After a major slowdown caused by the outbreak of COVID-19 in the first part of 2020, the Italian M&A market is now experiencing recovery, with a significant increase in deal flow from the second semester of 2020 (approximately 300 M&A transactions for an aggregate deal value of EUR22.4 billion in H2 2020) closing 2020 with a total volume of investments slightly higher than 2019. This positive trend has accelerated in H1 2021, thanks to the activism of private equity funds that announced 79 transactions for a total aggregate value of EUR26 billion, showing figures in line with those recorded in the pre-COVID-19 market.
On the other hand, it is worth noting that this positive business environment is mainly driven by selected strategic mega-deals, and that mid-market key indicators appear to have a longer recovery path ahead.
In general terms, the market outlook remains positive for the second half of 2021, with a strong appetite for investments by professional operators encouraged by the progress of the vaccination campaign, the public investments to be carried out as part of the EU public aid package (Next Generation EU), and the increased estimate of Italy GDP growth released by the International Monetary Fund (+4.9% expected in 2021).
The most attractive industries continue to be those which, due to their nature, tend to be more resilient or have sometimes even been positively affected by the pandemic:
Manufacturing, food & beverages and fashion & luxury, which are the traditional cornerstones of Italian M&A market, are also recording a growing number of deals. Private equity operators are also demonstrating increasing interest in asset classes that are not typically included in their portfolio of investments, such as professional football and circular economies.
Other key industries that have been more impacted by COVID-19 restrictions (including hospitality & leisure, automotive and consumer & retail) have recorded a lower level of investments in the past 12 months, mainly limited to opportunistic deals, but are now showing signals of rebound.
The equity capital markets sector has experienced few IPOs and public-to-private transactions, and more intense activity in the secondary market led by recapitalisations; this trend is expected to continue into 2022.
The uncertainty regarding the future results of target companies and the volatility of evaluation criteria in certain industries have led to increased popularity for mechanisms that allow the buyer to reduce upfront payments in exchange for a deferred sharing with the seller of possible future upside performances.
In particular, when acting buy-side, private equity operators are increasingly keen to include in the transaction documents sophisticated formulas of contingent deferred payments to bridge the gap between the price expectations of the seller and the lower risk appetite of the buyer. Such clauses range from traditional earn-out provisions based on EBIT/EBITDA or other key indicators (whose definition is often customised for the deal and heavily negotiated with the support of the financial advisers) to more complex forms of deferred contingent payments based on the actual return achieved by the private equity buyer on a future exit. In the latter case, when the seller remains a shareholder of the target after closing, the deferred contingent payments are often structured as a form of preferred equity.
The acquisition of control of any undertaking operating in Italy may be subject to the antitrust control of concentrations carried out by the Italian Antitrust Authority (AGCM). In particular, the prior notification of a transaction to the AGCM is mandatory if both the following thresholds are met:
The AGCM does not have competence over transactions that meet the separate thresholds set forth under Article 1 of Regulation (EC) No 139/2004 (the EC Merger Regulation), the filing of which has to be submitted before the European Commission.
Foreign Investment Control
In addition to the above, investments in undertakings that are active in Italy may be subject to prior control by the Italian government on foreign investments. In particular, according to currently applicable rules, the following sectors are included in the scope of foreign investment review:
Depending on the type of transaction (eg, the acquisition of control over a company holding strategic assets, or transactions directly concerning the strategic assets), the prior filing of a transaction is requested for any foreign company or only for extra-EU companies (taking into account also the nationality of the relevant controlling entity) acting on the buy-side. Furthermore, certain transactions involving exclusively Italian companies could require a mandatory filing by the entity that transfers the control of the strategic company or assets.
Until 31 December 2021, entities outside the EU are also requested to notify the Italian government of any acquisition of participations in companies operating strategic assets (even if such acquisition has merely financial purposes and does not determine an acquisition of control).
The powers granted to the Italian government according to the foreign investment control legislation include the possibility to veto a transaction or impose conditions on its completion in order to protect public security and safety, as well as the functioning and continuity of networks and supplies.
Finally, please note that further controls and/or authorisations may be required to complete the acquisition of specific targets, particularly in regulated fields, such as authorisation from the Bank of Italy for the acquisitions of banks or financial firms/intermediaries, and authorisation from IVASS (Italian insurance authority) for the acquisition of insurance companies and/or certain insurance assets.
Private equity funds usually require a thorough legal due diligence exercise to be carried out with reference to the target company. In most cases, the due diligence review is conducted by means of a virtual data room where the relevant documentation is uploaded. The advisers of the private equity firm are also generally allowed to submit questions or requests for clarification concerning the documentation reviewed and, most of the time, management meetings or site visits are also scheduled. The output generally requested by the private equity fund is not a full report with a detailed description of the documentation reviewed but rather a red-flag report where only the main critical issues are highlighted.
Key areas of focus for legal due diligence in private equity transactions generally include corporate, commercial/business contracts, financing, authorisations/licences, employment, tax, litigation and IP. Depending on the industry in which the target company operates, more business-specific areas may cover regulatory (eg, for banks, insurance companies or other regulated entities), environmental (eg, for industrial and production companies) or real estate issues (including for deals in the energy sector).
A vendor due diligence report is usually made available in the context of an auction, if the size of the target company justifies the costs relating thereto (in terms of both advisers’ fees and the internal resources involved in the process). To the contrary, no vendor due diligence activity is normally arranged for small or medium-sized deals.
