Private equity in Luxembourg: market and regulatory overview
A Q&A guide to private equity law in Luxembourg.
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.
To compare answers across multiple jurisdictions visit the Private Equity Country Q&A Tool.
This Q&A is part of the global guide to private equity. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateequity-mjg.
Family offices and private individuals were the most important source of private equity funding in France and Benelux in 2011 (figures published by the European Venture Capital Association (EVCA), 2012 Yearbook). Contributions to the total amount of funds raised in 2011 also came from the following sources:
Funds of funds: 20.5%.
Pension funds: 16.8%.
Banks: 10% (lower than in 2009 and 2010).
Government agencies: 14.1%.
Insurance companies: 7.8%.
Sovereign wealth funds: 7.3%.
The main players in private equity funds are private equity houses. However, information is not publicly available for non-regulated vehicles.
In relation to the geographical origin of initiators of sociétés d'investissement en capital à risque (SICARs) (the Luxembourg vehicle dedicated to private equity and venture capital):
European initiators dominate, with 87.9%. Of these, French investors initiated the most SICARs with 20.46%, followed by Swiss, German and Luxembourg investors.
US-based private equity houses set up the most non-European SICARs, with 7.788%.
In total, investors came from 31 different countries.
As of December 2012, Luxembourg private equity vehicles included:
15 pension funds (pension savings associations (Associations d' Épargne Pension) (ASSEPS) or pension savings companies with variable capital (sociétés d'épargne-pension à capital variable) (SEPCAVs)).
32 securitisation vehicles.
Some of the 1,485 specialised investment companies (fonds d'investissement specialisés) (SIFs).
Unlike SICARs, SIFs can in principle be used for any type of investment.
Non-regulated entities (incorporated as société de participation financières (Soparfi), société anonyme (SA), société à responsabilité limitée (SARL) and so on) can also be used. However, relevant information and statistics are not publicly available (see Question 3).
Current major trends include the following:
Luxembourg remains the second largest global leader for domiciled funds, behind the US, and is gaining significant ground against offshore centres. In recent years, more than 300 private equity and venture capital funds have been incorporated as SICARs and SIFs.
The industry has seen increasing use of non-regulated vehicles by private equity houses to structure their European acquisitions, such as the Soparfi (see Question 6), of which there are now more than 25,000.
In 2011, SICARs either limited their investment policy to a particular strategy (such as buy, build and sell, buyouts, mezzanine financing or risk capital funds) or a combination of them.
The growing number of SIFs shows that this vehicle is also suitable for private equity investors. SIFs structured as umbrella funds generally offer a compartment dedicated to private equity, alongside sub-funds investing in real estate, hedge funds and listed securities.
Many of the world's leading private equity houses have established sizeable operations in Luxembourg. Service providers such as banks, fund administrators, lawyers and accountants have set up specialised private equity teams.
A major trend resulting from the economic downturn has been the growth of regulation in the private equity industry. Investor concerns have led fund managers to seek well-regulated jurisdictions such as Luxembourg to domicile their funds.
In addition to regulation at European level (such as Directive 2011/61/EU on alternative investment funds managers (AIFM Directive) (AIF Managers) the authorities are working on various changes to the legal and tax regime (see Question 4).
2011 fundraising amount reached EUR39.8 billion (EUR4.85 billion for venture capital and EUR33.25 billion for buyout funds), an overall increase of 80% from 2010. This increase has been initiated by both:
Venture capital funds, with a 50% growth of their fundraising activity.
Buyout and growth funds, which doubled their new funds raised over 2011.
The level of activity in relation to investments by regulated vehicles (see Question 6, Regulated vehicles) is as follows:
SICARs. Based on the provisional figures as at 31 December 2011, the capital commitments of investors in SICARs totalled about EUR17.7 billion. The SICARs' total balance sheet was EUR30.6 billion (CSSF's annual activities report 2011).
Undertakings for Collective Investments (UCIs) (including SIFs). Net assets in non-listed transferable securities and venture capital totalled EUR10.875 billion and EUR0.969 billion respectively, as at September 2012.
There are presently no overall statistics relating to the volume of activity of non-regulated funds (see Question 6, Non-regulated vehicles).
The investment strategies followed by SICARs as at 31 December 2011 were as follows (CSSF Annual Activities Report 2011):
Buy, build and sell investments: 172.
Investments through buyout instruments: 31.
Investments through mezzanine instruments: 15.
Investments by risk capital funds in early stage investments: 83.
In practice, combined strategies are generally used in the area of risk capital.
In terms of assets, risk capital funds recorded an increase by 19.84% in 2011, whereas buy, build and sell decreased by 9.86%. The two other sectors remained quite stable between 2010 and 2011.
In relation to sector-based distribution, 161 entities prefer not to limit their investment policy to a particular investment sector. Among the entities having adopted a specialised policy, there is a certain concentration in the real estate, energy, technology and services sectors.
SICARs' net assets, according to the main investment policy, were as follows (CSSF's annual activities report 2011):
Private equity: EUR12.986 million.
Private equity and venture capital: EUR6.076 million.
Venture capital: EUR2.911 million.
Mezzanine: EUR631 million.
In addition, SIFs include a considerable number of vehicles investing in clean technologies, infrastructure projects and tangible assets such as art, wine, jewellery and similar assets.
No information is publicly available in this respect.
The amount divested increased by 50% to EUR30 billion, compared to EUR20 billion in 2010, matching the 2005 level.
The divestment upturn was triggered by buyout and growth fund activity, which accounted for 92% of the total amount. In 2011, about 1,000 companies were divested in both venture capital and buyout and growth funds.
The most realised exit routes in terms of amount divested in 2011 were trade sale and secondary sale, together representing more than 63% of the market (EUR18.8 billion).
Most divestments by number of companies in 2011 were in the sectors of business and industrial products, computer and consumer electronics and consumer goods and retail.
For venture capital, communications and life sciences were also two important sectors for divestments, as the business and industrial services sector was for the buyout and growth segment (EVCA divestments statistics).
A law of 26 March 2012, which came into force on 1 April 2012, significantly amended the Law of 13 February 2007 in relation to SIFs (SIF Law) to, among others:
Grant more flexibility in the structuring and operation of SIFs.
