1 Legal framework
1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?
There are no specific statutory provisions that regulate private equity transactions in Germany. Nonetheless, there are general limitations that apply in regulated industries (eg, banking, pharmaceuticals, healthcare, energy and military and defence).
1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?
Germany has an open and robust economy, with excellent global connectivity, which makes investment in German companies attractive. A secure legal framework and reliable courts and public authorities enable financial investors and private equity sponsors to plan their investments effectively. As a rule of thumb, German law generally makes no distinction between domestic and foreign investors, and foreign direct investments are permissible and welcome. An effective juridical system allows investors to enforce their rights where necessary.
2 Regulatory framework
2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?
As in all transactions that involve the acquisition of a business, the cartel authorities will play a role when certain turnover thresholds are exceeded, and may refuse to approve the transaction or make approval subject to the fulfilment of certain conditions. In private equity transactions involving foreign investors, the Federal Ministry for Economic Affairs and Energy (BMWi) will often have a say. When the transaction takes place in the financial sector, approval from the Federal Financial Supervisory Authority must be obtained; in particular, the parties must carry out holder control procedures under the Banking Act.
See also question 2.2.
2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?
Foreign direct investments in German targets can be subject to review by the BMWi. For acquisitions of domestic companies by investors from non-EU/European Free Trade Area countries, the Foreign Trade and Payments Act (and the corresponding ordinance) provide for a cross-sector investment review procedure if the transaction in question would result in the acquisition of at least 25% of the voting rights. The subject of the review is whether the acquisition represents an (actual and sufficiently serious) threat to the public order or security of Germany. Even stricter thresholds apply if the German target operates so-called ‘critical infrastructure' or provides other sensitive services in connection with the operation of such infrastructure. This applies in particular to companies that operate in sectors such as:
- IT and telecommunications;
- finance and insurance;
- transportation; or
If foreign investors acquire at least 10% of the voting rights of such companies, this transaction must be reported to the BMWi.
Under the Act against Restraints of Competition, a transaction is considered a ‘concentration' if certain thresholds are exceeded. If a transaction is caught by the German antitrust provisions, it must be notified to the Federal Cartel Office. The procedure at the Federal Cartel Office is similar to that at the European Commission: every concentration must be notified before it is consummated. The duty to notify rests with all undertakings concerned. If a party violates its duty to notify (eg, by filing incorrect information), it commits an administrative offence which may result in a substantial fine. Similar to EU law, the merger may not be put into effect within one month of receipt of the full notification by the Federal Cartel Office.
Due to further tightening of the regulations to prevent money laundering, the Anti-Money Laundering Act imposes an obligation to file certain information with a newly established transparency register. With the exception of listed companies, which are subject to equivalent disclosure under the Securities Trading Act, all German legal entities in particular must disclose information on their beneficial owners. In the case of legal persons, pursuant to the law, ‘beneficial owners' include any natural persons who, directly or indirectly:
- hold more than 25% of the capital stock;
- control more than 25% of the voting rights; or
- exercise control in a comparable manner.
3 Structuring considerations
3.1 How are private equity transactions typically structured in your jurisdiction?
Many national and international private equity funds prefer to use special purpose vehicles (SPV) in the form of German limited liability companies (GmbHs) to channel their investments into German targets. The reasons for doing so are sometimes based on:
- capital gains tax advantages linked to corporations that acquire targets in the form of corporations;
- the general liability blocker effect of a corporate acquisition company (AcquiCo); and/or
- the intention to implement tight governance systems in the target.
3.2 What are the potential advantages and disadvantages of the available transaction structures?
One major advantage of using a corporate AcquiCo to acquire a corporate target is the advantageous taxation scheme in case of a future sale of the target. Under the applicable tax laws, the sale of shares in a corporation (eg, a German GmbH) completed by an AcquiCo in the legal form of a corporation will be subject to German capital gains tax only to the extent that 5% of any capital gains are considered taxable income at the regular corporate tax rate. The liability blocker effect of a corporate AcquiCo means that direct liability of the private equity funds behind the AcquiCo can almost be eliminated. A minimum capital contribution into a GmbH AcquiCo in the amount of €25,000 protects the investor against personal liability deriving from activities at the target level.
