Private Equity 2021

Last Updated September 14, 2021

France

Law and Practice

Author



Valther Avocats is an independent law firm based in Paris which operates in all areas of business law (M&A/private equity, commercial litigation, restructuring, employment law and tax law). Its main activity is in the field of mergers and acquisitions and private equity transactions. Valther assists its clients in all aspects of these transactions, from the performance of due diligences to post-closing monitoring and the implementation of contractual documentation. The team at Valther is composed of 20 professionals, including five partners and 15 associates and lawyers, all of whom are dedicated to the satisfaction of the firm's clients and to the completion of the assignments entrusted to them. Valther offers a personal touch and more flexible service than some of the larger English and American law firms and this allows the firm to provide a wide range of expertise at fair costs while maintaining proximity and responsiveness to its clients.

If 2020 was a year filled with uncertainty for the M&A and private equity markets, the economic recovery has occurred much faster than expected, thanks to the abundance of available capital, the access to external financing which remains low cost, and the preservation of many sectors of the economy from the ravages of the pandemic.

Indeed, the second half of 2020 saw a great rebound in transactions and the first half of 2021 was strong.

One explanation for this was the rapid search for resilience as well as the increase in mega deals (valued at USD5 billion or more). This has had a huge impact on the market’s reaction to the pandemic.

From another standpoint, an increase in the use of the following clauses is evident:

  • warranty and indemnity insurance, more generally in Europe – its use was effective in 17% of transactions in 2020, and up to 50% of transactions that were worth more than EUR100 million; and
  • the MAC (material adverse change) clause has come back in the context of the pandemic, especially in small cap transactions – it seems to be used to counteract the forms of uncertainty that exist in the market and it benefits the buyers.

These are significant effects, which are not only consequences of the COVID-19 crisis but also deep underlying trends which demonstrate the profound transformation of the market.

French companies are entering the M&A market with the aim of reorganising their assets portfolios and positioning themselves for the economic recovery and the profound change in the industrial environment.

The transactions that are currently mainly supporting the M&A market consist of companies acquiring differentiating assets, providing short-term competitiveness and transforming their business model in depth.

These are complementary investments consisting of the acquisition of specific abilities. French companies want to focus on strengthening their digital and technological capabilities, in the context of increasing digitalisation of the business.

Innovative start-ups, offering buyers new technologies, are interesting cross-sector targets. Indeed, they enable companies to broaden their products or services offering, to increase their production capacity and strengthen their resilience. Therefore, they are now first-choice targets.

This means that digital and technological assets have enabled valuation growth for the companies that own them.

One of the major changes that the regulations governing M&A transactions has undergone over the last three years concerns the control of foreign investments in France. Indeed, an investment made by a foreign natural or legal person may, if it meets certain criteria of sector and ownership of the target, be subject to prior authorisation by the Minister of the Economy.

A number of protectionist measures have broadened the scope of application of this control mechanism. Thus, a decree and an order dated 31 December 2019 and supplementing the PACTE law have strengthened this control mechanism.

This control is also reinforced at the European level with the adoption in March 2019 of the regulation on the screening of foreign investments. 

Extension of Investment’s Control

The sectors that are subject to such control have continued to grow and concern so-called "sensitive" activities. The decree gives concrete expression to this notion by specifying the following sectors: aerospace and data hosting, the press, food safety, quantum technologies, energy storage, biotechnologies, etc).

Similarly, the thresholds for triggering the control system have been lowered to 10% for publicly traded companies until the end of 2021.

Taking This Control into Account in M&A Transactions

As the decree introduced the concept of "chain of control", the presence of a foreign investor is sufficient to trigger control even if the direct investor is actually owned by a French entity.

This is an important consideration for all transactions in which a foreign entity is present, which is peculiar to transactions in which investment funds intervene.

The role of legal due diligence is now increased and this investment control must be integrated into the negotiation process between the different actors of the transaction.

In France, private equity transactions may undergo review by the following regulatory authorities: 

  • the French Competition Authority; and/or
  • the Minister of the Economy and Finance. 

French Competition Authority (FCA)

Transactions outside the retail industry and meeting the following three conditions are subject to a merger control procedure by the French Competition Authority:

  • the total global pre-tax turnover of all the companies, groups of legal persons or individuals who are parties to the merger is greater than EUR150 million; 
  • the total pre-tax turnover generated in France by at least two of the companies, groups of legal persons or individuals concerned is greater than EUR50 million; and
  • the transaction is not within the European Union’s jurisdiction (the above-mentioned thresholds being EUR5 billion and EUR250 million respectively). 

If the aforementioned conditions are met, the intended transaction must be notified to the FCA, which will conduct a prospective analysis of the deal’s impact on competition. Following such review, the FCA can approve (with or without conditions) or block the transaction.

On 26 March 2021, the European Commission published guidance on the circumstances under which it would accept requests from national competition authorities within the EU to investigate mergers that do not meet the EU or even national jurisdictional tests (in particular, in order to prevent so-called “killer acquisitions”). The effect of such guidance is likely to generate, in the near future, a notification process – even in the absence of sufficient turnover to meet mandatory filing requirements. 

