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Debt financing structures and financial assistance rules

Earlier in 2004, the European Private Equity and Venture Capital Association published a Special Paper presenting an overview of the different regulatory frameworks across Europe that apply to debt financing structures. In particular, the paper highlighted the issue of financial assistance, asking whether, in practice, the differing frameworks operate to facilitate – or impede – management buyouts.

The legal and tax rules which regulate acquisition finance are vital to the private equity industry in Europe. External debt is usually a crucial part of an MBO. Most buyout structures depend on the assets of the target being pledged to a bank to secure the debt incurred by the buyer.

The acquisition debt is lent on the condition that, following the acquisition, the target will act as guarantor for the debt, applying its assets as supporting security.

Unfortunately this is exactly what European-wide rules on “financial assistance” prohibit: a company is generally not allowed to give such assistance for the acquisition of its own shares. The consequences of such rules have posed a significant challenge for private equity investors for many years, and countries with the least burdensome form of the rules offer a much more favourable environment for buyouts, compared to countries with stricter prohibitions.

Europe today

The EVCA paper highlights the inconsistencies that exist within Europe. For example, some countries – including Denmark and France – do not permit any kind of financial assistance, while others – including the UK – allow private companies to provide assistance when certain conditions (designed to protect third parties) are met.

Spanish rules allow private companies to secure acquisition debt with the target company’s assets, provided that the security is created after the acquisition, while in Germany financial assistance by private companies is permitted subject to certain capital maintenance restrictions. In all of the above cases, it is imperative that the buyout is structured in a way to take account of such conditions in order to ensure that effective security can be given.

However, complying with the various conditions and necessary procedures, particularly on cross border transactions, is often complex, time consuming and expensive. Above all, this paper highlights the difficulty involved in following the procedures required. Many (including policy-makers in the UK) believe that financial assistance rules should be swept away. They have no real purpose; other safeguards adequately protect minority shareholders and creditors.

The future

Increasingly we are seeing a pressing need to lobby the European Commission on this issue. A European-wide initiative to either remove, or at least harmonise, the rules relating to financial assistance would be welcome. Let’s hope that the increasing pressure on the Commission to reform company law generally will act as a catalyst for some long overdue reform of financial assistance rules.

Jeremy Cross is a partner in the banking department at SJ Berwin. He acts for a variety of UK and international banks and financial institutions, as well as for management teams and venture capitalists. He can be contacted on: T +44 (0)20 7533 2965 E jeremy.cross@sjberwin.com

SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on its services to the private equity industry please contact Simon Witney in its London office +44 (0)20 7533 2222 or visit their website at www.sjberwin.com