At the same time, using a GmbH AcquiCo structure enables the investor to apply a tight corporate governance system to the overall acquisition structure. This includes the power to directly instruct the management of AcquiCo on how to exercise its shareholder rights at the target level. Some private equity funds consider the slightly increased complexity of such acquisition structures as a disadvantage.
3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?
No specific regulatory restrictions apply to private equity funding structures. All types of funding are used in such transactions, from pure equity to combinations of equity and mezzanine or equity and debt, and structures that use asset-backed securities or the capital markets to fund the transaction.
However, when it comes to providing collateral for loans that are used for the funding, certain restrictions regarding cross-collateralisation may apply. This would include, for example, restrictions for AcquiCos in the legal form of a GmbH in respect of using assets of group companies or the target to secure loans granted to AcquiCo in respect of the transaction. From a taxation perspective, thin capitalisation rules may apply, which should be considered carefully when structuring the debt-equity ratio for funding AcquiCo.
3.4 What are the potential advantages and disadvantages of the available funding structures?
Pure equity funding is becoming increasingly common in private equity transactions. This is basically due to the increasing number of strategic investors participating in auctions for interesting targets. As auctions are common – not only in situations involving highly attractive targets – strategic investors are often the major competitors of private equity funds. The main reason for this is that strategic investors are typically in a position to structure the funding of the respective transaction as an integral part of their ongoing operations. Not being required to reach out to a sometimes fragmented limited partner or shareholder base may constitute a strategic (ie, timing) advantage in comparison to private equity funds, which must meet such requirements. Therefore, discussions with banks or alternative debt providers in many private equity transactions are scheduled after completion of the transaction.
3.5 What specific issues should be borne in mind when structuring cross-border private equity transactions?
Taxation aspects should be taken into consideration when planning an international transaction. Double tax treaties play an important role in this context.
3.6 What specific issues should be borne in mind when a private equity transaction involves multiple investors?
The EU Alternative Investment Fund Managers Directive was adopted by the German legislature in the form of the German Investment Code for Investment Management. The combination of multiple investors should be structured in line with certain requirements set out in the code. This may include a requirement to notify the Federal Financial Supervisory Authority.
4 Investment process
4.1 How does the investment process typically unfold? What are the key milestones?
Once contact between the private equity fund and the shareholders of the target (as the prospective sellers) has been established through the mediation of the investment bank, interested parties will receive a teaser regarding the target. If they are still interested, they and the sellers will first conclude a non-disclosure agreement. On this basis, interested parties then receive an information memorandum prepared by the investment bank. If, having evaluated this further information, the private equity fund is still interested in an acquisition, it will submit an indicative bid on the basis of the information memorandum. The sellers will review this offer and then continue the process with a selection of bidders, which in the next step will conduct due diligence on the target. Subsequently, the funds may be invited in a second round of bidding to confirm or adjust their indicative bids in light of the findings from the due diligence review (binding offer). Accordingly, the group of interested parties may be reduced further in this phase. The remaining bidders and the sellers will then negotiate the prospective purchase agreement.
At the end of the first or second round of negotiations, the bidder which, in the view of the sellers, has offered the best conditions will prevail. The purchase agreement is then finally negotiated and concluded with the winning bidder. In parallel to the purchase agreement negotiations, the bidder will negotiate the financing terms with the financing banks and/or other debt capital providers.
4.2 What level of due diligence does the private equity firm typically conduct into the target?
Both where the initiative for the transaction comes from the private equity fund and where the sellers want to put their company up for sale, the sellers – that is, the shareholders of the target – will typically carry out vendor due diligence to identify valuation-relevant risks and eliminate them as far as possible before the start of the sales process. The private equity fund interested in the acquisition will usually carry out at least confirmatory due diligence based on the information provided by the sellers about the target in the form of the vendor due diligence report (less common), or at least the descriptive legal fact book (more common). In the course of this due diligence, the sellers' information and the valuation of the target will be verified. The scope of the review is determined by the private equity fund in consultation with its advisers and individually in each case, so general statements on the scope cannot be made. It is determined by a wide variety of factors, such as the business sector of the target, the transaction volume and so on. Typically, however, the scope is limited to very material issues and eminent risks (eg, antitrust violations, infringements of data protection law and major product liability cases). Material contracts are also reviewed for change-of-control clauses.
