Private equity in Italy: market and regulatory overview
A Q&A guide to private equity law in Italy.
The Q&A gives a high level overview of the key practical issues including the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.
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This Q&A is part of the multi-jurisdictional guide to private equity. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateequity-mjg.
Private equity funds based in Italy continued to have a diverse investor base in 2013. Approximately 26% of the capital raised was sourced abroad (a significant increase from the 2012 figure of 11%). The sources of funding were:
Funds of funds (31.5%).
Pension funds (18.3%).
Banks and other financial institutions (20.6%).
Insurance companies (13.4%).
Government agencies (3.2%).
Private equity firms (0.1%).
The above statistics are sourced from Il mercato italiano del Private Equity e del Venture Capital nel 2013 published by the Italian Private Equity and Venture Capital Association (AIFI) (AIFI Statistics) (see box, Private equity/venture capital association).
In 2013 the Italian private equity and venture capital market has seen a slight increase in investment activity. There has been a growing trend for early stage and expansion investments, while some large buy-out transactions had a significant impact on the total amount invested.
Data sourced from the AIFI Statistics demonstrates that fund-raising remains critical. The total amount of capital raised by Italy-based funds during 2013 was recorded as EUR4, 047. This is a remarkable increase compared to the amount raised in 2012 (EUR1, 355 million). In 2013 the total amount from new transactions was equal to EUR3, 430 million (an increase of 6% compared to the amount of EUR3, 230 million recorded in 2012). This was distributed over 368 transactions (a slight increase from 2012 when the transactions were 349) and involving 281 companies.
The majority of resources continued to be channelled into buy-out transactions (EUR2, 151 million, a similar amount to the figure in 2012), followed by expansion investments and replacement transactions. For the second year running, early stage transactions were predominant (158 investments, a slight increase compared to 136 investments made in 2012), followed by expansion and buy-out transactions.
The total number of divestments in 2013 was 141 (a considerable increase of 32% from 107 in 2012), distributed over 119 target companies, for a total amount calculated at cost (that is, not including capital gains) equal to EUR1,933 million (marking a significant increase of 23% compared to 2012, when the total divested amount was EUR1,569 million).
Funds raised by Italy-based private equity firms in 2013 totalled EUR4,047 million, compared to EUR1,355 million in 2012. Funds raised were for the following type of funds:
Early stage investment (17%).
Expansion investments (49%).
Other investments (29%).
Private equity investments were made in 281 target companies in 2013, substantially in line with 2012 (277 companies). The total value of all private equity investment in Italy increased from EUR3,230 million in 2012 to EUR3,430 million in 2013.
The main sectors targeted by private equity investments in 2013 were:
Professional and social services (other than financial services) (48 transactions).
Industrial products and services (36 transactions).
Computing (36 transactions).
Media & entertainment (34 transactions).
Energy & utilities (33 transactions).
Medical (31 transactions).
Manufacturing (26 transactions).
Biotechnology (15 transactions).
Food and beverages (14 transactions).
Luxury (12 transactions).
Transportation (11 transactions).
Retail (ten transactions).
Financial services (ten transactions).
Consumer (ten transactions).
Chemicals (seven transactions).
Construction (seven transactions).
Industrial automation (six transactions).
Automotive (four transactions).
Electronics (three transactions).
Textile (three transactions).
Aerospace & defence (one transaction).
Agriculture (one transaction).
ICT (one transaction).
Other (nine transactions).
The investment amounts by stage in 2013 were:
Buyouts. This amounted to EUR2,151 million (50 transactions), of which:
66% were small;
26% were medium; and
18% were in the large and mega buyout classes.
Expansions. This amounted to EUR914 million (138 transactions).
Early stage. This amounted to EUR81 million (158 transactions).
Replacement capital. This amounted to EUR281 million(17 transactions).
Turnarounds. This amounted to EUR3 million (5 transactions).
Exits accounted for EUR1,933 million in 2013, compared to EUR1,569 million recorded in 2012 (source: AIFI statistics). The distribution of exits (by value) in 2013, was as follows:
Trade sales (27%).
Sales to other investors (secondary buyouts) (38%).
Public offerings (13%).
Write off (10%).
All historical data in this question is from Il mercato italiano del Private Equity e del Venture Capital nel 2013, published by the AIFI.
Status of the AIFMD implementation
Directive 2011/61/UE on alternative investment fund managers (AIFMD) introduces a harmonised regulatory framework with respect to the rules applicable to alternative investment fund managers (AIFM) of alternative investment funds (AIF), including private equity funds.
The deadline for the implementation of the AIFMD expired on 22 July 22 2013. However at the time of writing, the Italian implementation process has not been fully completed. More specifically:
Legislative Decree no. 44 of 4 March 2014, implementing the AIFMD (AIFMD Decree) entered into force on 9 April 2014. The AIFMD Decree amended the relevant provisions of the Legislative Decree no. 58 of 24 February 24 1998 (Consolidated Law on Financial Intermediation) and detailed the transitional regime applicable until the implementing regulations of the Ministry of Economy and Finance (MEF), the Bank of Italy and the Italian Securities and Exchange Commission (Commissione Nazionale per le Società e la Borsa) (Consob) enter into force.
The implementing regulations referred to above are still due to be issued by competent Italian authorities. It is expected that such regulations will be approved by 22 July 2014, although there could be further delays.
On 20 May 2014, a consultation paper was published by the MEF on the draft Ministerial Decree (Draft Ministerial Decree) that will define the main rules applicable to the functioning and structure of Italian collective investment undertakings, including Italian AIFs. It will replace the Ministerial Decree no. 228/1999.
Impact of the AIFMD
The implementation of the AIFMD will affect a number of aspects relating to the management and operation of Italian AIFs. With particular reference to the activities performed by private equity funds:
The AIFMD Decree introduced certain provisions aimed at regulating the acquisition of control or significant shareholdings in target companies by AIFs managed by Italian AIFMs, in line with Articles 26 to 29 of the AIFMD. Such rules will need to be specified in the implementing provisions that will be issued by Consob, along with the new restrictions on asset stripping (Article 30 of the AIFMD).
