The global effects and disruptions brought about by COVID-19 render any forecasts related to M&A activity in the second half of 2020 and beyond speculative. In line with many other jurisdictions, the Austrian M&A market has suffered from the COVID-19 crisis in terms of both volume and number of deals. Interestingly, and in sharp contrast with the disruptions brought about by COVID-19 starting in March 2020, the first quarter of 2020 saw more large transactions involving Austrian parties than in 2019.
Some investors are still in the process of assessing the medium-term implications and opportunities arising from the crisis, while a lot of private equity companies that have enough dry powder are intensively looking for attractive targets, particularly in the technology, life sciences, infrastructure and food sectors, and in sectors focusing on sustainability, such as renewable energy. As such targets are rare, the Austrian market remains seller-friendly to a certain extent.
Another trend is the growth desire of private equity buyers looking at distressed opportunities, with an increase in special situations expected in the last quarter of 2020 and beyond.
Private equity deals at the top end were rather rare and were spread across sectors rather than focusing on a specific sector. However, in the mid-market, technology, life sciences, infrastructure and sustainability sectors (environment in particular) are expected to see the strongest interest in 2020.
In recent years, the most significant legal development impacting domestic private equity funds and transactions was the implementation by the Austrian legislator of the Austrian Alternative Investment Fund Manager Act (AIFMG), based on Directive 2011/61/EU on Alternative Investment Fund Managers. Typically, Austrian funds that do not comply with Directive 2009/65/EC (ie, the UCITS Directive) qualify as alternative investment funds (AIFs) after the introduction of the AIFMG. An AIF is defined as a collective investment undertaking that raises capital from a number of investors, in order to invest it in accordance with a defined investment policy that does not use the capital for direct operational purposes.
Generally, managers of Austrian private equity funds are subject to the ongoing supervision of the Austrian Financial Market Authority (FMA). Managers of such AIFs are required to obtain a licence from the FMA, pursuant to the AIFMG. Exceptions to this rule apply with respect to most of the Austrian funds that do not require a licence for managers, provided that the cumulative AIFs under management fall below a threshold of EUR100 million in cases where leverage is used, or below a threshold of EUR500 million in cases where no leverage is used. When it comes to investments of private equity funds in Austria, the restrictions on asset stripping and additional disclosure requirements as outlined in the AIFMG based on the AIFMD may be relevant.
The primary regulators that are or may be relevant to private equity funds and transactions are the FMA, the Federal Competition Authority (FCA), the Austrian Takeover Commission (ATC) and the Ministry of Digital and Economic Affairs (Bundesminister für Digitalisierung und Wirtschaftsstandort – MDEA).
Generally, there are no specific regulations that specifically address or discriminate against private equity transactions. However, certain areas of public interest (eg, in case of investments into sectors such as banking) impose restrictions, depending on the identity of the buyer.
Austrian Investment Control Act
On 15 July 2020, the Austrian Parliament adopted the Austrian Investment Control Act (Investitionskontrollgesetz – ICA), aiming to further tighten the regulatory framework for foreign direct investments (FDI).
Pursuant to the ICA, a mandatory filing requirement is fulfilled if at least one of the investors is a foreign person (ie, non-EU/EEA/Swiss individual/entity) and directly or indirectly intends to carry out an investment in an Austrian undertaking (ie, has its seat or central administration in Austria) that is active in a sector listed in an Annex to the ICA. Such investment encompasses the acquisition of the following:
The mentioned Annex to the ICA distinguishes between particularly sensitive sectors, for which an additional materiality threshold of 10% applies, and other sectors, for which only the materiality thresholds of 25% and 50%, respectively, apply.
The highly sensitive sectors subject to the 10%, 25% and 50% thresholds (exhaustively) are as follows:
Other sectors subject to the 25% and 50% thresholds, in which a threat to security or public order might arise, are as follows:
An approval of the responsible member of the federal government (currently the MDEA) is not required with respect to investments in an undertaking that has fewer than ten employees and an annual turnover or balance sheet total of less than EUR2 million.
A foreign investor is advised to assess the compliance of the envisaged transaction with the ICA at an early stage, in order to avoid unexpected consequences.
The approval of the MDEA must be obtained prior to the signing of an applicable transaction. Generally, the MDEA has a one-month review period from the date of the delivery of the relevant notification, and the one-month Phase period only starts following a 35-day period within which the EU Commission and/or Member States can comment on the transaction. A case is deemed cleared if the MDEA does not issue a decision within these periods.
Lastly, the ICA foresees the possibility of requesting a letter (Unbedenklichkeitsbescheinigung) confirming that an envisaged investment in an Austrian undertaking is not subject to an approval pursuant to the ICA.
The Austrian merger control rules apply to concentrations as defined in Section 7 of the Austrian Cartel Act (ACA). Each of the following events constitutes a concentration:
A concentration must be notified prior to its completion if, in the last business year:
Pursuant to the de minimis exception, however, concentrations that meet these thresholds are exempted from the notification requirement if the Austrian turnover of only one of the undertakings concerned exceeded EUR5 million and the worldwide combined turnover of the other undertakings concerned did not exceed EUR30 million.
A concentration that does not meet the turnover thresholds mentioned above still has to be notified if, in the last business year:
Special rules apply to the calculation of the turnover of banks and insurance companies, and in relation to "media concentrations".
