Private Equity
Content
In Practice
Sharing advice and practical solutions
Our private equity practice - at the heart of Europe
May 2010
"Combining local insight with and international perspective," Allen & Overy has established a leading position in Central Europe and Russia and is successfully serving its international clients base. Chambers Global – CEE, 2009 edition "They know the region inside–out and have an excellent mixture of international and local partners," said clients of these "bright, tough lawyers." Chambers Global - CEE, 2009 edition "I think that office is fantastic - they tell what is in your best interests and what is the best answer." IFLR 1000 – CEE, 2010 edition The firm's regional network is made up of topnotch lawyers who are able to "uncover the various nuances of local law and link that into the wider picture." Chambers Global – CEE, 2009 edition Despite the large number of private equity investments already made over the years in Central and Eastern Europe (CEE), this is still a region with huge potential. Although some CEE countries have been badly affected by the current economic crisis, there are still some, such as Poland, the Czech Republic and Slovakia which are still held up as comparatively resilient, and well-positioned to forge ahead early on any wider global economic upturn. There are still plenty of opportunities in CEE to make investments into growing businesses with great potential - businesses which need the capital and the know how that private equity brings to unlock the value inherent in that potential.
Although, as predicted, 2009 was slow for private equity deals, this has started to change and in some countries, such as Poland and Romania, interest in deals is strong and there have also been large and high profile deals in the Czech Republic, for example. The successful private equity investor is going to be that which is the most "well-oiled" operation, with the ability to move fast when opportunities arise, and to adapt quickly with innovative solutions to rapidly evolving markets. To do this, the investor needs to know the pitfalls and quirks in a particular jurisdiction, and needs to be able to structure, present and complete the deal in the shortest possible time. This requires a comprehensive understanding of the local environment in which the Target is operating, at a "deal culture" level as well as at a legal level. Allen & Overy can offer you: ¡ expert knowledge and assistance to enable you to move fast on deal opportunities, while at the same time managing risk through careful structuring and thorough preparation; A&O's global private equity know how base, practitioners and transaction experience, whether it is PE, general M&A, financing or sector specific specialisation; innovative solutions to legal problems that we will have almost certainly encountered in the past; familiarity with private equity fund structures and the restrictions that affect them, and their implications for deal execution; flexibility on team structures: either leading a deal out of London with local capability, or led locally with input from London (or elsewhere) as required.
¡
¡
¡
¡
© Allen & Overy LLP 2010
1
Allen & Overy I In Practice I May 2010
10 things to think about when doing private equity deals in CEE
(1) Structuring the acquisition finance In current markets, financing a transaction is not easy. We hear varied reports about the availability of finance and conditions are tough. Some investors are choosing to structure their investments through 100% equity. Our comments below assume that at some stage, the finance markets will return to some semblance of normality, even if the highly leveraged deals of the past are unlikely to return. However, some of the comments below are still relevant in the context of all equity deals and minority "old development capital" style deals. When debt is to be introduced into the capital structure, some fundamental questions will need to be answered, such as: Will it be possible for the SPV and Target to offset interest on debt against taxable profits? Are there any thin capitalisation rules in the relevant jurisdiction? In most of the countries in CEE thin capitalisation rules apply, usually setting a related-party debt to equity ratio of 3:1 (Poland/Hungary/Romania) or 4:11 (Czech Republic) or 6:1 (in the Slovak Republic these thin capitalisation rules apply as from 1 January 2009), the main effect of which will be to affect the deductibility of interest paid on debt. The definition of who is a related person for these purposes varies, with some room for structural planning based on the percentage of voting rights. In Hungary and Romania the rules apply not only to loans and credits from related parties but also to those from any other unrelated companies, except financial institutions. Unrelated financing in the Czech Republic is also affected, but only to the extent that such financing qualifies as a ''back-to-back'' arrangement, as defined by law. Nevertheless, there are other disallowance rules that must be carefully addressed to ensure a tax deductibility of financing costs. In Romania, interest expenses on loans and credits from other entities than financial institutions are not deductible over certain thresholds, which are applied before considering the debt to equity ratio. In Poland, certain structures allow for intra-group lending without thin-capitalisation restrictions. Contrary to many EU countries, in CEE withholding tax may still be an issue which needs to be dealt with under double tax treaties. This is due to the
transitional period for implementing the Interest and 2 Royalties Directive. Further, no group taxation currently exists in the Czech Republic, Hungary or Slovakia. In Poland the provisions relating to group taxation are very strict and only a few tax groups have been created so far. In practice, in Poland and in the Czech Republic tax grouping is sometimes achieved through a partnership structure. Offset of interest on debt in an acquiring vehicle against taxable profits in a Target can be achieved in many countries by: (i) incorporating the acquiring vehicle in the relevant jurisdiction; and (ii) merging the Target into the acquiring vehicle as soon as it has acquired the Target. (2) Securing the acquisition finance
Rules on financial assistance vary from country to country in CEE. In most countries, there are financial assistance rules in relation to the acquisition of shares in 3 a joint stock company , but not a limited liability company. Czech financial assistance law also apply to Czech limited liability companies. The rules on financial assistance are invariably strict. Following the latest amendments to the 2nd Company Law Directive there is no equivalent of the old UK "whitewash" procedure but a number of steps may be carried out which are similar. In the Czech Republic, certain exceptions were introduced allowing financial assistance, but there are several important question marks as to whether they will work. As a result, many (joint stock company) CEE Targets may not provide assets as security and/or give a guarantee as collateral under the acquisition loan. However, in Hungary, the financial assistance rules will not apply where financing is provided by a bank. In Poland a joint-stock company may, either directly or indirectly, finance the acquisition of or subscription for its shares, in particular by granting loans, making an advance payment or establishing security interest. If a joint stock company finances the acquisition of its own shares, it must do so on arm’slength terms and for a fair price. In addition it must examine the debtor's solvency. A reserve capital from the funds planned to be paid as dividends has to be created. Other required formalities include a prior resolution of the company's shareholders and management report which has to be published and filed with the registered court. These restrictions (except for
2
1
6:1 if the borrower is a bank or an insurance company
Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States [published in the Official Journal L 157 , 26/06/2003 P. 0049 – 0054 as amended]. 3 Although a joint stock company has limited liability, these are the terms commonly used to differentiate the different types of company in the region.