The rules on the marketing of Italian and foreign AIFs (among other things) have been amended in order to introduce the passport regime provided under the AIFMD. This means that the restrictions that previously applied to the marketing in Italy of foreign AIFs have been relaxed. This is particularly for marketing activities carried out by AIFMs in relation to MiFID professional investors and other categories of investors that may purchase units or shares of Italian reserved AIFs (FIA italiani riservati) pursuant to applicable Italian regulations.
Certain new requirements will be introduced in relation to the remuneration of senior management and other relevant employees of Italian AIFMs, in compliance with the AIFMD framework.
The regulatory regime applicable to Italian AIFMs prior to the implementation of the AIFMD will be significantly reviewed. The review will examine the rules on risk and liquidity management, valuation, delegation of functions, depositary, internal organisation and controls, conflict of interests, initial capital and own funds, and reporting to competent authorities. Additional requirements will be introduced in relation to a number of areas that were not previously covered in detail by applicable laws and regulations. This includes leverage, coverage of professional liability risks and disclosure to investors.
The AIFMD Decree introduced a new set of provisions on investment companies with fixed share capital (società di investimento a capital fisso) (SICAF). This is a new form of AIFs that can also be used to set up private equity investment vehicles (see below).
Additional changes are provided in the Draft Ministerial Decree relating to the:
Frequency of the net asset value (NAV) calculation.
Information, duties and documents to be prepared by Italian AIFMs.
Minimum value of the units or shares of AIFs.
Conditions under which Italian collective investment undertakings must be set up in an open-ended or closed-ended form.
Categories of investors that are allowed to purchase units or shares of Italian reserved AIFs.
Assets eligible for investments by Italian closed-ended AIFs. The Draft Ministerial Decree expressly provides that Italian closed-ended AIFs can also use their assets for the provision of lending. However at this stage it is still uncertain whether such new provisions will also be included in the final version of the Draft Ministerial Decree.
The AIFMD Decree introduced a transitional regime applicable to the activities performed by Italian AIFMs as well as to the marketing in Italy of foreign AIFs, providing that:
The regulations in force on the basis of the provisions of the Consolidated Law on Financial Intermediation that have been repealed or amended pursuant to the AIFMD Decree will continue to apply until the implementing regulations of the AIFMD come into force. During the transition period, the Bank of Italy and Consob will continue to exercise regulatory and inspection powers provided for under the Consolidated Law on Financial Intermediation before the AIFMD Decree enters into force.
Any SGRs managing AIFs on the date the AIFMD Decree enters into force must be regarded as being already authorised as AIFM in accordance with the AIFMD framework. Such SGRs will have to inform the Bank of Italy and Consob by 22 July 2014 that they comply with the new AIFMD implementing provisions.
The new rules on the marketing of non-EU AIFs and AIFs managed by non-EU AIFMs that are consistent with the AIFMD passport regime for AIFMs or AIFs established in third countries will enter into force on the date specified in the delegated act to be adopted by the European Commission (Article 67, paragraph 6, AIFMD).
In addition, in a joint communication issued in July 2013, the Bank of Italy and Consob clarified that EU AIFs managed by EU AIFMs and already authorised in their home member state pursuant to the national provisions implementing the AIFMD, can be marketed in Italy under the AIFMD passport regime. This communication is in line with the ESMA opinion on the practical arrangements for the late transposition of the AIFMD (ESMA/2013/1072). Such EU AIFMs may also activate the AIFMD passport to provide their activities in Italy under the freedom to provide services or freedom of establishment.
Other recent reforms and legislative proposals that may affect Italian collective investment undertakings include:
The AIFMD introduced certain provisions aimed at defining the competent authorities and identifying the relevant authorisation and marketing procedures for the purpose of:
EU Regulation no. 345/2013 on European Venture Capital Funds (EuVECA).
EU Regulations no. 346/2013 European Social Entrepreneurship Funds (EuSEF).
Certain new provisions were introduced through Law Decree no. 145/2013 (amended to Law no. 9 of 21 February 2014). The new provisions clarified a number of aspects relating to securitisation transactions carried out through investment funds (fondi comuni di investimento). They extend the possibility for Italian insurance undertakings to invest in units of investment funds that are mainly invested in bonds or similar instruments issued by non-listed companies (so-called mini-bonds) to cover their technical provisions. The rules applicable in relation to any such investments made by Italian insurance undertakings have been further specified in the IVASS Communication of 23 January 2014 (IVASS Communication).
The IVASS Communication clarified that the units or shares of EU AIFs that are marketed in Italy under the AIFMD passport regime are included in the list of eligible assets for the investments made by Italian insurance undertakings to cover their technical provisions. This must be in accordance with the limits specified under the applicable regulations. Accordingly, the IVASS Communication has removed certain restrictions that were previously applicable to these kinds of investments, thereby facilitating the investments made by Italian insurance undertakings in EU AIFs marketed in Italy under the AIFMD passport regime.
A consultation paper has been issued by Consob on 28 May 2014 in relation to certain new provisions applicable to the distribution of complex financial products to retail clients. These rules will impose certain limitations, including in distribution to retail clients of AIFs with a leverage beyond a pre-determined threshold, AIFs investing in credits and/or securitisation instruments and in instruments issued by distressed companies (among others).
On 22 July 2013, the Bank of Italy issued a communication on the adequacy of the procedures for the assessment of credit risk and the use of ratings in the context of collective asset management activities.
On 8 May 2013, the Bank of Italy published certain amendments to the regulation of 8 May 2012 on collective asset management activities. These were mostly aimed at implementing the ESMA guidelines on ETF and other UCITS issues.
Other possible changes to the Italian regulatory framework may derive from the approval of the Proposal for a Regulation on European Long-term Investment Funds (ELTIFs) which has been put forward by the European Commission on 26 June 2013, as well as from the implementation of the UCITS V Directive.