A concentration that meets the turnover thresholds of the EU Merger Regulation and requires a merger control filing with the European Commission is not subject to Austrian merger control (unless the transaction qualifies as a "media concentration", in which case parallel notifications to the European Commission and the FCA may be required).
The scope and depth of private equity buyers' legal due diligence is usually significant, covering all relevant legal aspects of the target, such as title, contracts, compliance with law, change of control, reorganisations, real estate, employment, regulatory, IP, financings, disputes and, increasingly, GDPR compliance (based on recent fines levied as a result of breaches under the GDPR).
The typical reporting format is a red-flag reporting standard, but based on a full-scope legal due diligence. Commonly, the legal due diligence is done within a four to six-week timeframe, depending on the size of the target and how well prepared and committed the seller is. In urgent cases, the due diligence can be conducted within two weeks, or even a shorter period. There have been private equity deals where the due diligence is divided into two phases: in the first phase, the buyers focus more on the areas relevant to categorise the value of the target, followed by an in-depth due diligence in the second phase. Some auction sale processes are geared towards allowing bidders to do a limited due diligence in order to contain legal fees in the early phase of a transaction and, prior to a more limited number of bidders, committing to a full-scale process.
In the past few years, vendor due diligence or a fact book have been common features of private equity sellers. The seller usually prepares an information memorandum, conducts a vendor's due diligence, and often prepares a legal fact book (instead of a vendor due diligence report) that will be shared with the bidders in the data room. Commonly, the advisers of the sellers request the signing of a non-reliance letter before the disclosure of the vendor due diligence report and/or the legal fact book. In the recent past, there has been a slight trend towards sellers offering reliance, predominantly with private equity sellers. Private equity buyers regularly offer reliance on buy-side due diligence to the banks financing the buyer.
Commonly, disposals by private equity funds are carried out by auction sale, as such process is more stringent and seller-friendly, and allows the seller to maximise the sale proceeds. Typically, the auction process is handled by investment banks and/or other M&A advisers. No specific provisions apply with respect to an auction process – ie, the seller determines the rules and procedure of the auction by issuing detailed process letters. To a varying extent, the terms of an acquisition may differ between a privately negotiated transaction and an auction sale, depending on the overall circumstances of the transaction – eg, the size of the transaction, the percentage of the shareholding in the target, whether or not one of the parties is a listed company, etc. While set up as a broad auction process, in many cases bidders (particularly private equity entities) seek to shorten the transaction process by quickly proposing an agreement on key terms and by offering transaction certainly ahead of other bidders.
Generally, the acquisition structure is tax-driven, with financing requirements, liability and exit considerations, and specific transaction-related considerations all playing a role. Most typically, a non-Austrian TopCo (incorporated in a tax favourable jurisdiction such as Luxembourg, the Cayman Islands or the Netherlands) holds an Austrian AcquiCo in the form of a limited liability company, which acquires the Austrian target; this also helps to ring-fence the investment. Private equity funds are closely involved in structuring the key deal terms and the liability regime but otherwise rely on their lawyers to reach market-standard deal terms. Also, when acting for private equity-owned portfolio companies on add-on acquisitions, the private equity owners will be involved in the transaction (though to a more limited degree).
It is more typical for private equity funds to hold a majority stake. Although larger private equity funds have held minority stakes in target companies with regulated revenue streams, minority stake private equity deals are rather an exception.
The type and structure of the financing of private equity deals depends, inter alia, on the contemplated acquisition structure, the relevant tax environment, the industry of the target group, the aggregate deal volume (including the refinancing/working capital requirements of the target group) and the standing of the relevant private equity fund in the market. Typically, acquisitions by private equity funds are highly leveraged – ie, to a large extent financed by various debt instruments that are available in the market from a variety of potential funders (eg, commercial banks, debt funds, insurance companies, pension funds, mezzanine lenders, etc) – whereas the residual financing portion is provided by the private equity funds in the form of equity, equity-like means and/or junior funds.
Senior debt is provided by means of senior secured (and usually syndicated) loans (and may also take the form of senior secured bond instruments) and typically encompasses the following:
To the extent permitted by the applicable laws and as long as it is reasonable in light of the relevant tax environment, private equity funds may want senior debt to be pushed down to the target companies (in terms of debt service and security instruments).
Mezzanine debt is a hybrid of senior and junior debt, and ranks junior to senior debt and senior to junior debt. Typically, mezzanine instruments have lighter covenants on the obligors and may be secured second ranking behind the senior security package. Consequently, mezzanine debt carries higher interest, reflecting the risk position of the mezzanine debt providers.
Junior funds are usually provided in the form of shareholder loans, which are deeply subordinated and rank senior only to equity. Junior funds are, therefore, typically unsecured and will only be serviced if certain financial covenants are met and after senior and mezzanine debt service.
Deals involving a consortium of private equity sponsors and co-investments by other investors alongside the private equity fund are not very common in Austria, mostly because the target companies in Austria are not large; rather, such transactions are seen where Austrian players team up with international private equity funds and other investors, typically for big-ticket transactions. The so-called "club deals" in the private equity industry are seen on a global level, and allow each private equity participant to reduce its concentration, maintain the diversification of its portfolio of investments and allocate risks and costs. However, such club deals have certain downsides, including conflicts among the investment strategies of the various participants. An increase of club deals in Austria is not expected.