© Allen & Overy LLP 2010
2
Allen & Overy I In Practice I May 2010
the reserve capital requirement) do not apply to ordinary transactions conducted by financial institutions, or actions for the benefit of a company's employees or the employees of an affiliated company which aim to facilitate the acquisition of the company's shares. Generally, at completion of the acquisition, only the shares in the Target and/or in the acquiring SPV can be used as collateral (with some minor exceptions). This level of security is normally not considered sufficient by the banks and they tend to request that they can access also the assets in the Target. Therefore, in some CEE countries private equity acquisitions commonly employ a local SPV in acquiring the shares of the Target. Subsequently, as soon as possible after the acquisition, the Target is merged into the SPV. Once the merger is completed, the assets of the Target pass into the acquiring entity and can be pledged in favour of the banks. (3) Tapping cash in the Target
Though this used to be the case in Slovakia, this no longer applies if the seller has acquired an interest in the Slovak company on or after 1 January 2004, and in Poland and Hungary does not apply at all. In the Slovak Republic, dividends payable to individual shareholders are exempt from income tax. In Romania dividends paid to individuals are always imposed, while those paid to legal entities are imposed by different quotas or not imposed at all depending on the participation quota and the duration for which the participation was held. Dividends payable to a qualifying parent company are exempt under transposed provisions of the EU ParentSubsidiary Directive. (4) Management participation
In the Czech Republic, the proceeds from the sale of an interest in the Target received by a seller who is an individual are exempt from tax (capital gains are treated as ordinary income for tax purposes) where the seller has held the interest for a certain period of time. The minimum holding period varies, generally depending on the legal form of the Target, but with respect to shares acquired on or after 1 January 2008 the size of the shareholding also needs to be considered. Capital gains derived by a seller other than an individual may be exempt from tax under the Czech participation exemption rules if the seller is a qualifying parent company. As dividends payable to an individual shareholder are subject to final withholding of 15% in the Czech Republic, the individual planning a sale will instead of taking a preclosing dividend, try to accumulate cash (distributable reserves) in the Target with an aim to increase the purchase price and benefit from the exemption. Dividends payable to a qualifying parent company are exempt under the transposed provisions of the EU Parent-Subsidiary Directive (in line with respective ECJ case law, an early distribution is possible provided that the minimum holding period is met). Unless this issue is carefully addressed, the buyer will have to raise additional funding for buying the excess cash. However, because of the rules against financial assistance applicable in the Czech Republic, this cash cannot be used to service the acquisition debt. If the acquisition structure involves a merger of the Target into the acquisition SPV, the cash in the Target can be used only once the merger is completed.
In a situation where there is the possibility of a "genuine" management buy-out, i.e. the managers are not already selling shareholders, it is possible that managers in CEE could be cautious when offered share participation in the Target. As time goes by, and as managers become more financially aware, this problem is less apparent. However, in some jurisdictions, continuing management are still quite wary of typical incentivisation methods offered/demanded by private equity investors, particularly IRR demands, liquidation preferences and other mechanisms that private equity investors would tend to see as standard. Offering shares to the management may therefore require much more explanation and negotiation than Western private equity houses may be used to from other markets. (5) Structuring the management participation
Some CEE jurisdictions have rigid corporate laws which can, without careful drafting, make it difficult to ensure enforceability of the key arrangements between the investor and the management. For example, it will be critical for the investor to ensure that it can enforce dragalong rights arising on the investor's exit from the company. Similarly, the investor will want to keep control over the destination of the shares if the manager leaves the company, whether as a bad leaver or as a good leaver. In common with many other jurisdictions, this is not straightforward, as any transfer of title requires the involvement of the seller in cases where the shares have been issued. The seller either has to physically hand over share certificates to the new owner or to initiate a change of the owner in the registry of book-entered shares. As a result, it may not be enough to rely on the traditional drag-along and call option clauses in the shareholders' agreement or on taking "irrevocable" powers of attorney. The ability of the investor to access managers' shares may need to be secured by additional structures such as an escrow or custody arrangement.
© Allen & Overy LLP 2010
3
Allen & Overy I In Practice I May 2010
Local practice varies and this should be addressed up front. (6) Preference shares and classes of shares
Many private equity structures in Western Europe involved the Target issuing redeemable preference shares and/or shareholder loans to provide further leverage against the ordinary shares. The value of the ordinary shares may be potentially low until the debt and preference shares are repaid, but any surplus value beyond that will accrue to the ordinary shares and generate high rates of return on equity. In some jurisdictions in CEE, although preference shares are possible, redeemable preference shares with, for example, guaranteed levels of dividend or certainty of payment on redemption may not be possible. In addition to that, it will need to be considered whether there would be withholding tax on preference share dividends. Generally preference shares enjoy the same tax treatment as ordinary shares, but reductions in withholding taxes on dividends under relevant double taxation treaties may be conditional only on holding a qualifying share in voting rights instead of equity capital. Other equity structures may involve the use of different classes of shares, with the private equity investor and the management having different classes of shares. For example, these classes may rank equally on general economic and voting rights, but may provide for a liquidation preference for the private equity investor. This is not possible in most CEE jurisdictions (Hungary and Poland being notable exceptions, as well as Romania), although it may be possible to provide for liquidation preferences in other ways. (7) Mezzanine warrants
Despite a strong entrepreneurial culture, shareholder managers in CEE can be quite reluctant to cede control of the business that they have built up themselves and may need to be convinced of the benefits of an approach from a private equity investor. Often, the private equity investment was seen only as a source of funding comparable with bank finance (though this perception has changed recently since bank finance is of course much more difficult to obtain). The shareholder managers will also expect to be able to keep control at both shareholder and board level. If the investor is willing to take a minority stake as well as a minority on the board, it is essential to have a detailed understanding of the powers of the board and the general meeting, and of the most effective way to make veto rights enforceable in practice. Where operating subsidiaries are owned by a holding company in which the private equity investor and the shareholder managers share ownership, it may be important to address these issues of control in more detail, since the area of focus practically may not be with regard to decisions made by the holding company, but the manner of the taking of decisions by the subsidiaries. Investors may be less willing to rely only on contractual undertakings from the holding company to deal with this issue. (9) Exits