In carve-out transactions, it is particularly important to identify whether the carved-out business will still rely on resources and services that will remain with the seller, in order to identify the necessary interfaces and timely negotiate and agree on transitional services.
4.3 What disclosure requirements and restrictions may apply throughout the investment process, for both the private equity firm and the target?
The management of the target is typically caught between the request by the shareholders seeking to sell the company to disclose information about the target to the potential acquirers and management's obligation towards the target to protect this (sensitive) information. For example, if the management personnel of the target are interrogated in the course of a management interview, they may find that a conflict of interest arises as a result of this interview due to their obligation to maintain confidentiality. This is because sensitive topics –such as financial and liquidity planning, cash flow and business plans – are regularly on the agenda of such interviews. In this respect, it must be taken into account that when these interviews typically take place, the transaction is by no means so far advanced that a successful conclusion appears certain. Accordingly, corporate sellers tend to be reluctant to permit these interviews.
For the management and senior employees of the target, the disclosure of information about the company – whether in the management interview or by disclosing confidential documents to the prospective acquirer – carries a considerable risk of breaching their duty of confidentiality, which could result in liability to pay damages to the company. There is also the purely practical, because tactical, risk that information which has deliberately not yet been disclosed by the vendor at a certain point in time may be disclosed in a management interview against the sellers' will.
4.4 What advisers and other stakeholders are involved in the investment process?
If a private equity fund is interested in an acquisition, it will enter into engagement letters, first with investment banks and then with a law firm. The private equity fund will typically approach the shareholders of the target via the investment banks. In the opposite case, where the sellers are looking for buyers for their company, they will initially engage at least one investment bank. As a rule, this is subsequently followed by a mandate with a law firm, which will assist the sellers throughout the transaction process. If the law firm does not have the capabilities to cover the tax issues of the sale itself, external tax advisers will also be called in to assist.
On the acquirer side, tax advisers and consultants with special industry expertise will cover the further consulting needs of the private equity fund's in-house team. Where necessary in individual cases – for example, in cases where an environmental due diligence or complex technical due diligence review is required – experts in the relevant disciplines will be added to the team of consultants.
5 Investment terms
5.1 What closing mechanisms are typically used for private equity transactions in your jurisdiction (eg, locked box; closing accounts) and what factors influence the choice of mechanism?
As the locked-box mechanism provides the private equity fund with economic certainty, this approach is the preferred closing mechanism in private equity deals in Germany. However, the locked-box is not a one-size-fits-all solution: for example, in complex carve-out scenarios where historical financials are not available for the carved-out division, reliance on closing accounts appears to give more comfort to the investor.
5.2 Are break fees permitted in your jurisdiction? If so, under what conditions will they generally be payable? What restrictions or other considerations should be addressed in formulating break fees?
Yes, break fees are possible in principle, but the (formal) requirements that must be observed to validly agree thereon have not been definitively clarified by the Federal Supreme Court. Typically, such penalties are agreed in advance of the conclusion of the acquisition agreement, especially in the form of liquidated damages should one of the parties withdraw from the negotiations without cause or fail to comply with exclusivity. Very rarely are break fees found in the purchase agreement itself (eg, for cases in which an official permit that is required for the transaction is not granted). Private equity investors typically find it very difficult to deal with any form of break fee not agreed in their favour, as the non-occurrence of the event triggering the penalty is typically not under the affected party's full control.
5.3 How is risk typically allocated between the parties?
The purchaser will seek indemnification for known risks that have been disclosed or otherwise identified in the due diligence review. It will also try to cover other potential (material) risks by requesting the sellers to provide respective representations and warranties on the (non-) existence of certain facts and circumstances.