The advisers to the buyer provide credence to the vendor legal report drafted by external law firms, in general terms, but in any case the information therein is usually double checked based on the available due diligence documentation. Moreover, for certain specific areas or in relation to issues that are particularly material, an additional and more detailed due diligence analysis is carried out by the buyer’s advisers. Additional due diligence activities are also required when the vendor due diligence report does not address all the matters the buyer wishes to cover.
Regarding the due diligence report prepared on the buy-side, advisers usually provide reliance thereon to their client and, sometimes, to banks or financing parties (if any), subject to terms and conditions to be agreed from time to time.
The Italian economy is based on a banking lending system and its industrial sector is mainly composed of micro-small and medium-sized enterprises, which are the pillars of the Italian manufacturing industry. Italy has a very limited number of multinational corporations, and most companies are not listed. In this private sector scenario, the typical shareholding structure of an Italian corporation consists of a limited number of shareholders (sometimes belonging to the same family).
In such a framework, the following conditions apply:
In principle, although each deal may differ from the next, acquisition terms may be significantly different depending on whether the transaction is a peer-to-peer negotiation or an auction process, in the context of which the tension between the competitors often results in provisions that are more favourable to the seller.
Private equity deals are usually carried out through one or more acquisition vehicles – set up in Italy or abroad, based on tax-driven structures – belonging to the control chain of the private equity buyer.
If the vehicles are not already incorporated upon signing, the relevant transaction documents are entered into by the private equity firm, which reserves the right to designate a third party (ie, an acquisition vehicle) between signing and closing in order to complete the acquisition. In such a case, appropriate protections are normally included in the transaction documents to safeguard the interests of the seller to receive the funds at closing.
Private equity deals in the Italian market are usually financed through a mix of equity and debt, with the latter consisting more often of acquisition financing granted by banks or other financing institutions or, less frequently, by special debt instruments, such as acquisition bonds.
When the deal structure contemplates a special purpose vehicle acting on the buy-side, private equity operators might be requested by the seller to submit equity and debt commitment letters providing contractual certainty of the availability at closing of the funds necessary to close the deal, as an attachment to the binding offer, especially in the context of an auction sale.
Indeed, private equity buyers typically prefer to acquire a controlling stake in the target. However, depending on the target's operating business and the specific expertise that might be needed to run it, buyers might welcome – or be willing to consider – a minority investment in the target by the sellers and/or the management of the target, which is often carried out through the re-investment of part of the sale proceeds.
Minority investments are also carried out by specialised divisions of private equity firms, especially in tier-one companies or in companies operating in strategic sectors.
It is not uncommon for private equity sponsors to create a consortium in order to take part in an acquisition process, especially in the case of auction sales targeting a medium-large size company.
These types of consortia or joint ventures typically include institutional investors operating in the same industry; alliances between institutional investors and industrial operators are less often pursued. The consortium is generally created and agreed upon prior to signing although, in some instances, a syndication mechanism may take place in the interim period between signing and closing.
In the Italian market, the predominant forms of purchase price structures are as follows:
A fixed price structure (ie, a structure other than the locked-box mechanism or completion accounts mechanism) is relatively uncommon. Locked-box mechanisms are gaining popularity, particularly in auction sales involving private equity operators, as this mechanism makes it easier to compare the offers received and gives more certainty on the purchase price final amount.
A deferred purchase price is not common between Italian-based parties, while earn-outs (based on agreed future performance measured by reference to certain parameters) are not unusual.
Collateral in Case of Deferred Payments
A private equity seller is generally reluctant to provide guarantees to secure post-closing adjustments that are not market standard. To the contrary, in the case of corporate sellers, post-closing adjustments may be backed by an escrow or bank guarantee, which would also cover any possible indemnification obligations.
With respect to the locked-box consideration structure, the price has to be paid at closing and may provide for interest on the leakages occurred until closing, although this provision is not very common. Ultimately, this is more a matter of negotiation between the parties, and the acceptance of this principle depends on the type of transaction, on how the price is calculated and on the applicable interest rate.
A contractual dispute resolution mechanism is commonly used in private equity transactions to settle disputes on the calculation of leakages (in the locked-box consideration structure) or post-closing adjustments (in the completion accounts consideration structure), with the involvement of an independent accountant acting as an expert. The accountant is customarily entitled to settle only technical or accounting matters with binding effects on the parties, whilst disputes on any legal matter requiring an interpretation of the contract will be determined by the court or through arbitration.
The level of conditionality in private equity transactions varies according to the sector in which the target operates and the features of the buyer, among other factors. Regulatory conditions are typical, such as merger control clearance, foreign investment control, authorisation by the Bank of Italy, etc. A financing condition may be provided, although sellers are very reluctant to accept such conditions.
Material adverse change provisions are not uncommon, but the relevant definition is heavily negotiated and has become even more important following the COVID-19 emergency.
Third party consents (eg, major clients or strategic suppliers) are commonly provided as a condition to closing, but this mainly depends on the level of materiality for the transaction or the business. Sellers are not generally keen to accept this as a condition, as third parties may use it as leverage to bargain or re-open negotiations on the relevant business relationship. Also, the fulfilment of pre-closing covenants and the performance of pre-closing transactions are quite commonly regulated as conditions that would allow the buyer not to close in the case of a breach of the relevant covenant (or, less frequently, vice versa).
