Contributed By Deloitte Legal SLP
Private equity M&A transactions have reached record figures in recent years despite the uncertainty generated by the COVID-19 pandemic and the war in Ukraine.
Record Levels of PE Investment and VC Transactions
According to the Spanish Venture Capital and Private Equity Association ("SPAINCAP"), Spanish private equity (PE) capital investment in 2021 reached its second highest record ever, with a total invested volume of EUR7,572 million, in a total of 933 transactions. Venture capital (VC) transactions, in particular, have been especially intense, at 2.5 times the peak reached in 2020. In terms of divestments, a volume of EUR2,667.9 million was recorded in 361 transactions, most of which were carried out by private national operators.
Looking at the two main segments of the sector, PE investment reached EUR5,464.5 million spread across 160 investments, and VC investment reached a new all-time high of over EUR2,108 million (which represents an increase of 153% over 2020 figures) in 773 investments.
Regarding FY 2022, and as per the information in the monthly reports of TTR and Intralinks(available up to May 2022), there has been a 13% increase in the number of PE transactions and a 2% increase in the number of VC transactions.
Major Market Challenges
However, this upward tendency could be affected by major market challenges at European and national level, such as inflation, supply chain challenges, interest rate hikes, and environmental or social and governance (ESG) risks. It should be pointed out that PE funds now assess acquisitions much more carefully and with more thorough due diligence to avoid risk exposure after the transaction.
In this context, the use of warranty and indemnity (W&I) insurance is likely to continue to grow in Spain, not only through PE funds but also through industrial players that seek to ensure a clean transaction.
Technology in M&A Processes
It should also be noted that the use of technology in M&A processes has been consolidated, both at the negotiation level (Zoom or Teams negotiation meetings) and at the signing level, through electronic authentication platforms.
According to a recent SPAINCAP report, the following were the most active sectors in 2021:
It is noticeable that investment activity was largely directed at the most resilient sectors during the pandemic. This trend is expected to continue in FY 2022, but it should also be noted that according to TTR and Intralinks monthly reports, the real estate sector has been the most active in 2022, with a total of 208 transactions representing an increase of 52% compared to the first quarter of 2021.
It should also be noted that the war in Ukraine might lead to a decrease in Russian gas consumption in the short term, which opens up a great opportunity for the renewable energies sector as an alternative to gas. In this regard, price stabilisation formulas through power purchase agreements (PPAs) may materialise in significant M&A transactions.
As a consequence of COVID-19, several laws have been adopted over the last three years to alleviate the effects of the pandemic.
The insolvency moratorium was extended to 30 June 2022, meaning that companies in default situations did not have to complete a declaration of insolvency before the competent authorities, and applications from creditors seeking the onset of insolvency proceedings were not admitted, until such date.
The purpose of this regulation was to provide companies with a temporary margin in these uncertain times. However, this moratorium has now expired, so distress transactions carried out by PE funds will likely be the tendency in the coming months.
In addition to the above, and among other measures, regulations regarding electric power have also been changed, mainly aiming to minimise the impact of the war in Ukraine, enhance the use of renewable sources and regulate the remuneration to such sector. PE funds have actively followed these new regulations, despite the uncertainty generated by continuous change.
In general terms, M&A transactions are not subject to restrictions or regulatory filings in Spain, with the following exceptions.
Merger Control Regulations
These set out mandatory approval of the National Markets and Competition Commission (Comisión Nacional de los Mercados y la Competencia or CNMC) when certain thresholds of market share and target’s turnover are met. Transactions are suspended until such approval by the CNMC is issued. The CNMC may impose the fulfilment of certain actions to complete the relevant transaction (eg, carve-out of certain assets or business units).
