Contributed By Deloitte Legal
Private equity activity in Spain has grown tremendously during the past three years, setting its peak in 2019, in which the record for highest M&A activity both in terms of investment value and in terms of number of transactions was set.
It was envisaged that 2020 would be another positive year for private equity activity, following the growth trend achieved in previous years. However, the economic effects of the COVID-19 pandemic have severely disrupted M&A activity, with many deals being postponed or abandoned. There have been some exceptions, especially in sectors less affected by the pandemic.
The Impact of COVID-19
The COVID-19 pandemic is likely to accelerate structural changes in the economy (for example, digitalisation), which may have an asymmetrical impact in terms of sectors. There is consensus that some industries and businesses will have to reinvent themselves to survive this crisis and face the post COVID-19 future, and M&A activity may be one of the main factors that could drive this transformation.
In this regard, certain sectors (health, food, distribution, technology or telecommunications are some examples) are showing greater resilience to this new environment, with some companies seeing increased demand for their services or products. It is thus likely that companies in favourable financial positions will seek acquisitions to further strengthen their leadership.
For companies in the hardest-hit sectors, strategies have focused on identifying non-strategic assets as possible divestments (as a mechanism to protect the core business) are to be expected.
According to the Spanish Venture Capital & Private Equity Association (Asociación Española de Capital, Crecimiento e Inversión or ASCRI), private equity activity in Spain achieved in 2019 record-breaking amounts for three years in a row, reaching EUR8,526.9 million in 2019. This figure implies a 41.8% increase with respect to 2018, which was the highest before. In terms of numbers of deals, 2019 also set the record to date, with 760 investments (up 38% from 2018).
This surge in private equity activity has been attributed to the high level of liquidity available in the market as well as a positive trend in lending activity to businesses.
In terms of sectors, healthcare, technology and consumer goods have been the key drivers of growth during the last years.
The most significant legal development impacting private equity funds and transactions has been the authorisation regime set forth for certain foreign investments in 2020. This measure has been implemented through Royal Decree 8/2020, by virtue of which urgent and extraordinary measures were adopted to mitigate the impact of the COVID-19 outbreak.
As a result of this new regulation, any investment into Spain carried out by residents of countries outside the European Union (EU) and the European Free Trade Association (EFTA), or carried out by residents in the EU or the EFTA but whose ultimate beneficiary owner lies outside the EU or the EFTA- which:
will need prior authorisation by the Spanish government. Transactions carried out without the required prior authorisation will have no legal effects whatsoever until legalised and will entail an infringement punishable by law.
This new regulation considers as “strategic sectors” the following ones:
In general terms, M&A transactions and foreign investments are not subject to restrictions or regulatory scrutiny in Spain. There is no distinct specificity in terms of primary regulators and regulatory issues applicable to private equity deals with respect to general M&A activity.
Notwithstanding the above, merger control regulations as well as the new regulation established in 2020 in relation to foreign investments, see 2.1 Impact on Private Equity, shall be taken into consideration. Likewise, certain tightly regulated sectors (such as banking, insurance and utilities) are subject to regulatory oversight from the relevant supervisory authority.
Private equity funds require regulatory authorisation to operate from the Spanish National Securities Market Commission (CNMV), and are subject to specific disclosure obligations before the CNMV. However, such legal regime does not provide for regulatory oversight over the private equity fund’s M&A activity.
Merger Control Regulations
There is no distinction between private equity deals and other M&A transactions in terms of merger control. Any transaction leading to a concentration shall be subject to prior approval from the Spanish antitrust authority if any of the following alternative thresholds are met:
Until antitrust clearance is granted, a stand-still obligation to suspend the execution of the transaction applies. Penalties for not complying with this obligation and premature implementation (gun jumping) are foreseen and imposed regularly.
Under the so-called “one-stop-shop principle”, prior antitrust approval from the Spanish antitrust authority is not necessary if the concentration falls under the scope of applicable EU regulations (ie, it has a “community dimension”) and is thus notifiable to the European Commission.