The sellers will typically try to mitigate risks by negotiating with the aim of agreeing on baskets and thresholds, whereby only damages in excess of those amounts will be recoverable by the purchaser. Additionally, the sellers will aim to agree on specific and overall liability caps, and will request a rather short period for the statute of limitations. The sellers will also typically try to negotiate and implement comprehensive disclosure concepts, whereby any and all information given to the purchaser, its advisers and so on in the context of the transaction will be deemed to be known by the purchaser, whether positively known or negligently unknown; this then results in the sellers not being liable for breach of guarantee if the underlying facts were known by the purchaser. In this regard, the purchaser will most likely be willing to agree only to concepts of ‘fair disclosure' constituting the purchaser's knowledge.
5.4 What representations and warranties will typically be made and what are the consequences of breach? Is warranty and indemnity insurance commonly used?
All resolvable risks and issues that are identified in the course of the due diligence review must be cured or resolved before the conclusion of the purchase agreement at the latest. Market-standard representations and warranties in private equity transactions at minimum cover the sellers' right and title to the sold shares (or assets) and the sellers' capacity. In most cases, the representations and warranties also extend to operational aspects of the target in favour of the private equity fund – for example, the existence of relevant contracts and IP rights.
Under German law, the representations and warranties are made as independent promises of guarantee. If a guarantee is breached, the purchaser can typically first request restitution in kind from the sellers. If the sellers fail to remedy the breach by putting the purchaser in the position it would have been in had the guarantee not been breached within a reasonable timeframe following the purchaser's breach notice (eg, six weeks), the purchaser may claim monetary damages. It depends on the agreement of the parties in the individual case whether compensation for damages will cover only actual damages incurred by the purchaser, or whether consequential damages, lost profits and so on will also be included. Nevertheless, the right to rescind or otherwise withdraw from the purchase agreement due to breach of a guarantee is typically excluded by the parties.
As regards exits, there is a clear preference of private equity investors towards non-recourse deals. Thus, warranty and indemnity (W&I) insurance is an instrument of choice, as it allows the selling investors to allocate the warranty/liability risks to the insurance and to ‘cash in' the full amount of the purchase price immediately – that is, there no security retention for potential purchaser claims, no escrow account or similar (a so-called ‘clean exit'). In this respect, private equity funds directly offer potential buyers of their portfolio companies coverage through W&I insurance as part of the package of their sale offer. In such cases, the private equity fund will initiate the entire process of finding and negotiating with a suitable W&I insurer, and only at a later stage will pass this on to the buyer, which then takes out the pre-negotiated insurance (‘seller-buyer flip').
6 Management considerations
6.1 How are management incentive schemes typically structured in your jurisdiction? What are the potential advantages and disadvantages of these different structures?
In private equity transactions in Germany, management incentive schemes are most commonly established either as genuine equity participation in the target or as virtual share incentive plans. The aim of the private equity fund to motivate the management by aligning its interests with those of the private equity fund can best be realised by granting a ‘real' participation in the company; under such incentive schemes, the managers become actual shareholders in the company. However, this can be challenging in case of disagreements with the private equity fund during the term of its investment period. In addition, it is more complicated to get rid of an obstructive manager who is a co-shareholder than a manager who has only been granted virtual shares. In such case, comprehensive provisions are required in the shareholders' agreement, particularly with regard to exit, including call options, drag-along rights and the obligation of managers to cooperate in the exit transaction.
6.2 What are the tax implications of these different structures? What strategies are available to mitigate tax exposure?
Management participation schemes are generally structured in such a way that the proceeds are taxed as capital gains and taxation as wages is avoided. In recent years, the tax authorities have increasingly claimed that the predominant link of management participation to the service/employment relationship will trigger wage taxes. However, in 2016 the Federal Fiscal Court confirmed that the proceeds of management participation should be taxed as capital gains and rejected the tax authorities' practice of taxing such income as wages. The mere causality of the employment relationship for the acquisition of the participation is therefore not relevant if – and as long as – the participation is acquired and sold at the market price and an effective risk of loss exists.
