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-guide.
Government agencies were by far the largest contributor to fundraising in the Central and Eastern Europe (CEE) region in 2014 and this continued in 2015. Contributions to the total amount of funds raised in 2015 also came from the following sources:
Funds of funds: 12.6%.
Pension funds: 10.9%.
Government agencies: 41.9%.
Insurance companies: 2.0%.
Sovereign wealth funds: 16.4%.
Other asset manager: 2.1%.
Private individuals: 0.8%.
Other sources: 9%.
No numbers have been published yet for 2015. However government agencies contributed to the vast majority of PE funds set up in 2014, according to the CEE Statistics by the European Private Equity and Venture Capital Association's (EVCA) Central and European Europe Task Force.
Family offices play an increasingly important role in the fund raising process of most PE funds.
The main fund players in Luxembourg are private equity houses. Information is not publicly available for non-regulated vehicles. In relation to the geographical origin of initiators of mutual investment fund (organismes de placement collectif):
US investors dominate with 22.45% of the market.
16.16% came from the UK.
14.68% came from Germany.
13.98% came from Switzerland.
8.21% came from Italy.
7.58% came from France.
4.56% came from Belgium.
2.31% came from Luxembourg.
2.14% came from the Netherlands.
1.70% came from Sweden.
6.23% came from other countries.
Luxembourg is the leading private equity (PE) jurisdiction in Europe. The Luxembourg Law of 12 July 2013 on Alternative Investment Fund Managers (AIFM Law), transposing the Alternative Investment Fund Managers Directive (AIFM Directive) was the opportunity to roll out a new regime for limited partnerships, matching the expectations of many investors familiar with common law partnerships set up in the UK, Delaware or the British Virgin Islands (BVI).
Since the AIFM law, existing funds set up outside Europe have migrated to Luxembourg from offshore jurisdictions. Also, with the passport of alternative investments funds managers (AIFMs) now available, AIFMs that are set up outside of Luxembourg obtain their passport to manage alternative investments funds (in regulated and unregulated Alternative Investment Funds (AIFs)) in Luxembourg. The number of AIFs set up in Luxembourg continues to increase and Luxembourg remains the second largest global leader for domiciled funds. Net assets under management in Luxembourg funds were EUR 3,506,201 billion at the close of December 2015. This represents an increase of 13.29% since the 1st January 2015.
The vast majority of PE funds are unregulated funds. The PE industry has a strong appetite for Luxembourg limited partnerships, a fund structure that is universally understood by investors. The AIFM Law profoundly reformed the common limited partnership (société en commandite simple) (SCS) and introduced the special limited partnership (société en commandite spéciale) (SCSp) in the Luxembourg Act dated 10 August 1915 on commercial companies, as amended (Companies Act). The SCS and the SCSp are the structures of choice for PEs. The SCS (as a Scottish limited partnership and a Delaware limited partnership) has separate legal personality. The SCSp (as an English limited partnership and a Cayman limited partnership) does not.
Despite the lack of legal personality, the assets contributed to the SCSp are registered in the name of the partnership and can only satisfy the rights of creditors that have been created in relation to the creation, running or liquidation of the SCSp. Therefore, the assets of the SCSp are not available to personal creditors of the general partners or the limited partners but only to creditors of the SCSp. The introduction of the SCSp has led to 954 establishments of this type of vehicle from its creation since the AIFM Law to February 2016. No statistics are currently available on the number of unregulated structures used by PE funds. In practice, 80% of the structures are set up as unregulated funds.
As of January 2016, as per the CSSF's newsletter n. 180, Luxembourg private equity regulated vehicles included:
286 risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs).
32 securitisation vehicles.
Some of the 1,597 specialised investment companies (fonds d'investissement specialisés) (SIFs).
Most PE players are prepared for the implementation of the OECD base erosion and profit shifting initiative (BEPS) as they paid attention to the substance of the funds when they were established in Luxembourg. The market expects to see more Luxembourg-based AIFMs in funds structures when BEPS unfolds.
2015 was a successful year for fundraising, with a few new players on the market set-up by initiators spinning out of well-known houses to set their fund. There is a vast array of choices for limited partners to invest in new funds, although the number of funds closed last year was slightly less than in 2014 (2015: 1125 funds with, in aggregate, US$550.4 billion raised; 2014: 1368 funds with, in aggregate, US$551 billion raised). Net assets under management in Luxembourg funds increased by 13.29% since 1 January 2015.