“Hell or high water” undertakings are rare and not commonly accepted in Italian deals, except in very specific (and rather exceptional) circumstances (eg, a competitive auction sale where the buyer is extremely confident that no concerns will be raised by the antitrust authority on the filing).
A break fee in favour of the seller is not very common, even in conditional deals, particularly in the case of private equity-backed buyers, who are more frequently requested to provide evidence of the fact that all the funds required for the deal are fully committed upon signing. In any case, this mainly depends on the size of the deal, the reliability of the buyer or the restrictions or authorisations applicable to the use of funds by the buyer. On the other hand, reverse break fees are quite unusual in the Italian market.
The regulation of the break fee under the transaction documents has to be carefully assessed and evaluated as it may lead to different legal qualifications (and relevant deriving implications) under Italian law. In fact, if it is qualified as a penalty, the relevant amount may be subject to review by the judge if challenged by the party possibly obliged to pay it.
Termination of the acquisition agreement may be triggered by the non-occurrence of a condition precedent (to the extent not waived) within a certain agreed period of time. As conditions precedent are usually in the interest of the buyer (with certain exclusions, such as in case regulatory approvals are required), the buyer is more frequently entitled to terminate the agreement. It is relatively rare for parties to agree on an exclusive remedy provision in the case of a breach of pre-closing covenants; therefore, in such a case, the general provisions of the Italian Civil Code apply, including the right for a party to terminate the agreement and walk away from the deal if the breach of the other party(ies) is of material relevance.
In general terms, when acting as either seller or buyer, private equity operators tend to obtain more favourable risk allocation terms than those negotiated by industrial players. This is mainly due to the fact that private equity firms are less inclined to bear the business risk associated with the investment, and prefer to leverage on other deal items in order to accommodate the requests of their counterparty. For instance, when acting on the buy-side they might be willing to offer a more attractive price in exchange for a more generous set of protections, whilst when acting on the sell-side they might consider accepting a slightly lower price if the overall deal terms ensure a smooth exit with limited tails.
For the above reasons, all the items associated with post-closing liabilities (eg, the scope of representations and warranties, de minimis, threshold, cap and special indemnities – see 6.9 Warranty Protection for further details) are typically those which are more heavily negotiated in deals where private equity firms sit at both sides of the table.
That said, the allocation of risk between the buyer and the seller remains essentially a matter of negotiation and bargaining power, and is influenced by a number of factors that go beyond the mere nature of the parties involved (eg, market conditions, the type of sale process, the appeal of the target, etc).
Representations and Warranties of the Private Equity Operator
On the sell-side, private equity funds tend to minimise post-closing liabilities as they seek a clean exit, particularly in view of a distribution of the proceeds and/or in case of liquidation of the fund. Therefore, private equity sellers generally agree on a rather limited set of representations and warranties, and seek to avoid – or limit as much as possible – any warranties on business/operational matters. Ultimately, the extent and scope of such warranties depend on the features of the deal and the parties’ bargaining leverage.
On the buy-side, private equity funds usually expect a robust set of representations and warranties, including those on business or operational matters.
Bring-down clauses are common, providing for a repetition of the seller’s representations and warranties at closing, although the possibility for the seller to update disclosure at closing is not equally accepted.
Special indemnities for certain known and identified issues or risks may be agreed upon, although a private equity-backed seller is usually reluctant to accept them. Usually, no limitations (save for cap) apply to such specific indemnities.
It is commonly accepted for the seller’s liability to be qualified by the disclosure of specific events listed in a disclosure schedule. The extent to which disclosure against one representation applies to others is heavily negotiated. Whether the seller's liability is qualified by general disclosure of all the data room content or by the general knowledge of the buyer is heavily negotiated.
Also, the qualification of certain specific representations to the seller’s knowledge is not unseen. In such a case, the parties usually negotiate which representations shall be subject to the seller's knowledge qualification and the scope of the relevant definition (eg, whether the seller’s knowledge shall be deemed as actual or deemed knowledge, or if it shall be deemed as the knowledge of the seller only or also as the knowledge of the management of the target).
The amount of the seller’s liability is usually limited by de minimis and threshold (either deductible or tipping basket) clauses, and capped at a maximum amount; relevant figures are usually negotiated and mainly depend on the size of the transaction.
In addition, the seller’s liability is limited to a certain period of time post-closing (usually from 12 to 36 months), except for certain matters where the seller’s liability will customarily extend to the applicable statute of limitation (eg, fundamental representations, tax, social security/employment).
In the case of a private equity-backed seller, the time limit for the duration of the claim period (12 to 24 months) and cap (10% to 20% of the price) are usually lower compared to those generally accepted by a private seller. In any case, by operation of law, no limitation would apply in the case of the seller’s gross negligence or wilful misconduct.
It is uncommon for the management team to provide representations and warranties to the buyer, except when the managers are also sellers, in which case managers usually give limited representations on their stake. However, they may also be requested to provide warranties on business/operational matters alongside the seller of the majority stake, and to undertake relevant indemnification obligations vis-à-vis the buyer on a pro rata basis.
The seller’s liability for breach of representations and warranties is usually backed by an escrow or a first demand bank guarantee, for a limited period of time and up to a maximum agreed amount (usually lower than the cap).