6.3 What rights are typically granted and what restrictions typically apply to manager shareholders?
With regard to equity participations, transfer restrictions are imposed in the articles of association and in the shareholders' agreement. In addition, the private equity fund is granted rights of first refusal/pre-emption rights in case a manager intends to dispose of his or her participation and, further, is vested with drag-along rights with regard to the shares held by the manager. In turn, the manager shareholders are typically granted a right to request that their shares be tagged along, thereby participating in a sale to a third party initiated by the private equity fund.
The heirs of a manager are usually obliged to tolerate redemption of the shares or to transfer the shares to the private equity fund or a designated third party (in both cases against payment of compensation as provided for in the articles of association or the shareholders' agreement). In most cases, anti-embarrassment clauses grant the heirs the right to additional payments in relation to exit proceeds in case an exit occurs within a certain period after the redemption or forced transfer of shares has taken place.
In case of a virtual participation through a contractual participation scheme, a manager's contractual claims against the company/private equity fund in case of an exit transaction are heritable.
6.4 What leaver provisions typically apply to manager shareholders and how are ‘good' and ‘bad' leavers typically defined?
Irrespective of their nature – whether backed by equity or merely based on virtual shares – management incentive schemes usually provide for an option for the private equity fund to buy back the participation if a manager leaves the company – at least if the manager leaves the company within a certain period of time following the date of investment. There are also cases – in particular, when dealing with virtual incentive plans – where the participation vests over a certain vesting period (as is common in venture capital deals). Typically, the terms of the incentive scheme differentiate between:
- ‘involuntary' withdrawal of a manager (good leaver); and
- cases where the manager is ‘responsible' for the facts and circumstances underlying his or her departure.
Accordingly, different buy-back prices are agreed for good leavers and bad leavers. Typical good leaver events include:
- ordinary termination of the service agreement and/or release from office by the company;
- expiry of the fixed term of the manager's service agreement without the company making an extension offer on substantially the same terms;
- resignation from office and/or extraordinary termination of the service agreement by the manager for good cause given by the company; or
- death of the manager.
Common bad levers are managers who:
- freely and willingly terminate their service agreement without good cause; or
- in their person, give good cause for termination/release from office by the company.
7 Governance and oversight
7.1 What are the typical governance arrangements of private equity portfolio companies?
Typically, the private equity fund will seek to leave the management and daily operation of the portfolio company in the hands of experienced management, while at the same time, driven by its internal guidelines on the administration of portfolio companies, seeking to increase control and limit the decision-making power of the management. This also applies to co-shareholders, if the private equity fund acquires (only) a (majority) stake in the company. This can be realised to the best extent where the portfolio company is a limited liability company (GmbH), which allows for very flexible corporate governance in comparison to the more limited structuring possibilities for governance imposed by law on stock corporations. Hence, from a corporate governance perspective, investments in companies structured as GmbHs are the preferred choice of private equity funds.
In the GmbH context, the private equity fund will establish dedicated rules for the management of the portfolio company in the articles of association and in rules of procedure. These rules typically also provide for the fund's reservation of approval for business activities of a fundamental nature and/or that exceed certain monetary thresholds. In addition, special rights are agreed in the shareholders' agreement with the private equity fund's co-shareholders, ensuring that the fund retains overall control over the company (eg, by virtue of special voting or veto rights in favour of the fund).
7.2 What considerations should a private equity firm take into account when putting forward nominees to the board of the portfolio company?
Under German corporate law, the managing director has overall responsibility for managing and carrying on the company's (daily) business in all respects – in particular, with regard to legal, accounting and technical matters; while the shareholders direct the business policy. This also applies if more than one managing director has been appointed, even though in this case the shareholders' meeting or the managing directors may decide to divide the responsibilities for certain areas among themselves (eg, via rules of procedure for the management). Notwithstanding that each managing director is then primarily responsible for the area of activities assigned to him or her, it should be kept in mind that the principle of overall responsibility of all managing directors for all (business) activities carried out by the company continues to apply. Thus, each managing director – including the managing director who is the nominee director of the private equity fund – must stay adequately informed on all activities in the company and must monitor its management by his or her co-managing directors. If necessary – in particular, in case of imminent danger – a managing director must also take over tasks that have internally assigned to another managing director and may issue adequate and necessary instructions within that other managing director's area of responsibility. Therefore, where practicable, as an alternative, an advisory board could be established to advise and monitor the management, and to which nominees from the private equity fund's side could be appointed.