Increase the regulatory authority of the Commission for the Supervision of the Financial Sector (Commission de Surveillance du Secteur Financier) (CSSF).
Implement by anticipation some of the forthcoming requirements of the AIFM Directive.
The law covers the authorisation process, delegation of specific tasks and functions to third parties, risk management, and conflicts of interest. It also permits cross investment between compartments of SIFs, and modifies reporting and general meeting requirements.
The new bill implementing the AIFM Directive in Luxembourg (AIFM Law) submitted to Parliament on 24 August 2012 will be adopted by 22 July 2013.
In anticipation of the entry into force of the AIFM Directive, private equity fund managers will have to analyse the impact it will have on their business model. In addition, Luxembourg private equity funds' service providers (depositaries, asset managers, investment advisers, administrators, transfer agents, and so on) must also comply with the AIFM Directive.
The existing regulated private equity vehicles (SICARs and SIFs) already display many of the features that will become standard, such as:
Light and flexible supervision.
A depositary bank.
Standards relating to service providers.
Parent passporting of AIF Managers and Alternative Investments Funds (AIF).
Luxembourg limited partnerships
In the framework of the AIFM Directive implementation, the Luxembourg legislator is taking the opportunity in the AIFM Law to:
Modernise the regime of the existing société en commandite simple (common limited partnership) (SCS).
Introduce improvements to the société en commandite par actions (partnership limited by shares).
Introduce a new special limited partnership regime (société en commandite speciale) modelled on the Anglo-Saxon common law concept of the limited partnership (SCSp).
While the SCS has a legal personality of its own distinct from that of its limited partners, the SCSp does not have legal personality.
The provisions of the AIFM Law dealing with these matters, which are currently submitted to Parliament, focus on granting flexibility in the setting up of an SCS, and are inspired by the UK/US regimes. This modernisation of the structuring toolbox aims to eliminate onshore/offshore arbitrage, by offering onshore equivalent structuring solutions that will fit into a post AIFM Directive environment. Most authors agree that this new Luxembourg regime should meet market demands and expectations.
The modernisation of the SCS and the introduction of the SCSp will impact the 2004 SICAR and 2007 SIF regimes, as these limited partnership regimes are expected to become increasingly relevant in the regulated investment fund environment.
This reform of the limited partnership regime will be a major event in the company law field in 2013.
Tax reforms and AIFM Directive implementation in Luxembourg
The draft AIFM Law proposes various Luxembourg tax measures.
SCSp. The SCSp will have no legal personality and will be treated as tax transparent from a Luxembourg tax perspective. As with the SCS, the SCSp will generally not be subject to Luxembourg corporate income tax and net wealth tax. Its distributions will be free of withholding tax, and proceeds received from them will not be taxable in Luxembourg in the hands of non-resident investors.
However, SCSp, like the SCS and other Luxembourg partnerships, can be eventually subject to municipal business tax if it performs a commercial activity or its general partner is a capital company (Geprägetheorie theory and doctrine applied by Luxembourg tax law). The AIFM Law also foresees a relief from the application of the Geprägetheorie theory if its general partner is a capital company owning an interest of at least 5% in the partnership and the SCSp does not perform itself any commercial activity.
Carried interest regime. Introduction of a new regime for carried interest (reduced tax rate). Broadly, employees of AIF managers and of management companies of an AIF, can benefit from the following:
A full tax exemption on a capital gain realised on the sale/redemption of their interest in the AIF, if the holding period exceeds six months and the interest does not exceed 10% of the AIF.
A reduced tax rate of about 10% on the carried interest if the following conditions are met:
the employee transfers his residence to Luxembourg during the year this law enters into force, or during the following five years;
the employee was neither a Luxembourg tax resident nor taxable in Luxembourg on professional income during the five year period preceding the year of the enforcement of this law;
the carried interest is an incentive based on the net assets of the AIF or its profit; and
the other investors in the AIF have fully recovered their investment.
This reduced rate will be available for a maximum period of ten years following the year the employee applied for the regime or started its functions in the AIF.
Other tax reforms. These include:
VAT exemption on management services provided to AIFs.
AIFs established outside Luxembourg will not be subject to tax in Luxembourg, even if these AIFs are managed and controlled in Luxembourg by local managers or a local management company.
Commission proposals for European venture capital and social entrepreneurship fund regimes
In December 2011, the European Commission (Commission) presented its action plan, further to a consultation launched in June 2011, to create an internal market for European venture capital funds and European social entrepreneurship funds (EuSEF). The project includes a proposal to introduce a European passport for European venture capital funds and EuSEF, to raise capital from professional investors freely throughout the EU and to invest in small and medium-sized enterprises (SMEs).
Since the Commission proposal in December 2011, there has been no new regulation on this matter.
Tax incentive schemes
Luxembourg non-regulated vehicles benefit from a number of tax incentives. These are generally available to all Luxembourg resident companies (irrespective of their underlying investment(s) or the nature of their shareholders).
Participation exemption. Dividends received and capital gains realised by a fully taxable Luxembourg resident company are exempt from corporate income and municipal business tax if all of the following conditions are fulfilled (participation exemption):
The distributing company or the disposed participation is:
a fully taxable Luxembourg resident company;
a company resident in another EU member state that is covered by Article 2 of Directive 90/435/EEC on the taxation of parent companies and subsidiaries (Parent-Subsidiary Directive); or
a non-resident company that is fully liable to a foreign tax comparable to Luxembourg corporate income tax (it is generally accepted that a foreign corporate income tax is comparable, if it leads to at least an effective tax rate of about half of the Luxembourg corporate income tax, that is, about 10.5%).
At the date of realisation of the income (dividend and/or capital gain), the Luxembourg company has been holding (or undertakes to hold) the participation for at least an uninterrupted period of 12 months.
During this 12-month period, the participation does not fall below 10%, or the acquisition price of the participation does not fall below EUR1.2 million (for dividends) or EUR6 million (for capital gains).
If the above requirements are not met, it is possible in certain circumstances to apply for a tax relief of 50% off the dividend income.