The provision of warranty and indemnity insurance (W&I) is increasingly common, particularly in transactions involving private equity funds. W&I policies typically cover most of the representations and warranties, and the areas that may be difficult to insure are becoming very few (eg, in certain cases, environmental liability, criminal liability, etc); it is now even possible to insure certain special indemnities, subject to certain conditions that depend on the subject matters of the special indemnity and/or the specific insurance policy used.
Litigation on disputed matters may occur with respect to M&A transactions, including those where private equity players are sellers or buyers. Indeed, private equity funds prefer arbitration to national courts, which are much slower and less efficient, albeit definitely less expensive.
The most commonly litigated provisions are surely those related to the price adjustments, the seller’s representations and warranties and earn-out clauses. It is less common to have litigation on breaches of pre-closing covenants or actions related to conditions precedent, although the litigation risk associated with these items has recently increased after the outbreak of the COVID-19 pandemic.
A great number of the transactions involving major private equity firms over the last few months have been public-to-private transactions. In fact, the relatively low capitalisation of important and strategic companies has resulted in great activism among private equity funds in pursuing the acquisition of such companies with the aim of taking them private. In this respect, it is worth highlighting the great attention paid by all economic players to this kind of transaction, and the high level of scrutiny that the government is entitled to apply in accordance with the golden power legislation.
First Shareholding Reporting Thresholds and Common Features
The first shareholding disclosure threshold is set at 3% of the share capital for “large” Italian companies listed on Italian regulated markets. For “small/medium enterprises" (SMEs), the first threshold is set at 5% of the share capital. A list of SMEs is kept by CONSOB, the Italian securities regulator, and is available on the CONSOB website. Certain exemptions to the shareholding disclosure regime apply – eg, in connection with market making or stabilisation activities. If the participant reaches the above thresholds (or reduces its interest below them), it shall file a disclosure form with CONSOB and the participating company, within four trading days.
Additional Shareholding Reporting Thresholds
The same disclosure obligations apply if the participant exceeds 5% (for companies other than SMEs), 10%, 15%, 20%, 25%, 30%, 50%, 66.6% or 90% of the share capital of the participating company, and if it reduces its stake below each of the above thresholds.
Disclosure obligations analogous to those referred to above also apply if a participant holds a potential shareholding (eg, through derivatives) that reaches or exceeds – by itself or jointly with an actual shareholding – 5%, 10%, 15%, 20%, 25%, 30%, 50% or 66.6% of the share capital.
Declarations of Intents
As a separate obligation, whoever reaches 10%, 20% or 25% of the share capital of an Italian listed entity shall file a declaration within four trading days with CONSOB and the participating entity, stating its intents for the following six months, including with respect to the composition of the management and control bodies of the participated entity and with respect to its intention (if any) to acquire control over the entire entity. Certain exceptions apply – eg, if the exceeding of the threshold triggers the obligation to launch a mandatory tender offer.
Mandatory Offer Thresholds and General Remarks
A mandatory tender offer obligation is triggered when a person/entity, alone or acting in concert, comes to hold a participation in excess of 30% of the voting rights of an Italian listed company as a consequence of the purchase of securities. The same obligation is triggered with respect to companies not qualifying as SMEs upon reaching the 25% threshold (to the extent no other shareholder holds a higher stake in the company). The by-laws of SMEs can provide for different thresholds, ranging from 25% to 40% of voting rights.
The obligation to launch a mandatory tender offer is also triggered in the acquisition of derivatives that grant a long position to the relevant holder in excess of the above thresholds. For the calculation of the participation thresholds in such a case, reference shall be made to the shares underlying the derivative instrument. If a mandatory offer is triggered, it shall be addressed to all shareholders on an equal treatment basis, at a price equal to the higher price paid by the offeror or the persons acting in concert with it for the securities concerned by the offer in the 12 months preceding the date on which the offer is announced (or, in the absence of relevant purchases, at a price equal to the weighted average price of the securities during the same period referred to above).
Consolidation Mandatory Offer Threshold
The obligation to launch a tender offer is also triggered if a person/entity that holds more than 30% and less than 50% of the voting rights of an Italian listed company acquires, alone or acting in concern, more than 5% of the voting rights in such company over a 12-month period.
In the context of tender offers, cash is by far the most common consideration offered. Offering shares as a consideration is relatively rare due to the increased complexity of exchange offers (or cash/shares mixed offers). If the securities offered as consideration are not listed on an EU regulated market, the bidder is compelled to also offer cash as consideration, and the target shareholders will be free to choose between the two.
While conditions are not allowed in the context of mandatory offers, voluntary offers are generally subject to conditions set by the bidder. The most frequent conditions concern the absence of material adverse events; the absence of actions by the target company that could frustrate the purpose of the offer; the reaching of a certain percentage of the target voting rights (often set at 66.7% in order to be able to control the extraordinary shareholders’ meeting); and the obtainment of the necessary regulatory clearance – eg, antitrust. As a general principle, voluntary offers can be subject to any conditions, to the extent the satisfaction of such conditions is not dependent upon the mere will of the bidder.
The takeover offer cannot be conditional upon the bidder obtaining financing: upon the announcement of the offer, the bidder must be in a position to confirm it has sufficient funds to discharge the full payment obligations deriving from the offer.
