Finland: New Types of Closed-End Funds to The Finnish Market

Some time ago the only real closed-end funds managed by Finnish players were private equity and venture capital funds. Even on that front the past few years were really not labelled by active fund-raising. Now it seems we have come to a different point in the cycle. Not only new venture capital companies have emerged, but the structures and solutions first employed in venture capital and private equity fund vehicles have been successfully used in structuring funds of different types.

On a general level, the Finnish market has become more international than ever. It may not be big news to say that foreign private equity houses have become more eager to compete for Finnish deals or that large Finnish investors have had an increasing appetite for investments in funds that focus in European and US, and now even Asian, investments. Then again, a more recent change is that more often Finnish management companies approach also foreign investors when raising money to a new fund and that Finnish firms increasingly invest (or raise money for investments to be made) abroad, especially when it comes to property investments. And as regards property investments, foreign investors have become clearly more visible in Finland. According to some, the competition brought in by highly leveraged foreign funds has affected the pricing of the property market.

According to preliminary statistics gathered by FVCA for the last year, 2005 was a good fund-raising year for the members of the FVCA, in terms of money raised second only to the record year 2002.

Recently raised funds include Sentica Partners’ new fund (€23 million in 2005), CapMan’s first property fund (€500 million including leverage, partly through a special purpose vehicle issuing listed bonds; closed in June 2005) and its eighth buyout fund (first closing at €312 million announced in November 2005) and Eqvitec’s third technology fund (first closing of €130 million announced in February 2006). Also new players have raised smaller funds, Conor Venture Partners’ technology fund reaching €16 million in its first closing in January 2006 and Orienteq Capital raising €20 million to its first fund. Orienteq’s fund also attracted one foreign investor.

Finnish limited partnership funds have rarely had significant foreign investors, for which is largely to blame the Finnish interpretation of when an investment in Finland creates a permanent establishment to a foreign investor. According to a previous decision of the Finnish Supreme Administrative Court, a foreign investor who is a limited partner in a Finnish limited partnership was deemed to have a permanent establishment in Finland and, accordingly, subject to Finnish tax in respect of its share of the income of the limited partnership. Following an amendment to the tax law relating to taxation of non-resident partners resident in a tax treaty country, effective as of 1 January 2006, such non-resident partner’s share of profits received through a Finnish partnership is taxed in the same way as it would be if such investor had invested directly in the Finnish target company. If such non-resident partner’s share of the profits of a Finnish partnership includes capital gains or interest (other than gains from Finnish real estate as to which different rules apply), the non-resident partner shall not be taxed on capital gains or interest in Finland. Withholding tax on dividends paid from Finnish sources depend on the tax treaty between Finland and the country of residence of the investor. In Finnish tax treaties (with 63 countries) the withholding tax rate on dividends is usually 0-15%. One requirement for the applicability of the new relief provision to a non-resident partner is that the Finnish fund practises venture capital business in the manner prescribed in the Finnish Business Income Tax Act.

There does not seem to be a downturn in the fundraising in sight. CapMan has announced that it is raising a new life science fund and that it will start raising a new technology fund in 2006. Amanda Capital, another listed company, announced in March 2006 that it plans to form a new fund of funds targeting investments in Russia and East Europe. According to a January 2006 release by the Finnish investment bank Evli, it has started preparations plans to raise a successor to its first property fund. This time the fund would focus on the Russian property markets.

Aside from few listed property investments companies which are often not found particularly tax-effective, a few years ago the Finnish indirect property investment market was quiet – if there was even any market to speak of. Although Finland has had a special Act on Property Funds since 1997, primarily due to tax considerations (different from mutual funds, taxation both on fund and investor level) no funds have been formed under the Act.

Recently the market has begun to move. First of all, domestic players have raised closed-end property funds targeting not only the domestic property markets but Baltic countries and Russia as well. Property funds include, in addition to CapMan’s first property fund mentioned above, Evli’s EPI Baltic I (targeting a portfolio of €150 million in the Baltic countries), Vicus’ fund (aiming to invest €200 million in the Baltic countries and Russia) and Aberdeen’s partially open-ended fund (first close in December 2005 at €46 million).

Secondly, while foreign property investors have started following and participating in the Finnish property market, Finnish institutional investors seem also to have taken a new approach to property investments. During a relatively short period they have sold some of their domestic properties and made a number of investments in European property funds.

As a last note, although the legal framework has not been changed, a working group within the Ministry of Finance is looking at different options to implement changes to relevant legislation. The working group has considered, among other things, limited partnership structures, revising the Act on Property Funds and revising mutual funds legislation to enable property investments. The working group is scheduled to publish its report in spring 2006.

During the past two years the Finnish limited partnership structure has also been used as a vehicle for investments in listed securities. In some cases leveraged, these vehicles have had just a few investors and the incentive for the management company has either been on a "high watermark" or a deal-by-deal basis. The agreements for these funds have also included limited withdrawal rights which are also a novelty for Finnish fund vehicles.

Public players have not been sitting idle either. In addition to having made investments in a number of funds, Finnish Industry Investment (a state-owned investment company) is running its own seed finance program (comprising investments in 60 companies so far). Earlier it also noted that it was considering the formation of a separate fund making investments in the mining sector. However, according to recent news the fund had not raised sufficient interest and instead the company will launch a separate investment program of its own.

Sitra, an independent public foundation under the supervision of the Finnish Parliament, has for some time been planning to pack many of its life science investments into a new fund which would be partially sold to investors.

In 2005 Veraventure, another indirectly state-owned company, started its operations. It makes investments in regional Finnish funds. Later the same year Vera Oy, a newly formed investment company operated by Veraventure and its parent Finnvera, started its seed finance program.

The vast majority of Finnish private equity funds are Finnish limited partnerships (kommandiittiyhtiö, abbreviated ‘Ky’). Finnish limited partnerships are tax-transparent and closely resemble most ‘market standard’ limited partnership fund vehicles. Finnish general and limited partnerships have legal personality, and, different from many other jurisdictions, the limited liability of the limited partner of a limited partnership will not be jeopardized if the limited partner participates in the management of the partnership. Finnish limited companies are not as common a form for a fund vehicle, but two recent property funds investing outside Finland have been set up as limited companies.

Fund terms are in substance not significantly different from other European funds. The drawdown and profit distribution mechanisms are similar to most European funds. A catch-up clause was not as common earlier as it is nowadays. In some funds the carried interest may be increased above 20% after the investors have received a defined hurdle return. Nowadays Finnish fund agreements also tend to include provisions on issues such as distributions in specie, parallel funds, re-investments, borrowings and the like, all more or less similar to the terms for average non-domestic funds. Also no-default termination clauses have become relatively common. Previously the "investment committees" or "advisory boards" of Finnish funds had a more significant role, having a vote (an actual decision-making right or a veto right) on the making of investments and/or divestments (which, like noted above, was not an issue in securing the limited liability of investors). In recent funds, however, the powers of such bodies with investor representation have been tuned down, and their functions now more closely resemble the role of their foreign equivalents.

Finland has no specific legislation on venture capital funds or their management companies. Generally speaking management companies or venture capital funds have not been considered as investment firms or other entities subject to the supervision of the Finnish Financial Supervision Authority. Accordingly, at least for the time being, Finnish closed-end funds may usually operate with lesser regulatory burdens than funds in many other jurisdictions (in any event, marketing and securities law considerations need to be taken into account in marketing a fund). Although many Finnish players have considered forming an off-shore fund to attract a broader investor base, still only a few have done so. Compared to local structures, the formation and operating expenses of an offshore structure may sometimes prove to be too high in relation to the assets under management.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.