Minister of the Economy and Finance

If the private equity fund is incorporated in a foreign jurisdiction and therefore qualifies as a foreign investor, the transaction may be subject to prior approval by the French Minister of the Economy and Finance. 

The minister’s compulsory authorisation is required if:

  • the target is a French company operating in a business sector deemed strategic (such as national defence, public health, cybersecurity, biotechnologies, etc); and
  • the intended transaction implies:
    1. the acquisition by a foreign investor of a direct or indirect controlling stake in a French entity;
    2. the acquisition by a foreign investor of all or part of a branch of activity of a French company; or
    3. the acquisition, directly or indirectly, by a non-EU investor (acting alone or in concert with others) of more than 25% of the voting rights of a French company (it being specified that in the context of the COVID-19 pandemic, this threshold was lowered to 10% until 31 December 2021, but only for investments in publicly listed companies). 

Completion of the intended transaction can be either approved (with or without conditions) or rejected by the Minister of the Economy and Finance.

The scope and depth of due diligence reviews are determined on a case-by-case basis and therefore vary from deal to deal. In particular, the level of legal due diligence depends on factors such as the scale of the intended transaction, the kind of business run by the target company, the estimated risk level, etc. 

In order to identify the potential negative impacts of the transaction on the target’s business, buyers are advised to perform due diligence investigations covering as many areas as possible (these may, for instance, include corporate documentation, financial statements, commercial contracts, ongoing litigation, taxation, insurance, etc). 

During the due diligence process, confidential documents are usually exchanged through a virtual data room and the parties involved are often required to sign confidentiality agreements. 

Vendor due diligence is typically used in the context of a competitive auction process, in order to simplify and accelerate the transaction. More specifically, bidders may rely on the vendor due diligence report when drafting their initial offers.

In general, vendor due diligence reports are deemed to be reliable, because they are elaborated by an independent third party and not by the seller itself. However, arranging further buy-side due diligence in order to confirm the results presented in the sell-side due diligence report is always good practice and is quite customary. 

In France, most acquisitions by private equity funds are negotiated confidentially. If the negotiations between the seller and the buyer succeed, both parties may then enter into a share purchase and sale agreement (SPA), which is the most typical acquisition scheme in France. 

The terms of the SPA may vary slightly, depending on whether the target is sold by means of an auction process or through one-on-one negotiations. In the first case, one can expect the SPA to be more seller-friendly, since in a competitive process, the seller has greater negotiation power. 

Private equity funds often invest through a special-purpose vehicle (SPV), which is an entity created for the purpose of carrying out a specific transaction. 

Most SPVs are incorporated as a simplified joint-stock company (société par actions simplifiée or SAS). This corporate form is preferred by private equity investors for various reasons: 

  • an SAS can be formed with a single shareholder and the capital requirements are very low (an SAS can be incorporated with an initial share capital of EUR1); 
  • with no strict regulations, the SAS allows for great flexibility in terms of corporate governance, which is particularly appealing for private equity investors; and
  • the shareholders’ liability is limited to the amount of their contributions. 

In general, the acquisition documentation is signed by the SPV (which is a subsidiary of the private equity fund), rather than by the private equity fund itself. 

Private equity deals are financed either with cash, debt, or a combination of both. Despite the COVID-19 crisis, the large majority of deals negotiated during the first half of 2021 were at least partly financed with debt.

The structure of the debt can be particularly complex, although its purpose is almost always to finance the acquisition and refinance existing debt. In general, it may consist of:

  • senior debt, often granted for a term of five to seven years, comprising several tranches with distinct maturities;
  • junior debt, the repayment of which is subordinated to the repayment of the senior debt; and
  • mezzanine debt, often granted by specialised investment funds and structured in the form of securities giving access to the target's capital.

To contractually ensure the existence of funds from a privately funded buyer, an equity commitment letter is often used.

Private equity investors usually take both minority and majority positions. However, there has been a real increase in transactions in which investment funds take minority positions. These transactions are no longer the exclusive privilege of small companies, but also concern large medium-sized companies. Similarly, some large investment funds are more willing to take minority positions in order to gain access to more satisfying opportunities, in the context of a managers' buyout or of the acquisition of a minority stake in a family business.

With the development of public investment funds, such as the European Investment Bank at the European level or the Public Investment Bank at the French level, it is essential to note that co-investment strategies are increasingly common.

The implementation of such strategies can be explained by the desire not to neglect any growth potential. For example, co-investment is often used to invest in start-ups or in developing companies. These co-investment strategies are implemented in particular with venture capital funds, in the context of projects that target innovation-oriented companies in the science, information and communication technology, infrastructure and renewable energy sectors.

Family offices often invest alongside private equity or venture capital firms on smaller deals, as some of the family members of such family offices are also sometimes limited partners of the private equity fund.