Tax incentive schemes
The European Commission has issued guidelines in Communication Europe 2020 to facilitate access to venture capital and support the growth of new enterprises, using investment funds. According to these guidelines, any income from capital arising from participation in funds for venture capital (FVC) will not be subject to income tax. The FVCs and the target companies of FVC investments must meet certain conditions to qualify for the tax exemption. A decree of the Minister of Economy and Finance for applying these provisions and implementing the guidelines has recently been enacted.
In order to facilitate sustainable growth, economic development and young entrepreneur initiatives, additional tax incentives are provided for individuals and companies who invest in innovative start-up companies. For the purpose of such tax incentives, an innovative start-up company is a company resident in Italy or in a EEA country (with a permanent establishment in Italy) that has been established for longer than 48 months and whose exclusive or main object is the development, production and commercialisation of innovative goods or services of high technological value.
Such incentives consist of a percentage deduction of the investment made in the tax periods 2013, 2014, 2015 and 2016. In order to benefit from such tax incentives, the investment can be carried out directly or indirectly through participation in an investment fund or in a company whose assets comprise at least 70% by investments in innovative start-up companies.
The most common legal structure used by Italy-based funds is the closed-ended investment fund (fondo comune di investimento chiuso) managed by an Italian SGR. The structure is well adapted to the process of selection, managing, monitoring and divestment of investments in the private equity industry, because:
The separation between the fund and the management company allows the management team to choose investment opportunities autonomously and rapidly.
The fund's duration allows the investors to achieve the result of their investments within certain period of time.
The fund's closed-end term allows the investors to exit from the fund at predefined and specific times. This allows the management company to have a capital reserve available that remains relatively stable and constant over time.
Investment funds set up by SGRs are similar to limited partnerships organised under English law, with dissociation between managers, fund sponsors and third party investors. However, SGRs are more strictly regulated (to provide protection to retail investors) than limited partnerships and therefore there is less room for contractual autonomy.
As anticipated, the AIFMD Decree introduced a new form of collective investment undertaking (that is, the SICAF), which may be used also for the purpose of setting up private equity investment vehicles.
A SICAF is a closed-ended investment company organized in the form of a joint-stock company (società per azioni) which is subject to the same provisions applicable under Italian law as to Italian closed-ended investment funds. It can be managed by a board of directors or by an external management company (such as an Italian SGR).
According to the new provisions included in the Consolidated Law on Financial Intermediation:
A SICAF must be established in the form of a joint-stock company.
The corporate purpose of the SICAF must be limited to the collective investment of the capital collected through the issue of shares or participating financial instruments (strumenti finanziari participativi).
The registered and administrative office of the SICAF must be in Italy.
The SICAF must have a share capital at least equal to the minimum amount identified in the implementing regulations of the Bank of Italy.
The directors, statutory auditors and senior managers of the SICAF must satisfy certain reputational, professional and independence requirements.
The relevant shareholders of the SICAF must possess certain good standing requirements.
Other legal structures that may potentially be used in the context of private equity transactions include:
Joint stock companies (società per azioni) (SPA).
Limited liability companies (società a responsabilità limitata) (SRL).
Partnerships limited by shares (società in accomandita per azioni) (SAPA).
Co-operative and mutual insurance companies (società cooperative e mutue assicuratrici).
European companies (societá europee).
European co-operative companies (societá cooperative europee).
Special purpose acquisition companies (SPAC).
It should be noted; that the above legal structures cannot be used in order to set up private equity funds vehicles, in case they fall within the scope of the definition of collective investment undertaking introduced through the AIFMD Decree.
Foreign legal structures commonly used to invest in Italy include:
Luxembourg holding and financing company scheme (société de participation financière) (SOPARFI).
Luxembourg venture capital investment vehicle (société d'investissement en capital à risque) (SICAR).
UK limited partnership (LP) or general partnership (GP), usually investing through a Luxembourg special purpose vehicle.
Italian investment funds (OICR) are not subject to income tax. Interest income, dividends and capital gains are received by the fund gross of withholding taxes (with some exceptions), and contribute to the year-end operating result of the fund.
Investor income is taxed as income or capital gains. The tax treatment depends on the investor's tax residency.
Italian tax residents. Investor income includes:
Income received by investors on the distribution of earnings by the fund.
A positive difference between the value of units on redemption and their value on subscription or purchase.
Investor income is taxed as follows:
Individuals and non-commercial entities (for example, banking foundations) are subject to a 20% final withholding tax (26% as of 1 July 2014).
Individual entrepreneurs' investor income qualifies as business income, and is included in their taxable income subject to progressive individual income tax rates.
Corporate entities' investor income is taxed at the ordinary 27.5% corporate income tax rate.
Capital gains realised through the sale of units are taxed as follows:
Individuals and non-commercial entities are subject to 20% capital gains tax (26% as of 1 July 2014).
Individual entrepreneurs' investor income qualifies as business income, and is included in their taxable income, subject to progressive individual income tax rates.
Corporate entities are subject to corporate income tax at the ordinary 27.5% corporate income tax rate.
Capital loss relief may be available.
Non-Italian residents. Non-residents' investor income and capital gains from the sale of units are subject to a 20% final withholding tax (26% as of 1 July 2014). An exemption applies to a non-Italian resident investor who is any of the following:
A resident, for tax purposes, in a country which allows for a satisfactory exchange of information with the Italian tax authorities (a country on the white list).
An international body or entity set up under international agreements in force in Italy.
A central bank or other entity authorised to manage the official reserves of a state.
Subject to certain exceptions, an institutional investor established in a white-listed country, even if it is not a taxpayer in its country of establishment.
In addition, non-resident investors who do not qualify for this exemption may be exempt from tax in Italy under an applicable double tax treaty.
Joint stock companies, limited liability companies, partnerships limited by shares and co-operative and mutual insurance companies which are tax resident in Italy (see Question 6) are subject to Italian corporate income tax on their worldwide income. The ordinary corporate income tax rate is 27.5%.
