Private equity in Germany: a market in flux? Christopher Kellett of Clifford Chance Punder addresses the question

The German market has seen many changes since January 2000 – not only the collapse in stock markets, but also substantial changes in the legal and tax background against which deals are done. In 2002 this included, for example, an overhaul of German civil law and the new takeover regime introduced by the Securities Acquisition and Takeover Act. The reform of the German tax system introduced in 2000 has not stopped, but after the election of the new German government seems set to continue. This article addresses a number of issues arising out of these changes, which are relevant to private equity transactions in Germany.

Public-to-private transactions

When the new Takeover Act was introduced, it was hoped that this would provide a clear legal framework for doing deals. While some areas of uncertainty remain, the number of public takeover transactions, both private-equity related and strategically driven, in the last few months has developed market practice in a number of areas relevant to private equity.

Controlling stakes

The previous approach of securing the (controlling) stakes of majority shareholders through conditional off-market transactions and following up with a “sweep up” offer for the free float is shifting towards an English style approach using an offer to all shareholders coupled with irrevocable undertakings to accept the offer from major shareholders. This change is largely due to the lower 30 per cent control threshold under the new regime (in comparison to the 50 per cent plus one share previously) and to the stricter framework for mandatory offers.


The pricing rules imposed by the new regime and their application has become clear, in particular the relationship with prices paid prior to the launch of the offer. If the bidder (or parties associated with it) acquired shares in the last three months before the offer, the offer price must at least equal the highest price paid in that period. Similarly, if within one year of the expiry of an offer the bidder (or parties associated with it) acquires shares at a higher price, the increase must also be paid to those who accepted the offer (this does not apply to higher compensation paid under a squeeze-out). These two rules limit the scope of the acquirer to do “special deals” or pay a premium for a controlling stake.

Treatment of management

In a private equity transaction, management will be invited to take an equity stake in the bidder vehicle. This is one area where there is arguably a lack of certainty under the new takeover regime – it can be argued that the management equity stake is a benefit, which should be offered to all shareholders. The economics of a MBO/LBO clearly prohibit this and structures are being developed to avoid this risk; nonetheless additional legislative clarity would help.


The squeeze-out has proved to be a useful tool once a majority shareholder holds 95 per cent of the share capital of the target AG – in particular several German corporates have used this to “tidy up” their shareholder structures. However, from the point of view of an acquirer, the implementation process remains virtually identical to that for other restructuring measures (e.g. change of legal form, mergers/amalgamations) and is open to the same risks of challenge (Anfechtung). The 95 per cent shareholder must offer “adequate compensation” to the minority shareholders being squeezed out. The “adequate compensation” may well have to be higher than the offer price. As the minority can challenge the adequacy of the compensation offered, this creates a potential valuation risk and can lead to problems ensuring sufficient funds are available. Even though valuation disputes would not delay its implementation, it will still take at least four or five months for the squeeze-out to become effective.

Acceptance thresholds/restructuring

The bidder will make its offer conditional upon reaching an acceptance threshold that permits it to implement its restructuring plans and/or a de-listing. Often these matters will also be a condition to bank financing being made available. The squeeze-out requires a threshold of 95 per cent of the share capital of the target AG to be reached (this may not in all cases equate to 95 per cent of the votes, e.g. where preference shares are in issue or where voting restrictions are included in the articles). However, a majority of 75 per cent of the capital represented and voted in the general meeting is required to pass the resolution approving the squeeze-out.

This is the same majority required for other typical restructuring measures. In all these cases the level of compensation payable to minority shareholders is subject to challenge by the minority shareholders and possible (upward) adjustment. Therefore the lower the acceptance threshold is set, the greater the potential number of minority shareholders who may seek to benefit from this review and the higher the valuation risk for the private equity investor. In summary, the squeeze-out is not the panacea that was hoped for, but is of paramount importance for the subsequent conversion of target AG into the less-regulated private company (GmbH) or limited partnership (KG).

Requirements of financing banks

Where the acquisition of shares in a takeover under the new regime is financed by a syndicated loan (typically the case in an LBO/MBO), lenders have become accustomed to using a certainty-of-funds concept similar to that used in the UK under the UK Takeover Code. One of the main areas where further clarification is needed is to what extent (and what sort of) conditions relating to the economic situation of the target company can be included in the offer to protect the interests of the lenders. Another area of uncertainty revolves around the length of the certain-funds period, in particular with regard to counter-bids and protracted anti-trust proceedings.

In an offer a cash confirmation now has to be given by an independent qualifying financial institution. In an LBO/MBO scenario, this will often be given by one of the banks underwriting the syndicated loan. Initial concerns about whether the cash confirmation created an additional guarantee-like payment obligation on the issuer have been resolved; thus the issuer of a cash confirmation will not be liable if it proves that it was unaware that its confirmation was incorrect or incomplete and that this lack of knowledge does not result from gross negligence. Consequently the cash confirmation cannot be regarded as a payment guarantee overriding the terms of the underlying loan.

In cases where the acquisition is financed from the bidder’s own resources, including existing credit lines with no certainty-of-funds-concept (unlikely to be the case in an LBO/MBO), it remains unclear exactly what degree of due diligence needs to be undertaken by the relevant institution in order to issue the cash confirmation.


Reform of Civil Law (Schuldrechtsreform)

In January 2002 substantial revisions to the German Civil Code took effect. One effect of the reforms is that “warranties” cannot apparently be given on a “no-fault” basis if the vendor is to be certain that the agreed caps and other limitations are valid. The reform has therefore created a new tension between the need for legal certainty as regards the risk allocation effected by the “warranties” on a “no-fault” basis and the vendor’s need for certainty regarding the maximum level of its liabilities (as was possible under the old law). While no further legislative change remedying this defect is to be expected, market practice is developing towards an acceptable solution.

Tax changes

The new coalition government in Germany has proposed a number of further tax reforms that, if implemented, are likely to affect private equity transactions. For example, tax consolidation groups are to be disallowed for trade tax purposes. Consequently interest expenses incurred at the level of a German parent for the acquisition of a German target may not be used to offset the target’s income for trade tax purposes. Corporate tax consolidation will only apply for the fiscal year following the year in which the profit and loss transfer agreement was registered, eliminating the opportunity of consolidating a new subsidiary immediately after acquisition. The maximum loss that may be utilised in any one year is to be limited to 50 per cent of total tax income (thus ensuring that a minimum amount of tax would always be paid). The ability to carry losses forward is also to be restricted to a seven-year period. The actual effect of these changes, if implemented, on valuations and cash flows remains to be seen. However, the resultant uncertainty until any changes are finally implemented is an unwelcome impediment to private equity transactions in Germany.

While the economic, fiscal and legal frameworks within which private equity transactions in Germany operate has seen a number of substantial changes in the last period, the industry has met the challenge and continues to close major transactions such as Viatris, ATU, Haarmann & Reimer and Siemens/KKR in a difficult economic climate. Indeed, Germany ranks as the second most active Continental European market for buyouts and the largest by volume in the latest CMBOR European Review. The future will certainly bring new challenges, but it is to be expected that the industry and its advisors will respond to these as successfully as they have done in the past.