The scope of the due diligence usually depends on the size and industry of the target as well as the type of buyer, ranging from quite narrow-scoped due diligences to full and comprehensive ones. Private equity players in Spain (both national and foreign) generally request full due diligence scopes focusing on the following four areas:
Contingencies identified in the financial, tax and labour due diligence are typically addressed through valuation adjustments and/or guarantee mechanisms (escrows, bank guarantees, etc), insofar as they typically include an estimated amount per contingency. On the contrary, contingencies in the legal due diligence are often of a qualitative nature to which remedies should be adopted before or after the transaction. A prime example of this are change of control clauses included in the main agreements, which may entail the seller’s obligation to obtain a waiver before the closing of the transaction as a condition precedent.
Contingencies detected in the legal due diligence process may be addressed through:
Due Diligence Findings
With respect to due diligence findings, major bones of contention between the parties typically revolve around:
Due diligences are usually carried out through a virtual data room (VDR) into which the relevant requested documentation is uploaded. Due diligence processes also imply a constant question and answering process with the management of the target company carried out via conference-calls or physically at the premises of the target. It is usual for due diligence processes to be coordinated by a corporate finance team hired by the buyer or the seller.
Due diligence reports frequently contain an executive summary section, which highlights the identified contingencies, followed by a more descriptive section focusing in a more in-detail description of each area.
Vendor due diligences are not standard for most transactions except for competitive auctioning processes for medium and large cap targets, in which case they are fairly common.
In such cases, advisors typically provide credence to the vendor due diligence reports, although it is common for the buyer to additionally perform a buy-side “confirmatory due diligence” on the vendors’ due diligence provided.
The scope of “confirmatory due diligence” is narrower than a typical buyer’s due diligence, mainly focusing on areas which are not adequately covered in the vendors’ due diligence.
Private Purchase Agreements
The vast majority of private equity deals are carried out through private purchase agreements between the seller and the buyer. Court-approved schemes are reserved for liquidation procedures and tender offers to listed companies, so they are not generally part of a private equity transaction.
Most private purchase agreements are granted before public notaries. Public notaries in Spain are civil servants who, among other functions to which they are entrusted, advise clients in order to guarantee that transactions are carried out in accordance with the law. In particular, notaries are in charge of drafting the deed of transfer (which in private equity deals will commonly imply the granting into public deed of the SPA) and of ensuring that both parties understand and agree to the undertakings foreseen in the transaction. In some deals their presence is mandatory (such as the acquisition of shares of limited liability companies), but, in any case, they are typically involved in a private equity deal, as the legal certainty that they provide to the transaction benefits both buyer and seller. After the closing of the transaction, the deeds granted before the notary acquire probative value, and the parties may request at any time copies of said deeds.
Share deals are far more frequent than asset deals. This is mainly due to the fact that whereas in share deals the acquisition of the shares of a company entails the indirect acquisition of all its assets and liabilities, in asset deals there is the need for:
Typically, transactions involve the execution of a private share sale and purchase agreement (SPA) in addition to a shareholders' agreement between the private equity fund special purpose vehicle (SPV) and the manager-shareholders. In cases where the equity fund not only acquires the target company but also injects funds, it is frequent for the shareholders' agreement to be included within a broader investment agreement, which, in addition to the relationship between the parties' post-acquisition, also regulates the investment undertakings of the parties in relation to the target company.
Competitive auction processes are standard for medium and large cap companies, while in the case of small cap companies, the transaction usually entails a bilateral negotiation between the seller and the private equity fund. Terms of the transaction in case of competitive auction processes tend to slightly favour the seller, although this will immensely vary depending on the characteristics of the transaction (industry, type of parties involved, etc).
Typically, acquisitions are carried out through SPVs incorporated in Spain as limited liability companies (SL companies). Usually, SPVs are directly controlled by the private equity fund (if the fund is located in Spain) or by a foreign holding entity ultimately controlled by the fund located in a tax and investment-friendly country with which Spain has a favourable double taxation treaty (if the fund is not located in Spain).
It is unusual for the private equity fund to be a party to the transaction documents except for the equity commitment letter agreeing to fund the target.
Private equity funds are highly involved throughout all the stages of a transaction, from market prospection, signature of initial non-disclosure agreements and letters of intent, performance of the due diligence works and until closing of the transaction.