If the bidder comes to hold less than 100% of the voting rights of an Italian listed company as a consequence of a tender offer, it has the right to maintain the obtained shareholding and – depending on the relevant size – control the target (eg, appointing the majority of the board’s members and having the majority at shareholders’ meeting level); if the obtained shareholding is higher than 95% of the voting rights, the bidder has the right to squeeze-out the remaining shareholders, whose shares will be automatically transferred to the bidder. The squeeze-out operates to the extent the bidder has disclosed in advance its intention to exercise such right, in the context of the offer document.
In voluntary tender offers, it is common for the bidder to approach the largest shareholders and seek to obtain an irrevocable commitment to tender their shares to the offer. In these cases, bidders generally approach the largest shareholders before the announcement of the offer, so as to verify in advance the chances of the offer being successful. Irrevocable commitments usually qualify as a shareholders’ agreement and are subject to the relevant disclosure regime and limitations set out by the law. The shareholders who enter into the irrevocable commitment are allowed to withdraw from the commitment if a competing mandatory offer is launched and becomes successful.
Hostile takeovers are permitted under Italian law but are not common, mainly due to the concentrated ownership structure of most Italian listed companies (at the end of 2019, only 19 companies out of 228 had “widely held” shareholdings) and the increased complexity and costs associated with hostile offers, as opposed to negotiated/friendly offers. For these reasons, private equity buyers tend to avoid engaging in hostile offers.
Management incentive schemes have become quite common in Italian private equity practice and are often implemented for retention and management alignment purposes when private equity investors act on the buy-side.
In recent years, management incentive schemes have been addressed by specific legislation which, inter alia, sets forth a more favourable tax regime in case the management participation is sold upon the occurrence of an exit by the private equity investor, provided that the scheme complies with a number of specific features. In such a case, the proceeds deriving from the sale of the management participation are taxed as financial income, at a rate that is generally lower than that applied to ordinary employment income.
In order to take advantage of the above benefits, management incentive schemes are typically structured in the form of equity participation for an overall percentage which, in most cases, does not exceed 10%, with 1% being the minimum threshold required to benefit from the more favourable tax regime noted above.
Management participation schemes typically take the form of a special class of shares (sweet equity), which allows the managers to receive a preferred return if the private equity investor achieves a minimum “hurdle” on its investment. The exception made for this privilege is that sweet equity often provides for limited administrative and economic rights on other matters (eg, no right to vote in the ordinary shareholders’ meeting and restricted rights to interim dividends). In addition, the transfer of the sweet equity participation by the manager is typically subject to limitations in order to ensure that the relevant shares are kept by the manager until the exit or the occurrence of a good leaver/bad leaver event, whichever is earlier. In some circumstances, managers are also offered the possibility to invest in ordinary shares, alongside the private equity buyer, acting as minority financial investors.
Management participation schemes generally include vesting and leaver provisions, which make the shareholding interest held by the manager dependent upon the lapse of a certain period of time and the occurrence of events concerning the working relationship that the same manager has in place with the target group. In particular, rights associated with the manager participation commonly vest over a period of time (the so-called holding period), which is set in accordance with the retention and maturity targets of the investment. In order to take advantage of certain tax benefits, the minimum holding period is generally five years or the earlier date on which an exit is achieved by the private equity investor. The occurrence of a leaver event during the holding period and prior to the exit might lead the manager to lose all or part of his/her participation or the rights associated therewith.
Leaver events are normally divided between the following:
Managers and key employees are often bound by a number of undertakings aimed at preserving the know-how and competitive advantage of the target throughout the duration of the employment/working relationships and for a certain period after its termination. All these undertakings are normally included in the relevant employment/management agreement and then, to a certain extent, replicated as part of the arrangements that govern the participation of the managers in the target group.
Typical undertakings include non-compete, non-solicitation and exclusivity covenants, which have to comply with certain restrictions as to their scope (in terms of both territory and competing business) and duration in order to be enforceable vis-à-vis the managers. In particular, non-compete obligations cannot last for more than five years after the termination of the manager’s office, and shall be construed in such a way as not to prevent the manager exercising any activity within his/her reasonable professional background. In addition, non-compete undertakings assumed as part of an employment relationship have to be specifically remunerated. Non-disparaging undertakings are less common, except in certain specific industries characterised by high reputational standards.
As management incentive schemes are mainly conceived to recognise a preferred return on the investment in the case of a successful exit by the private equity investor, the minority protections associated therewith are, in principle, rather limited and typically restricted to a tag-along right in the case of a sale by the majority shareholder.
On the other side, a more articulated package of protections is normally granted to managers who acquire a minority stake in the target group as part of a financial investment made alongside the private equity buyer. In such a case, managers are generally offered a set of governance rights, which might include veto rights on selected matters (eg, capital increases, extraordinary transactions, material amendments to the business purpose, etc), possibly coupled with the right to appoint one or more directors within the board. The actual scope and content of the minority rights can vary depending upon the size of the investment made by the managers and their strategic importance for the development of the business plan. In any case, the control over certain specific strategic matters, such as the exit process, is generally retained by the private equity investor.
The level of control of a private equity fund over its portfolio company depends on whether the fund is the majority shareholder or whether there are other controlling shareholders and the fund is co-investing alongside them as a minority investor. Obviously, if the fund is the sole shareholder it has the full control over the company and can exercise all the economic and administrative rights without limitation, in compliance with the applicable law.