Foreign Investment Regulations
These were issued in March 2020 and have been extended until 31 December 2022. As a result of these regulations, any investment into Spain carried out by residents of countries outside the EU and the European Free Trade Association (EFTA), or carried out by residents of the EU or EFTA whose ultimate beneficiary owner lies outside the EU or EFTA, will need prior authorisation by the Spanish government if the investment:
“Strategic sectors” include, among others, critical physical or virtual infrastructures (energy, health, water, transport, communications, communications media, processing and data storage, aerospace, military, electoral and financial sectors); critical technology; essential commodities (such as energy or raw materials and “food safety”); sensitive data and the media.
The aforementioned investments will require prior authorisation from the Spanish government, otherwise they will have no legal effect whatsoever until legalised, and will entail an infringement punishable by law.
According to a report published by the Ministry of Industry, Consumption and Tourism, during FY 2021, 55 transactions were submitted for prior authorisation and a total of 48 were resolved positive, while seven applications were closed as there was no need for approval.
Other Tightly Regulated Sectors
Other tightly regulated sectors include banking, insurance and utilities, which are all subject to regulatory oversight from the relevant supervisory authority.
Due diligence is normally carried out through a virtual data room (VDR) into which the relevant requested documentation is uploaded. Due diligence procedures also imply a constant question-and-answer process with the management of the target company. It is usual for due diligence procedures to be co-ordinated by a corporate finance team.
The scope of due diligence usually depends on the size and industry of the target, as well as on the type of purchaser, who may demand a wide spectrum of due diligence, ranging from narrow-scoped to full and comprehensive. PE funds generally request the full scope of due diligence, including:
Due diligence areas which are not very common but are increasingly being included in the due diligence scope are: compliance, corporate social responsibility (ESG) and cybersecurity.
Contingencies Identified in Financial, Tax and Labour Due Diligence
In so far as they typically include an estimated amount per contingency, these contingencies are typically addressed through:
Contingencies Identified in Legal Due Diligence
Contingencies in legal due diligence are often of a qualitative nature, for which remedies should be adopted before or after the transaction. They are therefore usually addressed through:
On top of the above, given the current situation of uncertainty generated by the pandemic and the war, PE funds are increasingly requesting the revision of material adverse change (MAC) clauses in certain contracts that are important for the target company.
Due Diligence Findings
Due diligence reports are frequently divided into an executive summary/red flag section, in which the contingencies identified are highlighted, and a descriptive section in which each contingency and other aspects of the target company are detailed.
Expert sessions between the purchaser’s and seller’s advisers are usually held during the due diligence process.
Contingencies identified will thereafter be discussed among the parties in order to determine the seller’s liability in the SPA. The purchaser’s knowledge of the target company acquired during the due diligence process is a frequent point of discussion among the parties (ie, whether the seller’s liability would have to be limited by such buyer’s knowledge).
The completion of a vendor due diligence report depends primarily on the size of the target company and whether the sale is made through an auction process. It is therefore more common in medium and large-cap targets. In auction processes, where a vendor due diligence report is not initially provided to potential bidders, it is common to see a fact book which highlights key aspects of the target and where certain contingencies can be identified.
Advisers typically rely on vendor due diligence reports, although it is common for buyers to perform a buy-side “confirmatory due diligence”, which “challenges” the contingencies identified in the vendor due diligence, and covers additional matters.
Private Sale and Purchase Agreements
The vast majority of PE deals are carried out through private sale and purchase agreements between the seller and the purchaser. Court-approved schemes are reserved for liquidation procedures and tender offers are limited to listed companies, so they are not generally part of a PE transaction.
Private sale and purchase agreements are then notarised before Spanish notaries public, who, among other functions, attest the date and the capacity of the parties to execute the transaction documents. They also guarantee that transactions are carried out in accordance with the law and that the parties understand and agree to the terms of 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 PE deal, as the legal certainty that they provide to the transaction benefits all the parties involved. After the closing of the transaction, the deeds granted before the notary acquire probative value, and the parties may request copies of said deeds at any time.
Bilateral and Auction Processes
PE funds take part both in bilateral and auction processes, depending on the specific transaction. 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 PE fund.