Liquidation proceeds received by a fully taxable Luxembourg resident company are generally also exempt from corporate income and municipal business tax under the same conditions. Further, liquidation proceeds paid by a fully taxable Luxembourg resident company are free of withholding tax.
Capital duty. A fixed registration duty of EUR75 applies to transactions involving Luxembourg entities (that is, incorporation, amendments to the articles of association and transfers of the head office to Luxembourg). In addition, proportionate registration duties may also apply in certain cases.
Distribution to foreign investors. Interest paid by a Luxembourg company is not subject to withholding tax if it is a transaction made at arm's-length. However, Directive 2003/48/EC on taxation of savings income in the form of interest payments (Savings Directive, which is being reformed) imposes a withholding tax of 35% from 1 July 2011 on interest paid to individuals or residual entities that reside in the EU (or territories with similar measures to the Savings Directive and/or that have entered into bilateral agreements for the application of the Savings Directive). As an alternative to the withholding tax, the recipient of the interest can opt for the exchange of information procedure, in which case no withholding tax is imposed.
Dividends are generally subject to 15% withholding tax, unless an exemption (such as under the Parent-Subsidiary Directive) or reduced rates (arising from the investor's domestic tax law or any applicable double tax treaty) apply.
Except under limited circumstances, capital gains realised by foreign investors on the sale of Luxembourg companies (see below) are not subject to tax in Luxembourg.
Double tax treaties. As of December 2012, Luxembourg has 64 double tax treaties in force. In addition, 22 new double tax treaties have been signed and await ratification, 12 already existing treaties are being renegotiated, by means of addenda or new treaties. Talks have also been initiated with several additional countries.
Tax grouping rules. Fiscal unity is applicable to municipal business tax and corporate income tax, on a written request to the tax authorities. The companies commit to apply this regime for a period of at least five years. Fiscal unity means that there is only one sole taxpayer for the companies belonging to the group. The head of the group must be either a:
Luxembourg fully taxable corporation.
Luxembourg permanent establishment of a foreign company, if the foreign company is fully subject to a tax comparable to the Luxembourg one.
The companies that can belong to the group are Luxembourg fully taxable corporations that are owned, directly or indirectly, at least 95% by the head of the group, from the beginning of the financial year when the request for the application of this regime is made. Under special circumstances the Ministry of Finance can grant the fiscal unity regime to a company that is owned at a lower percentage than 95%, but at least 75%, if the participation and/or the group would be of special relevance to the Luxembourg economy.
Net-worth tax. There is no fiscal unity for net-worth tax purposes but it is possible to reduce net worth tax under certain conditions. A net worth tax credit is granted if a reserve equalling five times the amount of net worth tax is created and maintained for five years. The amount of net worth tax credited cannot exceed the amount of corporate tax, including solidarity surcharge, but before the deduction of corporate tax credits. As from 2013 (following the new Budget law for 2013) the amount of minimum tax cannot be considered for the net worth tax credit.
Thin capitalisation rules. There are no thin capitalisation rules. Administrative practice requires a debt-to-equity ratio of 85:15 for holding activities. Liabilities involved in financing activity are generally excluded. Under certain circumstances and subject to confirmation from the tax authorities, the ratio can be extended to 99:1.
Foreign controlled corporations. There is no list of foreign-controlled corporations. Certain foreign companies cannot benefit from the participation exemption (see above, Dividends and capital gains).
IP box regime. Luxembourg taxpayers owning an IP right can benefit under certain circumstances from both:
An exemption from 80% of the net income generated by the IP right.
An exemption from 80% of the capital gain on disposal of the IP right.
The IP right must have been either acquired or constituted by the Luxembourg taxpayer after 31 December 2007.
At whom is it directed
These tax incentives are directed at Luxembourg corporations (Soparfis) and are available irrespective of the nature of the investors and the underlying investments.
See above, Incentive schemes.
Soparfis are non-regulated vehicles that have the object of holding and financing participations in portfolio companies. Soparfis benefit from all EU directives, particularly the Parent-Subsidiary Directive, and also from double tax treaties signed by Luxembourg. The most commonly used forms of non-regulated vehicles currently are the:
Private limited company (société à responsabilité limitée) (SARL). This is commonly used for investing in private equity, since it offers significant flexibility. The minimum share capital is EUR12,500 and the number of shareholders is limited to 40. There are also restrictions on the transfer of SARL shares (for example, their transfer to a third party requires a prior agreement of a majority of shareholders representing 75% of the share capital, and they cannot be offered to the public).
Partnership limited by shares (société en commandite par action) (SCA). The SCA requires at least:
one general partner with unlimited liability being in charge of the management (commandités);
one limited partner with limited liability (commanditaires), who cannot be involved in the management of the SCA.
The rules applicable to public limited companies (société anonyme) (SA) (see below) generally also apply to SCAs. The SCA regime will be modernised by the AIFM Law (see Question 4).
Public limited companies (société anonyme) (SA). This is currently the most regulated type of company. Its minimum share capital is EUR31,000. There is no restriction on the number of shareholders, and its shares are freely transferable. The board of directors requires in principle at least three directors. It can also be listed.
However, Luxembourg players are expecting an extensive use of the SCS and SCSp in the near future (see Question 4).
The following vehicles are supervised and authorised by the regulatory authority the CSSF (www.cssf.lu).
SICARs. The SICAR was implemented to offer a new lightly regulated vehicle for investment in private equity to well-informed investors (see Question 12, Type of investors). It combines a flexible corporate structure for investing in risk capital, with the benefits of light supervision by the CSSF and a neutral tax regime.
SICAR is an optional regime, and must be formalised in the object clause of the company's articles of association. SICARs can be incorporated as one of the following companies:
SCSp (once the AIFM Law has been adopted).
Co-operative, in the form of a public limited company (société cooperative organisée sous forme de société anonyme) (co-operative).
These various possibilities offer significant contractual freedom. While general corporate law provisions apply to SICARs, they have substantial flexibility in determining their articles of association:
The share capital of the SICAR must be at least EUR1 million. This minimum must be subscribed to within one year of incorporation, and paid up in principle at least up to 5% of the capital, including share premium. It is also possible to opt for variable capital, whatever the corporate form, since the introduction of the SICAR Amendment Law. This new development should attract more foreign investors familiar with the tax incentive vehicles of common law limited partnerships.