Private Equity Fund as Controlling Shareholder
If the private equity firm controls the portfolio company but there are also other minority shareholders holding a stake that is not immaterial, the fund and the other shareholders usually enter into a shareholders’ agreement whereby certain rights are granted to the minority shareholders.
Generally speaking, such rights include the right for the minority shareholders to:
The rights granted to the minority shareholder are usually also reflected in the by-laws of the portfolio company, so that the relevant provisions are enforceable vis-à-vis third parties.
The rights above are in addition to those granted by operation of law to minority shareholders (eg, the rights to vote in the shareholders’ meeting, to examine certain corporate documentation and books, to sue directors or statutory auditors for damages in case of misconduct, to submit claims to the statutory auditors or before Italian courts, etc).
Private Equity Fund as Minority Shareholder
If the private equity firm is a minority investor, the rights granted to it are usually similar to those set out above, although it is quite likely that such private equity investor would require a wider set of rights if it intends to actively co-operate in the development of the target company. As a rule, in such scenario the fund requires the right to designate one or more non-executive directors at the portfolio company’s board level (even though it often wants to be involved in the selection process of certain top managers), and to be granted wide information rights and veto rights relating to the most relevant matters.
As a general rule, shareholders of companies incorporated as limited liability companies (società a responsabilità limitata) or joint-stock companies (società per azioni) cannot be held liable for actions carried out by the companies in which they have a stake. Nevertheless, in certain limited (and rather exceptional) circumstances, the shareholders may be held liable through the piercing of the corporate veil.
Such exceptional circumstances include the following scenarios, for instance:
In all the above cases – where, as a common feature, the shareholder has breached certain mandatory law provisions or has mismanaged the company – the liability of the shareholder to restore the damages caused to the other shareholders or third parties (eg, creditors) may be material and possibly go beyond the amounts actually invested in the company.
In addition to the above, in principle – under certain particular circumstances such as bankruptcy or distressed scenarios – managers of the private equity firm controlling the portfolio company may be deemed “shadow directors” of the portfolio company, even without a formal appointment, if they interfere, on a continuous and permanent basis, with the management strategic decisions of the portfolio company. Such “shadow directors” might be subject to the same liability regime as applies to the company’s directors.
In the context of the acquisition of a target company, private equity firms usually ensure that the target company implements a high standard of compliance, normally in line with the standard adopted by the firm itself. However, the specific policies implemented at the portfolio company level depend on a large number of factors (including the size, sector and other business conditions concerning the company) and, therefore, the standards actually applied by the company may differ from the ones implemented by the fund.
The average holding period for private equity transactions ranges between four and five years. However, an exit may also be implemented at an earlier stage if there are favourable market conditions and/or the possibility for the fund to pursue a particularly convenient transaction in terms of return. On the other hand, external elements may also have an impact on the value of the asset, which may delay the exit process (eg, economic crisis or exceptional events affecting the business environment where the target operates).
In 2021, the most common form of private equity exit has been the sale process, sometimes structured as an auction. Considering their costs and the relatively small size of the Italian capital market, IPOs are not easily achieved and are therefore not the most common exit strategy in Italy. “Dual track” processes (ie, an IPO and a sale process running simultaneously) are sometimes put in place in order to grant more options to the sellers. Normally, a “dual track” exit is implemented when a purchase offer matching the desired return of the shareholders is submitted during the IPO process pursued by the company.
In the context of an exit, it is not very common for private equity sellers to reinvest in the portfolio company, but obviously this depends on a large number of factors (including the investment strategy and the residual duration of the fund).
Equity arrangements between co-investors typically include a drag right in favour of the majority shareholder.
However, even if the drag right is provided for in the shareholders’ agreement (and generally also in the portfolio company’s by-laws), it is very rarely exercised as, in most cases, an exit is pursued with the general consent of all the shareholders. Nevertheless, there may be particular situations that require the exercise of the drag right – typically when the third party offer does not match the expected return of the minority shareholders. Drag rights usually also apply with reference to institutional minority co-investors.
The drag right is generally exercisable by the majority investor that intends to sell its entire stake in the company. The transaction documents may sometimes grant the drag right to the majority shareholder intending to sell not all of its shares but a stake representing more than 50% of the corporate capital (or, if different, the voting rights) in the portfolio company.
Please note that, under Italian law, the drag right must ensure the dragged shareholder a price that is at least equal to the fair market value of the dragged shareholding. If this is not the case, the dragged shareholder may challenge the lawfulness of the dragging shareholder’s right, even if such provision has been agreed at a contractual level.
The tag right generally applies to all minority shareholders (including institutional co-investors), and grants them the right to sell their stake in the company when the majority investor sells its own shares.
As a general rule, the tag right is provided in favour of the minority shareholders on a pro quota basis – ie, the minority shareholders have the right to sell a percentage of their shares equal to the percentage of the shareholding actually transferred by the majority shareholder. As an exception, should the majority shareholder intend to transfer more than 50% of the corporate capital (or, if different, the voting rights) of the company, the minority shareholders are usually entitled to sell all the shares they own in the company.
It is not common for private equity funds to exit by way of IPO, mainly due to the relatively smaller size of the Italian capital markets compared to other jurisdictions and the length and complexity of the listing process, although those are comparable to those existing in other EU jurisdictions. Over the past few years, only a handful of exits have been carried out through IPOs, notably in the financial sectors and mainly concerning large companies.
Joint Global Co-ordinators usually request the seller to abide by a lock-up period ranging from six to 12 months, starting from the IPO date.