Leveraged private equity acquisitions sometimes include a mezzanine financing, often involving the issue to the junior lenders of warrants which give them the right to subscribe on favourable terms for a portion of new shares in the Target, usually on the investor's exit. In many jurisdictions in CEE, the concept of mezzanine warrants does not exist, largely because the Target is not legally able to commit itself to issuing new shares to the junior lenders at some point in the future. It is then necessary to create an alternative structure tailored to the specifics of the particular deal in order to achieve a similar outcome. In Poland, however, the concept of mezzanine warrants has recently been developed in practice in relation to joint stock companies, which in certain circumstances are able to commit themselves to issue new shares in the future. (8)
4
As in other jurisdictions, the investor and the management alike will often be thinking of an IPO as a potential form of exit. A particularly relevant factor in CEE up until the current liquidity crisis, was the increasing level of activity on the Warsaw Stock Exchange (by far the largest and most actively traded stock exchange in CEE), which attracted significant attention from across the CEE region: the costs of obtaining a listing are presently much lower than those in London or Frankfurt, leading to different cost/benefit analyses and a lower valuation threshold for a listing to be regarded as viable. We expect that the recent weakened level of activity in respect of exit IPOs on the Warsaw Stock Exchange will end in due course. Given the relative caution of many CEE managers, and the new environment in CEE public markets following implementation of the Prospectus Directive, it may well be worthwhile to address up front with the managers issues regarding responsibility for statements made in a prospectus. (10) And finally…some practical points not necessarily peculiar to private equity deals
Heads of Terms/LOI/Term Sheet It is also vital to take local legal advice before signing any non-binding heads of terms so as to avoid
© Allen & Overy LLP 2010
Controlling interests (or "letting go"…)
Allen & Overy I In Practice I May 2010
inadvertently creating any unexpected binding obligations. In some CEE jurisdictions, there exists the concept of an "Agreement on Future Agreement". This kind of agreement sets out the basic terms of an agreement which is later to be signed "in full". The danger is that such an agreement can be binding, enabling a party to insist on entering into a proper sale agreement. Listed companies As private equity bidders also broaden their search to include listed companies, care should be taken to look at thresholds above which a buyer may be obliged to make a mandatory bid. The rules can be complex, and frequently the rules on pricing, rules prohibiting purchases in the offer period or within a stated period after the offer at a price which is above the offer price (or requiring the bidder to pay all accepting shareholders a higher price), restrictions on buying shares outside of the public offer process for certain periods of time, and suspensions on voting rights until approval is obtained for a prospectus can create problems for unwary investors. Governing law Sellers will often assume that the governing law will have to be the local law, because the transaction involves a local company. This is not the case although unavoidably many of the fundamental provisions of the SPA will need to be compliant with local laws. The treatment of remedies for breach of warranty will vary depending on the choice of governing law and there are also concepts which may not necessarily exist under, e.g. English law. For example, in many CEE jurisdictions, it is common, and enforceable, to include contractual penalties as a "stick" to encourage performance. Governing language It is sensible, if possible, to avoid agreeing to the concept of "equal force" translations, since this can lead to uncertainty and great additional cost. Similarly, agreeing to draft or negotiate documents in more than one language can add greatly to both time and cost and should be avoided if at all possible.
Czech Republic "The group is first-class in every respect, as excellent in Prague as anywhere else." Chambers Global 2010 Slovakia Clients appreciate the outfit's "tailored mix of international and local knowledge" and the firm's consistent adherence to "top-quality standards." Chambers Global 2010 Poland "The firm houses many sector-specific experts and always retains international service levels." Chambers Global 2010 Hungary Clients feel they can trust their businesses with the firm. "I would say they were a safehands firm and very professional, " says one. IFLR1000 2009 Romania Clients say the team is "commercial and exceptionally responsive, with an in-depth understanding of local issues." Chambers Global 2010
© Allen & Overy LLP 2010
5
Allen & Overy I In Practice I May 2010
Allen & Overy's private equity practice in CEE
Our Central and Eastern Europe (CEE) dedicated private equity practice combines expertise across the board in M&A, equity capital markets, and leveraged finance techniques. We have one of the largest practices in the CEE enabling us to deal with the most complex and high-profile transactions. We have a presence in five key centres in Central Europe: Warsaw, Prague, Bucharest, Budapest, Bratislava. We have advised on a number of private equity deals in Central and Eastern Europe which have been interesting and challenging in a number of ways. In the Czech Republic, Allen & Overy advised Pamplona Capital Partners I, LP, a UK private equity house, on a unique leveraged buy out of Pegas, a.s. The target is one of the leading European manufacturers of non-woven textiles, selling its products mainly to leading multinationals for use in personal hygiene products. The transaction required the acquisition vehicle to raise senior debt financing from a syndicate of banks, mezzanine financing, as well as several shareholder loans. For the deal, a multilevel structure of acquisition vehicles had to be set up in a number of jurisdictions. One year after the acquisition, Pegas became listed in Warsaw and Prague. The combined corporate and banking teams of Allen & Overy in Prague, London, Milan, Warsaw and Luxembourg were handling all aspects of this complex deal, the first project of its size and nature in the Czech Republic that we are aware of. This was one of the first Western European style complex financing structures introduced to the Czech market. We advised AIG Capital Partners on its acquisition of a majority stake in Bulgarian Telecommunications Company AD. The deal comprised an acquisition of a 65% stake from Novator and Viva Ventures GmbH, as well as the acquisition of a further 25% from minority shareholders, followed by a mandatory bid for the remaining shares. The acquisition price for the 65% stake was EUR 1.08 billion, with the entire equity valued at EUR 1.661 billion, making it the largest M&A transaction in Bulgaria and one of the largest leveraged finance transactions in C&SEE. The deal was particularly interesting because of the necessity to secure firm commitments on financing in what were becoming more challenging credit conditions. There were also a number of interesting issues to resolve on the mandatory bid, in particular satisfying the regulator on a very public offer, as well as resolving some complexities related to the repayment and releasing of security on existing finance drawn down by the target,