Dividends received by an Italian company from participation in a company (excluding partnerships) benefit from a 95% discount on the taxable amount of the dividend, for an effective tax rate of 1.375% on the dividend. This exemption does not require a minimum holding percentage or minimum holding period. The same exemption is available, under certain conditions, for capital gains realised by an Italian company from the disposal of shares or quotas in Italian companies, and non-resident companies that are not resident in a tax haven.
A 20% final withholding tax (26% as of 1 July 2014) is levied on dividends paid to both non-resident companies and individuals. For certain EU-resident companies, the final withholding tax rate for dividends received is 1.375%. These withholding taxes may be reduced or eliminated under an applicable double tax treaty or the EU Council Directive 90/435/EEC of 23 July 1990 (Parent Subsidiary Directive).
Partnerships are tax transparent entities and are not subject to corporate income tax. Their partners are directly taxed on their share of the partnership's profits.
Private equity funds typically seek to achieve medium-term capital gains on their investments, which are usually measured in terms of internal rate of return (IRR) and money multiples. Historically, private equity funds have targeted annual IRR of 20% and above.
The average term of a private equity fund ranges from three to five years. During the investment and commitment period, the fund manager may require the investors to draw down new investments, while the remainder of this period is used by the manager to increase the value of the portfolio investments and seek profitable exit opportunities.
Fund regulation and licensing
SGRs are treated as financial intermediaries, which must be authorised by the Bank of Italy to provide collective portfolio management services. SGRs must be set up as joint stock companies and have a minimum share capital of EUR1 million. SGRs' directors, auditors and general managers must satisfy certain reputational, professional and independence requirements. SGR shareholders must satisfy certain reputational requirements. An SGR's authorisation is subject to assessment by the Bank of Italy of the SGR's activity programme and organisational structure.
An SGR that manages private equity funds typically consists of:
A board of directors, which has final responsibility for decisions relating to the fund's investments and exits.
An executive committee, consisting of certain members of the board of directors, which assesses proposals presented to the board of directors.
One or more managing directors, who co-ordinate the SGR's activity.
A management team, composed of top managers, which represents the company's operational engine, selecting the options for the fund's investments and exits.
If SGRs lack the capabilities to manage a business or investment internally, they can delegate the management of one or more stages of the investment activity to third party advisers but cannot avoid responsibility for the activities carried out by them.
Private equity funds are normally set up as investment funds (fondi comuni di investimento) and, together with other forms of investment, are considered to be collective investment undertakings.
A public offering of private equity fund units requires prior approval by Consob and the publication of a prospectus. Certain exemptions may be available (see below, Exemptions).
An SGR can market the fund units directly, at its offices through distance marketing techniques or tied agents (promotori finanziari), or indirectly through one or more placement agents.
The same provisions specified above also apply to the marketing of private equity funds that have been set up in the form of a SICAF in accordance with the new provisions introduced by the AIFMD Decree.
A public offering of private equity fund units does not require publication of a prospectus and prior approval by Consob if certain exceptions, including any of the following exemptions, apply:
An offer of units addressed to no more than 150 potential investors in Italy (other than Markets in Financial Instruments Directive (MiFID) professional investors).
An offer addressed to MiFID professional investors.
An offer of units totalling less than EUR5 million, calculated over a period of 12 months.
An offer involving securities for a total consideration of at least EUR100,000 per investor in each separate offer.
As a general rule, no nationality or number restrictions are imposed on investors in private equity funds.
However, until the AIFMD implementing provisions enter into force, the current legal framework is applicable. Under the current framework, the units of private equity funds established in the form of Italian “reserved” AIFs (as it normally is the case in Italy) may only be marketed to qualified investors falling within one of the following categories:
Investment companies, banks, exchange agents, SGRs, SICAVs (that is, a common type of open-ended collective investment scheme), pension funds, insurance companies, finance companies that are parent companies of banking groups and other financial entities.
Authorised foreign entities that engage in the same investment activities as those referred to above.
Natural and legal persons and other entities with specific knowledge and experience in securities transactions.
As anticipated, the rules on the marketing of Italian reserved AIFs will change with the implementation of the AIFMD. In particular, under the new regime, the units or shares of Italian reserved AIFs may only be marketed to:
MiFID professional investors.
Other categories of investors that are identified under the Italian implementing regulations. Such types of investor will be specified in the final version of the Draft Ministerial Decree.
There are no statutory limits on investment periods in private equity funds, except that the maximum duration of a common fund cannot exceed 50 years.
For some specific funds, investors may be required to subscribe for a minimum quota of EUR50,000 each. However, based on the provisions included in the Draft Ministerial Decree, the minimum limit could be removed under the new regulatory regime.
For funds that are restricted to qualified investors, units can only be transferred to persons and entities included within specific categories (see Question 12).
The fund rules may contain other restrictions.
The relationship between investors and the private equity fund is governed by the fund rules. Approval of the fund's rules by the Bank of Italy is not required for funds reserved to particular categories of investors or for speculative funds. In addition, under the new regime introduced with the implementation of the AIFMD, no such approval will be required in relation to Italian reserved AIFs.
Typical protection terms that investors seek in the fund rules include:
Certain governance powers, such as the power to appoint the members of the fund's advisory committee, as these powers can express binding opinions on conflict of interest transactions and non-binding opinions on certain other matters.
The right to request, under certain circumstances, the suspension of the investment period or the early winding-up of the fund.
Information and reporting duties for the fund's managers.
Provisions regulating the meeting of participants of closed-end funds were issued in 2010. The rules of a closed end reserved to qualified investor fund can identify some issues which require authorisation by a resolution of a meeting. In any case, a meeting of the investors must be called to vote on a replacement of the SGR, admission to listing (where this is not provided for) and changes to the investment policy. However, some of these provisions are no longer included in the Draft Ministerial Decree regarding closed-ended AIFs.