The level of activity in relation to investments by regulated vehicles (see Question 6) is as follows, based on the CSSF Annual Activities Report 2014:
Risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs). Based on the provisional figures as at 31 December 2014, the capital commitments of investors in SICARs totalled about EUR20.8 billion. The SICARs' total balance sheet was EUR34.2 billion.
Undertakings for Collective Investments (UCIs). This includes specialised investment companies (fonds d'investissement specialisés) (SIFs). Net assets in non-listed transferable securities and venture capital totalled EUR10.87 billion and EUR0.94 billion respectively, as at December 2013.
There are presently no overall statistics relating to the volume of activity of non-regulated funds (see Question 6). Based on the statistics published by the European Private Equity & Venture Capital Association (EVCA), the number of companies financed and amounts injected in companies between 2012 and 2014 by PE funds and CV funds were as follows:
PE: EUR28 billion in 2012 and 2013 and EUR30 billion in 2014, in less than 1,000 companies in each calendar year.
VC: EUR3 billion in 2012, 2013 and 2014, in less than about 3,000 companies each calendar year.
2015 was generally a strong year for European PE deal activity, but there was a slight fall in the number of deals compared to 2014. In 2015, PE activity was noteworthy in Luxembourg due to the number of PE sponsors based in Luxembourg and the vast number of acquisition special purpose vehicles based in Luxembourg, which are as follows:
3,556 deals took place in 2015, in line with the average number of deals since 2011 (on average, 3,660 per year).
2015 saw a strong increase in deal value compared with 2014 (an aggregate amount of US$411 billion), showing a continued increase for the last four years, but this level remains far behind 2007 (US$694 billion).
The investment strategies followed by SICARs as at 31 December 2014 were as follows (Commission for the Supervision of the Financial Sector (Commission de Surveillance du Secteur Financier) (CSSF) Annual Activities Report 2014):
Buy, build and sell investments: 208.
Investments through buyout instruments: 38.
Investments through mezzanine instruments: 19.
Investments by risk capital funds in early stage investments: 123.
With sector-based distribution, 184 entities preferred 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 2014):
PE: EUR23.1 billion.
VC: EUR8.2 billion.
Mezzanine: EUR3 billion.
Public-to-private: EUR0.1 billion.
In addition, specialised investment companies (fonds d'investissement specialisés) (SIFs) include a considerable number of vehicles investing in clean technologies, infrastructure projects and tangible assets such as art, wine, jewellery and similar assets.
2015 was a good year for European PE deal activity, with fewer deals albeit a strong increase in value. Buyouts last year were, as with 2014, the highest volume sector. Many of the largest deals of the year had a Luxembourg component. There is a strong appetite for operational companies in the financial and trust services, insurance, fintech, luxury brands, pharmaceutical, and retirement sectors.
In Luxembourg, auctions are common even for smaller and medium-sized buyouts. Auctions are not specifically regulated, however competition law is always considered.
Categories of investments have not changed significantly since 2012 and remain overall less than 2011:
Growth investments totalled:
EUR4 billion in 2012 and 2013;
EUR5 billion in 2014.
Buyouts investments totalled:
EUR28 billion in 2012 and 2013;
EUR30 billion in 2014.
Venture capital totalled EUR3 billion for each of these years.
A total of 2,416 European companies were exited representing former equity investments of EUR37.8 billion.
The most prominent exit routes by amount were:
trade sale: 26.5%;
sale to another private equity firm: 24.3%;
sale of quoted equity: 10%. Almost 40% of all the divested companies followed these exit routes.
2015 was perceived locally as the year of big deals, with a widespread geographical cover. PE backed exits in 2015 surpassed the excellent records of 2014 for European buyout exits, with trade sales being at the core of the largest exits. Exits were dominated by corporations, with a slight reduction of IPOs and secondary buyouts.
The key takeaways for 2015 were the:
Uncertainty over remuneration rules.
European long-term investment funds (ELTIFs), which came into force at the end of last year.
European Fund for Strategic Investment, the proposed reform to create a regime for Revolution in the Alternative Investment Fund (see Question 6).