6
and putting in place new security arrangements for the lending banks in a very tight timeframe to enable a smooth completion. In Slovakia, one of our more memorable deals was when we advised a consortium of over ten private equity investors led by AIG on: (i) the USD 180 million acquisition of a 36% stake in Orange Slovensko, a.s.) from five Slovak utilities companies; and (ii) the exit at a price of USD 628 million, the largest private equity deal to date in Slovakia and one of the largest and most successful in CEE. We advised the consortium for over four years during its investment. We are also proud to have advised Enterprise Investors on their acquisition of a 47.65% stake in the leading Slovak electrical retail group NAY. The transaction represents something of a watershed in the Slovak private equity market, which has been slow to provide the same number of deals as the rest of Central Europe. The deal was therefore not only interesting because of the usual transactional and structural complexities involved, but also because of the confidence which Enterprise Investors showed in the Slovak market for private equity deals and the underlying message to Slovak business, that private equity has something to offer a growing business in terms of knowhow and experience, as well as capital. In Poland we recently advised Advent International in relation to a public tender offer to acquire 100 per cent of Wydawnictwa Szkolne i Pedagogiczne S.A., Poland's largest educational publisher as well as Société Générale Asset Management Alternative Investments on its acquisition of a controlling stake in Konsalnet S.A., a Polish security service provider. We also advised Bank Austria Creditanstalt AG in connection with its investment in Bioton S.A., the leading manufacturer of human insulin. Bioton S.A. was subsequently listed on the Warsaw Stock Exchange, and Bank Austria Creditanstalt AG recently exited from the investment by selling its stake through an accelerated book-building process to domestic and foreign financial investors. Allen & Overy also advised Bank Austria Creditanstalt AG on this sale process. The deal was interesting since, despite being structured as an equity investment, in practice it involved a mezzanine element and mezzanine structures which at that time were not commonly used in Poland. Secondly, it involved advice in relation to the exit by a private equity investor through a secondary public offering. We have also advised K.B. (C.I.) Nominees Ltd. (a private equity fund from Franklin Templeton Investments group) on the sale of its stake in Z.P.C. Mieszko S.A., a confectionary company, to Alta Capital Partners. We are also proud to have advised Apollo Real Estate Advisors L.P on one of the most
© Allen & Overy LLP 2010
Allen & Overy I In Practice I May 2010
important events of 2008 in the Polish media market, as a result of which Silver Screen will be incorporated to the Multikino network of cinema theatres and the private equity fund will become a shareholder in the combined Multikino group. The structure included a multi-jurisdictional restructuring of debt. In Hungary we advised on the IPO of Állami Nyomda Nyrt. (State Printing House plc) where Royalton, a private equity investor, sold part of its interest in the company. This was the first equity deal following the implementation of the Prospectus Directive in Hungary. In order to maximise the tax benefit for the selling shareholders, Állami Nyomda Nyrt. was first listed on the Budapest Stock Exchange and then offered its shares to the public. In Romania we recently advised Advent International Corporation in relation to the acquisition of a majority stake in Centrul Medical Unirea, a leading chain of medical clinics in Romania, from the private equity company 3i and the founders of
the business in a competitive sale purchase. We advised Enterprise Investors in relation to the loan to be raised for the acquisition of the Simcor Group, and in relation to the acquisition of Macon S.A., a leading company operating in the construction materials business. We also advised Enterprise Investors on the EUR 17 million acquisition of Artima, a FMCG retailer holding at that time a chain of 14 supermarkets in 13 cities from the western part of Romania. The transaction involved seven sellers (four individuals including the founder of the business (back in 2001) and three financial institutions) and five buyers (PEF V investment fund and its new management team). At the end of 2007 we advised Enterprise Investors on its EUR 55 million exit, through the sale of Artima (now holding 21 supermarkets), to Carrefour Romania. As the Romanian private equity market hots up, we are already advising on or have advised on a number of other private equity deals in recent months.
© Allen & Overy LLP 2010
7
Allen & Overy I In Practice I May 2010
Key contacts
If you require advice on any of the matters raised in this document, please call any of our partners or your usual contact at Allen & Overy.
CZECH REPUBLIC Jane Townsend Tel +420 222 107 125 [email protected] Robert David - Finance Tel +420 222 107 188 [email protected] SLOVAK REPUBLIC Hugh Owen Tel +421 2 5920 2414 [email protected] Renátus Kollár - Finance Tel +421 2 5920 2423 [email protected] POLAND Jarosław Iwanicki Tel +48 (0)22 820 6190 [email protected] Katarzyna Terlecka Tel +48 (0)22 820 6169 [email protected] HUNGARY Zoltán Lengyel +36 1 429 6033 [email protected] James Graham - Finance +36 1 429 6048 [email protected] ROMANIA Costin Tărăcilă Tel +40 31 405 7782 [email protected] Alexandru Retevoescu - Finance Tel +40 31 405 7784 [email protected] Dragoş Radu Tel +40 31 405 7781 [email protected] Mihai Ristici Tel +40 31 405 7785 [email protected] Balázs Sahin-Tóth +36 1 429 6003 [email protected] Arkadiusz Pędzich - Finance Tel +48 (0)22 820 6157 [email protected] Mirosław Fiałek Tel +48 (0)22 820 6224 [email protected] Vojtech Pálinkáš Tel +421 2 5920 2421 [email protected] Prokop Verner Tel +420 222 10 7140 [email protected]
8
© Allen & Overy LLP 2010
Allen & Overy I In Practice I May 2010
Allen & Overy LLP One Bishops Square London E1 6AD United Kingdom Tel +44 (0)20 3088 0000 Fax +44 (0)20 3088 0088 www.allenovery.com Allen & Overy maintains a database of business contact details in order to develop and improve its services to its clients. The information is not traded with any external bodies or organisations. If any of your details are incorrect or you no longer wish to receive publications from Allen & Overy, please contact [email protected]. In this document Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications, or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings. Allen & Overy LLP or an affiliated undertaking has an office in each of: Abu Dhabi, Amsterdam, Antwerp, Athens, Bangkok, Beijing, Bratislava, Brussels, Bucharest (associated office), Budapest, Doha, Dubai, Düsseldorf, Frankfurt, Hamburg, Hong Kong, London, Luxembourg, Madrid, Mannheim, Milan, Moscow, Munich, New York, Paris, Prague, Riyadh (associated office), Rome, São Paulo, Shanghai, Singapore, Sydney, Tokyo, Warsaw. © Allen & Overy LLP 2010. This document is for general guidance only and does not constitute definitive advice.
