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Private equity in Finland

Investment in venture capital from Finnish institutional investors has been steadily increasing since the early 1990s. Jyrki Tähtinen and Jari Vikjö of Borenius & Kemppinen examine the factors behind this trend, who the major players are, the legal issues concerned and current market trends.

In Finland the distinction between private equity and venture capital is seldom made. The term venture capital is often used in referring to private equity transactions and buy-out markets.

In Finland venture capital did not really start until the early nineties. At the moment the venture capital industry is growing rapidly: in 1994 new commitments worth E63.2m ($68.8m) were made into venture capital funds and investments in target companies were E28.9m. The corresponding figures in 1998 were E328.9m and E192.6m. At the end of 1998 approximately E1.3bn were managed by management companies of the funds.

Another essential change is the growing amount of private assets. In addition to public funding, pension companies and other private investors have shown growing interest in venture capital funds. The share of pension companies of the committed new capital in 1998 was approximately 43 per cent. There are now E269m of pension funds committed in venture capital funds. Correspondingly the share of the state financing companies is decreasing — their share of the committed capital has decreased from 60 per cent (1994) to six per cent (1998).

Venture capital investors expect the growth to continue. The IRR returns measured according to the European Venture Capital Association's principles have outperformed many other asset categories. An increasing number of institutional investors recognise venture capital as an investment method worthy of a substantial part of their investments. Some management firms have stated that there really is no shortage of deal flow, ie target companies. One cause supporting the further growth may also be the declined threshold to apply for public quotation. During the past few years several private equity-based companies have listed their shares on the Helsinki Stock Exchange, which has recently introduced the New Market for growth companies.

Public players

The largest public players are Sitra (the Finnish National Fund for Research and Development) and Finnish Industry Investment (FII). Other publicly funded venture capital companies include Finnish Fund for Industrial Cooperation (Finnfund), Indekon Management and Savo Invest Management.

FII has mainly acted as a fund of funds. In 1998 FII made eight new investment commitments amounting to E17m making the overall number of investments 75. By the end of 1998 FII had made investment commitments to 20 different funds for a total of E57m. The Ministry of Trade and Industry is drafting a government proposal according to which the assets of FII would be increased. The proposal is expected to be presented to parliament by the end of 1999.

Sitra's target is to invest in technology companies and venture capital funds in Finland and abroad. Sitra focuses its investment in early stage technology companies and other promising technology firms, which may involve too great a risk from a private investor's perspective. Sitra also provides a non-profit matching service that promotes contacts between business angels and small and medium-sized companies in need of financing.

Finnfund is an investment company which finances profitable enterprises in emerging countries. In 1998 Finnfund made commitments totalling E57m to 14 new projects in nine countries. E46m were allocated to projects in developing countries and E11m in central and eastern Europe. Finnfund has active plans of utilising its knowledge of emerging markets and also of moving into managing private funds.

Although not a management company, another public company that may be interesting to venture capital investors is Finnvera. Finnvera is a specialised financing company owned entirely by the Finnish state. It promotes Finnish exports by offering export credit guarantees and supports domestic operations of small and medium-sized companies by offering risk financing and guarantees. One of its products is a capital guarantee covering at the maximum half of the investors losses due to an unsuccessful investment transaction.

Private players

The largest private venture capital management companies are CapMan Capital Management and Leonia MB Group. Other significant private players are, among others, Sponsor Capital, SFK Finance, Euroventures Advisors, Fenno Management, Bio Fund, Nordic Mezzanine, Eqvitec Partners, Merita Capital and OKO Venture Capital.

CapMan manages eight funds comprising over E505m committed by Finnish and foreign investors. Over E118m of the committed capital is in mezzanine funds. CapMan also co-manages with foreign management companies other venture capital funds (eg Alliance ScanEast Fund which invests in eastern European countries and Alta-Berkley Nordic Partners Fund).

Leonia MB is a part of the state-owned Leonia group. Leonia MB's funds, two equity funds and two mezzanine funds, have capital commitments of approximately E420m. Most of the investors of the funds are Finnish pension and insurance companies.

Recently the growth of the industry has led to establishing funds of funds (eg CapMan's partly owned Access Capital Fund and Sitra's EQM Proventure) and collecting capital from business angels. Some private individuals have set up their own funds with proceeds from trade sales (Juha Sipilä/Solitra) or IPOs (Antti Piippo/Elcoteq).

Foreign players

Swedish venture capital companies operate actively in Finland. EQT Partners and Industry Capital have been very active in the higher end of the buy-out market with deals like Vaasan bakery, Konecranes, Salcomp and Enermet. Slottsbacken, the Swedish technology oriented fund manager and Nordic Capital have recently appointed Finnish representatives. EQT has a fund directed to the Finnish market that is managed from a Helsinki office. Other foreign players active in the Finnish transactions have been DB, Chase and Morgan Stanley.