Presentation by the OECD of the final package of measures relating to the Base Erosion and Profit Shifting (see Question 5), while there is room to hope for an improvement of the European Venture Capital Funds (EuVECA) regime.
The AIFM Directive's provisions on remuneration initially caused some degree of concern, with requirements that included the deferral of a proportion of "variable remuneration" and the need to pay a substantial part as fund interests (or equivalent). In Luxembourg, the AIFM Law permits carving out certain provisions on the remuneration rules in light of proportionality, taking into consideration the size of the AIFM, the scope of its activities and its internal organisation. Given that carried interest, combined with executive co-investment, aligns the interests of the fund manager with its investors and discourages excessive risk taking, many PE houses have been able to disapply the most onerous requirements under the proportionality test. This was confirmed in the European Securities and Markets Authority's (ESMA) final report released at the end of March 2016.
However, ESMA has also written to EU lawmakers suggesting that further clarification is needed, possibly through amendments to the AIFM Directive itself. While it is expected that the Commission for the Supervision of the Financial Sector (Commission de Surveillance du Secteur Financier) (CSSF) will keep its approach to proportionality, there is still the prospect of amendments to the AIFM Directive, potentially changing the way in which the principle of proportionality has to be applied by fund managers.
It is worth noting that one area in which ESMA did provide some clarification was for those managers subject to the AIFM Directive who are part of a group, where other entities are subject to different remuneration rules; for example, a fund manager within a banking group where other entities may be subject to the Fourth Capital Requirements Directive (CRD IV). In this case, the AIFMD remuneration rules will continue to apply to the fund manager, but some individuals within the AIFM who have group-level responsibilities or impact may be subject to the more stringent CRD IV remuneration rules.
In July 2013 Regulation (EU) 345/2013 on European venture capital funds (EuVECA) (European Venture Capital Funds Regulation) introduced the possibility for some AIFM Directive exempt managers to elect for EuVECA status of their venture capital funds (and benefit from a European marketing passport) provided that they complied with certain requirements.
However, EuVECAs had very little success. There are only 34 funds throughout the EU of which one is based in Luxembourg. A consultation was launched by the Commission in October 2015, which offered a chance for the entire industry to engage with the Commission by January 2016, in order to shape a wider regime that can be beneficial to funds, investors and companies throughout Europe. The results of this consultation are awaited to see if EuVECAs will gain momentum. Regulation of ELTIFS came into force on 9 December 2015 and we will see this year how many AIFs find it worth their while to become authorised as an ELTIF.
Managers who decide to use ELTIFs will need to issue a full prospectus, whether marketing to retail investors or not, and issue a key information document as prescribed under the Packaged Retail Investments Products legislative package when marketing to retail investors. Managers must have permission from their regulator to provide the additional services permitted (Article 6(4), AIFMD) and carry out an assessment on the suitability of the ELTIF for retail investors all of whom will need to receive appropriate investment advice from either the manager or a distributor before they invest.
Where a retail investor has an investment portfolio of less than EUR500,000 there will be additional requirements that its initial minimum investment in ELTIFs must be at least EUR10,000. However, the maximum aggregate investment must not exceed than 10% of the investment portfolio. The requirement to have a depositary is now familiar to authorised AIFMs, but for ELTIFs which are sold to retail investors, this must be a bank depositary in the same way as for Undertakings for Collective Investment in Transferable Securities (UCITs) funds.
The newly created EFSI established within the European Investment Bank and which aims to mobilise at least EUR315 billion of investment over the next few years, is the perfect way to seed a funds of funds program, if its commitments to each fund of funds are then matched by private sector institutional investors.
The outcome of the UK referendum on EU membership is crucial. The impact on fund managers will very much depend on the nature of the UK's relationship with the EU post-Brexit. In the event of Brexit, such funds may well reorganise and migrate to Luxembourg.
Tax incentive schemes
Luxembourg non-regulated vehicles benefit from several tax incentives. These are generally available to all Luxembourg resident companies (irrespective of their underlying investments or the nature of their shareholders).
Participation exemption. This regime applies to a financial interest holding company and is subject to Directive 2014/86/EU and Directive 2015/121/EU implementing new EU anti-abuse provisions in Parent-Subsidiary Directive (2011/96/EU) as transposed and into force in Luxembourg since 1 January 2016 and provides that if certain holding thresholds (percentage or value) are fulfilled, dividend payments and capital gains are tax exempt. In addition, Luxembourg has a far-reaching network of treaties avoiding double taxation.
