Europe’s main private equity and venture capital players have a keen eye on many European jurisdictions where substantial investment opportunities are likely to become available. The more ambitious and perhaps more risk-embracing of them are even looking to Central and Eastern Europe to generate their returns. But it is in the traditional continental European jurisdictions where the focus of many private equity and venture capital players is fixed.
Germany has seen a good deal of preparation in recent months ahead of eagerly awaited tax reforms to be implemented in 2002. As the country’s law firms step up a gear in anticipation of more private equity activity, there has also been what might be called an Anglo-Saxonisation of the legal community there. U.K. and U.S. law firms have made their presence clear in the German market by setting up offices. Last August, Freshfields merged with Bruckhaus Westrick Heller Lober to form Freshfields Bruckhaus Deringer.
European law firms are expecting a possible slowdown in certain types of deals in Germany this year ahead of more activity in 2002. “There will be some shifting effects,” says Christopher Kellett, joint head of corporate finance at Clifford Chance Punder in Frankfurt. “Corporate treasurers will ask themselves why they should do a deal [this year] when they can do it tax-free next year.”
A number of tax reforms become law in Germany next year that look likely to enhance the amount of corporate disposals of non-core assets. Lawyers are anticipating a wave of such deals from the ranks of traditional industrial conglomerates as they continue to concentrate on streamlining core activities.
Deutsche Bank, Dresdner Bank and insurance company Allianz are also expected to enter the disposals market but how much will be done through the private equity market is not clear.
As well as the law introducing tax-free disposals for corporates, Germany is introducing new depreciation laws next year. It is also anticipated that Germany will codify new legislation on a squeeze out structure some time this year for implementation next year. If this development materializes, there is expected to be sizeable growth in the domestic public-to-private market.
Kellett recounts how five years ago a deal in the region of DM100 million to DM200 million was considered to be very large. Now, however, these levels are seen as relatively standard. “The general size of the market is getting bigger,” he says.
But while there is growth in the size of deals in Germany, for example, the essential elements of providing legal advice have really not changed. “In cultural terms, particularly in private equity, you have to have the right mixture of Anglo-Saxon and local expertise,” says Charlie Geffen partner at Ashurst Morris Crisp in London. “You can’t just take U.K. or U.S. private equity documents and Germanise them.”
Lawyers are making it clear to their private equity and venture capital clients that although Germany and Europe have become like a domestic market, there are still extra issues to resolve. “MBOs, for example, are done in much the same way in different European countries,” explains Jonathan Blake, partner at S.J. Berwin & Co. in London. “The main difference is what constitutes a company in different European countries.”
Lawyers agree that this is where the crucial differences in law make doing private equity and venture capital deals across Europe a considerable challenge.
This is partly the reason for the sweeping trend of mergers and alliances in law circles in Europe, driven mainly by the acquisitive Anglo-Saxon firms.
Where venture capital and private equity funds are keen to take some management control in the companies in which they invest, it is up to the lawyers to make sure that they are not signing up to unnecessary amounts of liability. In France there is the ongoing debate about the supervisory management boards and what role the venture capital and private equity funds should take. There is concern over liability and how the French courts apply laws on liability when a company fails. “This makes agreements longer and more complex. But it’s a constant application of new trends,” says Olivier Edwards at Jones, Day, Reavis & Pogue in Paris.
Some venture capital funds take a full-on role in the management of investee companies while others are taking more of a cautious approach and are looking to distance themselves away from potential threats in deals that include a French element. As with any investment approach, the choice over which approach will depend on the level of risk the investors want to take. What the legal profession does is to endeavour to provide the legal framework that will satisfy that particular venture capitalists approach.
There are concerns in France that venture capital and private equity investments which run into financial losses will suffer the full weight of French legal judgement. But this opinion is counterbalanced by other schools of thought that suggest the law will be applied less harshly. Edwards says it is a process of developing case law to see what is acceptable to the country’s commercial courts. “There is a tendency from the French commercial courts to go out after those with the deep pockets,” he says. “But the magnitude of the damages at stake is certainly less than in the U.S.”
