for example, because the shareholding acquired at the end of the offer, or after a reopening does not permit the launch of a squeeze-out). This is a scenario that a private equity bidder will try to avoid, since it will constrain its capacity to perform a debt push-down to a large extent. If this were to happen, the private equity bidder would seek to negotiate certain governance rights with the other main shareholders (eg, one or several board seats). More extensive protective rights (eg, reserved matters, veto rights) would be very difficult to obtain in a listed company.
The squeeze-out procedure operates as follows. If the bidder, following the offer or its reopening, owns 95% of the voting securities, it may require all other holders of voting securities or securities giving access to voting rights to transfer their securities to it at the price of the offer, provided that it has acquired, by acceptance of the offer, securities representing at least 90% of the share capital with voting rights subject to the offer.
There is, therefore, a double threshold to be crossed by the bidder in order to be eligible for the application of the simplified takeover bid procedure after the closing of the offer. It must have collected, cumulatively:
If the bidder wants to apply this simplified squeeze-out procedure, it has to reopen the offer for at least 15 business days within three months after the end of the acceptance period.
In certain cases, it is clear that the offer of a potential bidder will only be successful insofar as the reference shareholders of the target company will sell their stake in it. One of the major disadvantages of the voluntary offer is that, in principle, the bidder can never be entirely sure that the reference shareholders will accept the offer, since, in accordance with Article 25 No 1 of the Takeover Decree, a holder of securities who has accepted pursuant to the offer may withdraw its acceptance at any time during the offer period.
As no clear and unambiguous legal stipulation exists about the validity of these irrevocable commitments, prudence is in order when one enters into such agreements.
Hostile takeover bids are permitted but are rare in Belgium.
Equity incentivisation of the management team is a common feature of private equity transactions in Belgium. Management usually invests alongside the investor, often through a management pooling vehicle which is controlled by the investor (eg, a Belgian civil law partnership or Dutch foundation is used for such purpose). The level of equity ownership held by management differs depending on the size of the transaction and whether it is a primary or secondary buy-out, but on average, management will typically be requested to re-invest approximately 50% of their net proceeds.
In buy-out transactions, management will typically invest on more favourable terms than the investor (so-called 'sweet equity') and hence benefit from an increased 'envy ratio' (ie, the ratio of the price paid by the investor to that paid by management for their respective shares of the equity). This can, however, be combined with an institutional strip as well for certain key investors (such investment being made on a pari passu basis with the investor and not subject to leaver provisions).
The sweet equity is usually structured through the interplay between different classes of securities. Additional upside for management can also be created through the setting up of 'ratchet mechanisms'. Various structures can be implemented to organise such ratchet (separate class of shares, subscription rights, options, etc) and will be based on IRR or 'money multiple' or both.
Preferred instruments are mainly used for the institutional strip (typically in combination with ordinary shares) and can have different forms, such as loan notes bearing a fixed interest rate, preferred shares with fixed annual dividend, etc.
A grant to/acquisition of stock options or subscription rights by management also remains common.
The investment and shareholders’ agreement will contain standard good, bad and intermediate leaver provisions for the management shareholders, which will only be relevant for their sweet equity (and not on the institutional strip held by the managers, if any). Such leaver provisions will be structured as a call option and provide for a compulsory transfer of shares held by the manager upon the occurrence of a leaver event. The leaver price will depend on whether the manager is considered a good, bad or intermediate leaver, knowing that in the case of a bad leaver a discount will typically be applied.
Vesting provisions are common but not systematically applied for all buy-out transactions. Vesting schemes typically run over three to six years or until exit. They can be gradual, progressive or with 'cliff vesting' features. (Cliff vesting means that the beneficiary becomes fully vested at a specified time rather than becoming partially vested in increasing amounts over an extended period of time.) Very often full vesting of the shares held by the management shareholders will occur only upon exit, so as to incentivise management to remain engaged and to fully co-operate towards a successful exit.
The shareholders’ agreement will typically include restrictive covenants for the management shareholders (including standard non-compete, non-solicitation and non-disparagement undertakings), often with a lump sum indemnification in the event of a breach.
Case law and legal doctrine have established criteria for the validity of non-compete clauses. A non-compete clause is valid only if (i) its duration, (ii) its geographical scope and (iii) its subject matter do not exceed what is reasonably necessary and proportional to achieve the legitimate expectations of the beneficiary of such restrictive covenant. The appreciation of the validity of the clause remains with the courts, which will decide on a case-by-case basis. Generally speaking, non-compete clauses are considered legitimate for periods of up to three years after the relevant shareholder has ceased to be a shareholder of the company.
The shareholders’ agreement will include customary anti-dilution protection for the management shareholders such as a pre-emption right in the event of future capital increases, protection against share splits, conversions and similar transactions and even catch-up rights in the event of a restructuring tranche.
Management will, in principle, not have any controlling powers over the company, which will remain solely with the private equity investor. In some transactions, we have seen management being allowed to nominate candidates for one board seat, but this management director will never be able to exercise control over the board meeting and/or be granted substantial veto rights for decisions to be made. Depending on the size of the management participation and the willingness of the investor, the shareholders’ agreement may contain a limited set of veto rights for the management shareholders (or the director appointed on their behalf) for those decisions that have a direct impact on the equity participation of the management shareholders which would be materially disproportionate when compared with the other shareholders of the company.