So-called “relationship agreements” are substantially unknown in the Italian market.
The Italian private equity market suffered a marked slowdown in the first half of 2020 as a consequence of the crisis caused by the COVID-19 outbreak and the ensuing lockdowns put in place by the Italian government to limit the spread of the virus. In those difficult times, companies operating in sectors that were negatively impacted by the pandemic saw their revenues significantly diminished, without being able to implement any type of reaction.
Fortunately enough, thanks to the advancement in the vaccination campaign against COVID-19 and the robust economic measures adopted by the Italian government and the European Central Bank, 2021 is seeing a general recovery in almost all economic sectors, with a consequent rediscovered activism by both national and international private equity firms. According to the data available on Mergermarket, 79 transactions were completed in the Italian private equity sector in the first semester of 2021, for a total deal value of about EUR26 billion. This data shows that the number of private equity deals is returning to pre-COVID-19 levels, while the total deal value is even higher than 2020.
Of course, the majority of deals have involved (and still involve) companies that are active in sectors that have been less impacted by the pandemic, together with those that have been positively affected – eg, financial services (especially fintech and payments), life sciences and healthcare, IT (software and hardware) and essential services. This trend is expected to continue for 2021 and beyond, considering that COVID-19 (and the variants of this virus) continues to affect sectors that are less resilient to the pandemic, such as travel, hospitality, retail and/or those that provide non-essential goods and services.
Types of Deals and Typical Transaction Structures
In the second semester of 2020, the uncertainties related to the COVID-19 pandemic led private equity firms to prefer the classic leveraged buyout and replacement deals concerning mature businesses, at the expense of riskier types of transactions such as expansion capital or start-up financing.
In this context, private equity funds also seized M&A opportunities by taking private listed companies with depressed stock prices, especially in those sectors that were most impacted by the pandemic. The structures of such kinds of public M&A deals were mainly driven by the concentrated ownership structure of Italian listed companies and the usual presence of a controlling or reference shareholder. Indeed, a first category of deals saw the private equity fund privately acquiring the controlling stake from the majority shareholder and then launching a mandatory tender offer on all remaining outstanding shares of the target company, at the same price paid to buy the controlling stake, aimed at delisting. In another set of deals, private equity operators supported a take-private transaction of the controlling shareholder by subscribing for a minority stake in the newco launching the tender offer aimed at delisting the target company.
That said, thanks to the good progress of the vaccination campaign against COVID-19, as well as certain signals of sustainable recovery in the Italian economy, 2021 is experiencing an increase in the number of transactions involving start-up companies and businesses that require capital to sustain their expansion. Moreover, a rise in turnaround transactions is expected in the coming months with respect to those companies that may have experienced financial tension or distress following the end of government support measures enacted as a consequence of the COVID-19 pandemic.
COVID-19 influenced not only the numbers and types of deals but also the relevant transaction structures and contractual clauses. In this respect, private equity operators and their respective legal counsels focused their attention on contractual arrangements that were able to address the risks caused by COVID-19 and future potential outbreaks. In more detail, particularly in the early stages of the COVID-19 outbreak, several M&A contracts contained strengthened conditions to closing, break-out/walk-away clauses linked to material adverse effect provisions (including potential changes in the legal and regulatory framework), as well as interim period clauses drafted to cope with the issues arising from the pandemic and lockdown measures.
Also, especially in those sectors heavily impacted by the pandemic (eg, hospitality, travel, retail and/or non-essential goods and services), potential sellers’ expectations (anchored to pre-pandemic valuation metrics) clashed against the valuations of private equity operators, who could not avoid – at least partially – factoring in the potential reduction in value generated by the COVID-19 crisis, as well as potential future risks and uncertainties.
Although these differences in valuation prevented the consummation of certain deals, private equity operators were also able to find unconventional ways to recognise the full value of the company and, consequently, the purchase price expected by the sellers. These alternative contractual mechanisms encompassed, among others, earn-out provisions as well as more sophisticated forms of deferred contingent payments based on the actual return to be possibly achieved by the private equity buyer upon exit. In this respect, the more classic earn-out clauses saw private equity funds agreeing to pay a portion of the target company’s value not immediately at closing, but only as a deferred component of the purchase price, conditional upon the achievement of specific targets of turnover and/or EBITDA in a period following the closing. The reach by the target of these performance goals (such as EBITDA or turnover) has resulted in a substantial alignment between the sellers’ need to maximise the sale price and the purchasers’ need not to overpay a business due, for example, to the relevant exposure to the recent downturn.
A crucial issue with these kinds of clauses has been to determine how the target company has to be managed in the reference period for the calculation of the performance indicators underlying the earn-out mechanism, and a well-balanced governance in this respect has been the subject of long discussions among the parties. In most deals, in addition to the financial advisers for the mere financial and economic part, the legal counsels play a crucial role in addressing both parties’ requests to find a compromise solution that enables the parties to close the deal and, at the same time, prevent distorting conduct.
The above aspects certainly increase the complexity of deal negotiations and the underlying agreements. However, in recent months, earn-out clauses have proved to be a useful legal device to bridge valuation differences between the parties (especially in those sectors less resilient to COVID-19), while at the same time mitigating private equity operators’ risks and uncertainties regarding the future performances of the target companies. This trend will no doubt continue until the end of 2021.