Locked-box and completion accounts are by far the most common forms of consideration structure in France.

The earn-out clause is also quite popular in the French jurisdiction. Although this clause is inserted in a minority of all private equity transactions, this clause appears in a good proportion of deals overall.

It goes without saying that the COVID-19 crisis has accelerated the resurgence of the earn-out and completion accounts mechanisms, as buyers wish to share the risks related to their acquisition with the sellers. 

Regarding the earn-out clause, the COVID-19 crisis is not the only explanation for this progression: the sellers may also see it as an opportunity to reap the benefits of developments or support that will continue after the deal.

Nonetheless, it is evident that the earn-out clause is more prevalent in transactions under EUR100 million. Above these amounts, the parties involved tend to prefer a price that is definitively fixed at the time of closing (usually, by using a locked-box mechanism) without any subsequent contingencies.

When a locked-box mechanism is used, there is typically no interest on the leakage and the adjustment is made on a euro basis.

Both the locked-box mechanism and the closing accounts mechanism can lead to an adjustment of the purchase price post-closing, in the event of a leakage (in the first case) or if the target’s assets and liabilities have changed (in the second case). But litigations are far more common with the use of the completion accounts mechanism.

In the event of persistent disagreement between the buyer and the seller concerning the purchase price adjustment, it is standard practice to include an expert determination clausein the share purchase agreement, as a resolution mechanism. Pursuant to this, either the buyer or the seller may seize the commercial courts in order to request the nomination of an independent expert. 

Following his appointment by the judge, the expert will determine the amount of the price adjustment, which will be binding on both parties (except where a serious error has been committed). 

Conditions Precedent Commonly Used

Most private equity deals are conditional upon the fulfilment or waiver of certain conditions precedent. 

Such conditions precedent generally include: 

  • obtainment of regulatory approvals (in particular, foreign investment and antitrust approvals); 
  • obtainment of funding (if any); 
  • obtainment of third-party consents (if key contracts containing change-of-control provisions were identified during the due diligence process); and
  • absence of any material adverse change between signing and closing (if the share purchase agreement contains a MAC clause). 

It should be noted that although the use of MAC clauses has increased due to the COVID-19 pandemic, they are not a predominant feature in French private equity deals.

“Hamon” Law

In addition, the so-called "Hamon" law has imposed several other conditions that must be met before a takeover of any company employing employees can be carried out. 

Indeed, the company's employees have to be informed before the transaction is carried out so that they are able to make an offer to the seller prior to the third party making an offer.

Similarly, the target’s working council have to be consulted sufficiently in advance of the transaction.

In so far as this information and consultation must be carried out before the sale takes place, it is not strictly speaking a condition precedent. The most commonly used formula is the signing of a put option, allowing the seller to exercise the option once the information/consultation obligations have been fulfilled.

This type of clause concerns, in principle, transactions of considerable size. And the acceptance by the purchaser of such a clause clearly depends on the negotiating power of each party, but especially on the applicable regulatory provision concerned.

When the regulatory provision relates to competition law, and particularly to antitrust provisions, this clause is difficult to accept for the purchaser. Agreeing to it is dangerous as the remedies can be harsh and costly.

On the other hand, in the case of provision pursuant to foreign investments in France, the negotiation of this type of clause seems to be easier. Indeed, prohibitions are very rare and remedies are easier to implement in this context. "Hell or high water" clauses are therefore less difficult to take on in this context.

In any case, this is a matter of bargaining power and the specific situation of the purchaser. If it is a private equity firm with no competing companies in the portfolio and not in the context of a build-up, a "hell or high water" clause is more likely to be accepted.

Although not specifically prohibited by French law, break fees in favour of the buyer or the seller are not commonly used in France. 

If stipulated, break fees will become due if either party decides to terminate a pending deal for a reason not attributable to the other party. 

That being said, it is important to bear in mind that there are no punitive or exemplary damages under French law. Therefore, if the amount of the break fees exceeds the value of the damage actually suffered by the claimant party, the amount of such termination fees can be reduced by a court decision. 

Acquisition agreements in France usually contain a right to terminate the transaction if the conditions precedent are not fulfilled or waived before the contractually agreed long stop date. Moreover, if a MAC clause is set forth in the acquisition agreement, the buyer is entitled to cancel the deal if the target’s business and operations suffer a material adverse change during the interim period (ie, between signing and closing). 

The allocation of risk generally depends on the negotiation leverage of the parties involved in the transaction and therefore may vary from deal to deal.

From a legal standpoint, the risk related to the acquired target company is supported by the purchaser unless provided otherwise in the sale and purchase agreement.

Usually, the sale and purchase agreement provides a representations and warranties mechanism pursuant to which the seller can indemnify the purchaser if the target suffers a liability as a result of events prior to closing.

There is usually a limitation on the amount of the liability of the seller, such as:

  • a cap (stated between 10% and 30% of the purchase price);
  • a threshold or a franchise; and
  • a de minimis.