© Allen & Overy LLP 2010
9
Sharing advice and practical solutions
Our private equity practice - at the heart of Europe
May 2010
"Combining local insight with and international perspective," Allen & Overy has established a leading position in Central Europe and Russia and is successfully serving its international clients base. Chambers Global – CEE, 2009 edition "They know the region inside–out and have an excellent mixture of international and local partners," said clients of these "bright, tough lawyers." Chambers Global - CEE, 2009 edition "I think that office is fantastic - they tell what is in your best interests and what is the best answer." IFLR 1000 – CEE, 2010 edition The firm's regional network is made up of topnotch lawyers who are able to "uncover the various nuances of local law and link that into the wider picture." Chambers Global – CEE, 2009 edition Despite the large number of private equity investments already made over the years in Central and Eastern Europe (CEE), this is still a region with huge potential. Although some CEE countries have been badly affected by the current economic crisis, there are still some, such as Poland, the Czech Republic and Slovakia which are still held up as comparatively resilient, and well-positioned to forge ahead early on any wider global economic upturn. There are still plenty of opportunities in CEE to make investments into growing businesses with great potential - businesses which need the capital and the know how that private equity brings to unlock the value inherent in that potential.
Although, as predicted, 2009 was slow for private equity deals, this has started to change and in some countries, such as Poland and Romania, interest in deals is strong and there have also been large and high profile deals in the Czech Republic, for example. The successful private equity investor is going to be that which is the most "well-oiled" operation, with the ability to move fast when opportunities arise, and to adapt quickly with innovative solutions to rapidly evolving markets. To do this, the investor needs to know the pitfalls and quirks in a particular jurisdiction, and needs to be able to structure, present and complete the deal in the shortest possible time. This requires a comprehensive understanding of the local environment in which the Target is operating, at a "deal culture" level as well as at a legal level. Allen & Overy can offer you: ¡ expert knowledge and assistance to enable you to move fast on deal opportunities, while at the same time managing risk through careful structuring and thorough preparation; A&O's global private equity know how base, practitioners and transaction experience, whether it is PE, general M&A, financing or sector specific specialisation; innovative solutions to legal problems that we will have almost certainly encountered in the past; familiarity with private equity fund structures and the restrictions that affect them, and their implications for deal execution; flexibility on team structures: either leading a deal out of London with local capability, or led locally with input from London (or elsewhere) as required.
¡
¡
¡
¡
© Allen & Overy LLP 2010
1
Allen & Overy I In Practice I May 2010
10 things to think about when doing private equity deals in CEE
(1) Structuring the acquisition finance In current markets, financing a transaction is not easy. We hear varied reports about the availability of finance and conditions are tough. Some investors are choosing to structure their investments through 100% equity. Our comments below assume that at some stage, the finance markets will return to some semblance of normality, even if the highly leveraged deals of the past are unlikely to return. However, some of the comments below are still relevant in the context of all equity deals and minority "old development capital" style deals. When debt is to be introduced into the capital structure, some fundamental questions will need to be answered, such as: Will it be possible for the SPV and Target to offset interest on debt against taxable profits? Are there any thin capitalisation rules in the relevant jurisdiction? In most of the countries in CEE thin capitalisation rules apply, usually setting a related-party debt to equity ratio of 3:1 (Poland/Hungary/Romania) or 4:11 (Czech Republic) or 6:1 (in the Slovak Republic these thin capitalisation rules apply as from 1 January 2009), the main effect of which will be to affect the deductibility of interest paid on debt. The definition of who is a related person for these purposes varies, with some room for structural planning based on the percentage of voting rights. In Hungary and Romania the rules apply not only to loans and credits from related parties but also to those from any other unrelated companies, except financial institutions. Unrelated financing in the Czech Republic is also affected, but only to the extent that such financing qualifies as a ''back-to-back'' arrangement, as defined by law. Nevertheless, there are other disallowance rules that must be carefully addressed to ensure a tax deductibility of financing costs. In Romania, interest expenses on loans and credits from other entities than financial institutions are not deductible over certain thresholds, which are applied before considering the debt to equity ratio. In Poland, certain structures allow for intra-group lending without thin-capitalisation restrictions. Contrary to many EU countries, in CEE withholding tax may still be an issue which needs to be dealt with under double tax treaties. This is due to the
transitional period for implementing the Interest and 2 Royalties Directive. Further, no group taxation currently exists in the Czech Republic, Hungary or Slovakia. In Poland the provisions relating to group taxation are very strict and only a few tax groups have been created so far. In practice, in Poland and in the Czech Republic tax grouping is sometimes achieved through a partnership structure. Offset of interest on debt in an acquiring vehicle against taxable profits in a Target can be achieved in many countries by: (i) incorporating the acquiring vehicle in the relevant jurisdiction; and (ii) merging the Target into the acquiring vehicle as soon as it has acquired the Target. (2) Securing the acquisition finance
Rules on financial assistance vary from country to country in CEE. In most countries, there are financial assistance rules in relation to the acquisition of shares in 3 a joint stock company , but not a limited liability company. Czech financial assistance law also apply to Czech limited liability companies. The rules on financial assistance are invariably strict. Following the latest amendments to the 2nd Company Law Directive there is no equivalent of the old UK "whitewash" procedure but a number of steps may be carried out which are similar. In the Czech Republic, certain exceptions were introduced allowing financial assistance, but there are several important question marks as to whether they will work. As a result, many (joint stock company) CEE Targets may not provide assets as security and/or give a guarantee as collateral under the acquisition loan. However, in Hungary, the financial assistance rules will not apply where financing is provided by a bank. In Poland a joint-stock company may, either directly or indirectly, finance the acquisition of or subscription for its shares, in particular by granting loans, making an advance payment or establishing security interest. If a joint stock company finances the acquisition of its own shares, it must do so on arm’slength terms and for a fair price. In addition it must examine the debtor's solvency. A reserve capital from the funds planned to be paid as dividends has to be created. Other required formalities include a prior resolution of the company's shareholders and management report which has to be published and filed with the registered court. These restrictions (except for
2
1
6:1 if the borrower is a bank or an insurance company
Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States [published in the Official Journal L 157 , 26/06/2003 P. 0049 – 0054 as amended]. 3 Although a joint stock company has limited liability, these are the terms commonly used to differentiate the different types of company in the region.