The terms of the transaction in the case of auction processes tend to slightly favour the seller, who seeks to get different buyers to compete with each other to obtain a better price and contractual terms and conditions in the agreement, although this varies, depending on the characteristics of the transaction (industry, type of parties involved, etc).
Share Deals and Asset Deals
Share deals are far more frequent than asset deals. 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 a need to:
Typically, PE transactions involve the execution of a SPA in addition to a shareholders' agreement between the PE fund special purpose vehicle (SPV) and the shareholders that manage the company and retain a stake, regulating the relationships between the shareholders, and between the shareholders and the company.
A management incentive plan (MIP) is also very common in PE transactions. These plans aim to increase the value of the target company and its affiliates by providing an extraordinary incentive to the target’s managers (independent and additional to their employment or mercantile relationship with the company), in exchange for maximising the value of the company in a liquidity/exit event. The amount of the extraordinary remuneration ("ratchet") usually depends on the return on investment (ROI) of the PE fund.
Acquisitions are typically carried out through SPVs incorporated in Spain as limited liability companies (“SL companies”). PE prefers such companies for the following reasons:
Usually, SPVs are directly controlled by a PE fund (if the fund is located in Spain) or by a foreign holding entity ultimately controlled by a fund located in a tax and investment-friendly country with which Spain has a favourable double-taxation treaty.
It is unusual for a PE fund to be a party to the transaction documents except for the equity commitment letter agreeing to fund the target.
Funding Structure of PE Transactions
Most PE transactions are financially leveraged, involving a combination of equity and debt (the proportion depends on the size of the transaction and the business involved).
Funding structure normally consists of partial financing of the acquisition although the financing purpose could be other tranches, such as to refinance existing debt or to partially finance investments in capital expenditure (capex).
In those funding structures, banks usually act as lenders. It is customary for the due diligence report to be shared with and analysed by the lending banks as a condition precedent to the signing of the facility agreement. The lending banks may require reliance on the due diligence report.
Depending on the characteristics of the acquisition, lenders may require collateral or the establishment of the parent company as guarantor.
When the purchaser contemplates an SPV, the sellers might request an equity and debt commitment letter.
According to SPAINCAP, 55% of PE transactions were financed with debt in FY 2021. Leveraged transactions have been favoured by the market conditions of the last few years due to ease of access to traditional bank debt.
PE typically prefers to acquire a majority stake in the target company, with the key managers remaining as managers and minority shareholders.
Deals involving a consortium of PE sponsors are not typical in Spain, except for transactions involving large-cap companies. Certain PE transactions involve other investors alongside the PE fund, but this does not happen very frequently (although it is common in VC deals), and it is normally driven by the modus operandi of the PE fund rather than being a general feature of PE transactions.
External co-investors in such transactions will usually have very limited political rights in the target company, which will be governed by the fund.
In the PE market in Spain, completion and locked-box accounts are the predominant consideration mechanisms.
Completion Accounts Mechanism
The initial agreed price is subject to a post-closing adjustment. On the closing date, the seller's auditor determines the parameters that have been used to agree the equity value (mainly, net debt and working capital). The purchaser will have a period of time after the closing date (normally three months) to review those parameters and, where appropriate, challenge the calculation of the purchase price.
In this mechanism, the parties agree on a fixed price based on the financial statements closed on a specific reference date. Usually, the parties agree that the financial statements must be audited or at least agreed between the parties.
The purchase price can then be adjusted in the case of leakages, that is, actions executed by the seller between the reference date and the closing date which are not within the ordinary course of business.
In general terms and in order to ensure a fixed price at closing date, PE funds prefer a locked-box mechanism in the sale with, in some cases, a ticking fee for the cash generated from the reference date to the closing date.
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 funding the acquisition vehicle at the closing of the transaction.
Where locked-box consideration structures are agreed, it is quite common for the seller to try to charge interest on the price after the date of opening of the locked-box account (ticking fee). However, such interest is heavily negotiated, and it is common for the parties to agree that no interest will apply.