On private equity deals, more risks are taken by the purchaser since the representations and warranties are usually more limited (and sometimes there are almost none, except for the fundamental ones, eg, capacity, titles to share etc).

When selling off their stakes, private equity funds are generally reluctant to make representations and guarantees other than warranties of title and capacity.

By contrast, the representations and warranties given by the management team usually cover a broad range of topics. Such warranties may, for instance, include: 

  • warranties regarding the target’s financial situation and financial statements; 
  • warranties regarding the conduct of business; 
  • operational warranties; and
  • warranties regarding compliance with all the applicable laws and regulations.

As mentioned in 6.8 Allocation of Risk, representations and warranties are usually limited by a cap, a franchise/threshold, and a de minimis.

The liability of the seller can also be limited by the duration of the warranties, which is usually from 12 to 36 months.

Finally, it is worth noting that full disclosure of the data room is typically allowed against the warranties in open bid.

The other protections included in acquisition documentation mainly consist of an escrow agreement set between 25% and 50% of the cap.

The purchaser also often asks the seller to find a guarantor who may have to commit personal funds.

Also, in the biggest deals, the stakeholders may contract representation and warranties insurance.

In the French jurisdiction, the provisions that are most likely to lead to a dispute relating to private equity transactions are those that provide for completion accounts and earn-out mechanisms. They are a breeding ground for litigation, despite their good drafting. Nevertheless, and despite the adjustment discussed above, the private equity market remains a pro-seller market and locked-box mechanisms are becoming more common.

Similarly, warranties indemnification may give rise to litigation when implemented.

Public-to-private deals are uncommon in France.

In France, shareholders acting either alone or in concert with others are required to disclose their stakes in publicly traded companies when exceeding or falling below one of the following thresholds (whether in capital or voting rights): 5%, 10%, 15%, 20%, 25%, 30%; 33.33%, 50%, 75%, 90% and 95%.

The French Commercial Code also requires the shareholder, when crossing certain thresholds of shareholding (10%, 15%, 20% and 25% of the capital and voting rights) in a publicly listed company, to declare the objectives they plan to pursue during the next six months.

If one of the previously enumerated thresholds has been reached, the relevant investor must file a report with the French Financial Markets Authority (with a copy to the issuer) within four trading days. 

Failure to comply with this disclosure requirement may lead to a suspension of the voting rights attached to the shares exceeding the threshold that should have been disclosed, for a period of up to two years. 

Under French law, there are two situations in which the obligation to make a mandatory offer for 100% of the shares of a publicly listed company can arise: 

  • when a person or entity, acting alone or in concert with any other party, exceeds 30% of the voting rights or the share capital of the target company; or
  • if a shareholder who already holds between 30% and 50% of the target’s share capital or voting rights increases its stake by 1% or more within 12 consecutive months.

In either case, the mandatory offer price must be at least equal to the highest price paid by the bidder for securities of the target during the 12 months preceding the obligation to file such mandatory offer. 

It should be noted that exemptions and dispensations from the obligation to file a mandatory offer may be granted by the French Financial Markets Authority in certain limited circumstances including the following: 

  • subscription to a capital increase of a company in financial difficulty, subject to the approval of the shareholders’ general meeting; 
  • merger or asset contribution subject to the approval of the shareholders’ general meeting; 
  • holding of the majority of the company’s voting rights by the requesting party or by a third party, acting alone or in concert;etc. 

If the required mandatory offer is not filed, voting rights exceeding the 30% threshold will be suspended. 

In France, cash (rather than stock) is by far the most common consideration for financing an M&A transaction. Indeed, offering cash instead of shares enables the buyer to avoid dilution of its own shareholders. Thus, controlling stakes at the level of the buying company remain unchanged. 

Takeover bids may be subject to certain conditions precedent. In general, the conditions precedent accepted by the French Financial Markets Authority are the following: 

  • the obtainment of antitrust approvals; 
  • if the offer includes stock as consideration, authorisation of the issuance of new shares of the offeror by its shareholders' meeting;
  • reaching a certain threshold of target shareholder participation (in capital ownership or voting rights); and
  • the success of two tender offers conditional upon each other. 

However, conditions precedent relating to the obtainment of financing by the bidder are not accepted. 

Squeeze-Out Mechanisms

A squeeze-out procedure can be launched every time a given shareholder, acting alone or in concert with others, reaches no less than 90% of the target’s voting rights. 

If the 90% threshold is reached following the closing of a tender offer, the squeeze-out procedure can be implemented immediately, provided that the offer prospectus expressly mentioned the bidder’s intention to proceed with a squeeze-out. 

Commitments to tender shares from actual shareholders depend on the way the takeover is structured. Takeovers involving the participation of the shareholders of the target (and especially friendly takeovers) are usually structured in two different ways:

  • a block of shares sold by the shareholders of the target to the bidder with an immediate transfer of ownership and then the launch of a tender offer by the bidder; or
  • a tender commitment – in this case, the bidder undertakes to launch a public offer for the target at a price agreed with one or more shareholders, who will then tender their shares at such price.