Private equity funds are always assisted by an advisory services firm who typically provides, at least, legal advisory services in relation to the transaction.
Transactions commonly involve the private equity fund taking a majority stake in the target company, with the key managers remaining as minority manager-shareholders. Private equity deals involving a minority stake are quite rare.
Most private equity transactions are financially leveraged, involving a combination of equity and debt (usually, with banks as lenders). It is customary for the due diligence report to be shared with and analysed by the lending banks as part of the approval process for the financing. The lending banks may require reliance of the due diligence report.
Deals involving a consortium of private equity sponsors are not very typical in Spain, except for transactions involving large cap companies.
Despite certain private equity transactions involving other investors alongside the private equity fund, this is not very frequent (as opposed to what is common in venture capital deals), and it is normally driven by the “modus operandi” of the private equity fund rather than being a general feature of private equity transactions.
In private equity (PE) transactions, it could be said that the predominant consideration mechanism, and still the preferred for PE sellers, would be the locked-box mechanism. As a general rule of thumb, it could be argued that locked-box mechanisms are preferred over the completion accounts mechanisms, especially for PE Sellers, given the price certainty granted by such mechanism.
On the other hand, it can be stated that completion accounts mechanisms are seen as well, but perhaps, this is more generalised and spread on mid-sized deals.
As regards the protection provided by a PE buyer, and although the PE buyer is usually quite reluctant to provide any sort of protection, the most common one would be an Equity Commitment Letter, by virtue of which the fund commits to fund the acquisition vehicle at the closing of the transaction.
Where locked-box considerations structures are agreed, it is quite common for the seller to try and charge an interest on price since the date of the locked-box account. However, such interest is heavily negotiated, and it would be common to agree by the parties that no interest would apply.
As regards any interest charged on leakages, the usual provisions to be negotiated would be to directly reduce the purchase price on a euro for euro basis when any such leakages arise prior to closing. If any leakages arise post-closing, it could be charged with interest.
Specific dispute resolution mechanisms are usually included. The parties would first agree to negotiate in good faith and find an amicable solution within a short period of time. In case this proves not to be possible, the parties agree to defer the decision to be adopted by an independent expert appointed by both parties in accordance with the conditions set out in the SPA.
It is highly uncommon to apply the general dispute resolution agreed by the parties and governing the SPA.
Most common condition would consist of the notification the acquisition to Spanish antitrust authorities (Comisión Nacional de los Mercados y la Competencia), and where applicable, to the antitrust authorities in other countries, especially in large deals.
Moreover, applicable Spanish legislation sets out that if the assets being transferred represent a significant percentage of the seller's assets percentage, approval of the transaction by the GSM of the seller is required, and therefore, such condition usually finds its way through the SPA.
Other conditions, although less common, would include financing of the acquisition by the buyer, third party consents to be obtained for major agreements of target containing change of control provisions (termination of which would have a significant impact on the business being acquired) or any carve-out or reorganisation that might need to take place before closing of the transaction.
PE buyers are very reluctant to accept any “hell or high water” undertakings. Therefore, it is not very common to include such undertakings, although they have been seen on several occasions.
Break fees or reverse break fees are rarely seen in any PE transactions. Sellers are highly reluctant to accept any walk out rights in an SPA (other than any condition precedent previously negotiated and agreed by the parties).
It is very unusual for a signed SPA to be terminated prior to closing. The only scenario would be the case where any of the conditions precedent set out in the SPA are not met. In such a scenario, the parties would usually find an amicable way to proceed with closing and given that such conditions precedent (if not regulatory) can be waived by the parties, it makes it very uncommon for either party to terminate or walk out from a signed SPA.
Material Adverse Change (MAC) clauses are quite uncommon. Any PE seller will be very reluctant to accept any MAC clauses as it reduces significantly the deal certainty.
Despite these clauses being uncommon, in some cases, “soft” MAC clauses have been introduced in an SPA. These refer to macroeconomic situations which are difficult to materialise. However, specific business-related MAC clauses is highly uncommon.
The risk allocation varies and would need to be analysed on a case by case basis. In general terms, the risk allocation would favour the seller.
