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New opportunities for private equity in Sweden

Recent changes to the Swedish Priority Rights Act, pursuant to which credits are placed in order of precedence in bankruptcies, may provide the foundation for an entirely new private equity market in Sweden, according to Niclas Högström of Hamilton & Co.

During the past decade the amount of private equity funds invested in Sweden (measured as a percentage of GDP) has been consistently higher than in most other European countries. Over the same period, Swedish private equity firms have further managed to yield returns on invested capital, which on an international comparison have tended towards the high-end. Both these circumstances help to explain the continuing interest from international private equity houses for the Swedish market. Only since January 1st 2001 not less than five of Europe's leading private equity firms have established offices in Sweden (Apax, Permira, Doughty Hanson, 3i and Bridgepoint). Amongst themselves these funds have access to considerable investment funds to be allocated to investments in medium to large sized Nordic enterprises.

The increased presence in Sweden of foreign private equity firms, with essentially the same investment focus as many of the leading domestic players, will further contribute to increase the competition for suitable target companies. This is likely to result in price increases on future acquisitions and may lead to a squeeze on the profits received at exit. The increased competition in the Nordics, combined with the ever existing desire to uphold profit margins, is further likely to result in not only increased efforts from private equity firms to identify targets at an earlier stage, and before they become subject to sale by auction, but also in that equity firms will be obliged to spend additional management time on each portfolio company.

The legislative changes referred to above are of particular interest against this background, as they hold the potential to create an entirely new market for venture investments in Sweden.

The opportunity that now presents itself consists of the possibility to establish and run turn-around funds in Sweden, this being a fund type which is well established elsewhere in Europe and in the United States, but which hardly exists at all in Sweden at the moment.

Sweden has since 1996 had in place legislation on corporate reorganisations. The intention, at the time the relevant legislation was adopted was to provide a possibility to reorganise enterprises, in line with the American Chapter 11 proceedings, that otherwise faced bankruptcy. Since the Act on Reconstructions was passed, however, it is notable that only a very limited number of enterprises have sought refuge under this law, and that accordingly bankruptcy proceedings have remained the main venue for companies in financial distress.

A supposed reason for why corporate reorganisations have not taken off and received a more prominent position vis a vis bankruptcies, has been that the legislation which determines in what order outstanding credits receive payment in bankruptcies, has had a restraining effect on the corporate reorganisation-alternative. The changes that have now been implemented in the Priority Rights Act are intended to alleviate this effect and to create a priority rights order which is designed to facilitate corporate reorganisations of commercially viable enterprises.

The point of departure in any insolvency situation in Sweden is that all claims against a debtor have equal rights. The Priority Rights Act is an exception to this rule of equal treatment, in that it stipulates what type of claims has better rights than others, and the order in which claims are to be paid. The Act differentiates between special and general priority rights. Assets that remain in a bankruptcy estate after settlement has been made to the prioritised creditors are shared equally amongst un-prioritised creditors. The priority rights order that applied before to the recent legislative changes commonly resulted in that only limited assets remained for un-prioritised creditors. As the priority rights order accordingly regulates how bankruptcy losses are shared amongst creditor groups, these rules have a direct impact on the financial position of many enterprises. Not least do they influence the creditors' choice between corporate reorganisation and bankruptcy. The objective of the legislative reform has therefore been to achieve a better balance between these two alternatives and to ensure that viable enterprises are reorganised, rather than made subject to bankruptcy proceedings.

In brief, the amendments to the Priority Rights Act involve:

1) an abolishment of the priority right for taxes and government fees and a restriction of the government's priority right with regard to wage claims;
2) a reformation of the wage guarantee and of the rights of employees in bankruptcy estates to receive wage payments from the state;
3) an amendment of the floating charge institute, whereby holders of such rights will have a right of priority in 55 per cent of all property (instead of 100 per cent).

As a result of the fact that the priority rights for taxes and government fees are abolished and the changes to the priority rights associated with floating charges, un-prioritised creditors will be placed in a more advantageous position. At the same time the number of special interest groups is decreased and also the importance of each individual interest group. Hereby the creditors are given an increased common interest to work towards a corporate reorganisation.

The fact that the Swedish government and holders of floating charges as a result of the amendments to the Act have been downgraded as bankruptcy creditors, ought reasonably to encourage both these groups to become less disposed towards accepting bankruptcies and to instead become more motivated towards accepting corporate reorganisations of debtor enterprises. As indicated above, corporate reorganisations may occur in accordance with the Act on Corporate Reorganisations. There is however, nothing that prevents creditors from agreeing among themselves to carry out a reorganisation of a debtor company on a voluntary basis. It is in this context that new opportunities arise for the use of venture capital. A recent such case involving the bank Nordea has been reported in Swedish media. According to the news coverage, Nordea agreed to convert part of an outstanding credit to the company Pan Fish A/S, into equity. Following a set-off against the credit, the bank became a shareholder in the company and consequently the overall debt burden of Pan Fish decreased. The Pan Fish-case suggests that banks are not unfamiliar to solutions which involve them joining a company as a shareholder. If, in a situation such as this, a venture capital firm (i.e. a turn-around fund) expresses a desire to participate in a share issue and to invest fresh capital into a company with financial problems, then the readiness among existing creditors - especially in light of the recent legislative amendments to the Act - to convert part of the debt into equity, and thereby also the incentive to participate in a corporate reorganisation of the company, should increase further. The fresh capital invested would in the first instance be used to further decrease the debt burden of the company. As a capital injection, from the perspective of the debtor's other creditors, reasonably must be considered an advantage, the necessary prerequisites may even be at hand to enable the venture capital firm to agree with other creditors on a share structure that enables the venture capital firm to receive preferential shares with preference rights to dividends and repayments of its capital in the event of a future bankruptcy. Such a share structure would from the perspective of the venture capital firm be preferable as it allows an increased possibility to secure the interests of its own investors. Creditors who agree to receive equity would be given common stock in the company.

The result of the above could be a win-win situation for all involved. The company with the financial difficulties receives a welcome capital injection. The creditors are able to avoid a bankruptcy and are presented with the opportunity to participate in future value growth of the company as shareholders. The turn-around fund is given an opportunity to acquire a portfolio company and is (or may be) able to limit its own exposure by receiving preference shares.

Hamilton & Co law firm is principally active within the spheres of Swedish and international business and financial law. As legal advisors to Swedish and foreign companies, banks and public enterprises, we have, over the years, built up a comprehensive and thorough competence within the entire area of business law.

Hamilton & Co is represented in Stockholm, Falun, Gothenburg, Karlstad, Malmö, Växjö, and London.