The choice is important in the bidding process, and is made on a case-by-case basis.

In the case of a simple sale of a significant block, the risk of a competing bid by another candidate will be reduced or even eliminated if the bidder has acquired the majority of the capital.

On the other hand, the purchaser will have to obtain any necessary antitrust clearances prior to the acquisition of the block which may delay the public offer process.

Moreover, in the case of a minority block acquisition, the acquirer will run the risk of holding a non-controlling interest if few shares are tendered to the public offer. In the event of an acquisition giving the shareholder a stake of more than 30% of the capital or voting rights, the bidder will be in a mandatory public offer situation, with price control by the AMF.

In the case of a commitment to tender, the bidder only acquires ownership of the reference shareholders' shares at the time of settlement of the takeover bid. Thus, the bidder acquires these shares at the same time as the shares tendered by the other shareholders. If the bidder does not reach the 50% condition threshold set by French law or the condition threshold freely set by the bidder, the bidder will not acquire any shares and will not find itself a minority shareholder of the target.

On the other hand, the Autorité des Marchés Financiers (the state authority in charge of controlling financial market operations) requires that the undertakings to tender be revocable in the event of a competing bid. Thus, the bidder must accept the risk that the shareholders who have given the commitment to tender may sell their shares to a competitor in the event of a better bid.

While possible in principle, hostile takeover bids are far less common than friendly tender offers in France.

Indeed, each year, very few hostile takeovers are attempted. The figure remains around one per year, although the financial and social stakes remain considerable.

The lack of hostile takeovers can be explained in part by the French economic culture, but also by the fact that takeover procedures are very cumbersome and particularly regulated. This makes hostile takeovers less attractive.

The last famous hostile takeover bid that took place in France was the bid made by Veolia on Suez. The two companies have since concluded an agreement for the operation.

Private equity funds often give key managers the opportunity to take part in a transaction by investing alongside them in the target. 

To this end, an SPV gathering all key managers (ManCo) is often created. The stake of ManCo in the target company usually ranges from 5% to 15%, depending on the characteristics of the deal. In an MBO (management buyout) situation, the management obviously has the majority of the capital.

The indirect participation of managers in the target is generally preferred over direct participation, mainly because the former scheme is more practical in terms of corporate governance. 

In general, management participation in private equity transactions is structured through a management package, which may take the form of ordinary shares, sweet equity and/or fixed-rate instruments. 

The idea is to align the interests of the management with those of private equity investors. To this end, managing shareholders benefit from higher returns on their investment.

Tax Implications

In practice, incentive schemes may vary according to tax considerations. For instance, in order to avoid tax liability, managers should acquire their shares at a purchase price equal to the shares’ fair market value. In addition, France's highest administrative court issued three decisions on 13 July 2021 stating that the acquisition of shares at a preferential rate constituted a benefit directly taxed in the category of salaries and wages.

Similarly, the capital gain realised on the sale of these warrants would be taxed in the category of salaries and wages if these gains are the counterpart of the functions of an employee or manager, and not as capital gains for individuals.

These decisions have been and will be commented on and the consequences of these decisions are still being analysed by tax specialists, but all the commentators agree that these decisions are creating legal and tax insecurity on incentive schemes. 

In private equity transactions involving management participation, good and bad leaver provisions are usually set out in the shareholders’ agreement.

In general, a manager is deemed to be a “good leaver” if they leave the company for one of the following reasons: 

  • death; 
  • physical or mental incapacity; or
  • departure approved by the investors; 

In this case their shares will be transferred back to the portfolio company or the private equity investors, as the case may be, at fair market value. 

On the contrary, if the relevant manager is deemed to be a “bad leaver”, their shares will be transferred at a price lower than the fair market value. In general, a manager is considered to be a “bad leaver” either if they leave the company:

  • for any reason other than death, physical or mental incapacity, or upon authorisation by private equity investors; or
  • in a case of gross negligence, wilful misconduct, breach of the shareholders’ agreement or sometimes underperformance. 

In both cases, managers are required to sell their shares back to the company or the private equity investors. To this end, each manager must grant a call option to the private equity fund. 

Manager shareholders often play a dual role, as they are both shareholders and employees or service providers of the portfolio company. Given this situation, manager shareholders are subject to certain obligations deriving directly from their status. Such obligations usually include non-solicit, non-compete and confidentiality obligations, which are set out in both the shareholders’ agreement and the employment contract (or service agreement) signed by the relevant manager.

Under French law, the non-competition undertaking must be proportionate to the legitimate interests involved. To this end, these commitments are limited in time and space and to strictly defined activities. Moreover, if the manager who undertakes such a commitment is an employee, the non-competition undertaking must be stipulated in the employment contract and must be remunerated.