Generally, the parties agree on either a locked-box consideration structure or a closing accounts consideration structure, which may be combined with an earn-out element in private M&A transactions. In recent years, there has been an increase in the application of locked-box structures compared to previous years. Transaction speed and transaction certainty are increasingly key features for M&A transactions. Private equity funds prefer locked-box consideration structures, particularly when acting as sellers.
In connection with locked-box consideration structures, private equity sellers provide the following protection(s):
Warranty insurance is widely used by private equity sellers in order to limit recourse against the seller.
Some buyers consider whether interest should accrue on the amount of leakage and/or whether leakage (exceeding a certain threshold) should lead to any walk-away right. However, there have not been many private equity deals where interest was in fact charged on a locked-box leakage or where a walk-away right was agreed in the case of leakage.
It is common to have a dispute resolution mechanism in place for locked-box consideration structures and completion accounts consideration structures in private equity transactions. In the case of completion accounts, the parties agree on expert determination proceedings and arbitration proceedings in the case of disagreement with respect to the adjustment of the purchase price. In many cases, the agreements provide for an expert determination in relation to the purchase price adjustment and additionally for a broad arbitration clause (as opposed to ordinary courts having jurisdiction). A similar dispute resolution mechanism is common with respect to locked-box consideration structures – ie, the parties agree on an expert determination in addition to arbitration proceedings in relation to the leakage (adjustment) amount.
The acquisition agreements of a private equity deal are usually subject to a very limited number of (regulatory) conditions. The typical level of conditionality in private equity transactions is limited to mandatory regulatory clearances, such as merger clearance. In particular, a private equity seller is unlikely to accept other conditions, such as a "no material adverse change" condition, a financing condition or any similar condition. Process letters of sellers in an auction scenario typically require binding bids to not be subject to conditions other than regulatory clearances. Depending on the target, private equity buyers take a more prudent approach by seeking strong sell-side protection in return for an attractive price offer. This includes material adverse effect or change of control protection.
Usually, a "hell or high water" provision describes an independent and absolute commitment of the buyer to undertake any obligation that is required to obtain antitrust or other regulatory approval. Whereas it is common for buyers to agree on prompt filing and consulting with the seller, it is not common for a private equity buyer to accept a "hell or high water" undertaking in deals where there is a regulatory condition.
Parties to a purchase agreement may agree on a "light hell or high water" undertaking with respect to merger control clearance by introducing thresholds or other criteria (eg, divestment of an entity with an EBITDA below a certain threshold) in order to quantify and allocate antitrust risks connected with the transaction between the parties.
In private acquisitions (see 7.5 Conditions in Takeovers), with respect to break fees in public M&A transactions, the parties frequently agree on (reverse) break fees in order to avoid damages, keep the cost risk low, and increase deal security. If the obliged party is a stock corporation, the permissibility of the amount of the break fee is based on the appropriateness of the break fee, considering all of the individual circumstances on a case-by-case basis. In this context in particular, the type, scope and strategic importance of the particular transaction play an essential role and must be assessed on the basis of the obligations of the management resulting from the business judgement rule. No such limitations apply to the extent the obliged party is a limited liability company and the relevant corporate approvals are in place (eg, the approval of the supervisory board or shareholder, if necessary).
Break fees are not very common in conditional deals with a private equity-backed buyer, as private equity deals are typically subject to a very limited number of conditions and there is limited space for deal security elements. The same applies to reverse break fees, which typically result in payment obligations for the buyer and are usually only agreed to with respect to the fulfilment of financing conditions.
Commonly, acquisition agreements exclude all rights provided by law to the parties to terminate the contract, to the fullest extent possible. Important exceptions are the right of both parties to terminate the agreement if closing cannot be brought about by a certain date ("longstop date") or if regulatory approvals are subject to obligations that the purchaser is not prepared to accept (ie, in the absence of a "hell and high water" clause). Occasionally, purchase agreements also provide for a material adverse change clause, including instances where the business deteriorates dramatically prior to closing, which entitle the buyer to not proceed to closing and terminate the agreement; such arrangements do not tend to occur in situations with private equity sellers. However, the termination rights of a party upon a break fee payment event (ie, non-compliance with the obligation of the buyer or the seller in connection with the conditions precedent agreed in the acquisition agreements) are in evidence.
As in private equity transactions, the parties usually agree on locked-box consideration structures – the typical allocation of risk between the locked-box date and the closing date is the agreement on protection by way of ordinary course of business provisions and no leakage provisions and covenants. Private equity sellers typically seek to limit any legal recourse by the buyer to the maximum degree possible, so as to fully protect the availability of the transaction proceeds for their investors.
Private equity sellers typically provide a high level of disclosure by way of a well-prepared due diligence process and the possibility for bidders to conduct an extensive due diligence.
Matters so disclosed typically eliminate the warranty protection of a buyer that is deemed to have priced its offer based on information available to it on the basis of the due diligence. In addition, private equity sellers offer very limited contractual protection to buyers. This means that the quality of the due diligence process is very important for the buyer.
In addition, warranty insurance protection is widely used to protect the private equity seller against possible warranty claims by a buyer. The costs of warranty insurance have come down significantly over the last two years.