© Allen & Overy LLP 2010
2
Allen & Overy I In Practice I May 2010
the reserve capital requirement) do not apply to ordinary transactions conducted by financial institutions, or actions for the benefit of a company's employees or the employees of an affiliated company which aim to facilitate the acquisition of the company's shares. Generally, at completion of the acquisition, only the shares in the Target and/or in the acquiring SPV can be used as collateral (with some minor exceptions). This level of security is normally not considered sufficient by the banks and they tend to request that they can access also the assets in the Target. Therefore, in some CEE countries private equity acquisitions commonly employ a local SPV in acquiring the shares of the Target. Subsequently, as soon as possible after the acquisition, the Target is merged into the SPV. Once the merger is completed, the assets of the Target pass into the acquiring entity and can be pledged in favour of the banks. (3) Tapping cash in the Target
Though this used to be the case in Slovakia, this no longer applies if the seller has acquired an interest in the Slovak company on or after 1 January 2004, and in Poland and Hungary does not apply at all. In the Slovak Republic, dividends payable to individual shareholders are exempt from income tax. In Romania dividends paid to individuals are always imposed, while those paid to legal entities are imposed by different quotas or not imposed at all depending on the participation quota and the duration for which the participation was held. Dividends payable to a qualifying parent company are exempt under transposed provisions of the EU ParentSubsidiary Directive. (4) Management participation
In the Czech Republic, the proceeds from the sale of an interest in the Target received by a seller who is an individual are exempt from tax (capital gains are treated as ordinary income for tax purposes) where the seller has held the interest for a certain period of time. The minimum holding period varies, generally depending on the legal form of the Target, but with respect to shares acquired on or after 1 January 2008 the size of the shareholding also needs to be considered. Capital gains derived by a seller other than an individual may be exempt from tax under the Czech participation exemption rules if the seller is a qualifying parent company. As dividends payable to an individual shareholder are subject to final withholding of 15% in the Czech Republic, the individual planning a sale will instead of taking a preclosing dividend, try to accumulate cash (distributable reserves) in the Target with an aim to increase the purchase price and benefit from the exemption. Dividends payable to a qualifying parent company are exempt under the transposed provisions of the EU Parent-Subsidiary Directive (in line with respective ECJ case law, an early distribution is possible provided that the minimum holding period is met). Unless this issue is carefully addressed, the buyer will have to raise additional funding for buying the excess cash. However, because of the rules against financial assistance applicable in the Czech Republic, this cash cannot be used to service the acquisition debt. If the acquisition structure involves a merger of the Target into the acquisition SPV, the cash in the Target can be used only once the merger is completed.
In a situation where there is the possibility of a "genuine" management buy-out, i.e. the managers are not already selling shareholders, it is possible that managers in CEE could be cautious when offered share participation in the Target. As time goes by, and as managers become more financially aware, this problem is less apparent. However, in some jurisdictions, continuing management are still quite wary of typical incentivisation methods offered/demanded by private equity investors, particularly IRR demands, liquidation preferences and other mechanisms that private equity investors would tend to see as standard. Offering shares to the management may therefore require much more explanation and negotiation than Western private equity houses may be used to from other markets. (5) Structuring the management participation
Some CEE jurisdictions have rigid corporate laws which can, without careful drafting, make it difficult to ensure enforceability of the key arrangements between the investor and the management. For example, it will be critical for the investor to ensure that it can enforce dragalong rights arising on the investor's exit from the company. Similarly, the investor will want to keep control over the destination of the shares if the manager leaves the company, whether as a bad leaver or as a good leaver. In common with many other jurisdictions, this is not straightforward, as any transfer of title requires the involvement of the seller in cases where the shares have been issued. The seller either has to physically hand over share certificates to the new owner or to initiate a change of the owner in the registry of book-entered shares. As a result, it may not be enough to rely on the traditional drag-along and call option clauses in the shareholders' agreement or on taking "irrevocable" powers of attorney. The ability of the investor to access managers' shares may need to be secured by additional structures such as an escrow or custody arrangement.
© Allen & Overy LLP 2010
3
Allen & Overy I In Practice I May 2010
Local practice varies and this should be addressed up front. (6) Preference shares and classes of shares
Many private equity structures in Western Europe involved the Target issuing redeemable preference shares and/or shareholder loans to provide further leverage against the ordinary shares. The value of the ordinary shares may be potentially low until the debt and preference shares are repaid, but any surplus value beyond that will accrue to the ordinary shares and generate high rates of return on equity. In some jurisdictions in CEE, although preference shares are possible, redeemable preference shares with, for example, guaranteed levels of dividend or certainty of payment on redemption may not be possible. In addition to that, it will need to be considered whether there would be withholding tax on preference share dividends. Generally preference shares enjoy the same tax treatment as ordinary shares, but reductions in withholding taxes on dividends under relevant double taxation treaties may be conditional only on holding a qualifying share in voting rights instead of equity capital. Other equity structures may involve the use of different classes of shares, with the private equity investor and the management having different classes of shares. For example, these classes may rank equally on general economic and voting rights, but may provide for a liquidation preference for the private equity investor. This is not possible in most CEE jurisdictions (Hungary and Poland being notable exceptions, as well as Romania), although it may be possible to provide for liquidation preferences in other ways. (7) Mezzanine warrants
Despite a strong entrepreneurial culture, shareholder managers in CEE can be quite reluctant to cede control of the business that they have built up themselves and may need to be convinced of the benefits of an approach from a private equity investor. Often, the private equity investment was seen only as a source of funding comparable with bank finance (though this perception has changed recently since bank finance is of course much more difficult to obtain). The shareholder managers will also expect to be able to keep control at both shareholder and board level. If the investor is willing to take a minority stake as well as a minority on the board, it is essential to have a detailed understanding of the powers of the board and the general meeting, and of the most effective way to make veto rights enforceable in practice. Where operating subsidiaries are owned by a holding company in which the private equity investor and the shareholder managers share ownership, it may be important to address these issues of control in more detail, since the area of focus practically may not be with regard to decisions made by the holding company, but the manner of the taking of decisions by the subsidiaries. Investors may be less willing to rely only on contractual undertakings from the holding company to deal with this issue. (9) Exits