Specialised investment fund
The specialised investment fund is not subject to tax, apart from a registration tax (taxe d'abonnement) of 0.01% on the net asset value per annum, which is, itself, subject to certain exemptions.
Participation exemption regime
This regime applies to a financial interest holding company and is subject to Directive 2014/86/EU and Directive 2015/121/EU implementing new EU anti-abuse provisions in Parent-Subsidiary Directive (2011/96/EU) as transposed and into force in Luxembourg since 1 January 2016 and provides that if certain holding thresholds (percentage or value) are fulfilled, dividend payments and capital gains are tax exempt. In addition, Luxembourg has a far-reaching network of treaties avoiding double taxation.
Taxation of RAIFs
A Revolution in the Alternative Investment Fund (RAIF) that invests in risk capital and that is not a mutual fund (fonds commun de placement) (FCP) will be subject to a tax regime similar to the one applicable to SICARs as provided below:
The RAIF will be fully subject to corporate income tax and municipal business tax (unless it is established as a SCS or SCSp in which case, as a transparent entity, it will be as a rule exempt from corporate income tax and municipal business tax) but income and gains derived from securities will be exempt.
It will be exempt from net wealth tax, except for the minimum net wealth tax amounting, in most cases, to EUR3,210 which replaces the minimum corporate income tax as from 1 January 2016 (unless it is established as a SCS or SCSp in which case it will also be exempt from this minimum net wealth tax).
Its distributions will generally not be subject to any withholding tax and must not be subject to Luxembourg taxation in the hands of non-resident investors.
The OECD released the final reports on the 15 Actions of the Base Erosion and Profit Shifting Project (BEPS) which aims at addressing double non-taxation as well as double taxation issues in the global economy, which impact on venture capital firms' returns on investments. The OECD is currently dealing with treaty-shopping. This enables an investor to take advantage of a tax treaty by investing into a portfolio company through an intermediate jurisdiction, and thereby getting an advantage which would not be available had the same investor invested directly.
Funds tend to pool investors from a range of countries, for obvious commercial reasons, and not to take advantage of tax treaties. However, the OECD's concern is that a fund might include investors who would not be entitled to the benefit of a tax treaty if they invested directly. If funds are not carved out, then many investors might be in a worse position, or fund managers would be subject to a significant compliance cost in differentiating between the two types of investors.
At whom is it directed
These tax incentives are directed at Luxembourg holding companies (sociétés de participations financière (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 actions) (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) generally also apply to SCAs. The SCA regime has been modernised by the Alternative Investment Fund Managers (AIFM) Law. When the SCS or SCSp are structures available to sponsors, these are now much preferred in comparison to the SCA (see Question 4).
Public limited companies (société anonyme) (SA). 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 has seen extensive use of the SCS and SCSp since the introduction of the AIFM Law (see Question 4).
The following vehicles are supervised and authorised by the regulatory authority, the Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF) (www.cssf.lu).
Risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs) were implemented to offer a new lightly regulated vehicle for investment in private equity to well-informed investors (see Question 12). 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:
Co-operative (société cooperative organisée sous forme de société anonyme).
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 Undertakings for Collective Investments (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.
The duty of the custodian is the same as for specialised investment companies (fonds d'investissement specialisés) (SIFs) (that is, its monitoring duty is restricted to the general safekeeping of the assets).
SIFs. SIFs are subject to lighter statutory rules than other UCIs. The following can create or invest in a SIF (see Question 12):
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:
A company with a fixed share capital (société d'investissement à capital fixe) (SICAF), which is incorporated as any of the following:
unlimited company (société en nom collectif) (SNC);
civil company (société civile).
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 as are 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.
RAIFs, which are expected to have, once the reform is adopted, a legal regime close to the regime of specialised investment fund, will be regulated through the authorised AIFM managing them, without the supervision of the CSSF.
Risk capital investment companies (sociétés d'investissement en capital à risque) (SICAR)
The tax status of SICARs depends on the legal form chosen and these are discussed below.
SCS and SCSp are tax transparent and, therefore, not subject to tax in Luxembourg, except for municipal business tax if they perform or are deemed to 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 Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF).