To the extent a buyer identifies a risk in the course of the due diligence, the parties either price such risk into the calculation of the purchase price or provide for an indemnity protection. Generally, indemnities are not subject to limitations other than with respect to amount and time limitations. Private equity sellers will not easily accept indemnification obligations for the reasons already stated.
Typically, the parties agree on further liability limitations of the seller, depending on the transaction, such as:
Usually, the parties agree on short periods upon the expiry of which the warranty or indemnity claims become time-barred, with claims on the basis of title warranties or no leakage obligations allowing for longer claim periods. The liability of the seller is usually capped at a certain percentage of the purchase price. The liability of the seller with respect to fundamental warranties such as claims for a breach of the title are usually capped at an amount corresponding to the purchase price amount.
Please see 6.8 Allocation of Risk with respect to warranty and indemnities in private equity deals. Generally, the private equity sellers seek to offer almost no warranties and indemnities in order to be able to allow for a clear financial exit to their investors. However, there are now more and more structures where either warranty insurance bridges the gap between the offered warranty/indemnity package and the requested protection needs of buyers, or private equity sellers accept a warranty/indemnity package to a certain extent (eg, a small portion of the purchase price is kept as an escrow hold-back).
Typically, the private equity seller provides exit warranties to a buyer on legal organisation, taxes, financial statements, employment, properties and assets, intellectual property, financing, commercial agreements, litigation and compliance. However, there is an increasing trend to limit operational warranties.
In some cases, the management team provides a buyer with statements that do not qualify as warranties but are aimed at providing comfort to the buyer on a non-recourse basis, mostly in relation to operational aspects (for example, that there is no pending or threatened litigation).
In recent years, warranty and indemnity insurance covering damages resulting from breaches of warranties and indemnities has become a key part of transactions, including transactions in the Austrian private equity market. Excluded from the insurance package are commonly known risks or statements where the due diligence exercise has been weak. Such warranty and indemnity insurance is increasingly used to cover the gap between the seller's interest in limiting its exposure and achieving a clean exit and the protection and recourse requirements of the buyer (please also see 6.9 Warranty Protection).
Litigation in connection with private equity transactions is common. The frequency of litigation is volatile, and generally depends to an essential extent on the performance of the private equity market and related transactions.
It is standard market practice in international private equity transactions to agree on arbitration clauses. The main advantages of arbitration are that the tribunal has experience in international transactions and knowledge of the underlying economic aspects of such deals, compared with court litigation. In particular, failure to complete the transaction, price adjustment, leakage amounts, leakage adjustments, earn-outs, and breaches of warranties are the subject of share purchase agreement-related arbitration. Disputes over financial aspects of a private equity transaction (such as leakage adjustment disputes) may alternatively or additionally be subjected to arbitral expert (Schiedsgutachter) procedures if accounting principles, calculation aspects or auditing processes are concerned.
Public-to-private transactions are uncommon in the Austrian market, particularly with respect to private equity transactions, as there are only a few Austrian public companies with a large number of free-float shareholders. In public-to-private deals, the private equity fund would have to launch a voluntary takeover offer aiming for control, typically combined with the condition of reaching the acceptance threshold of at least 90% of the shares of the target company. Upon reaching such threshold, the private equity fund can squeeze out the remaining minority shareholders. While public takeovers by private equity are on the rise globally, an increase of such transactions is not expected in Austria.
A shareholder of a public company is required to publicly disclose its shareholdings to the FMA, the Stock Exchange and the issuer, if it – directly, indirectly or through financial instruments or derivatives – reaches, exceeds or falls below 4%, 5%, 10%, 15%, 20%, 25%, 30%, 35%, 40%, 45%, 50%, 75% or 90% of the voting rights. The articles of association may contain an additional disclosure threshold at 3%, which will need to be published on the website of the issuer; the FMA will also need to be informed. A shareholder is required to disclose immediately – and in any event within two trading days – each time a relevant threshold falls below or exceeds any of the threshold amounts.
If a shareholder does not comply with the above-mentioned disclosure obligations, voting rights attached to the shares not disclosed will be automatically suspended. The articles of association of the company may also extend the suspension of voting rights to all voting rights of the shareholder breaching the required disclosure obligation.
A bidder who acquires a direct or indirect controlling interest in a public company must launch a mandatory offer in relation to all shares, pursuant to Section 22 et seq of the Takeover Act (TA). The initial acquisition of a controlling interest and any change of control are encompassed by the above-mentioned provision, and each trigger the obligation to launch an offer. However, the acquisition of up to 30% of the voting rights does not trigger any obligation to launch a mandatory offer (safe harbour). However, a shareholding between 26% and 30% must be notified to the ATC. Consequently, the acquisition of voting rights of more than 30% triggers the obligation to launch a mandatory bid for all shares.
Commonly, cash considerations are used in public M&A transactions. The bidder is entitled to offer cash, shares or a combination of cash and shares. There are generally no minimum pricing rules or cash requirements. However, in a mandatory offer and a voluntary offer aimed at control, the bidder must offer a cash consideration, and can only offer shares as an alternative to such cash offer. In such a case, the cash consideration offered must comply with the minimum price requirements – ie, the cash offer must be at least, the higher of the average share price of the target shares during the six-month prior to the publication of the offer, or the highest price paid or offered for the target shares by the bidder in the 12 months prior to filing the offer.