As regards any interest charged on leakages, the usual provision 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, interest could be charged.
In both structures (locked-box and completion accounts) it is common to establish a dispute resolution mechanism.
Initially, the parties would agree to engage in good faith negotiations with the aim of reaching a mutually agreeable resolution. If this proves to be impossible, the parties agree to delay the decision, which will be made by an independent expert selected by both parties in accordance with the SPA’s conditions (usually an international audit company). The independent expert's opinion is usually binding for the parties, excluding the possibility to submit the dispute to the court or arbitration unless the independent expert is grossly negligent.
Applying the general dispute resolution system established by the parties and governing the SPA (court or arbitration) is very uncommon.
The most common condition is notifying the CNMC, which is the Spanish antitrust authority.
Other conditions consist of:
MAC provisions are rarely used as a condition precedent but have become more relevant due to theCOVID-19 pandemic.
Approval of the seller or the purchaser by the general shareholders’ meeting is likely to be a requirement to execute the transaction (especially when the transferred assets represent 25% of the purchaser's or seller's assets, according to applicable Spanish law) but is not included as a condition precedent to executing the agreement.
Due to their nature, PE funds typically adopt a very aggressive negotiating position and PE purchasers are usually very reluctant to accept any “hell or high water” undertakings. It is not therefore very common to include such undertakings in PE transactions, although a trend towards sellers trying to push the execution risk onto the purchaser through such clauses is becoming apparent.
Generally, in Spain, break fees or reverse break fees are very rare in PE transactions. In sale and purchase agreements, sellers are hesitant to accept any walk-out rights other than the conditions precedent previously negotiated and agreed by the parties.
As a general rule, SPAs exclude the application of Spanish law and are governed by their provisions. An acquisition agreement could not therefore be terminated by a legal cause other than the provisions agreed therein, except for wilful misconduct, the application of which cannot be excluded by the parties. Common provisions of termination of a SPA usually include the following.
Nevertheless, negotiations on MAC clauses have increased to regulate the impact of COVID-19 and the war in Ukraine. The exclusion of the pandemic from MAC clauses has been common (a fact that is well known and assumed by the purchaser). Only a limited number of deals have taken certain effects of the pandemic into consideration as part of MAC events, thereby precluding the closing of the transaction.
Risk allocation varies and would need to be analysed on a case-by-case basis. In general terms, risk allocation favours the seller.
In competitive auction processes, especially where a PE seller is involved, SPAs are drafted in a seller-friendly manner, meaning that the scope of representations and warranties (R&W) insurance is narrowed, and the quantum is also limited.
In the case of a PE seller, R&W insurance would basically refer to capacity, title to the shares being sold and the absence of liens or encumbrances over the shares. In the case of a trade seller, a more complete set of R&W is usually agreed (including business-related R&W).
The most common limitation on liability for a seller would include full disclosure of the data room. On some occasions, known issues as a consequence of the due diligence exercise also limit the liability of the seller.
Warranty Protection to a Purchaser
Warranties under a SPA include the following.
As the granting of business R&W is an essential requirement for the purchaser to enter into a SPA, the uptake of warranty and indemnity (W&I) insurance has increased in recent years, as detailed in the subsequent section.
Fundamental R&W are in all, or almost all, cases limited to the purchase price. On the contrary, Business R&W are normally subject to certain time and quantitative limitations. Time limitations usually range from 12 to 24 months after the closing of the transaction (except for any tax, employment and environmental warranties, which are usually limited to the relevant statutory limitation period). Quantitative limitations could include the following.
In auction processes, liability for known issues is normally excluded and general disclosure of the data room against the R&W is also very common. Specific indemnities are usually included in the SPA or in a side letter signed by the seller and the purchaser, to ensure specific protection of the known issues arising from the due diligence exercise.
Escrow or deferred prices are only common when the purchaser is the PE fund. PE sellers are usually unwilling to accept escrow or any sort of price retentions.