Although SICARs are supervised by the CSSF (see Question 10), their reporting obligations are lighter than those of UCIs, although they must prepare and publish annual accounts, and update the prospectus on the issue of additional shares. An independent auditor (approved by the CSSF) must audit the annual accounts. However, a SICAR is not required to publish a bi-annual report.
Since the SICAR Amendment Law, there is no mandatory legal requirement to calculate the net asset value on a compulsory bi-annual basis. The net asset value must be based on the principle of fair value (similar to the SIF regime).
SICARs must invest in risk capital and have no obligation of investment diversification (unlike UCIs). Therefore, SICARs can invest all of their funds in a single company or project. A SICAR can also be structured as an umbrella vehicle with separate compartments enabling it to run different investment policies in each compartment.
In addition, the duty of the custodian is the same as for SIFs (that is, its monitoring duty is restricted to the general safekeeping of the assets) (SICAR Amendment Law).
SIFs. SIFs are subject to lighter statutory rules than other UCIs. The following can create and/or invest in a SIF (see Question 12, Type of investors):
Other well-informed investors (whether legal or physical persons).
The SIF aims to be an attractive vehicle through its flexible functioning rules, and the extensive scope of assets open to investment. A SIF can be used to invest in any kind of assets without limitation, to the extent it complies with the general risk spreading rules (see Question 13). It is authorised and supervised by the CSSF and has a neutral tax regime. A SIF can be created as:
A common fund (fonds commun de placement) (FCP). This is a contractually drawn up set of jointly owned assets with no legal personality, managed by a Luxembourg management company.
An investment company with a variable share capital (société d'investissement à capital variable) (SICAV), incorporated as any of the following:
SCA (partnership limited by shares);
SCS (once the AIFM Law has been adopted);
SCSp (once the AIFM Law has been adopted);
A company with a fixed share capital (société d'investissement à capital fixe) (SICAF), which is incorporated as any of the following:
SCSp (once the AIFM Law has been adopted);
SCA (partnership limited by shares);
SNC (société en nom collectif) (unlimited company);
société civile (civil company).
The legal provisions and types of companies under which a SIF can be incorporated allow investors to set up their own corporate governance rules in a flexible manner:
The subscribed share capital (including share premium) must be at least EUR1.25 million, within 12 months of the date of CSSF approval. The shares need only be paid up to a minimum of 5%.
SIF supervision and its reporting obligations are the same as for a SICAR (see above, SICARs), as well as the issuing document requirements (that is, information necessary for the investors to form their view on the investments proposed and its related risks). The SIF's issuing document must provide for the quantifiable limits to be complied with (CSSF' s circular 07/309 relating to the risk-spreading principle for the SIF) (see Questions 10, 11 and 13).
A SIF can be organised with several segregated sub-funds.
The tax status of SICARs depends on the legal form chosen.
SCS and SCSp. SCS and SCSp are tax transparent and therefore not subject to tax in Luxembourg, except for municipal business tax if they perform commercial activities (see Question 4). Tax is levied at investor level, according to the law of where they are tax resident. Double tax treaties or EU directives may apply in the country of the investor and the country of the portfolio company, depending on the relevant regulations.
SICARs as corporations. They are in principle fully taxable in Luxembourg at 29.22% (from 2013), including contributions to the employment fund and municipal business tax for the city of Luxembourg (this can vary slightly for other municipalities). They should in principle benefit from double tax treaties and the Parent-Subsidiary Directive, at least from a Luxembourg perspective. If a country does not recognise the SICAR, alternative structuring is available.
The tax regime applicable to SICARs incorporated as a corporation is as follows:
Gains or income from transferable securities are not subject to tax.
Income from cash arising from investment in risk capital is not subject to tax, subject to certain conditions.
SICARs are not subject to net-wealth tax.
SICARs are not eligible for the tax group regime (see Question 5).
Distributions by SICARs are free of withholding tax.
There is generally no tax in Luxembourg on the disposal of an interest in a SICAR by non-resident investors.
SICARs are considered as VAT persons but their activities are exempt from VAT. They therefore cannot deduct input VAT. Management services for these vehicles are also exempt from VAT.
SICARs are subject to a fixed annual fee of EUR1,500 and a registration fee of EUR1,500 (EUR2,650 for umbrella SICARs) payable to the CSSF.
The tax regime applicable to SIFs is as follows:
SIFs are not subject to corporate income tax, municipal business tax and net-wealth tax. They are subject to a subscription tax on the net asset value (0.01%) which is calculated quarterly. The law allows some specific exemptions.
Distributions made by SIFs to their investors are not generally subject to withholding tax, except under:
the Law dated 21 July 2005 implementing the Savings Directive; and
several other agreements with third countries implementing similar measures to the Savings Directive.
A SIF is subject to either:
an annual fee of EUR1,500 (EUR2,650 for umbrella structures);
a registration fee of EUR1,500 (EUR2,650 for umbrella structures).
SIFs formed as investment companies (SICAVs) can benefit from double tax treaties. 35 double tax treaties currently apply to these vehicles and their application is generally complex and must be reviewed on a case by case basis. SIFs formed as FCPs generally do not benefit from double tax treaties.
SIFs are considered as VAT persons but their activities are exempt from VAT. They therefore cannot deduct input VAT. Management services for these vehicles are also exempt from VAT.
The following tax treatment applies.
Domestic investors. Income received by both individuals and corporate domestic investors from SIFs is taxable under the usual Luxembourg tax rules. Capital gains realised by individual investors are taxable if the sale occurs less than six months following the purchase of the units and the seller holds more than 10% of the SIF.
Foreign investors. No Luxembourg tax applies. Income derived from a SIF is taxed in the country where the investors are resident.
For non-regulated vehicles (Soparfis), see Question 6.
The use of a foreign structure is unlikely, as Luxembourg is typically used as a platform for holding and acquisition vehicles in operating groups, either in Luxembourg itself or abroad. The features of Luxembourg as a holding location are equally strong for Luxembourg targets as for foreign targets. Therefore it is unlikely that foreign holding vehicles would be set up to acquire a Luxembourg group.