Pursuant to Section 8 of the TA, in the case of voluntary offers and voluntary offers to acquire control, the offer can be conditional on the fulfilment of conditions. Generally, conditions are permissible pursuant to the TA to the extent the conditions are objectively justified. In practice, that means that each relevant condition with respect to a takeover offer must be analysed and assessed on a case-by-case basis. Generally, conditions are not permitted to the extent their fulfilment is at the discretion of the bidder. Pursuant to Section 25b of the TA, mandatory offers can only be subject to conditions that are required by law, such as approval from the antitrust authorities.
The agreement of break fees is generally not prohibited in public M&A transactions, but break fees are fairly uncommon in practice. Depending on the amount of break fees, such agreement may hinder competing offers and thereby violate the provisions of the TA. An agreement with respect to break fees must be explicitly contained in the offer document.
If a private equity bidder does not seek or obtain 100% ownership of a listed target, the governance rights with respect to the target outside of its shareholdings very much depend on the rights connected with the shareholding of such bidder by law and under the existing by-laws of the target. Therefore, the investor should first analyse the details of the rights available to it by law, based on the level of its shareholding, and in the existing governance documents prior to developing a strategy on optimising corporate governance.
Shareholders holding more than 25% of a company's share capital present at a shareholders’ meeting may object to the amendments of the articles of the company (including capital measures) and measures excluding shareholder subscription rights. Shareholders holding at least 30% of a company's share capital have the right to elect an additional supervisory board member if three or more members of the supervisory board are elected in one shareholders’ meeting and one candidate received at least one-third of the votes in all prior elections without being successfully elected. In that case, the unsuccessful candidate who received the one-third vote in prior elections will be declared as elected without any further votes.
Private equity funds are expected to seek the right to nominate board members and to request veto rights (although there is no Austrian practice in relation to private equity targeting listed companies).
Pursuant to the Squeeze-Out Act, a majority shareholder that directly or indirectly owns 90% of the share capital of a target is entitled to squeeze out the remaining minority shareholders. The minority shareholders cannot stop the squeeze-out but can generally request the compensation granted to them to be reviewed by a court. This squeeze-out process applies to public and private companies. Therefore, a voluntary offer aimed at control often contains a minimum acceptance threshold of 90% in order to ensure the possibility of a squeeze-out and the acquisition of all the shares in the target following a successful tender offer.
Irrevocable commitments are usually only concluded with the principal shareholder of the target, and are promises by security holders of the target to tender their shares to the bidder in the course of a takeover offer. This way, the bidder tries to secure securities in the target company prior to the announcement of its decision to make an offer. In particular, the agreement of irrevocable commitments makes it easier for the bidder to determine an offer price for the envisaged transaction (the value arrived at during the negotiations for the acquisition of a controlling stake – please see 7.4 Consideration).
Irrevocables are not prohibited under the TA and there are good arguments as to why they are permitted. Generally, principal shareholders are entitled to freely dispose of their shares and, in particular, to agree on the sale of their shares to the bidder. However, the literature points out that irrevocables may discourage competing offers and not comply with the duty of confidentiality, and should therefore be cleared with the ATC in advance.
Hostile takeover offers (ie, offers that are not supported by the management board and supervisory board of the target) are permitted, but are uncommon in Austria. The TA does not differentiate between hostile and friendly takeovers – the same rules apply to both types of takeover offer. Private equity-backed buyers have not yet engaged in hostile takeover offers in Austria. In the case of a hostile takeover, the management and supervisory board of a public company are not entitled to implement defensive measures, but are required to remain neutral pursuant to Section 12 of the TA in consideration of the interest of the shareholders.
Equity incentivisation of the management team is a common feature of private equity transactions in Austria, in order to ensure the team's commitment following the change of the ownership in the target. Therefore, the management usually has the opportunity to acquire an interest in the target company. The level of equity ownership for the management team depends on the specific circumstances of a transaction, but often a shareholding corresponding to 10% is granted to the management team; in smaller deals, an even higher shareholding, corresponding to up to 20%, may be granted.
Commonly, the management team of the target has the opportunity to acquire shares in the target company, and sometimes such participation and commitment are required by the buyer. The structure of the management participation is also tax-driven. There are also deals where the management team is offered the opportunity to invest in the same instruments ("institutional strip") acquired by the private equity buyer, to ensure that the interests of the management and such buyer are fully aligned. To the extent the management is invested on a target level, different structures have been used, such as share options, profit participation rights without any voting rights, and phantom stock options.
Typically, shares held by the management are pooled (ie, the investor has one de facto co-investor). Commonly, restrictions encompass a drag right of the private equity fund and other obligations to transfer the shares to the extent the management and employment agreements are terminated. The pricing formula that is to apply to the transfer of shares following termination depends on the reason for such termination.
Commonly, leaver provisions for management shareholders are the so-called "good leaver" and "bad leaver" provisions, which particularly affect the price for their shares to be transferred following the termination of their management agreement, vesting provisions and the option for the investor to purchase the shareholding of the management team in the case of termination. Typically, good leaver provisions are more favourable to management and apply in the case of the termination of a management agreement without cause, or due to the illness of the manager or the expiry of the term, whereas other termination causes usually qualify as bad leaver events, which provide for less favourable sale terms for the management.