Liability is a real concern when structuring deals anywhere in Europe, explains Blake. Private equity and venture capital deals do take longer perhaps to structure, but the systems are developing nonetheless. “Several years ago there was a debate over whether to put directors on the board, but this has settled down now,” he adds.
Like in the German AG company structure, which features a supervisory board and a management board, a debate is taking place in France about whether investors should distance themselves from greater risks of liability by sitting on a supervisory board only. In Germany, outside investors are only permitted to take seats on the supervisory board while the management board membership is restricted to company employees.
On that note, venture capitalists seeking to invest in GmbH-type companies, are encouraged to help that company convert to the AG structure at the time of investment. Undertaking this process during the preparation stage of an IPO can be complex. So, perhaps the German market has lessons to teach the French.
For the U.S. investor, with a thorough understanding of U.S. stock companies, the different company structures in France can sometimes be daunting.
In France, Edwards says the market is starting to pick up once again. IPO’s are resuming, with greater confidence displayed in the market. First round venture capital financing is returning, also reflecting the market’s sentiments. However, typical private equity deals are now in the hundreds of millions of Francs as opposed to last year they would have been in billions of Francs. This reflects what the deal is worth, post dotcom frenzy.
Software, biotech and high-tech companies continue as the source of much of the French venture capital market. With Paris firmly entrenched as the center of new ventures, most of the legal expertise is likely to be based there. But positive signals are coming from Marseille and Nice and the surrounding areas that have strong growth businesses and may soon attract greater legal presence in these areas.
In Germany the picture is much the same. “Technology and life sciences have to be the biggest growth areas,” says Alan Greenough, head of corporate at Pinsent Curtis Biddle in London. Munich is attracting the domestic private equity players in Germany and also cross border investors for biotech start-ups, emerging from the larger research institutes. Lawyers are also pointing to Berlin for its growing role in the biotech and high- tech sectors.
Spain has a growing venture capital market. But perhaps more attractive to investors than Spain and Italy is the number of promising deals coming out of Scandinavia, in the fields of high-tech, media and telecom. Sweden has a number of large corporations which lead their fields in certain modern industries, but it is a homegrown phenomenon rather than a multinational one. There is also interest in similar activity coming out of Finland with its strong domestic telecoms industry.
Lawyers involved in structuring limited partnerships agree that there needs to a common approach in Europe, but how long this would take to develop is anyone’s guess. “At the moment, if you’re raising funds for venture capital in Europe, you have to balance a huge number of competing issues,” says Blake.
In Anglo-Saxon terms, the limited partnership structures are tax transparent. This means no that tax liability, in the form of capital or corporation tax passes onto the investor, who can often offset profits and taxes. These funds also allow investors to take the benefits of double tax treaties between their domicile country and that of the investee company.
The differences across Europe are stark. In France such funds are considered to be fiscally opaque and carry with them tax liabilities. Partnerships owning more than 25% of capital of the underlying French portfolio company may have to pay tax on realisation of the stake. One of the most common ways of getting around this is to use a common intermediate corporate structure such as a Luxembourg Holding company, which is fully owned by the partnership.
In Germany, the status is open to interpretation based on whether the partnership is perceived by the commercial courts as acting as a business. If it is, it will be liable for tax. Under German tax law a partnership can be perceived to be in a business if it is the sole partner in company or if it is engaged in business-type activities. The very nuances of the conditions placed on limited partnerships in Germany would seem to require a very experienced domestic lawyer.
Again the cultural differences in Europe raise their many heads. Successfully lobbying the European Commission to introduce new directives or laws invariably takes a good deal of time to achieve and the waiting list for discussing proposals is long.
There is strong expectation that the Anglo-Saxonisation of the legal scene in Europe will replicate its self-professed creativity and proactiveness in firms in France and Germany, for example. The cultural differences between lawyers will perhaps be more ironed out as inter-firm communication heightens. But the essential differences will still remain in many other ways.