In the case of a majority leveraged buyout (LBO), the manager shareholders of a company do not have specific rights that would allow them to influence certain decisions that would commit the company or the structure of the company itself. Nor, for the majority of deals, do they have specific rights to influence the capital ownership or the exit of the investor. Indeed, the main purpose of managers taking a stake in a company is to give employees an interest in the company's results.

Moreover, certain important decisions need to be approved by the investors.

However, as an exception to the above, some managers may be offered certain rights as a party to an investment agreement. The content of these rights depends mainly on the negotiating capacity and the final weight that the management team is expected to carry in the company following the investment. This can go as far as veto rights on certain issues involving the company, anti-dilution protection or an influence on the exit of the private equity fund.

Corporate Governance

In order to monitor the performance of a portfolio company, private equity investors usually negotiate the following corporate governance arrangements, which are generally set out in the shareholders’ agreement: 

  • appointment of representatives in the supervisory committee;
  • veto rights on strategic decisions; and 
  • information and audit rights. 

Nomination of Supervisory Committee Members

Most private equity investors are granted the right to appoint a certain number of members of the supervisory committee. Such members represent the interests of the private equity fund at the level of the committee, whose main role is monitoring business performance and voting in strategic decisions. 

Veto Rights on Strategic Decisions

Besides the right to appoint members of the supervisory committee, private equity investors are usually granted veto rights over extraordinary management decisions affecting the organisation, structure or performance of the portfolio company, which may include: 

  • amending the company’s by-laws; 
  • issuing additional shares or transferring shares; 
  • adopting financial budgets; 
  • incurring new debt above a certain threshold; 
  • hiring or dismissing directors and key employees; 
  • investing above a certain amount;
  • setting up new subsidiaries or entering into a new line of business; 
  • pursuing a merger, an acquisition or a carve-out; etc.

The list of strategic decisions is usually set out in the shareholders’ agreement and is sometimes reiterated in the company’s by-laws. 

Information and Audit Rights 

Information and audit rights are also commonly requested by private equity investors. Consequently, the management of the portfolio company has a reporting obligation towards investors and must provide financial reports to the private equity fund every month or at the end of every quarter. 

Furthermore, as part of their audit rights, private equity investors are entitled to conduct on-site investigations and can therefore audit the company’s books and records, either alone or assisted by legal advisers. 

In general, private equity investors do not wish to interfere with the daily management of the portfolio company, in order to limit their liability in this regard. Hence, private equity investors prefer to perform a supervisory role.

However, under certain conditions, private equity funds, in their capacity as shareholders, may be held liable in the context of their activity, and the principle of limited liability may fall.

Thus, when shareholders are found to have committed a personal error which cannot be linked to the management of the company and which has caused damage to others, it is established case law that the personal liability of the shareholder will be engaged.

Above all, shareholders will be personally liable if they are qualified as de facto managers. Thus, when a shareholder interferes in the management of the partnership in a manner which leads to a loss for the company, this interference will engage the personal liability of the shareholder.

This is why counsels of private equity funds have to draft the shareholders' agreement so carefully. Indeed, the rights that are granted to the fund have to remain information, reporting or veto rights on strategic issues. If the rights granted to the fund go further and grant it decision-making power, the fund may be held liable as a de facto manager.

Socially responsible investment, respecting environmental, social and governance (ESG) standards, is increasingly important in France, as in the rest of the Western world in general.

The French financial community is now more aware of these extra-financial criteria and is more inclined to invest in companies that respect these standards.

Many funds specialised in socially responsible investment now exist, with a considerable acceleration in growth in 2020 and 2021. Accordingly, these investment funds have doubled in number (from around 300 to 600). This generalisation is gradually forcing target companies to comply with these ESG standards in order to remain competitive and attractive to investors.

Most private equity funds expect to sell their investment and therefore exit the target company four to seven years after the deal’s completion date, since the senior debt is granted for such a duration.

In the French jurisdiction, the most common forms of private equity exit include secondary buyouts, initial public offerings (IPOs) and trade sales. In numerous cases, the exit of the LBO can intervene by merging the holding company and the operating company before the launch of the initial public offering.

The so-called "drag-along clause" is often used in private equity transactions. It is possibly even one of the most fundamental clauses.

Sometimes, the drag right is in the hands of the sole majority shareholder. Sometimes the threshold varies if there are several majority shareholders. It mainly depends on the negotiating power of each majority shareholder.

The so-called "tag-along clause" is also frequently included in private equity transactions. It can be drafted in two different ways:

  • firstly, it can be a full tag-along right, allowing shareholders to transfer all of their shares to the purchaser for control of the company; or
  • secondly, it may be a proportional tag-along right, the purpose of which is to allow the beneficiaries to transfer, together with a transferring shareholder, a proportional share of their holding.

This clause can typically be applied to institutional investors or to managers.

The lock-up agreement is a period during which the shareholders of a company undertake to hold the company's shares for a given period following the IPO. This period is usually quite short and rarely exceeds nine months, although some clauses make the lock-up last for a year.

IPOs are typically subject to a lock-up arrangement of 180 calendar days.