Foreign investors have also noticed Finnish venture capital funds. European Investment Bank and European Investment Fund have made investment commitments in Finnish funds. Others are expected to follow.

FVCA

The Finnish Venture Capital Association (FVCA) was established in 1990. FVCA´s objectives are:

· to develop venture capital activities and practices in Finland;
· to represent its members' views and interests in discussions with the government and institutions;
· provide a forum for the exchange of views and experiences between members;
· to spread information on matters related to the interests of members and companies funded by venture capital;
· to arrange courses and seminars and assist in improving professional practice; and
· to liase and co-operate with international and national venture capital associations. FVCA is a member of the European Venture Capital Association.

FVCA has 30 full members and 24 associate members. Membership has been approved for equity investors and risk financiers representing public and private investment capital, captive funds and corporate ventures. Associate membership can be given to organisations and individuals with an interest in the venture capital industry such as auditing and law firms.

Legal issues, instruments and structure of venture capital funds

There is no specific legislation on venture capital in Finland. Management companies or venture capital funds are not considered as investment firms or other entities with specific legal nature and thus their activities in general are not subject to the rules of the Financial Supervision.

Most of the Finnish venture capital funds are limited partnerships (due to fiscal reasons), the management company being the general partner and the investors limited partners. The Finnish Act on Limited Partnerships allows the parties considerable freedom in drafting all necessary documentation for setting up and managing the funds. The funds have mostly been closed-end funds with an average term of ten years.

The documentation for the Finnish funds bears a strong resemblance to English ones. Normally the fund pays a management fee to the management company based on the commitments and/or capital invested by the fund. In addition the management company takes a percentage share of the profit of the fund that exceeds a certain hurdle rate (carried interest), with or without a ‘catch-up clause'.

The venture capital funds have used a variety of investment instruments, share capital, convertible debentures, warrants, subordinated loans and profit loans. Some funds are specialised in mezzanine financing while others make only equity investments.

MBO arrangements in particular have kept lawyers busy by including an extended variety of different agreements (sale and purchase, shareholders', financing agreements, including equity, mezzanine and senior instruments, and agreements for key employees). Due to the fiduciary duty of the management firm to the fund's investors, legal due diligence by an outside counsel is a standard issue in almost all the venture capital deals. As most growth companies, the primary targets of venture capitalists, are technology driven, law firms with strong IPR teams are in increasing demand.

Market trends and recent transactions

As the fund managers have gathered experience and as the industry has become more well known, the size of the funds and the deals have grown. Nowadays some Finnish funds are able to invest well over E20m to a single target company and together with mezzanine and senior finance and domestic and international syndication partners to close deals in excess of E300m. Some funds have changed their strategy of minority ownership into majority ownership. There has also been an increasing amount of second and third round equity investments into growth companies not yet ready for listing or trade sale. Platform strategy ie buying new businesses to existing target companies is gaining in popularity.

The legal and financing structure of private equity transactions have varied extensively. Special emphasis has been placed on innovating structures that would give a substantial incentive to the management of the target companies.

Recent transactions that can be mentioned include Enermet, Normet, PPTH Steel, Espe, Royal-Rest, Machinium and Salcomp. The common nominator for all was that private equity investors (individually or through syndication) acted in the leading role. Overall the private equity players are now recognised as appealing buyers by many of the industrial sellers because they do not have to open their books to competitors. Financial buyers like private equity funds do not buy factories to close them thus making them also socially acceptable buyers.

The growth of the industry has forced the funds to define their field of activity and investment policy more precisely — the investors do not like the idea of funds competing for the same investments. It is likely that only a limited amount of general equity funds can be established in the future; most of the funds will probably concentrate in making investments in buy-outs/MBO and MBI arrangements, certain business areas (IT, telecom, biotechnology etc) or seed financing. Since the exchange risk is no longer an issue due to the introduction of the euro and because the share of foreign investors is increasing, it is expected that some of the funds will become internationally oriented and focus on certain industry fields instead of domestic companies. This trend will also create a growing demand for specialist services relating to the transactions covering two or more jurisdictions.

Copyright © 2002 Borenius & Kemppinen   

Jyrki Tähtinen and Jari Vikjö are attorneys with Finnish law firm Borenius & Kemppinen. Borenius & Kemppinen is one of the largest and most experienced law firms in Finland. The firm provides a full range of high quality legal advice and services in all fields of corporate and business law. For more information please visit www.borenius.fi