It is common for a newly established fund to adopt rules aimed at facilitating fundraising on both domestic and international markets in line with international best practices.
Interests in portfolio companies
In a typical buyout, a company is acquired by the private equity fund, using equity and bank loans. Equity is provided by the private equity fund, the target company's management (either incumbent or new) and, occasionally, the seller.
A typical equity package comprises both true equity, in the form of ordinary shares or preference shares (whether convertible or not) or a combination of these, and quasi-equity, usually in the form of a subordinated shareholder loan or convertible bonds/warrants. Generally, management equity consists of ordinary shares only.
A preference share is a form of hybrid security. Preference shares differ from ordinary shares in that they generally have a preferential right to receive dividends and participate in any distribution on liquidation of the company. A convertible preference share, in addition to the traditional preference share rights, entitles the holder to convert it at some future point into another security, such as an ordinary share.
Investor loans are often used because of their tax advantages. Typically, they have a long maturity and interest payment is capitalised due to restrictions on dividends and other payments under the acquisition finance package. They are generally treated as if they were equity by acquisition finance providers because of these characteristics.
For an overview of the main forms of debt financing, see Question 23.
Advantages and disadvantages
See above, Common forms.
The issuance and transfer of shares in a company are not themselves subject to any legal restrictions. However, the company's bye-laws or the shareholders' agreement generally include restrictions on the transfer of shares, such as tag-along, drag-along rights and similar provisions, which entitle the fund to force the other shareholders (and give them the right) to sell their shares on exit. The management team is typically prohibited from transferring their shares until exit and is subject to good and bad leaver provisions under their service agreements.
In the last few years auctions have become fairly standard for buyouts of private companies. Although there are no specific laws or rules governing auctions, these procedures generally follow a specific path. First, a limited number of potential buyers are contacted by the seller's financial advisers. After signing a non-disclosure agreement, interested buyers receive an information memorandum with information on the target company and its business. Buyers are then invited to submit indicative, non-binding offers, following which a limited number of them are invited to conduct due diligence (with documents normally posted in a virtual or physical data room) and attend management presentations. Vendor due diligence reports are fairly standard. Generally, during this phase, buyers receive a first draft of the purchase agreement prepared by seller's counsel. At the end of this phase buyers submit their bid, together with a mark-up of the purchase agreement and other related documents. One buyer is then selected to conduct final negotiations with the seller and finally sign the definitive agreement.
Occasionally, businesses are sold in private transactions. This is much preferred by private equity houses because of the lack of competition and because of the higher level of information that they typically receive from sellers. Sellers have been willing to follow this path (instead of an auction) where there is a very committed buyer who could offer certainty of closing within a relatively short time frame.
Public to private transactions are not uncommon but are more complex to execute compared to transactions involving private companies.
Italian public to private transactions are regulated by the Consolidated Securities Act of 1998 and numerous Consob regulations. These transactions are generally structured as multi-step acquisitions in which the buyer:
First acquires all of the shares of the target company owned by one or more sellers owning a controlling block of shares.
Then commences a mandatory tender offer seeking to acquire all of the target company's outstanding voting shares.
To take the target company private, the offer is generally followed by a mandatory buyout of the remaining shares if the buyer is able to acquire 90% or more of the voting shares (and the subsequent exercise of a squeeze-out right over the minority shareholders of the target company if the buyer acquires 95% or more of the target shares).
Alternatively, assuming the buyer then holds a sufficient number of target company voting shares to approve it, the second end of the transaction can be structured as a forward merger of the target company with and into the buyer, with the latter remaining as the surviving entity. A merger triggers withdrawal rights for the target company's dissenting shareholders.
The principal document between the seller and the buyer is typically the sale and purchase agreement. In a cross-border transaction the parties usually have a master purchase agreement and local transfer instruments that are designed to make the transfer effective in each local jurisdiction in accordance with applicable legal requirements.
The buyer and the incumbent management team, in connection with the funding of the acquisition entity, usually enter into investment agreements, shareholders' agreements and directorship/employment agreements. Depending on the structure of the financing, the buyer may also be required to grant the acquisition entity one or more loans in addition to equity capital contributions.
Private equity firms usually provide the seller with an equity commitment letter, under which the fund commits to provide the equity capital to the acquisition entity, subject to certain conditions in the acquisition agreement. It is not uncommon for the seller to seek the status of a third party beneficiary under the equity commitment letter, to have a right against the fund if the fund fails to provide the equity capital at closing. However, the parties enjoy broad powers to shape the rights of recourse against the fund in favour of the seller.
Bank financing is almost invariably present in any private equity transaction (see Question 23).
In the highly competitive pre-financial crisis environment and also remaining in the current market environment for highly contested target companies, the offering of very limited contractual protection to buyers was and is still common. Thereby requiring buyers to conduct deeper due diligence to compensate for low contractual protection, which often did not extend beyond:
Title and other very basic warranties.
Restrictive covenants to maintain the status of the target as of the reference accounts date by preventing cash leakage (such as a locked box mechanism).
Locked-box mechanisms involve both:
A fixed equity price for the target company agreed between the parties based on pre-signing accounts (generally audited).
A warranty from the seller (with corresponding indemnity) that no leakage has occurred or will occur from the date of accounts and completion. Leakage is broadly defined to include dividends, distributions, management fees and other charges paid to the sellers, for example, the repayment of shareholder debts. Exceptions include payments in the ordinary course of business.
They are still widely used in secondary buyouts and are favoured by sellers as they provide price certainty.
An alternative to a locked-box mechanism is an estimated equity price and post-closing price adjustment. Typical price adjustment factors include net financial debt and net working capital. This is generally used in a corporate carve out or similar transactions, in which stand-alone accounts are missing. Purchase price adjustment clauses are usually heavily negotiated between the parties.
Buyers can also use vendor financing and contingent purchase price payments (earn outs or similar mechanisms) to bridge the gap between the seller's price expectations and the buyer's available resources or business valuation.