W&I insurance is becoming increasingly common in PE transactions, although it still has certain drawbacks, such as, the additional costs of the transaction and the exclusion of certain known issues.
Litigation provisions are always introduced in the SPA, although PE purchasers and sellers usually prefer to settle any situations amicably and try to avoid initiating any litigation proceedings.
As regards any consideration mechanisms or earn-out discussions, PE transactions usually agree to refer these 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, the most commonly litigated provisions refer to liability for breach of R&W granted by the sellers.
Public-to-private (P2P) transactions are not very common in Spain since the number of listed companies is relatively low in comparison with other jurisdictions such as the UK or the USA.
P2P transactions in Spain are mainly carried out by:
The rationale behind these P2P transactions is usually:
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, must be notified to the listed company and the market regulator (CNMV).
When the shareholder is a tax-haven resident, the above-mentioned percentages are lowered to multiples of 1% (eg, 1%, 2%, 3%, etc).
Mandatory takeover bids are required when a person acquires “control” of a listed company. In such event, the shareholder acquiring control must make a bid for 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 has paid or agreed to pay for the same shares during the 12 months prior to the announcement of the bid).
Control is gained when a person (i) acquires, directly or indirectly, a percentage of voting rights equal to or greater than 30%; and (ii) appoints, within 24 months of the acquisition of the listed company shares, more than half of the members of the board of directors, even if the person's holding stake is lower than 30%.
The breach of duty to make a takeover bid (ie, failure to make a takeover bid, late submission of a takeover bid, or submission of a takeover bid with material irregularities) might entail:
Consideration in most takeovers is paid in cash. Shares could also be used as consideration (eg, shares of the consolidating entity), however cash is far more common.
Mandatory takeover bids can only be conditional to the approval of the competition authorities and/or supervisory bodies, while voluntary bids can be subject to additional conditions, such as:
A condition based on obtaining the required financing for the bid would not be admissible under Spanish law, as it would breach the principle of irrevocability of the bid and would be contrary to:
In the event of 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. Such break-up fees:
Any bidder who has acquired at least a 90% stake of the share capital with voting rights of a listed company, as a result of a takeover bid, is entitled to require the remaining shareholders to sell their holding stake in the listed company at a fair price (ie, the consideration of the bid).
The prospectus must indicate the intention of the offeror to execute the squeeze-out right in the event of acquisition of 90% of the stake, which has to be executed within three months after the date of expiry of the acceptance period of the takeover bid.
Remaining shareholders also have a sell-out right which must be executed under similar terms and conditions to the squeeze-out right.
To ensure the success of the takeover bid, it is common to reach irrevocable commitments with significant shareholders prior to the issuance of the offer.
These commitments often include not only an irrevocable right to sell, but also a commitment to exercise their voting rights in such a way as 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 are less common than non-hostile takeovers in Spain.
Unlike in other jurisdictions (eg, the USA, which has the “poison pill” mechanism), the target listed company has no other protection mechanism to persuade its shareholders to reject the offer or find another bidder.
Hostile takeovers usually take place among competitors or private investors and not between PE investors.
Equity incentivisation of the management team is very common in PE transactions. The management will often retain equity between 5% and 10%.
Incentivisation is normally structured through management incentive plans, that might include:
Rights and obligations of the management are regulated through shareholders’ agreements, management incentive agreements and/or executive director agreements.
PE investors hold preferred shares to retain the decision-making control of the company, by holding either or both the majority of the voting rights of the company and/or certain veto rights over key decisions.
It is also quite common that the PE finances the acquisition of the managers’ equity (especially when the managers are not former shareholders of the company).
Vesting provisions are very common in management incentive plans as they ensure the continuation of the management team. They usually range between four to five years.
Accelerated vesting provisions are also very common, meaning that in the event that the liquidity event occurs prior to vesting of 100% of the incentive, and provided that the beneficiary complies with all the terms and conditions set forth in the incentive agreement, the beneficiary would normally be entitled to receive 100% of the incentive amount at the time of the liquidity event.