Foreign Direct Investment Screening
Another trend impacting the private equity industry (and, more generally, all M&A dealmakers) in Italy and in Europe since the COVID-19 outbreak is represented by governments’ increased scrutiny on foreign direct investment (FDI) in sectors that are considered strategic for the national economy.
In Italy, the government has been given special powers of control relating to FDI screening, known as “golden powers”. Control on investments made by any extra-EU entity (or, in certain cases, by EU entities, including Italian ones) is exercised by making certain kinds of transactions (eg, acquisition of control or asset deals), acts and resolutions that relate to companies or assets that are classified as strategic subject to notification to the Italian government, which then analyses the transaction and decides whether to exercise its “golden powers”.
Specifically, the Italian government has the power to veto a transaction or impose conditions on its completion with the aim to prevent the following:
According to the current applicable rules (including governmental decrees no 179/2020 and 180/2020), the sectors included in the scope of foreign investment review have been significantly widened, and now include:
Although the mentioned decrees represent a step towards a higher level of clarity in the application of the rules regarding the golden powers, they still make extensive use of general concepts and references to previous regulations, thus keeping the interpretation of the legislative provisions complex and often uncertain.
In addition to the above, it is worth noting that, as a reaction to the market vulnerability caused by the COVID-19 pandemic, an emergency regime was enacted in the first half of 2020 (initially envisaged to last until 31 December 2020) in order to prevent the risk of strategic companies and assets being acquired "on the cheap". This emergency regime has recently been extended and will remain in force until at least the end of 2021. According to this exceptional set of rules, in addition to those transactions and resolutions that are normally subject to control under the "ordinary" regime, the following are also subject to notification:
In light of the large spectrum of sectors that are now considered strategic and the ambiguities that continue to characterise the Italian golden power regulation (notwithstanding the entry into force of the two decrees mentioned above), it is crucial for private equity firms to carefully analyse the activity of the target company, with the assistance of legal counsel, in order to decide whether to notify the transaction and properly assess the regulatory risk associated with the potential exercise of the Italian government’s golden powers.
Moreover, as the tightening of FDI screening in strategic industries is a pan-European phenomenon (due to the implementation of the mechanism set forth by EU Regulation 452/2019), the FDI analysis concerning potential acquisitions of multinational groups should have a multi-jurisdictional approach aimed at ensuring compliance with all FDI regulations in force throughout Europe.
Environmental, Social and Governance
Another recent trend in the private equity industry (and in the M&A market in general) is the increasing importance of environmental, social and governance criteria (ESG) in the assessment of investment opportunities. In this respect, a growing number of private equity firms now perform a specific ESG analysis in the early stage of a potential deal and ask their legal counsel to include ESG matters in the legal due diligence investigation.
The attention placed on ESG matters varies depending on the specific sector in which the potential target operates, but the general trend is towards a heightened focus on these aspects, aimed not only at verifying compliance with the applicable ESG regulatory framework, but also at evaluating the existence, in the potential target, of ESG-oriented governance structures and internal policies, which now tend to be considered as a good indicator of long-term sustainable and reliable performance. Indeed, recent data showed that companies that committed themselves to sustainability and social responsibility are better able to attract and retain talented employees and capture the favour of a rising amount of ESG-minded customers.
The private equity firms’ focus on ESG matters is also prompted by the willingness to attract those limited partners that make investment decisions on the basis of ESG performance indicators.
The development of this ESG trend is further accompanied by a series of hard and soft law provisions regarding both disclosure obligations relating to ESG issues and sustainability goals to be pursued by the management in the long term. In this respect, the following is worth noting:
As a final remark, it is worth noting that the quality of the governance structure or the internal policies implemented by a potential target with respect to ESG matters is not always easy to assess, especially if there are no rules that impose specific obligations in this respect. In these cases, it becomes challenging for private equity operators and their legal counsel to quantify specific risks and potential liabilities and require legal guarantees or protection in the agreements governing the deal.
“Virtual” Shareholders’ Meetings and Written Resolutions
As far as the management of portfolio companies is concerned, another notable continuing trend is holding the meetings of corporate bodies without the physical attendance of shareholders, directors and/or statutory auditors. This practice was already common before the COVID-19 outbreak and has been further expanded by the special rules contained in the emergency legislation enacted to limit the spread of the virus, which have recently been extended until 31 December 2021.
Under this temporary regime, shareholders are allowed to attend shareholder meetings through telecommunication means and to vote electronically or by mail, even if this possibility is not provided or is expressly prohibited by the company’s by-laws. Moreover, companies are permitted to hold “fully virtual” shareholders’ meeting (ie, meetings exclusively held by audioconference, videoconference or other telecommunication means that ensure the attendees’ identification), derogating the principle that requires the chairman and the secretary of the meeting (or the public notary, if applicable) to be physically present in the same venue during the shareholders’ meeting.
This special regime has represented a remarkable change, especially for the meetings of publicly traded companies, which are usually convened in large conference rooms to allow all shareholders to be physically present. Indeed, until 31 December 2021, all companies that have shares publicly traded on a regulated market or on a multilateral trading facility (including AIM Italia), as well as companies with widespread shares (emittenti titoli diffusi), may:
Finally, Italian limited liability companies (so-called Srl) may also adopt written resolutions for matters that are normally reserved to the shareholders’ meeting by the law, even if this option is not provided for by the relevant articles of association.