Specialised investment companies (fonds d'investissement specialisés) (SIFs)
SIFs are not subject to:
Corporate income tax.
Municipal business tax.
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.
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(société d'investissement à capital fixe) (SICAFs) 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 common funds (fonds commun de placement) (FCPs) generally do not benefit from double tax treaties.
SIFs are considered as VAT persons but their activities are exempt from VAT. Therefore, they 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 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.
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.
Delaware limited liability companies.
Fund duration and investment objectives
Despite the recent trend in the market for longer term funds, in the large buyout space the vast majority of funds are still ten years, either from the first or final closing date. There are then typically two possible extensions of one year each. In some cases the first extension can be at the manager's discretion, but in the vast majority of our sample both extensions either require advisory board consent or often an investors' 50% consent.
The main objective of private equity (PE) 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. Return is usually measured by the internal rate of return (IRR) achieved by the fund over its life cycle. Closed-ended PE funds have a life cycle of eight to 12 years. Some PE funds are evergreen. PE investors usually expect an average annual IRR of 20% to 25%. The volume of equity bridge financings has increased considerably because, in the current market conditions, they boost the IRR of funds.
Fund regulation and licensing
Whether the management bodies require Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF) approval depends on the type of investment vehicle used.
The Luxembourg Law of 12 July 2013 on Alternative Investment Fund Managers (AIFM Law) imposes new requirements on Luxembourg based alternative investment fund managers (AIFMs), which must now be authorised by the CSSF when managing assets acquired with leverage in the fund of EUR100 million or more, or assets under management with no leverage in the fund of EUR500 million or more. These requirements include, among other things:
The obligation to retain eligible conducting officers.
The enhancement of the central administration and substance of the structure.
The necessity to introduce rules or policies on risk management, compliance, internal audit, transparency, remuneration and conflict of interest situation.
The CSSF is also the competent authority for approving risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs) and specialised investment companies (fonds d'investissement specialisés) (SIFs), and specifically requires the following:
SICAR or SIF directors and managers must prove their ability to perform their duties. The AIFM Law implies 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.
Specialised investment companies (fonds d'investissement specialisés) (SIFs) and risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs) are regulated entities, and are, therefore, subject to prior approval by the Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF) before they are launched. These vehicles must issue a prospectus or issuing document, which is examined 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. RAIFs will be supervised through the AIFM managing them.
Soparfis are non-regulated vehicles and therefore do not require regulatory approval. For the avoidance of doubt, this includes the limited partnerships. However, for those Soparfis whose equity can be offered to the public, 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.
Exemptions from publishing a prospectus apply in some circumstances.
Number of investors
A private limited company (société à responsabilité limitée) SARL must have a minimum of one shareholder and a maximum of 40. A partnership limited by shares (société en commandite par actions) (SCA), a common limited partnership (société en commandite simple) (SCS) and a limited partnership (société en commandite special) (SCSp) must have a minimum of two shareholders (at least one unlimited partner, who often is the general partner, and one limited partner) with no maximum limit. The minimum required for an SA is one shareholder.
Type of investors
The investors of risk capital investment companies (sociétés d'investissement en capital à risque) (SICARs) and specialised investment companies (fonds d'investissement specialisés) (SIFs) must be well-informed investors, which are any of the following:
An institutional investor.
A professional investor.
Any other investor that:
confirms in writing that it adheres to the status of a well-informed investor;
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. Furthermore, as for any fund, the manager is responsible for the compliance with anti-money laundering requirements for any investor in the fund it manages.
There are no statutory or other limits on maximum or minimum investment periods, amounts or transfers of investments in SICARs and SIFs as well as in any unregulated fund vehicle. Any limits are subject to the contractual terms agreed by the parties themselves. The investments in a SICAR must be made for a certain period of time with the intention of a later sale at a profit. For a SICAR or a SIF, the Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF) can 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. No "best practice" guidances are published in Luxembourg.
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:
The investment strategy.
Key man provisions.
Fees, expenses and the remuneration policy.
Regarding key investor protections trends, with no fault provisions, voting thresholds are usually 75%, whereas for fault provisions only a simple, or occasionally two-third, majority is typically required. The pendulum tends to swing in favour of investors in relation to no fault removal provisions. A key feature of the investor protections is the treatment of carried interest following removal of the general partner or termination of the fund. In the overwhelming majority of cases, general partners are permitted to retain all the carried interest from investments made prior to the no fault event. On a fault removal or termination, the carried interest treatment is generally much more investor-friendly.