This commitment is often made to reassure investors.

Shareholders' agreements can also be concluded after the IPO, in particular, for the management or to give a priority right in the event of a share transfer.

Valther Avocats

46 avenue d’Iéna
75116
Paris
France

+33 1 81 80 44 24

+33 1 81 80 44 49

ihebbat@valther.com www.valther.com
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DLA Piper has one of the world's leading private equity practices, with 200 lawyers spread across the Americas, Asia-Pacific, Europe and the Middle East, including more than 30 lawyers and four partners based in Paris. The lawyers in the private equity practice group have extensive knowledge of the private equity market. Their experience covers all aspects of the private equity life cycle, including fund structuring, equity investment, structuring of management participation and incentive schemes, portfolio management, pre-insolvency restructuring, and exit (pre-sale restructuring, flotation, trade sales and secondary buyouts). The team has been involved in major private equity matters, such as advising the founders and management of Circet on the sale of their stake in Circet and their co-investment alongside ICG; advising The Carlyle Group on a growth capital transaction in the Inova Group, a bio-pharmaceutical software company; and advising ARIADNEXT, a French company specialising in remote identity verification and digital identity creation, on the acquisition of its share capital by German company IDnow. The team is a member of France Invest, the largest private equity think tank.

2021: the French LBO Market Has Never Been So Dynamic

As many as 139 operations were announced in the first half of the year 2021, according to the July issue of Capital Finance International magazine. An ever-growing number of buyers with increasingly specific strategies is playing the economic recovery card to the full. 

Investment activity in 2020 could be defined in three phases: the early part of the year, when activity was on track for the best year since the 2008 global financial crisis; the lockdowns, when deal activity effectively ground to a halt; and H2, when PE activity rebounded strongly, led by investments in technology. The atmosphere clearly contrasts with that of the first half of 2020 and the beginning of the health crisis. The leveraged buyout (LBO) players have regained enough confidence to be in a position to break records. No less than 139 new leveraged operations on Tricolor companies were announced between January and June 2021. This is almost twice as many as in the first part of last year (74 transactions). If buyers show as much appetite throughout the second half of this year – which is more than likely – the activity will clearly pass that of 2018, the year of the largest number of LBOs ever seen in France, with 245 operations.

As for climate framework: environmental, social and governance (ESG) aspects have gained significant relevance for PE investors. The climate, governance, social value and carbon emissions have become recurring topics of discussion among investors. The legacy of the pandemic is expected to persist in fundraising, and increased dependence on collaboration platforms, remote working and virtual fundraising is gradually becoming the "new normal".

PE Climate Framework

Greater sophistication

During the first half of the year, there are never usually many XXL deals. However, during the first half of 2021, 11 transactions were announced with a valuation greater than or equal to EUR1 billion, ie, as much as over the whole of 2020. 

Better still, the three operations that are at the top are among the largest LBOs ever carried out in France, although still behind that of KKR and Goldman Sachs on Yellow Pages, in 2006, for EUR6.5 billion. The same KKR was invited in the spring to Cegid's capital by Silver Lake, the investor that withdrew the software publisher from the stock market four years ago. The two funds did business for EUR5.5 billion. Two operations in the world of health complete the top three with a valuation of around EUR4.5 billion, one on Cerba, the other on DomusVi. The sixth LBO of the group of bio-analysis laboratories involved an investor (EQT) replacing another (Partners Group). The transaction signed on the operator of retirement homes is much more atypical. At the end of the day, the two shareholders who share the capital of DomusVi have not changed. The founder has increased its capital by inviting half a dozen investors (including Merieux Equity Partners) into a holding company that it controls. ICG, on the other hand, returns to the capital via a more recent vehicle, but also by attracting new investors through a continuation fund. This type of operation, which will probably call for other deals of the same kind in future, is testimony to the ever-increasing sophistication of the French LBO market.

The middle market has also experienced unprecedented dynamism. At least 32 operations established on the basis of a valuation of between EUR100 billion and EUR1 billion (including 28 in the EUR100–500 million segment) have materialised, according to capital finance estimates. This represents ten more LBOs than the volume recorded for the 12 months of last year.

Platform effects

How can we be surprised to see so many LBOs come to fruition in 2021? Like many economic actors, they have shown since mid-2020 that they have adapted to the health crisis. All this to the point of giving the impression of having barely been affected, in their transactional activity, by the successive epidemic waves. They need to deploy the mountains of liquidity coming from LPs whose desire for non-rating is not decreasing. Meanwhile, the ranks of the LBO players keep on expanding. Management companies continue to be created on a fairly broad spectrum – from small cap regional (Albarest Partners, created by ex-MBO & Co) to mid-market (Adagia Partners, with PAI alumni, Montagu and Roland Berger), through very specialised players according to the type of operation (eg, Trajan Capital, a "pure player" of MBI) or the sector. Tricolour SMEs are attracting more and more foreign investors, such as, Insight Partners (which has established its first deal in France by entering the capital of IAD), but also Ambienta, a Lone Star or Marlin Equity Partner, which is among the last to have opened an office in Paris. 