Foreign investment vehicles commonly used for private equity funds in other jurisdictions would generally be tax transparent in Luxembourg, such as UK Channel Islands limited partnerships, Caribbean alternative investment vehicles and Delaware limited liability companies.
The main objective of private equity funds is to have the highest return on capital possible at the time of the exit (capital gain) and a seamless repatriation without tax leakage.
For mezzanine funds, the main objective is to distribute a regular return to their investors.
The average duration of private equity funds is between seven and ten years.
Fund regulation and licensing
Whether the management bodies require CSSF approval depends on the type of investment vehicle used.
The AIFM Directive will imply changes in this respect (see Question 4). The rules regarding the approval of the management body will depend on the localisation of the alternative fund manager, the alternative fund and the marketing of the alternative fund. Some exemptions will apply, as well as a light regime, and the possible benefit of the grandfathering provisions.
Soparfis do not require CSSF approval (see Question 6, Non-regulated vehicles).
The CSSF is the competent authority for approving SICARs and SIFs, and specifically requires the following:
SICAR or SIF directors and managers must prove their ability to perform their duties. The AIFM Directive will imply changes in this respect (see Question 4).
Constitutive documents to be produced (prospectus, issuing documentation, management regulations or articles of incorporation), which must comply with the applicable laws.
The appointment of a custodian with whom the SICAR's or SIF's assets are deposited.
The appointment of an independent auditor (for monitoring obligations, see Question 6).
There is no requirement for a promoter.
SIFs and SICARs are regulated entities, and are therefore subject to prior approval by the CSSF before they are launched. These vehicles must issue a prospectus or issuing document, which is examined and/or approved by the CSSF (see Question 14). The central administration of the fund (bookkeeping, share registrar and transfer agent services) must be located in Luxembourg.
Soparfis are non-regulated vehicles and therefore do not require regulatory approval. However, if Soparfi shares (in the corporate forms of SA or SCA) are offered to the public (that is, marketed in any manner) then a prospectus complying with the rules of the Law dated 10 July 2005 implementing Directive 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to trading (Prospectus Directive) must be approved by the CSSF.
Soparfis in the corporate forms of SCA and SA can be offered to the public (see Question 6). If they are, they may be exempt from publishing a prospectus in some circumstances, for example if the shares are offered to fewer than 150 persons or to existing or former directors.
Number of investors
A SARL must have a minimum of one shareholder and a maximum of 40. An SCA must have a minimum of two shareholders (at least one general partner and one limited partner) with no maximum limit. The minimum required for an SA is one shareholder.
Nationality of investors
There are no nationality restrictions.
Generally, there are no age restrictions. There are general restrictions on minors (under 18 years old) being investors.
Type of investors
The investors of SICARs and SIFs must be well-informed investors, which are any of the following:
An institutional investor.
A professional investor.
Any other investor which:
confirms in writing that it adheres to the status of a well-informed investor; and
invests a minimum of EUR125,000 or is certified by a credit institution, a investment firm or a management company as having expertise, experience and knowledge in adequately appraising an investment in the SICAR or in the SIF.
Managers and other persons who are involved in the management of a SICAR or a SIF are no longer required to certify their status as a well-informed investor to be an eligible investor.
There are no specific limits on maximum or minimum investment periods, amounts or transfers of investments in the SICAR. Any limits are subject to the contractual terms agreed by the parties themselves. The investment(s) in a SICAR must be made for a certain period of time with the intention of a later sale at a profit.
The risk-spreading principle applies for a SIF fund. A SIF cannot invest more than 30% of its net assets in the same investment, subject to certain exceptions (CSSF circular 07/309). In practice, on CSSF approval, this spreading rule can be reached within 12 months following the SIF's launch. The CSSF may also give some additional requirements for a specific investment policy.
The prospectus or issuing document and the articles of association or management regulations regulate the relationship between the investors and the fund.
The main aim of the prospectus or issuing document is to protect the investors by giving them information on the nature of the investments to be made. Among other provisions, the prospectus states the rules relating to:
Commitments required from investors.
The investment's policy.
Subscription or redemption rights.
Protections sought by investors include:
Establishing an investors' committee within the fund with the right of information and consultation.
Veto rights for certain matters or actions.
Conflict of interests and corporate governance rules.
Information rights (a minimum reporting obligation is required for regulated vehicles).
An obligation to disclose the agreements to the other investors where co-investment agreements are entered into with the managers or with some investors.
Interests in portfolio companies
Private equity funds commonly take securities or financial instruments in a portfolio company, which may carry specific financial or voting rights (such as preferred dividend rights).
More complex and hybrid instruments may be used, depending on the financial arrangements and ultimate tax planning at investor level, which enable profit repatriation, capital gains or dividend flows in a tax efficient manner. These instruments include tracking stocks, preferred equity certificates (PECs), convertible preferred equity certificates (CPECs), profit participating loans and credit linked notes, and income participating loans. For information on debt interests, see Question 23.
As a general rule, a pure Soparfi can be financed up to 85% by debt, provided equity represents the remaining 15% of the company's total financing. Sometimes this ratio can be reduced to 99/1. However, for mixed Soparfis (companies conducting certain other activities in addition to holding participations) the 85/15 (or 99/1) ratio generally only applies to their holding activities.
The issue or transfer of shares is subject to statutory legal requirements and the specific provisions of the company's articles of association. Generally, transfers or issues require approval by an extraordinary general meeting of shareholders (general meeting), or by the board for authorised capital.
Advantages and disadvantages
Subject to specific exceptions, the issue of shares in exchange for contributions in kind in an SA and an SCA requires the issue of a valuation report by an independent auditor. The same may apply be for the issue, conversion and/or redemption of convertible instruments, depending on their features. These rules are much more flexible for a SICAR or a SIF, and do not apply to a SARL.
The legal restrictions on the transfer of shares depend on the type of company.