Key contract terms relating to deal certainty, such as financing conditions and other customary conditions precedent, material adverse change provisions and reverse break-up fees, receive significant attention.
Representations and warranties
Buyers usually expect to receive a full range of representations and warranties covering all matters regarding the target company. However, in the secondary buyout market, private equity funds generally limit the representations and warranties they give to title and the seller's ability to complete the transaction. Similarly, in public to private transactions, bidders proceed with a transaction based only on due diligence without warranty or indemnity protection (other than those that may be given by controlling selling shareholders).
If sellers are not willing to give representations and warranties concerning the target business, buyers generally look for warranties from selling managers. Although these warranties have financial and practical limitations, they are generally sought to get disclosure of information.
The warrantor's liability for breach of warranties is usually subject to a number of limitations, which are usually heavily negotiated. Key limitations are:
A time limitation.
Financial limitations, such as:
an overall cap on the aggregate maximum liability;
a minimum level for individual claims; and
basket limits (a minimum amount of claims before liability attaches).
Whether the buyer has knowledge of the relevant matter.
Whether other sources of redress (that is, third-party claims or insurance) have been exhausted.
Specific known issues (including, for example, pre-closing tax or contingent environmental liabilities) are sometimes dealt with through specific indemnities.
Part of the consideration may be put in escrow to cover risks under warranty claims or other specific liabilities.
Other buyer protection
Other forms of buyer's protection include:
An M&A insurance policy for the benefit of the acquirer.
Interim covenants, which limit the seller's actions between signing and closing without the buyer's consent. Key areas are the buyer's control over debt, working capital, capital expenditure, litigation, personnel and M&A transactions involving the target company.
These contractual protections normally do not apply in buyouts of listed companies. However, if there is a multi-step acquisition in which the buyer first acquires a controlling block of shares, some of the above contractual protections may apply (see Question 17).
Managers of a portfolio company who take a position as director owe fiduciary duties to the company. In general terms, directors must act in the best interests of the company. The interests of the company are normally equated with the long-term interests of its shareholders.
While the law does not prohibit directors from being involved in or soliciting a management buy-out (MBO), they must act in good faith and in a manner that avoids conflicts of interests or misuse of fiduciary powers. Directors have a statutory duty to declare at a directors' meeting the nature of any interest that they may have in any contract, or proposed contract, with the company. If they are executive directors of an Italian joint stock company, they should even abstain from voting on the relevant matter. Directors must therefore inform the competent body of the company when they expect to approach potential investors in relation to an MBO.
Typical terms of employment in individual service contracts and the shareholders' agreement include:
Restrictive covenants (under which managers are prevented from taking various actions).
Non-compete obligations (under which managers assume obligations not to compete with its employer for a specified period of time).
Non-solicitation obligations (under which managers are prevented from soliciting another employee to leave the company and/or customers to do business with another company).
Confidentiality obligations (under which managers are prevented from using or disclosing any of the company's confidential information).
Managers are commonly incentivised in their capacity as shareholders (by good leaver or bad leaver provisions) or other employment instruments giving share options or other incentive securities. The bye-laws or the shareholders' agreement may give additional protection to the investor by:
Allowing the company to redeem management shares.
Granting to other shareholders an option to purchase management shares, when the holders leave the company.
Prohibiting transfer of management shares without the prior consent of the private equity investor.
A private equity fund controls the majority of the acquisition vehicle's equity in a typical single sponsor transaction. Therefore, private equity funds secure rights to nominate and elect directors and they do so with a view to protecting their interest in both the acquisition vehicle and the target company.
However, once appointed, the nominee is legally required to ignore the underlying rationale for the appointment and to promote the company's interests at the expense of those of the fund. The private equity fund can remove directors at any time, although if the removal is without cause, then directors are entitled to recover damages, which are usually determined as an amount equal to the remaining compensation that they would have received if they had held the office until its natural expiration.
It is common for the private equity fund and the other equity holders (including managers) to enter into a shareholders' agreement giving the fund a right to nominate a majority of the company's directors and appropriate voting provisions to ensure that the sponsor controls a board majority. If the sponsor invites minority investors to participate in the transaction, shareholders' agreements may offer the minority shareholders exit rights and veto rights over certain fundamental matters. However, the sponsor typically exerts control over exit transactions by reserving drag-along rights, rights to request an initial public offering (IPO) of the shares of the company and other similar rights.
In general, 2013 also saw an increased use of leverage by private equity funds. The average net debt used to finance transactions grew more than 50%, reaching EUR52.5 million, against EUR25 million in 2012. On average, in 2013, the net debt paid was 2.5 times the target's earnings before interest, tax, depreciation and amortisation (EBITDA), higher than the 2.2 multiple reached in 2012, but still below the pre-crisis value of 4.5 times EBITDA experienced in 2007. In addition, the debt-to-equity ratio in buyout measures 1:2 compared to 1:3 in 2010 and may further increase in the future depending on the economic downturn and on the forms of debt financing used in private equity.
In this respect, the principal form of debt finance continues to be senior debt, which is provided by banks and institutional lenders. Senior debt is generally guaranteed by all companies of the group (including the target company) and is secured over all of their assets, subject to certain limitations. Senior debt has a shorter maturity compared to the other debt finance and is typically amortising. The facilities generally provided in a senior finance package include a:
Term facility (used to fund the acquisition).
Capital expenditures facility.
Revolving credit facility (working capital facility).
The senior loan facility agreement typically contains detailed provisions designed to protect the lenders' investment (see Question 24, Contractual and structural mechanisms).
Junior debt is used, particularly in larger transactions, to increase the total amount of debt available and to bridge the gap with the equity package. Junior debt generally takes the form of:
Second lien debt.
Payment in kind (PIK) loans.
All junior debt ranks behind the senior debt in terms of priority of repayment.
The seller can also provide a source of finance, typically in the form of deferred consideration or an earn-out.