In competitive auction processes and, specially, in case of a PE seller being involved, the SPAs are drafted in a seller-friendly manner, meaning that the scope of the representations and warranties (R&Ws) is narrowed, and the quantum is also limited.
In case of a PE seller, R&Ws would basically refer to capacity, title to the shares being sold and absence of liens or encumbrances over the shares. In case of a trade seller, a more complete set of R&Ws is usually agreed (including business related R&Ws).
Most common limitation on liability for a seller would include full disclosure of the data room. In some occasions, known issue as a consequence of the due diligence (DD) exercise also limits the liability of the seller.
Customary R&Ws granted by a PE seller would usually include those referring to the valid existence of target, title to the shares and absence of lines or encumbrances over the shares being sold. For these R&Ws, the liability would be only capped at the purchase price.
In certain deals, whether being granted by a PE seller or by the management, business related R&Ws are also granted. Most common reps in this sense would include those relating to the accounts, the main contracts or agreements to which target is a party, compliance with tax obligations, litigation, employees or the business being conducted in the ordinary course of business.
As regards these business-related set of R&Ws certain limitations would apply. Mainly, a time limitation which usually would be ranging from 12 to 24 months since closing of the transaction (except for any tax or employees related warranties which usually are limited to a four-year term).
Specific indemnities are also included for known issues arising from the DD exercise which importance make necessary a specific protection.
In most cases, liability for known issues is excluded and general disclosure of the data room against the R&Ws is highly common (particularly in competitive auction processes).
As stated above, full disclosure of the content of the data room to limit the seller’s liability is generally accepted.
W&I is becoming increasingly common although cannot be considered as common practice yet. The product is not yet well known by trade sellers and the need for additional DD to be conducted by the W&I insurer, the exclusions of certain known issues (namely known tax issues) and the impact on timing, refrain the W&I insurance from being highly common as of yet.
PE sellers are usually unwilling to accept escrow or any sort of price retentions, especially in auction processes.
Litigation proceedings in respect of PE transactions is not common in Spain. Although the usual applicable jurisdiction provisions are always introduced in the SPA, PE buyers or sellers usually prefer to settle any situations amicably and usually try to avoid initiating any litigation proceeding.
As regards any consideration mechanics or earn outs discussions, PE transactions usually agree to defer this to an external expert to be appointed by the parties in accordance with the provisions previously set out in the SPA.
Apart from those referring to consideration mechanisms or earn outs, most commonly litigated provisions would refer to any sort of reps and warranties being granted by the sellers, or specific indemnities.
Public-to-private (P2P) transactions are not very common in Spain since, in comparison with other jurisdictions such as the UK or the USA, the number of listed companies in Spain is comparatively low.
P2P transactions in Spain are mainly carried out by:
The rationale behind these P2P transactions are usually:
During 2020, two P2P transactions have been announced and they might be executed by the end of September 2020. One of them is led by a pool of private equity investors and the other by a competitor of the listed company.
Any “Transaction” by virtue of which a “Shareholder” reaches, exceeds or falls below a voting right stake threshold of 3%, 5%, 10%, 15%, 20%, 25% 30%, 35%, 40%, 45%, 50%, 60%, 70%, 75%, 80% and 90% in a listed company (both in the Spanish secondary market or another EU regulated market), must notify the listed company and the CNMV (ie, the market regulator).
When the shareholder is a tax heaven resident, the above-mentioned percentages are lowered to multiples of 1% (eg, 1%, 2%, 3%, etc.)
Under certain requirements, the listed company must also notify to the CNMV when it acquires, directly or indirectly, a stake of its own shares exceeding 1% of the voting rights of the company
For the purpose of this section:
Mandatory takeover bids are required when a person acquires “control” of a listed company. In such event, the shareholder acquiring control shall make a bid for the 100% of the issued shares of the listed company at a fair price (ie, a price not lower than the highest price that the offeror have paid or agreed to pay for the same shares during the 12 months prior to the announcement of the bid).
For the purpose of this section, a person shall be deemed to have Control when that person (directly or indirectly):
Control might be achieved not only voluntarily but also in a supervening way (eg, by way of a share capital decrease of the listed company). In those particular cases, the Spanish law allows the person achieving Control to sell the number of shares exceeding the above-mentioned thresholds for a period of three months (as long as it doesn’t make use of the control achieved).