SARL. A SARL's shares can be transferred to non-shareholders if a majority of the current shareholder(s), representing at least three-quarters of the corporate capital, agree to this in a general meeting. In addition, specific clauses can be included in the articles of association relating for example to pre-emptions and rights of first refusal for the benefit of the remaining shareholders.
SCA and SA. The general partner's and limited partner(s)' shares of an SCA are freely transferable. An SA's shares are also freely transferable. Other provisions relating to restrictions on transfers, pre-emption and first-refusal rights are generally allowed, but are subject to certain restrictions, since a shareholder of an SA or SCA cannot be fully restricted from selling its shares.
SCS and SCSp (once the AIFM Law has been adopted). The general partner's and limited partner(s)' shares in a SCS or a SCSp are not freely transferable. The conditions of transferability will be provided in the articles of association. If the articles of association are silent in this respect, unanimous approval of all partners is required.
Buyouts of listed companies in Luxembourg are not common, since few companies have their shares (as opposed to debt instruments) listed on the regulated market of the Luxembourg stock exchange.
Until recently, Luxembourg did not have specific legislation regulating takeover bids. The hostile takeover bid by Rotterdam-based Mittal Steel for steel producer Arcelor prompted the Luxembourg government to implement Directive 2004/25/EC on takeover bids. As a result, security holders are now protected, and have enough time and information to allow them to reach a properly informed decision on the bid. In addition, new principles of mandatory offer, squeeze out, sell out and right of withdrawal regulate takeover bids and better secure this kind of transaction.
Due diligence phase
The documents usually provided in relation to the target include:
Documents containing financial information.
Authorisation(s) relating to the company's activity.
Employment or insurance contracts.
Documents relating to the guarantees granted by the company (pledge and mortgages).
Other material contracts.
Implementing the buyout
The documents usually produced relating to the implementation of the buyout include the:
Letter of intent.
Binding offer/memorandum of understanding.
Share purchase agreement.
Amended and restated employment and service contracts.
Documents relating to the guarantees concerning the purchase price payment and the satisfaction of potential liabilities (for example, in case of breach of a representation and warranty).
Debt financing documents.
Certain documents are often produced to meet the conditions precedent to the closing.
Representations and warranties
The buyer typically requires the seller (and sometimes the managers) to give representations and warranties in the share purchase agreement in relation to various matters relating to the seller's business, for example:
The seller's capacity to enter into the share purchase agreement.
The target's shares.
Compliance with corporate and tax law.
The target's financial position (particularly the accuracy of the accounts on which the purchase price is based).
Specific representations and warranties relating to employment, insurance, IP, litigation matters and so on, as the case may be.
The seller provides the buyer with indemnification guarantees for breach of the representations and warranties. In addition, guarantees are often provided to secure the payment of the indemnity.
Purchase price adjustment
The transaction documents typically provide for an adjustment of the purchase price on the target's post-closing financial results.
The transaction documents can also provide for conditions to be fulfilled for the acquisition to take effect, for example:
Approval from a regulatory authority.
Evidence of the seller granting the guarantees.
Managers' letters of resignation.
The share purchase agreement usually provides:
A non-compete clause.
An obligation to properly manage the company before closing.
The fund may also require an undertaking from the target's management to remain in office for a minimum duration. Some service contracts (such as IT and accounting) can be extended for an agreed duration.
Domestic public-to-private transactions are not common in Luxembourg (see Question 17).
Non-contractual duties, such as duties of confidentiality and loyalty to the portfolio company, derive from general civil law obligations to act in good faith in the execution of any contract. These obligations are also usually set out contractually (common in employment contracts, but less common in the corporate mandate between the company's management body (managers or directors) and the company).
In addition, managers with a corporate mandate must exercise their mandate in line with the principles of good management, and act in the company's interest. If not, the managers are liable to third parties and the company under corporate law and general law (Articles 1382 and 1383, Civil Code).
A private equity investor typically imposes the following terms on management in an MBO:
Exclusivity. This restricts the manager from carrying out other professional activities (such as, other employment, self-employed activity or another corporate mandate) during the course of employment.
Non-solicitation. This prevents the manager, during or after termination of the employment contract, from:
contacting the company's clients for his own interest or the interest of another company;
approaching the company's employees with alternative employment.
Confidentiality. The employee undertakes, both during the performance of his contract and at any time after its termination, to keep confidential information or data collected during the employment relationship to third parties, unless specifically authorised.
Ownership. This gives the exclusive ownership to the company of all documents and equipment that are used by the manager or put at his disposal during employment.
Copyright. The literary and artistic works a manager creates in the course of their employment belong to the manager. The employer can, therefore, require an assignment of the patrimonial rights on any works created during the period of employment.
Non-competition clause. This prevents the employee from competing with the employer after termination of the employment contract.
Communication. This prevents the management from speaking in public on behalf of the company, unless expressly authorised to do so.
This depends on the outcome of negotiations between the fund and its management, and the legal rules regulating the target.
However, a fund typically requires from its portfolio company:
Shareholder approval of some major decisions, stricter quorum rules, majority voting for some decisions and veto rights.
The right to submit a list of candidates from which the shareholder meeting must choose a manager.
Stricter quorum rules and majority requirements for board resolutions.
The right to receive certain relevant information.
The creation of internal committees in the portfolio company (right of information and consultation).
Whether these protections should be inserted in the articles of association or in a shareholder agreement is considered on a case-by-case basis.
Financing by debt can come either from the investors (to benefit from the deduction of interest) or from third parties.
Investors' debt financing can take several forms, ranging from straightforward shareholder loans to hybrid, convertible or subordinated instruments. Interest paid to investors must be at arm's length. In addition, as far as holding activities are concerned, an 85:15 debt-to-equity ratio is generally regarded in practice as acceptable (other ratios may be acceptable provided the overall interest is not excessive). Excessive interest is regarded as deemed dividends (subject to withholding tax, if applicable) and as such is not tax deductible.
Third party financings usually take the form of senior or mezzanine loans (syndicated or otherwise). Bond issues are also an option (parties enjoy a large degree of freedom in their terms and conditions). Such third party loans are generally not taken into consideration for the computation of the above ratio.