Leveraged private equity acquisitions sometimes include a mezzanine financing, often involving the issue to the junior lenders of warrants which give them the right to subscribe on favourable terms for a portion of new shares in the Target, usually on the investor's exit. In many jurisdictions in CEE, the concept of mezzanine warrants does not exist, largely because the Target is not legally able to commit itself to issuing new shares to the junior lenders at some point in the future. It is then necessary to create an alternative structure tailored to the specifics of the particular deal in order to achieve a similar outcome. In Poland, however, the concept of mezzanine warrants has recently been developed in practice in relation to joint stock companies, which in certain circumstances are able to commit themselves to issue new shares in the future. (8)
4
As in other jurisdictions, the investor and the management alike will often be thinking of an IPO as a potential form of exit. A particularly relevant factor in CEE up until the current liquidity crisis, was the increasing level of activity on the Warsaw Stock Exchange (by far the largest and most actively traded stock exchange in CEE), which attracted significant attention from across the CEE region: the costs of obtaining a listing are presently much lower than those in London or Frankfurt, leading to different cost/benefit analyses and a lower valuation threshold for a listing to be regarded as viable. We expect that the recent weakened level of activity in respect of exit IPOs on the Warsaw Stock Exchange will end in due course. Given the relative caution of many CEE managers, and the new environment in CEE public markets following implementation of the Prospectus Directive, it may well be worthwhile to address up front with the managers issues regarding responsibility for statements made in a prospectus. (10) And finally…some practical points not necessarily peculiar to private equity deals
Heads of Terms/LOI/Term Sheet It is also vital to take local legal advice before signing any non-binding heads of terms so as to avoid
© Allen & Overy LLP 2010
Controlling interests (or "letting go"…)
Allen & Overy I In Practice I May 2010
inadvertently creating any unexpected binding obligations. In some CEE jurisdictions, there exists the concept of an "Agreement on Future Agreement". This kind of agreement sets out the basic terms of an agreement which is later to be signed "in full". The danger is that such an agreement can be binding, enabling a party to insist on entering into a proper sale agreement. Listed companies As private equity bidders also broaden their search to include listed companies, care should be taken to look at thresholds above which a buyer may be obliged to make a mandatory bid. The rules can be complex, and frequently the rules on pricing, rules prohibiting purchases in the offer period or within a stated period after the offer at a price which is above the offer price (or requiring the bidder to pay all accepting shareholders a higher price), restrictions on buying shares outside of the public offer process for certain periods of time, and suspensions on voting rights until approval is obtained for a prospectus can create problems for unwary investors. Governing law Sellers will often assume that the governing law will have to be the local law, because the transaction involves a local company. This is not the case although unavoidably many of the fundamental provisions of the SPA will need to be compliant with local laws. The treatment of remedies for breach of warranty will vary depending on the choice of governing law and there are also concepts which may not necessarily exist under, e.g. English law. For example, in many CEE jurisdictions, it is common, and enforceable, to include contractual penalties as a "stick" to encourage performance. Governing language It is sensible, if possible, to avoid agreeing to the concept of "equal force" translations, since this can lead to uncertainty and great additional cost. Similarly, agreeing to draft or negotiate documents in more than one language can add greatly to both time and cost and should be avoided if at all possible.
Czech Republic "The group is first-class in every respect, as excellent in Prague as anywhere else." Chambers Global 2010 Slovakia Clients appreciate the outfit's "tailored mix of international and local knowledge" and the firm's consistent adherence to "top-quality standards." Chambers Global 2010 Poland "The firm houses many sector-specific experts and always retains international service levels." Chambers Global 2010 Hungary Clients feel they can trust their businesses with the firm. "I would say they were a safehands firm and very professional, " says one. IFLR1000 2009 Romania Clients say the team is "commercial and exceptionally responsive, with an in-depth understanding of local issues." Chambers Global 2010
© Allen & Overy LLP 2010
5
Allen & Overy I In Practice I May 2010
Allen & Overy's private equity practice in CEE
Our Central and Eastern Europe (CEE) dedicated private equity practice combines expertise across the board in M&A, equity capital markets, and leveraged finance techniques. We have one of the largest practices in the CEE enabling us to deal with the most complex and high-profile transactions. We have a presence in five key centres in Central Europe: Warsaw, Prague, Bucharest, Budapest, Bratislava. We have advised on a number of private equity deals in Central and Eastern Europe which have been interesting and challenging in a number of ways. In the Czech Republic, Allen & Overy advised Pamplona Capital Partners I, LP, a UK private equity house, on a unique leveraged buy out of Pegas, a.s. The target is one of the leading European manufacturers of non-woven textiles, selling its products mainly to leading multinationals for use in personal hygiene products. The transaction required the acquisition vehicle to raise senior debt financing from a syndicate of banks, mezzanine financing, as well as several shareholder loans. For the deal, a multilevel structure of acquisition vehicles had to be set up in a number of jurisdictions. One year after the acquisition, Pegas became listed in Warsaw and Prague. The combined corporate and banking teams of Allen & Overy in Prague, London, Milan, Warsaw and Luxembourg were handling all aspects of this complex deal, the first project of its size and nature in the Czech Republic that we are aware of. This was one of the first Western European style complex financing structures introduced to the Czech market. We advised AIG Capital Partners on its acquisition of a majority stake in Bulgarian Telecommunications Company AD. The deal comprised an acquisition of a 65% stake from Novator and Viva Ventures GmbH, as well as the acquisition of a further 25% from minority shareholders, followed by a mandatory bid for the remaining shares. The acquisition price for the 65% stake was EUR 1.08 billion, with the entire equity valued at EUR 1.661 billion, making it the largest M&A transaction in Bulgaria and one of the largest leveraged finance transactions in C&SEE. The deal was particularly interesting because of the necessity to secure firm commitments on financing in what were becoming more challenging credit conditions. There were also a number of interesting issues to resolve on the mandatory bid, in particular satisfying the regulator on a very public offer, as well as resolving some complexities related to the repayment and releasing of security on existing finance drawn down by the target,