Typically, acquisition finance is funded by a bridge facility provided by the senior lenders, which is taken out sometime after the funding of the senior term facility following a merger of the acquisition vehicle with the target (which then becomes the borrower) or through a refinancing (debt pushdown). Most often, the senior debt is made available to the acquisition vehicle (in the form of a bridge loan) to finance the acquisition, and to the target company to refinance its existing debt and for working capital purposes.
Mezzanine debt ranks behind senior debt and, as a result, has a higher interest rate. Typically, there is just one borrower, the acquisition vehicle, but sometimes senior lenders require junior debt to be structurally subordinated (see Question 24, Contractual and structural mechanisms). It generally matures later than the last tranche of the senior debt and is repayable in one bullet instalment. The margin generally includes a PIK element in addition to a cash element. Financial covenants are present but typically contain more headroom. It is fairly common for warrants giving the right to subscribe for shares in the borrower at a predetermined price to be issued to the mezzanine lender as part of the package.
Law Decree no. 83/2012 introduced urgent measures for growth (Decree for Growth), as implemented into law by Law no. 134/2012 (Act of Conversion). It has introduced significant regulatory changes to expand opportunities for Italian non-listed companies to access the capital market. It removes fiscal and corporate limitations that penalised such companies in comparison to equivalent companies in other European countries. In particular, in relation to:
Abolishing the obligation of non-listed Italian companies to meet certain conditions to issue bonds.
The duration of, and conditions for the issue of, finance bills.
The tasks assigned to the sponsor.
The tax regime applicable to such securities has been aligned to the more favourable tax regime for securities issued by larger issuers (that is, banks and listed companies). In particular, in relation to the following:
Exemption from withholding tax.
Deductibility of interest expenses.
Deductibility of expenses of the issue.
Exemption from stamp duty.
The Act of Conversion confirms that the quantitative limits on the issue of bonds set out in the Civil Code should not apply to securities, to the extent that the bonds are intended to be traded on regulated markets or multilateral trading facilities, if certain conditions are met.
All historical data in this question is from Il mercato italiano del Private Equity e del Venture Capital nel 2010, published by the AIFI and from Private Equity Monitor Italia 2010, published by PEM Observatory.
Bridge acquisition facilities are usually secured by either or both of:
A pledge over the shares of the acquisition vehicle and the shares of the target group.
An assignment by way of security or a pledge of the receivables arising under the acquisition documents or under any shareholder loan documents.
Following the debt pushdown, the senior debt security package typically includes full asset security from each company in the target group (including the acquisition vehicle), sometimes subject to a materiality threshold. Although Legislative Decree no.142/2008 has introduced the possibility to give financial assistance (subject to certain limitations and compliance with certain requirements (see Question 25)), significant legal and tax constraints still apply to the giving of upstream or cross guarantees and related security.
Contractual and structural mechanisms
Typically, structural subordination is effected by using more than one special purpose vehicle.
Senior debt is typically at the top of the capital structure and is not subordinated to any other type of finance. The acquisition facility is first borrowed directly by the acquisition vehicle and then pushed down to the level of the target company after the acquisition. Other senior facilities are generally made available to the target company after the acquisition.
Typically, senior creditors are party to an inter-creditor agreement with the other finance providers. This agreement governs matters such as:
Acceleration and enforcement rights.
Incurrence of additional indebtedness.
Release of security and guarantees.
The senior loan facility agreement typically contains detailed provisions designed to protect the lenders' investment. These mechanisms are generally determined on a case-by-case basis but such provisions almost invariably include:
Voluntary and mandatory prepayments.
Extensive representations and warranties.
Information, business and financial covenants.
Events of default.
Milestones to be complied with to continue to use the financing.
Subordination of any other ways of financing to the senior loan.
The giving of financial assistance by a company, through either granting of loans or providing securities or guarantees, for the purposes of the acquisition or subscription of shares in itself is prohibited. In addition, a company is prevented from accepting its own shares as security or guarantee, even through a fiduciary or any other entity.
The Civil Code now permits the giving of financial assistance when it has been approved by special resolution of the extraordinary shareholders' meeting of the company. There are two limitations on this to protect the interests of creditors:
The assistance must be provided out of distributable profits and available reserves as reflected in the latest approved accounts.
There must be a statutory declaration of solvency by the directors of the company.
Other exemptions exist which are intended to allow companies to support employees' share schemes and other share acquisitions by employees.
In a leveraged buyout (LBO) before completion, the directors of the acquisition vehicle and target must consider the financial resources that are necessary to repay the debt incurred due to the acquisition, and there are specified procedural requirements for this. However, this does not exclude the financial assistance rules.
The order of priority on insolvent liquidation is regulated by the Bankruptcy Act. Creditors have priority over equity holders, which are regarded by law as residual claimants. This may apply to shareholders' loans, which may be subject to equitable subordination.
As a general principle, secured creditors holding valid fixed charges over specific assets of a company are satisfied to the exclusion of all other creditors, including secured creditors of a lower rank (for example, first degree mortgage over second degree mortgage).
Certain other creditors enjoy the status of preferred creditors (such as employees with outstanding wages). The Civil Code gives very detailed rules regulating priority conflicts between secured and preferred creditors.
Creditors can agree to contractual subordination by signing subordination or other inter-creditor agreements. Inter-creditor agreements also typically prohibit any payments to shareholders by way of dividends or through redemption of shares until full repayment of senior creditors.
Debt holders can achieve equity appreciation through conversion features on terms which provide for the investor to be able to convert its debt security into a share in the borrower at a later date.
A debt instrument with an attached warrant is similar to a convertible bond. The warrant gives the holder the option to subscribe to shares. The debt-plus-warrant structure differs from convertible bonds in that exercise of the warrant does not bring the debt instrument to an end, whereas the debt instrument disappears when a conversion right is exercised.
The characteristic shared by convertible bonds and warrants, and which makes them both hybrid securities, is that they offer their holder the opportunity to participate in capital growth, thereby requiring the portfolio company to set aside a portion of its share capital to service such holders.