The customary restrictive covenants agreed to by the management shareholders are usually non-compete and non-solicitation undertakings. To the extent the management shareholders are employees of the target (assuming the target is either a limited liability or a stock corporation), such managing directors are required by law to fulfil non-compete and non-solicitation obligations throughout the period of their management position.
Generally, non-compete and non-solicitation provisions are enforceable for a period of two years after the termination of the relationship with the company in combination with the sale of shares. To the extent the shareholder is an employee of the company, the enforceability of the above-mentioned non-compete and non-solicitation provisions is generally limited to one year from the termination of the employment agreement, provided the above-mentioned undertakings do not limit the shareholders' future professional opportunities.
Please see 10.3 Tag Rights.
Management shareholders sometimes enjoy tag rights, particularly in start-up companies and companies with considerable upside potential. Also in evidence are anti-dilution protection mechanisms in favour of the management owning target shares.
Typically, the management team does not have a right to control or influence the exit. However, a strong management team will have de facto influence on the process through the bidders seeking to incentivise such a team to stay on.
The level of control for a private equity fund shareholder over its portfolio companies depends in particular on the legal form of the portfolio companies. Most typically, a non-Austrian entity holds an Austrian entity in the form of a limited liability company, which acquires the Austrian target (please see 5.2 Structure of the Buyer). The private equity fund is usually the sole or majority shareholder of each portfolio company that is organised as a limited liability company in Austria. The majority shareholder of a limited liability has far-reaching control rights and instruction rights vis-à-vis the management. In particular, the shareholders can:
Typically, the management board is required to comply with pre-defined rules of procedure setting out the requirement of shareholder consent or the consent of an advisory board with respect to important measures of the company. The above-mentioned rules of procedure and the instalment of an advisory board that has information and consent rights – together with the shareholder right to dismiss and appoint the management board – are essential shareholder rights enabling the private equity shareholder to exercise tight control over its portfolio companies.
Generally, a private equity fund majority shareholder cannot be held liable for the actions of its portfolio companies. However, certain exceptions to this general rule apply, particularly in the following cases:
Private equity fund shareholders typically impose their stringent compliance policies on the portfolio companies to the extent such compliance policies do not violate Austrian law. In most cases, this is required by the investors in the private equity fund in order to meet investment criteria. It is also an important element in preparing the company for a future sale.
The typical holding period for private equity transactions before the investment is sold or disposed of is about four to five years, and private equity sellers typically reinvest upon exit. As a result of the 2008 financial crisis, longer holding periods have been seen, particularly in relation to financial institutions owned by private equity entities. The most common forms of private equity exit thus far are trade sales (ie, sales to a strategic investor) and secondary transactions (ie, sales to a financial investor). Some of the recent exits in Austria were run as dual-track processes and finally did take the IPO route (financial institutions in both cases).
Typically, shareholder agreements include a transfer obligation of the shares of a limited liability company, such as drag rights; private equity sellers have been seen utilising the drag mechanism. To the extent an agreement contains drag rights, tag rights or other option rights (such as put or call options), for a limited liability company said agreement must be executed in the form of an Austrian notarial deed (Notariatsakt) in order to be enforceable.
Please see 10.2 Drag Rights.
Management shareholders sometimes enjoy tag rights, depending on the deal; such rights are rather prevalent in start-up companies and firms with considerable growth potential.
Generally, an IPO may provide for certain advantages compared to other disinvestment types; on average, higher prices for the participation are achieved when going public. In addition, in the case of a sale, the private equity investor remains flexible and does not have to bind itself to one contractual partner. Moreover, the investor can usually profit from the increase in value of its unsold shares.
Typically, the underwriting banks request the lock-up of the private equity seller to a certain extent – ie, with respect to a limited portion of the shares and subject to time limitations (usually between three and six months following the IPO).
The New Foreign Direct Investment Screening Regime Under The Austrian Investment Control Act
Subsequent to many years of liberalisation and globalisation, the recent years show a reversal on the European Union's approach as concerns foreign direct investments from third countries. Similar to worldwide trends, a more restrictive view has gained momentum within the European Union and has been addressed on its legislative level with the FDI Screening Regulation. As consequence thereof, the Austrian legislator has decided to renew its foreign direct investment regime, following a growing trend in a number of neighboring EU Member States (which has been accelerated by the COVID-19 crisis).
Legal framework of the EU Foreign Direct Investment Screening Regulation
In March 2019, the European legislator introduced the so called FDI Screening Regulation (EU 2019/452 or FDI-R) establishing a European framework for screening foreign direct investments (FDI) into the bloc in an effort to balance the EU's openness to foreign investment with the necessity of implementing appropriate screening tools. The FDI-R will be effective as from 11 October 2020 and must be implemented by each Member State by that date.
The applicability of the FDI-R and the requirements stipulated therein will have no effect on the existing discretion of each Member State to put in place control or screening mechanisms for FDI on a national level. However, where a Member State has implemented national control or screening mechanisms – eg, approval requirements for foreign entities or foreign individuals acquiring an interest in a company carrying out activities affecting security and public order – the Member States must ensure that the national measures are compliant with the principles set forth in Article 3 FDI-R, such as in particular fair and transparent rules and procedures for FDI screening mechanisms, protection of confidential information as well as the possibility of recourse against decisions of authorities. To guide Members States in its implementation, the FDI-R also provides a list of factors to be taken into consideration when determining whether a FDI is likely to affect the Member States' security or public order. The objective of providing such guidance is to improve the transparency and predictability of Member States' screening mechanisms for foreign investors considering making investments in the EU.