Interests in portfolio companies
Most common forms
Private equity (PE) funds commonly take securities or financial instruments in a portfolio company (that is not situated in Luxembourg but in the country of the target to be acquired by the PE or venture capital fund), which may carry specific financial or voting rights (such as preferred dividend rights). More complex and hybrid instruments can 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. The nature of certain hybrid instruments are currently being revised in the light of the OECD base erosion and profit shifting project (BPES). 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.
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.
PE funds can take a preferred equity interest in an investee company. However, debt investments or a mix of preferred equity and debt are also common.
The legal restrictions on the transfer of shares depend on the type of company:
Private limited company (société à responsabilité limitée) (SARL). A SARL's shares can be transferred to non-shareholders if a majority of the current shareholders, representing at least three-quarters of the corporate capital, agree to this in a general meeting. Specific clauses can also be included in the articles of association relating for example to pre-emption and rights of first refusal for the benefit of the remaining shareholders.
Partnership limited by shares (société en commandite par actions) (SCA) and public limited liability companies (Société Anonyme) (SA). The general partners' and limited partners' 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, as a shareholder of an SA or SCA cannot be fully restricted from selling its shares.
Common limited partnerships (société en commandite simple) (SCS) and the special limited partnerships(société en commandite special) (SCSp). The general partners' and limited partners' shares in a SCS or a SCSp are generally not freely transferable. The conditions of transferability are usually provided in the limited partnership agreement.
The potential payment of withholding tax and capital gains tax is assessed on a case-by-case basis; based on the specifics of the fund and the investor.
Buyouts of listed companies in Luxembourg are not common, as 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 on mandatory offers, squeeze-outs, sell-outs and rights of withdrawal all regulate takeover bids and allow for better security for this type of transaction.
These documents usually include:
Letter of intent.
Binding offer or 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).
These documents usually include:
Senior or mezzanine facility agreements.
Security documents granting security over the shares and assets of the acquisition vehicle and the target.
Representations and indemnities
The most standard representations and warranties include the following:
The organisation of the target and its ownership.
The target's capitalisation (equity and shareholder debt, if any).
Legal and regulatory compliance.
The target's financial position (particularly the accuracy of the accounts on which the purchase price is based).
Important contracts relating to the business of the target.
Usually, warranty and indemnity protection are provided from both the seller in the sale and purchase agreement and management in the investment and shareholders agreement. If the seller is a PE fund, the scope of the representations and indemnity deal protection is more limited.
Purchase price adjustment
Lockbox arrangements are much less common since the financial crisis. Earn-out provisions are now the preference with a substantial part of the purchase price dependent on the target's financial performance after closing.
Information rights in favour of the sponsor
The sponsor is usually represented at the board of the target and also obtains (as a shareholder) regular reporting from management.
The fund can 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.
The articles of association of the target include the sponsor's rights to various exit routes, for example:
Sale of all or part of the target.
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).
Managers with a corporate mandate must also exercise their mandate in line with the principles of good management, and act in the company's best interest.
A private equity investor typically imposes the following terms on management in an MBO:
Management incentive plan with an economic return to management in line with the performance of the target.
Good leaver or bad leaver rights and obligations for those managers leaving the target prior to an exit.
The measures depend 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.
The remuneration of key managers of the target or target group is usually tied to the performance of the target or target group with a management incentive plan often set-up as one of the various corporate vehicles.
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).
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) with bonds becoming very common for financings from EUR200 million for add-on and refinancing. Debt-to-EDITDA (earnings before interest, taxes, depreciation, and amortisation) ratios have been, in most cases in 2013 and 2014 around six to 6.3 times EDITDA.
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. Pledge over shares or intra-group receivables and bank accounts are usually taken over all securities issued down to the target and certain members of the group. Ring-fencing is usually one notch below the fund and the management company set-up for the management incentive plan to ensure that the fund or management are not a party to the inter-creditor arrangements and, in the case of small PE funds, that the Alternative Investment Fund Managers Directive (AIFM Directive) thresholds are not reached. Depending on the business of the target or target group, a pledge over various items such as the business, IT rights and insurance contract rights will be granted in favour of third party lenders. Mortgages remain rare in the practice of leveraged finance deals.