Since the thin capitalisation rules are an administrative tax practice, and not set out by the tax law (see Question 5), it is generally recommended to obtain in each case a confirmation from the tax authorities that the tax administrative requirements are fulfilled.
On 28 January 2011, the Luxembourg direct tax authorities issued a circular (LIR 164/2) (Circular). This clarifies the tax treatment of Luxembourg companies that perform intra-group financing activities, and sets out the framework for granting advance tax clearance. The Circular refers to application of the arm's length principle in Article 9 of the OECD Model Tax Convention, to determine the transfer price between related entities.
Protection for debt providers is regulated by the Law of 5 August 2005 on collateral arrangements, implementing Directive 2002/47/EC on financial collateral arrangements.
Pledge of assets (contrat de gage). This is the most common way of taking security over Luxembourg assets. The pledge is usually granted over (present and/or future) bank accounts, financial instruments (which include all type of securities) and/or receivables of the pledgor.
Luxembourg law provides for efficient and effective methods of enforcing a pledge. On default, the pledgee can:
Take ownership of the pledged assets at the price determined in accordance with the rules of valuation agreed between the parties.
Sell the pledged assets through legally permitted means (for example, through an arm's-length sale).
Obtain a court decision stating that the pledged assets will be transferred to the pledgee as payment up to the amount of the debt owed, as estimated by an expert.
Transfer of ownership by way of security interest (transfert de propriété à titre de garantie). This transfer can apply to the same assets as for a pledge of assets (see above, Pledge of assets). On default, the transferor does not need to transfer ownership back, in accordance with the terms and conditions agreed in advance by the parties.
Contractual and structural mechanisms
Contractual subordination, acceleration and netting mechanisms are frequently used to secure investments.
SA/SCA. In principle, an SA or SCA can advance funds, make loans or provide security with a view to the acquisition of its shares by a third party, under the following conditions:
Transactions must take place under the supervision of the board of directors or the management board (which must issue a specific report), and gain prior approval at a general meeting of shareholders.
The transaction must be at fair market value, particularly in relation to interest received by the company and in relation to security provided to the company for the loans and advances.
The credit standing of the third party must be duly investigated.
The aggregate financial assistance granted must at no point result in the reduction of the net assets below the amount specified in the Law of 10 August 1915 on commercial companies.
The company must include a reserve in the liabilities in the balance sheet, which is unavailable for distribution, of the total amount of the financial assistance.
However, this rule does not apply to the acquisition of shares by, or for, the company's employees.
SARL. The law remains silent on the rules applicable to SARLs. There are arguments that there is no current prohibition applicable to SARLs, but this is open to interpretation. There is a bill pending before the Luxembourg parliament (which does not seem to be progressing) that provides for the prohibition of financial assistance in SARLs.
See above, Rules.
Insolvency procedures are regulated by law, notably the Commercial and Civil Codes, the Law of 24 May 1989 relating to employment contracts, the Law of 5 August 2005 on collateral arrangements and Regulation (EC) No 1346/2000 on insolvency proceedings.
All creditors, other than secured and privileged creditors, must be treated equally. Payments to secured and privileged creditors are made in the following order:
The receiver's fees and the liquidation expenses.
Privileged claims, for example, money owed to employees, certain social security contributions and outstanding taxes.
Payment of the lower ranking privileges and secured creditors.
However, pledges and transfers of ownership by way of security interest remain valid and fully enforceable, despite the start of insolvency proceedings against the grantor, to the extent they apply to financial instruments (including all types of securities) and/or receivables (including those resulting from bank accounts), as well as netting arrangements. Secured assets covered by these security interests are, therefore, not included in the assets available for distribution to the general pool of creditors.
Shareholders' capital contributions are only repaid if and when all other creditors have been fully satisfied.
It is possible, and common in some circumstances, for debt holders to achieve equity appreciation through using conversion features on convertible debt instruments, warrants and/or options.
Typically such instruments are highly subordinated and have a lower interest rate, as their remuneration/appreciation is embedded in the conversion feature. Through the conversion feature, the instrument appreciates in value according to the appreciation of the shares into which the instrument is convertible. The design of such instruments must be tailor-made. The conversion features should generally be balanced with other debt features, to allow for efficient repatriation and treatment. Depending on their features, the issue, conversion and/or redemption of convertible instruments require an auditor's report.
Luxembourg law permits high legal flexibility for the design of these instruments, combined with extensive administrative tax practice. It is advisable to confirm the tax treatment with the Luxembourg direct tax authorities.
Portfolio company management
There is no specific legislation regulating management incentives. General labour, corporate and financial law provisions apply.
Share options are most commonly used to encourage management to be involved in the company's development, since they can benefit from favourable tax treatment in certain circumstances (see Question 29).
Share purchase plans, phantom share plans or other types of bonus schemes linked to the company's results are also used.
In addition, ratchets are used and their mechanism is defined contractually, since they are not regulated and can take different forms.
Share options are most commonly granted to encourage management to be involved in the company's development, since they may benefit from favourable tax treatment in certain circumstances.
On 20 December 2012, the Luxembourg tax authorities issued a new circular (LIR 104/02) on the taxation of stock option plans granted to employees. This circular applies from 1 January 2013 and replaces the old circular from 11 January 2002.
A promise made by the employer to the employee that he will receive a benefit under certain conditions is not taxable employment income (it only becomes taxable for the employee when the asset is put at the disposal of the employee). In this respect, a distinction is made between a transferable and non-transferable stock option.
As a general rule, capital gains on the disposal of options or shares are taxable as extraordinary income (Articles 99bis and 100, LIR). The calculation of the taxable basis (that is, the gain) differs depending on the transferability features of the options/shares.
Both interim and annual dividends require distributable reserves. Soparfis must retain a legal reserve of 5% of the yearly profit, up to an amount of 10% of the share capital of the company.
There are no other restrictions on interim dividend distributions for limited liability companies or SARLs. SAs and SCAs can only distribute interim dividends in certain circumstances, and if their articles of association allow this.
Distribution of dividends is generally subject to a 15% Luxembourg withholding tax, unless the rate is reduced by a:
Double tax treaty or the rules implementing the Parent Subsidiary Directive (which have been extended and adapted to dividend distributions).