The second main pillar of the FDI-R – besides providing the Member States with rules on how to implement screening regimes for FDI – is the creation of an European cooperation mechanism which shall enable the Member States and the European Commission to cooperate and assist each other with regard to FDI screening procedures falling under the scope of the FDI-R.
Impact of COVID-19
In the wake of the COVID-19 pandemic, the European Commission has furthermore published guidelines (Communication of 13 March 2020 and 25 March 2020) warning the Member States of an increased risk of foreign entities attempting to acquire stakes in strategic industries, in particular in healthcare capacities (eg, for the production of medical or protective equipment) or related industries such as research establishments. In its communications the European Commission has urged the Member States to be vigilant and to make full use of existing control mechanisms to avoid the loss of critical assets and technology and, if deemed necessary, to introduce investment control mechanisms which have not yet been implemented on a national level.
Former Austrian FDI Control Regime
In 2013, the Austrian legislator introduced provisions on controlling foreign investments by implementing Section 25a of the Austrian Foreign Trade Act (Außenwirtschaftsgesetz or AFT). Under this provision, foreign individuals or foreign legal entities intending to acquire an interest in an Austrian company operating in an area of public safety and order had to obtain prior approval – ie, before concluding the underlying contracts for the investment – by the Austrian authorities. The approval requirement set forth in Section 25a AFT was subject to an ex ante assessment by the Austrian authorities. Potential foreign investors were therefore obliged to submit an application for approval before the underlying acquisition or investment contracts were executed.
The material scope of the approval requirement (Section 25a AFT) was interpreted relatively broad and was to some extent unclear in its wording, particularly with regard to the presence of a threat to public safety and order, and therefore allowed the competent authorities a considerable degree of flexibility in its application. For an investor, it was not always clear in advance whether a envisaged acquisition was subject to the approval requirement or not, which is why the approval procedure was burdened by legal uncertainties and lack of transparency.
Under the former Austrian FDI control regime, such acquisitions were subject to approval which posed a threat to security or public order and whereby the foreign individual or foreign legal entity intended to acquire an interest in an Austrian company that secured control of at least 25% of the voting rights. Insofar as the investment did not, however, reach the necessary 25% control threshold, the approval requirement would not apply.
Furthermore, the approval requirement set forth in Section 25a ATF only applied if the acquisition of the stake in the Austrian company was made directly by an investor located outside the EU, the European Economic Area (EEA) or Switzerland. In practice, third-country investors were therefore able to avoid the approval requirement relatively easily by acquiring equity interests indirectly via their EU based subsidiaries acting as intermediaries.
The New Austrian Investment Control Act
On 25 July 2020, the Austrian legislator enacted a new FDI control regime by adapting Section 25a ATF and consolidating the provisions into a new law – the Austrian Investment Control Act (Investitionskontrollgesetz or InvKG), in an effort to fully comply with the requirements of the FDI-R as well as to tighten the grip on FDI by amending key aspects of the approval requirements and procedures.
By implementing the InvKG, the previously existing "lean" Austrian FDI control regime (as stipulated in Section 25a AFT) has been significantly expanded both in terms of scope and procedure, and in particular by a more comprehensive, Europe-wide coordinated control of third country investments in systemically important Austrian companies.
Approvals for foreign investments
Under Section 2 (1) of the InvKG, a foreign investment in an Austrian company is now subject to approval by the Austrian Federal Minister for Digital and Economic Affairs (Bundesministerin für Digitalisierung und Wirtschaftsstandort) if (a) the target company is active in one of the sensitive or system-relevant sectors as listed in the Annex to the InvKG and (b) the shares to be acquired in the target company reach or exceed certain voting rights thresholds, provide a controlling influence, or the investor obtains a controlling influence of the target company through the acquisition of significant assets.
As already similarly regulated in the former Austrian FDI control regime, there is an exemption to the approval requirement with regard to the size of the Austrian target company. Accordingly, the acquisition of an interest in a small-sized or start-up company with fewer than ten employees and an annual turnover or annual balance sheet total of less than EUR2 million is generally exempt from the approval requirement, regardless of whether the requirements of Section 2 (1) InvKG are fulfilled or not.
List of sectors triggering the approval requirement
The applicability of the approval requirement under the InvKG requires that the Austrian target company is active in one of the sectors listed in the newly introduced Annex to the InvKG.
The Annex distinguishes between "particularly sensitive sectors" (Part 1 of the Annex), namely defense equipment and technologies, the operation of critical energy infrastructure and critical digital infrastructure (in particular 5G infrastructure), water, the operation of systems to ensure data sovereignty and – related to the COVID-19 outbreak – research and development in the areas of pharmaceuticals, vaccines, medical devices and personal protective equipment, and "other sectors in which a threat to security or public order, including crisis and general interest services may arise" (Part 2 of the Annex), namely other critical infrastructure, critical technology, supply with critical resources, access to sensitive information and freedom and plurality of the media. While the enumeration in Part 1 of the Annex (sensitive sectors) is exhaustive, Part 2 of the Annex (other sectors) contains a merely exemplary – albeit detailed – list of areas and sectors subject to approval.