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. 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.
Partnership limited by shares (société en commandite par actions) (SCA) and public limited liability companies (Société Anonyme) (SA). 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 Luxembourg Act dated 10 August 1915 on commercial companies, as amended (Companies Act).
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.
Private limited company (société à responsabilité limitée) (SARL), common limited partnership (société en commandite simple) (SCS) and the special limited partnership (société en commandite special) (SCSp). The above rules do not apply.
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 through 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) 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 or 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 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. 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).
The following are also used:
Share purchase plans.
Phantom share plans.
Other types of bonus schemes linked to the company's results.
Ratchets are used and their mechanism is defined contractually, as 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, as they may benefit from favourable tax treatment in certain circumstances.
On 20 December 2012, the 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). Therefore, a distinction is made between a transferable and non-transferable stock option.
Generally, 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 or 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 private limited company (société à responsabilité limitée). Partnership limited by shares (société en commandite par actions) and public limited liability companies (société anonyme) 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% 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 or on interest payments (see Question 5).
Anti-corruption provisions are usually included in the warranties and restrictive covenants of the acquisition agreement. In addition, it is increasingly common to include principles of good governance into the rules of procedure for the management.
In general, it is prohibited to corruptly solicit, receive, promise or offer any gift, reward or other advantage, whether directly or indirectly, as an inducement to a person to do or forbear from doing anything (Articles 246 and 247, Luxembourg Criminal Code).
Active and passive corruption in the private sector is punishable, for natural persons, by one month's to five years' imprisonment and a fine (Article 36, Luxembourg Criminal Code).
Forms of exit
Trade sales and secondary buyouts remain the most common form of exit. The form of exit used mainly depends on:
The form of the corporate vehicle.
Where the portfolio company is located.
The contractual and commercial reasons for the exit.
With corporate vehicles, an exit (full or partial) can be made through the following ways, or a combination of all or some of them:
Forms of exit
In most cases, the form of exit from an unsuccessful portfolio company depends on the foreign law applicable to that company. The usual forms of exit are the sale to another buy-out fund or to the management. An asset sale is rarer in practice, as is an insolvent 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 or disadvantages to the different methods. Liquidation should not trigger any adverse legal, in particular tax, consequences (see Questions 5).
Private equity/venture capital associations
Luxembourg Private Equity and Venture Capital Association (LPEA)
Description. The LPEA represents, promotes and protects the interests of the Luxembourg private equity and venture capital industry.
The Association of the Luxembourg Fund Industry (ALFI)
Description. ALFI is the official representative body for the Luxembourg investment fund industry.
Invest Europe Association formerly European Private Equity and Venture Capital Association (EVCA)
Description. EVCA is the representative body for the European private equity industry.
Luxembourg Commission for the Supervision of the Financial Sector's (Commission de Surveillance du Secteur Financier) (CSSF)
Description. This is the website of the Luxembourg financial supervisory authority. Laws and regulations are generally accessible in French and English. English translations are not binding.
Luxembourg Private Equity and Venture Capital Association (LPEA)
Description. The LPEA represents, promotes and protects the interests of the Luxembourg private equity and venture capital industry.
The Association of the Luxembourg Fund Industry (ALFI)
Description. ALFI is the official representative body for the Luxembourg investment fund industry.
Invest Europe Association formerly European Private Equity and Venture Capital Association (EVCA)
Description. EVCA is the representative body for the European private equity industry.
Direct tax authorities (Administration des Contributions Directes)
Description. This is the website of the Luxembourg direct tax authorities.
Indirect tax authorities (Administration de l'Enregistrement et des Domaines)
Description. This is the website of Luxembourg indirect tax authorities.
Alexandrine Armstrong-Cerfontaine, Managing Partner
King & Wood Mallesons
Professional qualifications. Luxembourg, Avocat; France, Avocat; England and Wales, Solicitor
Areas of practice. Private equity; venture capital; fund formation; corporate finance; restructurings.
Languages. English, French, German
Professional associations/memberships. Luxembourg Bar; Paris Bar; Law Society; LPEA; ALFI.
Publications. Regular publications on regulatory issues in fund formation, corporate finance including leverage finance and private equity issues.