A debt holder can receive newly issued shares of the company in exchange for a waiver of its outstanding claim against the company, subject to passing a specific resolution of the extraordinary shareholders' meeting, and other procedural requirements. The terms of this transaction may be part of investment agreements and in many cases are conditional on various circumstances.
Portfolio company management
Common management incentives, which may be combined, include:
Compensation plan based on performance. Individual service agreements may provide for a variable compensation scheme based on the performance of either the portfolio company or the individual. Payments are usually related to key metrics reflecting the performance of the portfolio company, such as EBITDA, sales or net income. Compensation plans are allocated to have minimal effect on reported earnings. Payments are treated as employment income for tax purposes and are fully subject to personal income tax (at a maximum 43% rate) in the hands of the recipient. In some cases, a tax efficient structuring of such schemes may be based on the issuance of equity-like securities.
Stock options. Managers may be granted options structured as a right for an individual manager, or group, to buy shares of the portfolio company at a fixed or formula price (subject to adjustments) over a stated period of time. The option is usually issued by the company itself, to be satisfied by newly issued shares, but this is not necessarily the case.
The use of stock options is less common than in other jurisdictions due to an unfavourable tax regime. There is no exemption from personal income tax on the increase in value between the grant and the exercise of the options. Under certain circumstances, some forms of phantom stock plans can prove to be more tax efficient.
Equity interests. Managers may be granted direct or indirect (strumenti finanziari partecipativi) equity participations in their portfolio company, which may enhance their attractiveness by issuing securities at a discount.
Golden parachutes. Employment contracts may provide for parachute payments to managers, contingent on a change in ownership or control of a portfolio company or its assets. Their value usually does not exceed the individual's average annual compensation for two fiscal years.
Compliance with anti-corruption laws is typically included in the representations and warranties of the sale and purchase agreement. In addition, it is fairly common to include specific anti-bribery and/or anti-corruption policies in the shareholders’ agreement with the management.
Violations of anti-corruption or anti-bribery laws by directors can give rise to civil liability for breach of fiduciary duties. In addition, criminal sanctions can apply, with monetary fines and/or imprisonment depending on the specific factual circumstances. In certain cases, a company whose directors are found guilty of violations of anti-corruption or anti-bribery laws can be sanctioned with monetary fines and/or interdiction orders (Law Decree no. 231/2001).
Forms of exit
IPO, sale (trade sale or secondary buyout) and recapitalisations are all typical forms of a successful exit.
Advantages and disadvantages
IPO. Historically, the IPO has been a successful form of exit for private equity funds. The major benefit of an IPO is that the private equity fund does not need to subscribe to burdensome warranties or absorb price contingencies, which can happen in a trade sale. Other advantages can include a higher valuation (depending on the market), prestige and access to more capital and liquidity for the longer-term shareholders (including managers). The downside is that the process is longer, relatively costly and may not allow a full exit by the private equity house. The exit through an IPO is typically delayed by lock-up periods, usually ranging from six to 12 months for financial selling shareholders.
Trade sale. Trade sales, either to a trade buyer or to another private equity house (usually with the management reinvesting), are generally structured as a sale of 100% of the shares of the acquisition holding company. Trade sales usually offer the advantages of deal speed and closing certainty while minimising continuing exposure to liability. Sales by private equity houses generally take the form of an auction.
Dual tracking. Sometimes, especially in the case of larger companies with well-recognised brands and strong management teams, private equity houses pursue an exit through an IPO in parallel with a trade sale until they choose which route will achieve the highest value.
Recapitalisations. Typically, in a leveraged recapitalisation the portfolio company borrows debt and uses the proceeds to pay a special dividend to the private equity house. Financial assistance issues need to be carefully addressed in this type of transaction (see Question 25).
Private equity sponsors typically exit from an unsuccessful portfolio company due to financial distress, unless the management is willing to try to acquire the company and attempt a turnaround. Private equity sponsors usually enter into negotiations with financial investors specialising in turnaround situations and restructuring.
Some forms of pre-packaged bankruptcy have continued to remain attractive in 2013 because of the number of healthy companies that were unable to refinance pending debt maturities in what remains a closed debt market. Other techniques used by private equity funds to avoid the costs and value loss of bankruptcy are the restructuring plans provided for by the Bankruptcy Act and other forms of compositions with creditors.
*This chapter was written in collaboration with Massimo Antonini (Tax), Luca Bonetti (Banking) and Alessandro Portolano (Regulatory).
Private equity/venture capital association
Italian Private Equity and Venture Capital Association (Associazione Italiana del Private Equity e Venture Capital) (AIFI)
Status. AIFI is a non-governmental organisation and a non-profit association.
Membership. AIFI has 123 full members and 119 associate members.
Principal activities. AIFI's main activities are:
Supporting and facilitating the development of private equity and venture capital activity in Italy and abroad.
Representing its members.
Increasing awareness and understanding of the private equity and venture capital industry in Italy.
Conducting research and publishing reports and working papers.
Collecting and presenting information about the industry.
Organising educational programmes.
Italian Tax Authority (Agenzia delle Entrate)
W http://def.finanze.it/DocTribFrontend/RS1_HomePage.jsp (only in Italian)
Description. This is the official website of the Italian tax authority.
National Commission for Companies and the Stock Exchange (Commissione Nazionale per le Società e la Borsa) (CONSOB)
Description. This is the official website of CONSOB, the public authority responsible for regulating the Italian securities market. In the legal framework section, there is the updated text of Legislative Decree 58 of 24 February 1998 (Consolidated Law on Financial Intermediation), including an English version (only the Italian version is authentic).
National Central Bank: Italy
Description. This is the official website of the Bank of Italy. In the legal framework section, there is the text of Legislative Decree 385 of 1 September 1993 (Consolidated Law on Banking) but only in Italian.
Chiomenti Studio Legale
Areas of practice. Corporate; M&A; private equity.