Finance, Mergers & Acquisitions, and Private Equity Practices

OCTOBER 2019 Nine Key Differences When Doing Deals in Europe U.S. private equity houses and debt funds often encounter unexpected differences when undertaking European buyout transactions. In this article, we explore the key issues that American clients should consider when embarking on a deal in Europe, especially when debt financing is required.

Structuring Differences 1. Transaction Structuring 2. Funding Arrangements A range of factors impacting European transactions Like in the U.S, the typical leveraged buyout will make every international transaction unique. Like in the involve both acquisition funding and working capital U.S., each transaction starts with investing the equity financing. Term funding may be provided in the form monies into an acquisition vehicle on an efficient basis of a bond or a loan. There are different regulatory and and structuring to mitigate the effects of capital gains tax tax consequences depending on the jurisdiction of on an exit. But there is an added need to balance the the borrower. So, the private equity sponsor should be desire to obtain a deduction for the maximum amount careful to ensure that the proposed lender or arranger of debt (both shareholder and external) while meeting confirms that they can actually comply with the structuring minimum equity requirements and thin capitalisation requirements for the transaction before agreeing to rules, which vary between countries. terms.

It is unusual (unless the target company is in one of Since there are more deal variables to be worked out a small number of European countries,1 or is a public on a typical European term loan and documentation is acquisition,) for European transactions to involve a less standardised than U.S. documentation, term sheets merger of the acquisition vehicle into the target. This for term debt in Europe are considerably more detailed is more common in the U.S. to squeeze out minority than those in the U.S. U.S. sponsors should be wary of holders or to facilitate debt structuring. Increasingly agreeing short form term sheets with U.S. lenders without public acquisitions are structured as an English law obtaining advice, since this typically exposes them to scheme of arrangement, in order to remove minorities. worse terms than are generally obtained in the European market and the possibility that the lender has not worked Debt financing may lead to additional transaction out whether it can meet all of the relevant withholding tax structuring differences. In Europe, there is extra and regulatory requirements. pressure to lend senior debt direct to the entities that holds the assets and operations in order to meet the Increasingly, the working capital financing is provided by external lenders’ security requirements.2 The absence a different funding source than the term debt. Non-bank of Chapter 11 proceedings in Europe means that lenders typically won’t be able to provide banks accounts, workouts are generally consensual. This means that, let alone the efficient overdrafts, cheque facilities, letters subordinated debt is usually structurally subordinated of credit or credit cards that a business needs. Also, the to the operating companies, often requiring additional business may need intra-day payment lines, currency holding companies. Finally, it may be necessary to exchange facilities or interest or currency hedging. take into account lending regulatory requirements and Typically, a local bank, perhaps one with a track record withholding tax rules which mean that certain lenders, with the business, is needed to provide these services. notably debt funds lending from the U.S., may have problems lending directly to European borrowers. All However, U.S. sponsor should be aware that banks of these issues are surmountable, but experienced in Europe can be very slow to commit to this type of advisors are more able to provide quick solutions. transaction and may not be fully familiar with what is

1 Mergers are commonly used in Italy and Spain to overcome financial assistance concerns. 2 This is a complex area but rules applicable to European companies concerning corporate benefit and financial assistance often prohibit upstream guarantees and security. Attorney advertising materials – © 2019 Winston & Strawn LLP Structuring Differences Organisation

2. Funding Arrangements continued 4. Planning and Delivery required. This is even the case where a bank is only being Due to the complexity of arranging any complex cross- asked to open a bank account. Typically, discussions border transaction in Europe, sponsors are more reliant on working capital lines and related services can take a on a large team of advisors coming together to align significant amount of time, and the bank will need to be the tax, accounting, equity, debt and M&A aspects of given super-priority in order to agree to fulfil these roles. each individual transaction. It is critical to have an outline timetable worked out which allows sufficient time to work 3. Public Bid Financing through the issues and then implement the solutions that Financing of European public bids (referred to in the are reached. U.S. as the financing of a “take private” transaction) have additional financing issues. Sponsors will be familiar Changes in one part of an international transaction may with the concept of “certain funding,” which has been have profound, unexpected effects in other areas, so the imported from Europe to the U.S. relatively recently. sponsor, its advisors and other deal participants should Certain funding is used in Europe on both public and agree on a clear strawman proposal for the structure at private transactions. But its use in private transactions an early stage which all advisers can review, refine and, actually originated from public bids, where takeover ultimately, agree before drafting the key deal documents regulation requires certainty of funding for the offer and otherwise taking the steps necessary to implement price. the transaction.

The form of “certainty” for public bids varies from country Regular calls (weekly or even bi-weekly) can be helpful, to country, but it ranges from requiring debt financing to if not essential, to ensure that all advisers are on the have a very limited set of defined conditions to requiring same page and working to the same timetable. Even a qualifying financial institutions to issue a guarantee of if the sponsor is not personally involved on the calls, it the offer price. In extreme cases, the financial promoter will be important to make sure that this co-ordination is for the bid is required to actually accept liability itself to happening. pay the offer price if the bidder does not pay. 5. Advisors Depending on the requirements, the sponsor will need Consider whether the specific advisory team you are to ensure that it has appropriately structured facility to engaging has the appropriate experience. For instance, support any bid, and that may include requiring some not all U.S. accounting firms are as fluent in structuring form of credit enhancement or pre-funding of the equity European transactions. Where the firm has the right commitment as well as the debt commitment. experience, you may need to engage the European office of the advisory team you typically use in the United States to access that advice.