The CNMV may also waive, in very limited scenarios, the obligation to conduct a mandatory offer.
The consideration in most of takeovers is paid in cash.
However, is not unusual that some takeovers provide for other securities as total or partial consideration.
The conditions to be established in an offer of a takeover bid rely on the nature of the takeover bid.
In this sense:
For these purposes, the CNMV considers a condition to be acceptable when it meets the following requirements:
In accordance with the above, the condition consisting in obtaining the required financing for the bid is not admissible under Spanish Law as it would go against the principle of irrevocability of the bid and would be contrary to:
Two Competitive Takeover Bids
In the event that there are two competitive takeover bids, the listed company and the first offeror may agree a break-up fee by virtue of which the latter is compensated for the expenses incurred in preparing the bid. This break-up fee must be subject to the following four conditions:
Any bidder who has acquired, at least, a 90% stake of the share capital with voting rights of the listed company as a result of a takeover bid, is entitled to require the remaining shareholders to sell its holding stake in the listed company at a fair price (ie, the consideration of the bid).
The offeror shall indicate in the prospectus its intention of executing the squeeze-out right in the event of acquisition of at least a 90% stake of the share capital with voting rights of the listed company. Three days after the announcement of the result of the offer, the offeror shall communicate its intention of exercising or not its squeeze-out rights, which decision is irrevocable.
The squeeze-out shall be executed within three-months since the date of expiry of the acceptance period of the takeover bid.
It should be pointed out that the remaining shareholders also have a sell-out right which shall be executed under similar terms and conditions to the squeeze-out right.
It is relatively common to reach irrevocable commitments with significant shareholders prior to issuing a takeover bid in order to ensure the success of the same.
These commitments often include not also an irrevocable right to sell, but also a commitment to exercise their voting rights in such a way to facilitate the success of the bid (both at a shareholder level and, as far as legally possible, at the board of directors' level).
Hostile takeovers are legally possible but less common that non-hostile takeovers in Spain.
Unlike other jurisdictions (ie, the USA's poison pill mechanism), the target listed company has no other protection mechanism that persuade its shareholders to reject the offer or find another bidder.
Hostile takeovers usually take place amongst competitors or private investors and not between Private Equity investors.
Equity incentivisation of the management team is a very common feature of private equity transactions. Management equity ownership often ranges between a 5% and a 10%. The previously mentioned equity ownership stake may be increased up to a 15/20% in secondary buyouts.
In addition, or as an alternative to equity incentivisation, management incentives may also be structured through:
Depending on the structure of the management incentivisation, the rights and obligations of the management team and the PE investor may be regulated through the bylaws of the company, a shareholder’s agreement, a management incentive/equity plan, and/or and employment/director agreement.
Management participation is typically structured through:
Other forms of equity investment such us stock options, are not common in private equity transactions in Spain.
Under this structure, private equity investors hold preferred shares which conferred them the decision-making control of the company by holding either or both the majority of the voting rights of the company or certain veto rights over certain decisions.
Managers often obtain financing from the private equity investors for the execution of its investment (especially when the same were not part of the former shareholders of the company and therefore did not obtain funds from the private equity investment in the same).
Management equity plans in Spain usually provide for a good leaver, early (good) leaver and bad leaver provisions.
Generally speaking, managers are considered:
In these early (good) leaver scenarios, the percentage of the agreed ratchet will depend on the vesting period agreed by the parties and the time at which the good early leaver cause takes place.
Vesting periods in Spain usually range between four to five years, accruing more of the ratchet by the end of the same (eg, 5% during the first year, 10% during the second year, 40% during the third year, 80% during the fourth year and 100% during the fifth year).
Restrictive covenants such us non-compete, non-hiring/non-solicitation are absolutely customary to managers shareholders (as well as to management with no equity interest in the company). These restrictive covenants are limited to two/three years under Spanish law. When the manager is also an employee of the company, this non-compete covenants must be remunerated.
A non-disparagement covenant is not so common in Spain, but it can be agreed between the parties.