The transformation of a growing number of management companies into real platforms with complementary strategies (according to size or target company) also contributes to the strong activity of the market. The example of Capza provides a good illustration: it has been able to participate in a dozen new deals in six months, with its Flex Equity, Expansion, Transition and Growth Tech franchises. The recent break-up (or return) of some firms in segments of the size of companies smaller than those of their "flagship" fund has also fed the explosion in the number of deals. PAI (with a mid-market vehicle) and Sagard (via its NewGen team) are among the last to be launched, waiting for other signatures, such as Astorg or ICG, which have also created funds to follow the movement.

PE Climate Framework

ESG is an area of significant and growing focus for PE

Several firms took additional steps to increase their commitment to driving social value when five PE firms came together to fight against climate change. Ardian, The Carlyle Group, Global Infrastructure Partners, Macquarie Infrastructure and SoftBank Investment Advisers have joined a number of sovereign wealth funds under the One Planet initiative to create the One Planet Private Equity Funds. In a joint statement, the group said “as long-term investors in companies and real assets that underpin both economies and communities, our goal is to advance the understanding of climate-related risks and opportunities within our investment portfolios so that we can build better and more sustainable businesses”.

Virtual fundraising is likely here to stay

One of the concerns heading into the pandemic was that, in addition to challenges with deals, PE firms would have a hard time connecting with limited partners (LPs) to conduct fundraising roadshows. For many funds, though, the shift to virtual forms of fundraising could be permanent. Carlyle’s Kew Lee was reported in a recent pensions and investments piece as saying “... having conversations that start in the morning with Korea, Japan and China before moving on to Europe in the afternoon is something you couldn’t do... in a world where you’re hopping on an airplane”. One important caveat is that fundraising via Zoom is generally thought to benefit larger, well-established funds more than smaller or newer funds. Nonetheless, for many managers, integrating the best of virtual fundraising alongside existing practices could become a way of life. 

Perspectives

Naturally, the liveliness of the LBO market is fuelled by the recovery. And this is expected to continue.

Even though the threat of the delta COVID-19 variant looms, the vaccination campaign continues its course in France, and is supporting recovery. At the end of June, the French National Institute of Statistics and Economic Studies (INSEE) formulated the hypothesis of a growth of 6% for 2021, more than that anticipated by the government. The so-called "COVID-19-proof" business sectors – health, software and financial services in the lead – are still as popular as the year goes by. The enthusiasm they generate alone pulls up the acquisition multiples of the market – the Argos index estimated the media valuation in the LBOs of the eurozone at 12.4 times EBITDA in the first quarter. On the other hand, setting up an operation in the sectors heavily affected by the pandemic and the restrictions or successive administrative closures (hotel, catering, non-food distribution), still remains a challenge. Between these two extremes, more and more opportunities are constantly opening, although discussions around valuations and effects (positive or negative) related to COVID-19 can still be the subject of long debate. 

We have no doubt that private equity firms will seek to boost growth with the vast operational knowledge they have gained over the past decade.

DLA Piper

27 rue Laffitte
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Paris
France

+33 140 15 2400

+33 140 15 2401

Xavier.Norlain@dlapiper.com www.dlapiper.com/en/france/
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Law and Practice

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Valther Avocats is an independent law firm based in Paris which operates in all areas of business law (M&A/private equity, commercial litigation, restructuring, employment law and tax law). Its main activity is in the field of mergers and acquisitions and private equity transactions. Valther assists its clients in all aspects of these transactions, from the performance of due diligences to post-closing monitoring and the implementation of contractual documentation. The team at Valther is composed of 20 professionals, including five partners and 15 associates and lawyers, all of whom are dedicated to the satisfaction of the firm's clients and to the completion of the assignments entrusted to them. Valther offers a personal touch and more flexible service than some of the larger English and American law firms and this allows the firm to provide a wide range of expertise at fair costs while maintaining proximity and responsiveness to its clients.

Trends and Development

Authors



DLA Piper has one of the world's leading private equity practices, with 200 lawyers spread across the Americas, Asia-Pacific, Europe and the Middle East, including more than 30 lawyers and four partners based in Paris. The lawyers in the private equity practice group have extensive knowledge of the private equity market. Their experience covers all aspects of the private equity life cycle, including fund structuring, equity investment, structuring of management participation and incentive schemes, portfolio management, pre-insolvency restructuring, and exit (pre-sale restructuring, flotation, trade sales and secondary buyouts). The team has been involved in major private equity matters, such as advising the founders and management of Circet on the sale of their stake in Circet and their co-investment alongside ICG; advising The Carlyle Group on a growth capital transaction in the Inova Group, a bio-pharmaceutical software company; and advising ARIADNEXT, a French company specialising in remote identity verification and digital identity creation, on the acquisition of its share capital by German company IDnow. The team is a member of France Invest, the largest private equity think tank.

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