6
and putting in place new security arrangements for the lending banks in a very tight timeframe to enable a smooth completion. In Slovakia, one of our more memorable deals was when we advised a consortium of over ten private equity investors led by AIG on: (i) the USD 180 million acquisition of a 36% stake in Orange Slovensko, a.s.) from five Slovak utilities companies; and (ii) the exit at a price of USD 628 million, the largest private equity deal to date in Slovakia and one of the largest and most successful in CEE. We advised the consortium for over four years during its investment. We are also proud to have advised Enterprise Investors on their acquisition of a 47.65% stake in the leading Slovak electrical retail group NAY. The transaction represents something of a watershed in the Slovak private equity market, which has been slow to provide the same number of deals as the rest of Central Europe. The deal was therefore not only interesting because of the usual transactional and structural complexities involved, but also because of the confidence which Enterprise Investors showed in the Slovak market for private equity deals and the underlying message to Slovak business, that private equity has something to offer a growing business in terms of knowhow and experience, as well as capital. In Poland we recently advised Advent International in relation to a public tender offer to acquire 100 per cent of Wydawnictwa Szkolne i Pedagogiczne S.A., Poland's largest educational publisher as well as Société Générale Asset Management Alternative Investments on its acquisition of a controlling stake in Konsalnet S.A., a Polish security service provider. We also advised Bank Austria Creditanstalt AG in connection with its investment in Bioton S.A., the leading manufacturer of human insulin. Bioton S.A. was subsequently listed on the Warsaw Stock Exchange, and Bank Austria Creditanstalt AG recently exited from the investment by selling its stake through an accelerated book-building process to domestic and foreign financial investors. Allen & Overy also advised Bank Austria Creditanstalt AG on this sale process. The deal was interesting since, despite being structured as an equity investment, in practice it involved a mezzanine element and mezzanine structures which at that time were not commonly used in Poland. Secondly, it involved advice in relation to the exit by a private equity investor through a secondary public offering. We have also advised K.B. (C.I.) Nominees Ltd. (a private equity fund from Franklin Templeton Investments group) on the sale of its stake in Z.P.C. Mieszko S.A., a confectionary company, to Alta Capital Partners. We are also proud to have advised Apollo Real Estate Advisors L.P on one of the most
© Allen & Overy LLP 2010
Allen & Overy I In Practice I May 2010
important events of 2008 in the Polish media market, as a result of which Silver Screen will be incorporated to the Multikino network of cinema theatres and the private equity fund will become a shareholder in the combined Multikino group. The structure included a multi-jurisdictional restructuring of debt. In Hungary we advised on the IPO of Állami Nyomda Nyrt. (State Printing House plc) where Royalton, a private equity investor, sold part of its interest in the company. This was the first equity deal following the implementation of the Prospectus Directive in Hungary. In order to maximise the tax benefit for the selling shareholders, Állami Nyomda Nyrt. was first listed on the Budapest Stock Exchange and then offered its shares to the public. In Romania we recently advised Advent International Corporation in relation to the acquisition of a majority stake in Centrul Medical Unirea, a leading chain of medical clinics in Romania, from the private equity company 3i and the founders of
the business in a competitive sale purchase. We advised Enterprise Investors in relation to the loan to be raised for the acquisition of the Simcor Group, and in relation to the acquisition of Macon S.A., a leading company operating in the construction materials business. We also advised Enterprise Investors on the EUR 17 million acquisition of Artima, a FMCG retailer holding at that time a chain of 14 supermarkets in 13 cities from the western part of Romania. The transaction involved seven sellers (four individuals including the founder of the business (back in 2001) and three financial institutions) and five buyers (PEF V investment fund and its new management team). At the end of 2007 we advised Enterprise Investors on its EUR 55 million exit, through the sale of Artima (now holding 21 supermarkets), to Carrefour Romania. As the Romanian private equity market hots up, we are already advising on or have advised on a number of other private equity deals in recent months.
© Allen & Overy LLP 2010
7
Allen & Overy I In Practice I May 2010
Key contacts
If you require advice on any of the matters raised in this document, please call any of our partners or your usual contact at Allen & Overy.
CZECH REPUBLIC Jane Townsend Tel +420 222 107 125 [email protected] Robert David - Finance Tel +420 222 107 188 [email protected] SLOVAK REPUBLIC Hugh Owen Tel +421 2 5920 2414 [email protected] Renátus Kollár - Finance Tel +421 2 5920 2423 [email protected] POLAND Jarosław Iwanicki Tel +48 (0)22 820 6190 [email protected] Katarzyna Terlecka Tel +48 (0)22 820 6169 [email protected] HUNGARY Zoltán Lengyel +36 1 429 6033 [email protected] James Graham - Finance +36 1 429 6048 [email protected] ROMANIA Costin Tărăcilă Tel +40 31 405 7782 [email protected] Alexandru Retevoescu - Finance Tel +40 31 405 7784 [email protected] Dragoş Radu Tel +40 31 405 7781 [email protected] Mihai Ristici Tel +40 31 405 7785 [email protected] Balázs Sahin-Tóth +36 1 429 6003 [email protected] Arkadiusz Pędzich - Finance Tel +48 (0)22 820 6157 [email protected] Mirosław Fiałek Tel +48 (0)22 820 6224 [email protected] Vojtech Pálinkáš Tel +421 2 5920 2421 [email protected] Prokop Verner Tel +420 222 10 7140 [email protected]
8
© Allen & Overy LLP 2010
Allen & Overy I In Practice I May 2010
Allen & Overy LLP One Bishops Square London E1 6AD United Kingdom Tel +44 (0)20 3088 0000 Fax +44 (0)20 3088 0088 www.allenovery.com Allen & Overy maintains a database of business contact details in order to develop and improve its services to its clients. The information is not traded with any external bodies or organisations. If any of your details are incorrect or you no longer wish to receive publications from Allen & Overy, please contact [email protected]. In this document Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications, or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings. Allen & Overy LLP or an affiliated undertaking has an office in each of: Abu Dhabi, Amsterdam, Antwerp, Athens, Bangkok, Beijing, Bratislava, Brussels, Bucharest (associated office), Budapest, Doha, Dubai, Düsseldorf, Frankfurt, Hamburg, Hong Kong, London, Luxembourg, Madrid, Mannheim, Milan, Moscow, Munich, New York, Paris, Prague, Riyadh (associated office), Rome, São Paulo, Shanghai, Singapore, Sydney, Tokyo, Warsaw. © Allen & Overy LLP 2010. This document is for general guidance only and does not constitute definitive advice.
© Allen & Overy LLP 2010
9