The material scope of applicability of the Annex has thus been considerably extended compared to the scope of the former FDI control regime pursuant to Section 25a ATF and now also explicitly covers sectors which were previously practically exempt from approval (in particular critical infrastructures and technologies, the supply of critical resources, the preservation of Austrian data sovereignty and the development of or supply with drugs and vaccines).
Control of indirect acquisitions
The possibilities of circumvention apparent in the former FDI control regime through indirect acquisition schemes, in particular through execution via subsidiaries established in the EU, has been under strong criticism since the introduction of Section 25a ATF in 2013. The importance of avoiding circumvention with regard to the FDI screening mechanisms is now also explicitly stated in Article 3(6) of the FDI-R.
In response thereto, the Austrian legislator has decided to extend the scope of applicability with regard to activities requiring approval. Under the new Austrian FDI control regime, not only the direct but also the indirect acquisition of shares or assets in an Austrian company require the approval of the Austrian Federal Minister for Digitalization and Economic Affairs (Bundesministerin für Digitalisierung und Wirtschaftsstandort). The InvKG (Section 1 No 3) defines direct investments as the direct or indirect acquisition:
With the extension to indirect acquisitions, the scope of application of the InvKG goes considerably beyond the system of the former Section 25a AFT. As a result, acquisitions by a special purpose vehicle (SPV) based in the EU/EEA and controlled by a foreign individual or foreign entity are now subject to approval.
Threshold of voting rights
According to the former FDI control regime, transactions were only subject to approval if the investor planned to acquire an Austrian company (operating in a sector relevant to security or public order) or an interest in such company which secured control of at least 25% of the voting rights. This voting right threshold was adopted in the former FDI control regime as it potentially ensures a blocking minority (Sperrminorität) under Austrian corporate law through which a decisive influence on the management can be exercised.
In the explanatory notes of the government bill it is noted that according to the benchmark definition of the OECD (2008), direct investments – which are characterised by a long-term interest and the investor's desire for control – typically already exist if the acquirer holds at least 10% of the company. With regard to the threshold and taking into account the OECD definition of direct investments the Austrian legislator has deemed it necessary to lower the relevant approval threshold from currently 25% to 10% for the particularly sensitive sectors as defined in Part 1 of the Annex.
With regard to the voting right thresholds that are decisive for the approval requirement, Section 4 InvKG differentiates between (i) "particularly sensitive sectors", for which a 10%, 25% and 50% interest of the voting rights is decisive, and (ii) "other sectors" in which there may be a threat to security or public order, for which a 25% and 50% share of the voting rights is decisive.
Due to the structure of Section 4 InvKG it is therefore possible that transactions concerning the same target company have to be approved several times, for example when increasing voting rights to over 25% or 50%. This represents a significant change from the former FDI control regime.
Implementation of the transaction and approval procedure
If the approval is required under the InvKG, the direct or indirect acquirer must submit a detailed application for approval to the Austrian Federal Minister for Digitalization and Economic Affairs (Bundesministerin für Digitalisierung und Wirtschaftsstandort) immediately after concluding the underlying contractual agreement for the transaction (signing).
Any transaction subject to approval under the InvKG may only be completed and effected (closing) after approval by the relevant authority has been obtained. As long as the approval has not been granted, the transaction is deemed to be concluded under the condition precedent of obtaining the approval. In the transaction practice, it is to be assumed that the approval requirement under the InvKG will continue to be stipulated as a condition precedent for closing the transaction.
A completion of the legal transaction (closing) is strictly prohibited prior to approval; a transaction that is nevertheless completed and effected prior to approval (closing) constitutes a judicial offence that is subject to a prison sentence of up to one year. Further consequence is that the underlying legal transaction is invalid under Austrian civil law. Compared to the former legal regime under Section 25a AFT, the legal consequences for violations against the InvKG have therefore become considerably stricter.
Outlook and implementation in practice
As mentioned, the new Austrian FDI control regime follows political trends on stricter scrutiny of investments from third countries. With the implementation of the new FDI control regime, the Austrian legislator is attempting to ensure in particular that foreign investors are prevented from having access to critical technologies and sensitive information prior to approval.
As regards the legal implications it can be assumed that the new FDI control regime will present new challenges for transaction practice in Austria. Especially when determining the minimum thresholds of voting rights (10%, 25% and 50%), it seems rather unavoidable that in practice considerable questions of ambiguity will arise, eg, with regard to the aggregation of voting rights of several foreign entities or the attribution of voting rights in case of group companies as well as intra-group transfers.
In addition, due to the extension of the FDI control regime to indirect acquisitions as well as the extensive expansion of sectors being subject to approval, both in view of the increasing cross-border economic relationships, a considerable influx of new approval procedures are to be expected.
New approval proceedings
This increase in approval proceedings is amplified by the fact that the sensitive areas listed in the Annex to the InvKG are very broadly defined and therefore offer a considerable margin for interpretation. Furthermore, the sectors listed in Part 2 of the Annex are not exhaustively regulated. As a result, the competent authority is enabled to comprehensively apply the approval requirement under the InvKG.
It can therefore be assumed that in the future there will only be a limited number of international transactions for which the question of the approval requirement under the InvKG does not arise or for which it can be completely ruled out. Moreover, investments into companies in distress (which will be more frequent specifically in the initial phases of the recovery) and where time is an important factor, may even be more difficult to carry-out.