Funding instrument allowing repatriation of the profits free of withholding tax (see Question 27).
There is no withholding tax on liquidation proceeds nor on interest payments, unless the outbound payments fall in the scope of the Saving Directive (see Question 5).
Forms of exit
Trade sales and secondary buyouts are the most common form of exit. The form of exit used mainly depends on the form of the Luxembourg vehicle, where the portfolio company is located and on the contractual and commercial reasons for the exit.
In the case of corporate vehicles, an exit (full or partial) can be made through the following ways, or a combination of all or some of them:
Advantages and disadvantages
There are no particular advantages/disadvantages to the different methods. If the structure has been correctly implemented, the exit should not trigger any adverse legal or tax consequences (see Question 5).
Forms of exit
In most cases, the form of exit from an unsuccessful portfolio company depends on the foreign law applicable to that company.
Unsuccessful companies are often written off in the balance sheet of the private equity funds. From a Luxembourg perspective, a number of methods remain available (see Question 31, Forms of exit). However, a voluntary winding-up is most likely to be the preferred exit of the Luxembourg holding vehicle. In some cases, the bankruptcy rules can also apply.
Advantages and disadvantages
There are no particular advantages/disadvantages to the different methods. A liquidation should not trigger any adverse legal and, in particular, tax consequences (see Question 5).
Private equity/venture capital associations
Luxembourg Private Equity and Venture Capital Association (LPEA)
Status. The LPEA is a non-profit organisation.
Membership. Full members include:
PE or venture capital management companies.
Organisations that directly or indirectly invest in private equity and venture capital funds.
Organisations that act as intermediaries (for example, fund of funds and secondary private equity funds).
Associate members include organisations or persons who provide ancillary services to the private equity and venture capital industry, or who represent special interest groups.
Principal activities. These include:
Representing and promoting the interests of Luxembourg private equity and venture capital players.
Supporting government and private initiatives to enhance the attractiveness, competitiveness and efficiency of the Luxembourg economic, legal, regulatory and operational framework, as an international hub for carrying out private equity and venture capital business and/or servicing the industry.
Representing the interests of LPEA members towards the European Venture Capital and Private Equity Association, and other relevant international industry bodies.
Association of the Luxembourg Fund Industry (ALFI)
Status. The ALFI is a non-profit organisation.
Membership. The following may be full members, provided that they are established and authorised to carry out their activities in Luxembourg, and regardless of their legal form:
Undertakings for collective investment and other regulated investment vehicles.
Service providers to the Luxembourg collective investment management industry.
Associate members include fund industry players established abroad, provided that they offer services to full members.
Principal activities. The five key objectives set out in ALFI's mission statement are to:
Ensure UCITS remains the best-in-its-class for investor protection.
Help fund managers and institutional investors to leverage the development of regulated European alternative funds, with the AIFM Directive.
Stimulate innovation in the funds industry.
Facilitate cross-border fund distribution.
Ensure Luxembourg remains the partner of choice for the asset management industry.
Description. Legilux is the legal portal of the Government of Luxembourg. It provides access to the official gazette (Mémorial) containing pdf or html versions of all Luxembourg laws and regulations. Legilux is updated daily. Laws are available in the official languages (French and/or German). No English or other translations are available.
Commission de Surveillance du Secteur Financier (CSSF)
Description. Official website of the Luxembourg regulator of the financial sector, the CSSF. Luxembourg laws and regulations governing the financial sector and circulars issued by the CSSF are available as pdf-files. English courtesy translations of some documents may be available.
Administration des Contributions Directes
Description. Official website of the Luxembourg direct tax authorities updated and maintained by the tax administration. Major laws and other regulations are available in the original language (French and/or German). Official translations are generally not available. In limited cases, English courtesy translations or excerpts may be available.
Administration de l'Enregistrement et des Domaines
Description. Official website of the Luxembourg indirect tax authorities updated and maintained by the tax administration. Major laws and other regulations are available in the original language (French and/or German). Official translations are generally not available. In limited cases, English courtesy translations or excerpts may be available.
Please note that only laws and regulations published by the official publication journal of the Luxembourg government (Mémorial) via Legilux are official documents.
Professional qualifications. Luxembourg, 1995
Areas of practice. Corporate structuring; private equity; M&A; corporate real estate; incentives; commercial contracts; litigation.
- Assisting an e-commerce start-up company in connection with its financing, contributed by several private equity funds.
- Assisting a major private equity fund in the partial acquisition and refinancing of a top domiciliation company operating in Luxembourg.
- Assisting the management of an industrial group in connection with a management incentive scheme negotiated with the private equity house majority shareholder.
- Assisting private equity funds in their Luxembourg activities including structuring the carried interest system for their investment managers.
Professional qualifications. Luxembourg, 1996
Areas of practice. Corporate structuring; M&A; banking and finance; financing transactions; investment funds; private equity; regulatory.
- Acting for a global financial group traded on the NYSE in the acquisition of an additional stake in a joint venture bank in Luxembourg.
- Advising a leading real estate company in Austria on the implementation of an international joint venture.
- Assisting a fund management company on various deals including the setting up of Luxembourg private equity funds, the fundraising process, secondary sales and the reorganisation as an umbrella SICAR.
- Assisting a private equity investment firm in structuring a sophisticated back-to-back debt (hybrid) financing structure in Luxembourg via tracking convertible preferred equity certificates and an additional senior credit agreement for the purpose of acquiring a leading service provider for online gaming in Europe.
Professional qualifications. Spain, 1999
Areas of practice. Private equity; international tax; corporate income tax law; M&A.
- Assisting a Middle East investor in relation to the acquisition of real estate objects located in Europe and held by a Luxembourg company.
- Assisting a US real estate investment firm in structuring work to allow different investors to efficiently participate in a Luxembourg joint venture vehicle.
- Advising an e-commerce start-up company in connection with its financing, contributed by several private equity funds.
- Assisting a private equity investment firm in structuring a sophisticated back-to-back debt (hybrid) financing structure in Luxembourg via tracking convertible preferred equity certificates and an additional senior credit agreement for the purpose of acquiring a leading service provider for online gaming in Europe.