Private equity investors usually require manager shareholders (as well as to management with no equity interest in the company that are part of a management incentive plan) the following obligations:
All these restrictive covenants and obligations are usually regulated both in the shareholders agreement, the employment/director contract with the company and the corresponding management equity/incentive plan.
Manager shareholders usually obtain two type of protection in their investment:
In this sense, it is common for manager shareholders to obtain a tag along right so they can divest in the company at the same time as the private equity investor.
Regarding the anti-dilution protection, it is also common to guarantee to the manager shareholders either to maintain its percentage of sweet equity in the company during the investment period of the private equity investors or the commitment to grant them the required financing for the subscription of additional shares.
On the other hand, veto rights are generally reserved to the private equity investors through its preferred shares, either by having directly a veto right on certain decisions or by keeping the control over the majority of the voting rights of the company (sometimes, the sweet equity directly has no voting rights). However, some veto rights may also be granted to the managers shareholders.
As a general rule, the management team of the portfolio company is entrusted with the day-to-day management activities related to the business.
Provisions related to the control of the private equity fund over the portfolio company are usually incorporated into a shareholders’ agreement, which is typically executed by the private equity fund SPV with the minority manager-shareholders upon closing of the acquisition of the portfolio company.
The following measures are customarily included in the shareholders’ agreement for the exercise of control over the portfolio company:
Spanish corporate law establishes as a matter of principle the liability system, according to which shareholders limit their liability to the amount of their contributions to the company.
However, Spanish corporate law also envisages the possibility, in certain exceptional circumstances, for shareholders to be held personally liable through the application of the "corporate veil" doctrine, based on which courts can declare shareholders liable for damages caused to the company and/or third parties where they have profited fraudulently by benefitting from the fact that the company has its own separate legal personality and independent assets.
In addition, de facto directors (that is, those who carry out the functions of director of a company without a title, with a void or extinguished title or other kind of title, and those on whose instructions the directors act) are also liable for damages caused to the company and/or third parties and/or shareholders for acts or omissions carried out illegally or in breach of their duties.
In recent years there has been a notable growth in compliance and corporate social responsibility (CSR) or environmental social and governance (ESG) obligations for portfolio companies. In fact, portfolio companies should have their own compliance management systems and should act in compliance with the CSR or ESG standards and policies of the private equity fund.
This trend has also been reflected in the scope of due diligences carried out by private equity funds, which increasingly include a review of the target’s criminal risks, compliance systems and ESG policies in place.
Additionally, it is increasingly common for portfolio companies to periodically report on the evolution and management of their risks and the application and effectiveness of their policies to the private equity fund.
The usual holding period for a PE before a divestment takes place varies, usually going from four to six years. In some cases, PE sellers have sold their interest in a business as soon as two years since its acquisition, although it remains uncommon.
Dual tracks are quite common in large deals. In this scenario it is not unusual that the sale process derails a potential IPO if the PE sellers find there is appetite in the market for the assets they are selling.
All in all, auction sales have been the most common form of a PE exit, although bilateral sales either to a PE buyer in a secondary buy-out or to a trade seller are also common.
In PE deals we have seen reinvestment in certain secondary buyouts, but we could not consider these as common. On the other hand, reinvestment of any kind is seldom seen in trade seals.
PE transactions usually include drag along rights in favour of the PE investors in the relevant shareholders’ agreement to ensure such investors can implement at all times both partial or total divestments.
Depending on the majority held by the PE investor, it would apply to any other co-investor regardless of its nature. However, it is more common and easier to enforce in respect of minority shareholders (managers or other).
If the co-investor is another PE entity, the lock-up period and exit by either of the investors is heavily negotiated and introduced in the shareholders’ agreement.
As a general rule, the management team does not usually enjoy any sort of tag-along rights while PE shareholders usually do in the rare event they hold a minority stake.
In these scenarios, such tag rights would not be typically triggered until a change of control occurs.
Given the economic crisis before and now because of the pandemic, there have not been many IPOs in Spain in recent years. Although it is still a preferred exit route for PEs in larger deals, this has been quite uncommon.
Lock-up arrangements would be in the region of 18 months.
In an IPO scenario, any existing Shareholders’ Agreement would be usually terminated. Otherwise, in case there is any new Shareholders’ Agreement in place, it should be disclosed to the regulator.