If a transaction is going to be financed in Europe, lenders will expect that due diligence reports prepared by outside experts on the target or structure to be addressed to the lenders. This is perfectly normal for European firms and the European arms of international firms, but this lender requirement regularly becomes a critical issue at a late stage in transactions where the engagement is made out of the U.S., where such practice is not customary and would typically be rejected by U.S. advisors.

The above also apply to multinational law firms. Determine the “local office” transactional and structuring

© 2019 Winston & Strawn LLP 2 Organisation 7. Accounting Principles It is customary on a European transaction for the buyer 5. Advisors continued to prepare business a financial model which is shared experience of the multinational law firm based on the with the lenders and used to set the financial covenants. elements of the subject transaction. For example, there On completion the SPV and/or the target will generally are particular issues, and solutions, where U.S. funds or be required to confirm to the lenders that this model institutions acquire or lend to European targets. Those has been prepared in accordance with the formal issues vary depending on which countries are involved. accounting principles that will be used by the business While the U.S. offices of the multinational firm may be going forward, for financial reporting and testing financial very experienced in doing deals, the local office may not covenants. have the experience necessary to advise on a leveraged buyout transaction. In Europe, each country has its own accounting principles but generally also allow companies to use IFRS. Since If the local office doesn’t have sufficient international most sponsors require IFRS accounts it is not unusual deal expertise, consider having ‘deal counsel’ serve for companies which were previously using local GAAP as lead and co-ordinate the overall deal process with to change accounting principles on completion of a reliance on and engagement of local firms with the exact transaction, which can cause difficulties. experience needed in the local jurisdiction. Increasingly, the real expertise in particular specialisms resides in U.S. sponsors typically do prepare a financial model on boutique firms, in any event. This approach is more the basis of the anticipated cashflows of the underlying closely tied to what a U.S. private equity shop would business, based on certain assumptions the sponsor expect. builds in. But they may not expect to have to tie the model back to the recognized accounting principles and/ Practical Issues or share the detailed model (as opposed to outputs) with the lenders. 6. Employee Issues Worker rights in some European jurisdictions can Other common problems are failing to completely be quite stringent and time consuming. The rights, bottom out tax effects in the model and not breaking out again, vary from country to country, but they range the model on a quarterly or even monthly basis, which from significantly greater compensation for dismissal European lenders will expect and may be necessary to in general, through minimum pay and strict limits on set covenants. maximum working hours, to elaborate mechanisms for worker consultation on transactions, including in 8. Currencies some countries3 mandatory works councils for business Even in less turbulent times, currencies can cause issues over a certain size. Works councils can rarely prevent for funding and completing transactions, and have a a transaction occurring but they typically have the profound effect on returns. Given the particularly volatile right to be consulted for a period of time and receive movements in currencies of late, it is critical to adequate information in relation to any change of consider currency hedging for completion cash flows control transaction and any related financing, and the and potentially for return of capital. transaction may be invalid if the process is not followed. Whether or not sponsors opt to hedge, converting Particular issues can arise with regard to pension funded capital from one currency to another to complete entitlements. A small number of UK companies still have a transaction requires careful co-ordination and defined benefit pension schemes which can have very preparation in order to ensure that it occurs in a timely substantial outstanding deficits. In this case the trustees and efficient way. Banks providing currency conversion must be engaged and a decision needs to be made will typically require KYC checks to be completed and whether to consult with the Pensions Regulator. Other trades to be implemented. If this all occurs without countries, such as Germany, still allow companies to preparation, the sponsor may be exposed to trading at maintain unfunded pension schemes. whatever rate the bank wishes to provide or, worse, the required funds not being available to complete.

3 Works counsel requirements are common in Europe for business over a certain size including in key jurisdictions such as France, Germany, Netherlands, Spain.

9. Setting Up Companies continued Acquisitions in Europe typically are made by a local holding company, or more likely several holding companies in at least two countries. In some countries, companies can be acquired “off the shelf,” but this is not the case in all countries and increasingly, setting up companies from scratch can be a complicated process. Ian Borman Partner, London [email protected] Like the U.S., there are the basic decisions about who will be directors, registered office address and accounting year. However, these will need to be compatible with any tax requirements to have ‘substance’ in certain holding companies, which may require a majority of locally resident directors and physical office premises in a country where the target does not even operate. Local Eva Davis corporate service providers will need to be engaged to Co-Chair, Private Equity Office Managing Partner, advise on these specifics. Corporate service companies Los Angeles can assist with these requirements but will need to be [email protected] engaged.

In some countries in Europe,4 it is practically impossible to set up and capitalise a company without a bank account, which means that all of the bank’s requirements for account opening need to be met before the process can even start. Even then, the process is often frustratingly slow, with surprising last minute requirements and, sometimes, unexplained refusals. With or without bank account, there will be a need to gather KYC information on the officers.

Finally, there will be the process of registering the company correctly with the local registry and obtaining any VAT or other registrations where required. This process can take weeks in some cases, and if companies act before they are fully formed, the directors and officers can be personally liable for actions taken prior to the formal registration requirements being met. In particular, where private equity sponsors have few connections in Europe, the process of forming the required companies for the transaction needs to be started early.

4 E.g. France and Luxembourg.

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