The management team will typically not have any rights to control or influence the exit of the private equity fund, as this decision will be solely made by the fund. However, the shareholders’ agreement may include consultation undertakings of the investor with the company’s key management shareholders (such as the CEO and CFO) and will in any event also provide for full co-operation undertakings from the management team in relation to the preparation and implementation of an exit.
A private equity shareholder will negotiate for shareholder control over its portfolio companies. Such shareholder control is typically realised by means of board representation of the private equity shareholder and by veto rights over all key decisions to be taken at various levels of the group (so-called 'reserved matters'). It is documented in the shareholders’ agreement or in the investment agreement. Sometimes these arrangements are also reflected in the articles of association of the relevant companies (depending on the level of confidentiality).
The level at which the private equity shareholder will seek representation depends on the transaction structure and the importance of (the subsidiaries of) the portfolio companies. If the private equity shareholder is only represented on the Bidco SPV’s board, it is common to negotiate 'waterfall' provisions, making it mandatory for the portfolio company and all its subsidiaries to also escalate these reserved matters to its shareholder (up to the Bidco SPV level).
The reserved matters for the private equity shareholder typically include, among others:
As a general rule, a private equity fund majority shareholder cannot be held liable for the debts incurred or transactions carried out by a limited liability portfolio company. Shareholders of limited liability companies are only liable to the extent of their subscription to the registered capital of such company. Belgian case law and legal authors have, however, in exceptional cases, softened this principle.
Application of Liability of Founding Shareholders for Company’s Debts
This liability of founding shareholders is triggered inter alia in the case of certain irregularities, at the time of incorporation, and in the case of bankruptcy of the company, within three years following incorporation, whereby the initial capital of the company was manifestly insufficient to ensure its activities for at least two years.
Application of Liability of Directors-in-fact or Shadow Directors
In the event of bankruptcy of the company and of insufficiency of the assets, and provided a severe and particular fault is established, any director or person having effectively managed the company can be found personally liable for all or part of the company’s debts up to the insufficiency of the assets. Shareholders could be considered as 'default directors' or 'shadow directors' if they have interacted with the management of the company to such a degree that their actions substitute those of the board of directors, assuming power over the company. In that case, shareholders lose the benefit of their limited liability and become responsible for the performance of their management duties under the rules applicable to directors of Belgian companies.
Piercing the Corporate Veil
The concept of piercing the corporate veil – ie, extending corporate insolvency to the 'true operator' in order to render shareholders or other group companies liable to the full extent of the company’s debts – is typically applied in the framework of insolvency if it can be established that the parent company or the shareholders have taken advantage of the subsidiary’s legal personality in an unlawful manner. The application of this concept is highly exceptional and depends on the facts in each case. Typical facts leading to its application are the intermingling of funds or assets (whereby a shareholder treats the relevant company’s funds as its own), absence of consistent accounting, and absence or only pro forma organisation of board of directors’ meetings and other corporate formalities, and the existence of agreements clearly detrimental to the subsidiary. This concept typically applies where a private person operates behind the company and is less likely to apply in the case of a company with numerous shareholders that are legal persons.
As mentioned before, compliance is becoming an increasingly important area of focus for private equity investors, not only in the due diligence phase but also once the transaction is completed. Typically, the private equity investor will implement the key findings/recommendations that have been identified in the context of its compliance due diligence on the target group (eg, ESG, anti-bribery and anti-corruption, etc).
The typical holding period for private equity investors ranges from three to seven years, although there are notable exceptions, since exit strategies are heavily dependent on company-specific elements and on the macro-economic climate. Most exits take the form of a private sale, as it offers more flexibility and can be run with relative discretion (and put on hold if need be without too much scrutiny). 'Dual track' exits are sometimes considered, but, in practice, they are only a credible option with larger target companies, since they should be able to attract a sufficient range of IPO investors. In secondary and tertiary buy-outs, when the management team is selling, it is customary for it to reinvest upon exit.
Drag rights are typically granted by the management shareholders in favour of a private equity investor. In practice, their mere existence acts as an incentive for alignment between the managers and the private equity investor at exit, so that they do not need to be enforced.
The drag-along right will typically be available upon a transfer by the private equity investor of a controlling stake in the company. The drag-along right will in principle apply to all other shareholders, including institutional co-investors.
It is not unusual (although not automatic) for management shareholders to benefit from a mirror tag-along in the shareholders’ and investment agreement. If provided, there will typically be a threshold as from when the management shareholders are able to exercise their tag-along right. We usually see as a primary threshold the sale by the private equity investor of at least 30% of the total shares in the company, which enables the management shareholders to exercise a pro rata tag-along right, provided that a full tag-along right is granted to the management shareholders upon the sale by the private equity investor of a controlling stake in the company. The tag-along right, if provided, can also apply to the co-investors, but this will depend on the arrangements being made among such co-investors and the private equity investor.
In IPO exits, it is customary for the private equity seller to dispose of part of its stake, and to benefit from the structural liquidity obtained from a listing to sell its remaining stake further down the line. It is usual for the selling shareholder to enter into lockup arrangements at the time of the IPO. The typical lockup arrangement for the private equity seller is six to 12 months.
'Relationship agreements' can be entered into between the private equity seller and the target company, at the time of the partial exit, but this is very unusual. The main terms of such a relationship agreement would have to be disclosed in the IPO prospectus. The new Belgian Code of Corporate Governance, which enters into force on 1 January 2020, encourages a listed company to enter into a relationship agreement with its significant shareholder(s).