Management incentive plans also include certain "good leaver" and "bad leaver" provisions.
Restrictive covenants and obligations are usually regulated between the PE and the beneficiary in the shareholders’ agreement, the employment/director's agreement and/or the management incentive plan.
PE funds usually require the beneficiaries:
Non-disparagement covenants are not that common in Spain but can be agreed between the parties.
Manager shareholders are usually granted protection as regards exit/divestment of the PE fund and anti-dilution.
In this sense, in some cases, manager shareholders have tag-along rights, so they are entitled to divest in the company at the same time as the PE investor.
Regarding anti-dilution protection, it is also common to guarantee to manager shareholders either that they can maintain their percentage of sweet equity in the company during the investment period of the PE investors, or to grant them the required financing for subscription to additional shares.
On the other hand, veto rights are generally reserved for the PE investors through their preferred shares, either by having a direct veto right in certain decisions or by keeping control over the majority of the voting rights of the company (sometimes, sweet equity has no direct voting rights). However, some veto rights may also be granted to manager shareholders.
As a general rule, the management team is entrusted with the day-to-day activities of the company, while the PE has control over the key matters at the levels of both the shareholders and the board of directors.
This control is ensured in the shareholders’ agreement by means of the following:
The liability of the shareholders is, in principle, limited to the share capital contributed to the company. However, under certain exceptional circumstances, shareholders could be found personally liable through the application of the “corporate veil” doctrine, when they have fraudulently benefited from the establishment of the limited liability company or group of companies.
The corporate veil doctrine was established by the Spanish Supreme Court in May 1984 with the aim of preventing the legal personality of a company from being used as a means or instrument of fraud or for a fraudulent purpose. Its use is restricted and generally requires fraudulent use of the corporate personality and (i) control of several companies by the same person; (ii) related transactions between such companies; and (iii) no economic and legal justification for such transactions.
Compliance and corporate social responsibility (CSR) and environmental, social and governance (ESG) obligations for portfolio companies have become more important in recent years. PE funds will typically require the adoption of compliance systems in the acquired companies.
This trend has also been reflected in the scope of due diligences carried out by PE funds, which increasingly include a review of the target’s criminal risks, compliance systems and ESG policies.
The usual holding period for a PE fund before a divestment takes place usually ranges from four to six years, but depends on many aspects, such as the expected return or market momentum.
Auction and bilateral sales have been the most common form of PE exit.
Dual-track processes require a significant investment of resources and time to materialise and are therefore only attractive to large-cap companies under specific circumstances (market appetite, potential acquirers, etc). However, if carried out effectively, dual-track processes increase the chances of an investor achieving a favourable divestment and maximising value for existing market conditions.
In PE deals there is sometimes reinvestment in certain secondary buyouts.
PE transactions usually include drag-along rights in favour of the PE investors. Such rights are included in the shareholders’ agreement and aim to ensure partial or total divestment by the PE investors.
Threshold varies, depending on the specific case, but in PE transactions would apply to any other co-investors, regardless of its nature and the percentage held.
If the co-investor is another PE entity, the lock-up period and exit by either of the investors is heavily negotiated.
Minority shareholders and manager shareholders are in some cases manager shareholders with tag-along rights in the shareholders’ agreement. There is no standard threshold for the granting of such rights.
In the event that the PE investor is the minority shareholder, or two PE investors are co-investors in the same target company, such PE shareholders will usually have tag and drag-along rights.
Although an IPO is still the preferred exit strategy for PE investors in large deals, this has become increasingly unusual, especially after the severe economic conditions brought on by the 2007–2008 financial crisis and the COVID-19 pandemic and today's economic uncertainty.
In FY 2021, the number of IPOs in the Spanish market increased in respect of FY 2020 (Soltec), but only Acciona Energía and Ecoener were listed.
On other hand, IPOs to BME Growth (a stock market for smaller companies with a more flexible regulatory regime, like the Alternative Investment Market (AIM) of the London Stock Exchange) are more common.