7.3 Can the private equity firm and/or its nominated directors typically veto significant corporate decisions of the portfolio company?
Yes. Typically, the rules of procedure and the shareholders' agreement contain special resolution matters which specify that certain corporate decisions and material business activities require the prior approval of the shareholders, including the (affirmative) vote of the private equity fund.
7.4 What other tools and strategies are available to the private equity firm to monitor and influence the performance of the portfolio company?
The private equity fund – which typically will not have its own member of the management of the portfolio company – is usually granted extensive information, control and monitoring rights in the shareholders' agreement; and the management usually has elaborate and comprehensive reporting duties towards the private equity fund.
8.1 What exit strategies are typically negotiated by private equity firms in your jurisdiction?
Given the limited investment horizon of its investors, the private equity fund must sell the portfolio company after a certain period in order to be able to repay the investors their respective investment (plus gains). Depending on the size of the company and the business environment, the disposal will be implemented by way of a sale or an initial public offering (IPO). If necessary, the private equity fund will take a dual-track approach, preparing for both options in order to be able to implement that which proves to be more profitable at short notice.
8.2 What specific legal and regulatory considerations (if any) must be borne in mind when pursuing each of these different strategies in your jurisdiction?
The portfolio company will be sold either directly to a strategic investor or through an auction, which obviously may also result in a secondary buyout by another private equity fund. There are no specific legal considerations or regulatory restrictions to be kept in mind, other than those that also applied to the private equity fund when acquiring the company.
If the private equity fund chooses an IPO as route for its exit, the first thing to keep in mind is that the portfolio company must have a legal form that is suitable for the capital markets. If it is not a stock corporation (AG), a Societas Europeae (SE) or a limited partnership of shares – which is often the case for German small and medium-sized enterprises, which are most commonly structured as a limited liability company – the portfolio company must first be transformed into one of these legal forms (usually an AG). The Transformation Act provides the necessary instruments for this. Listing on the stock exchange also requires the preparation of a securities prospectus, which serves investors and future shareholders as a source of information for their investment decisions. The Federal Financial Supervisory Authority must also approve the prospectus.
9 Tax considerations
9.1 What are the key tax considerations for private equity transactions in your jurisdiction?
The Directive on Administrative Cooperation has been transposed into national law with 1 January 2020. The law introduces an obligation to report cross-border tax arrangements. Accordingly, as of 1 July 2020, the Federal Central Tax Office must be notified of cross-border tax arrangements within 30 days. The main prerequisite for the notification obligation is the existence of certain defined hallmarks. In addition, the law stipulates that in specific cases, the main benefit of the arrangement must be the achievement of a tax advantage (the so-called ‘main benefit test'). Violation of the notification obligation is an administrative offence that can be sanctioned by a fine of up to €25,000.
Regarding the hallmarks – which, when given, additionally require an assessment of the tax advantage – for private equity investors and funds, the use of standardised documentation and a standardised structure, as well as the agreement of a confidentiality clause, are likely to be relevant. To be on the safe side and avoid fines and, in particular, reputational damage, private equity funds should not be too restrictive when examining the existence of hallmarks and, in case of doubt, should affirm the reporting obligation if the main benefit test is also answered in the positive (which is also likely to be the case as a rule).
9.2 What indirect tax risks and opportunities can arise from private equity transactions in your jurisdiction?
Sometimes sellers tend to attach value to the fact that the target may have loss carry-forwards. However, acquirers should be careful in assessing the real value of such positions to them. As a general rule, they should be aware that loss carry-forwards will be lost if more than 50% of the shares or voting rights in the target will be acquired by the buyer.
If the acquirer intends to effect the acquisition by using the tools available under the Transformation Act and its tax counterpart, the Transformation Tax Act, it might be advisable to consider the potential taxation risks resulting from minimum holding periods in respect of new shares in the target being subscribed for by the acquirer in the course of a capital increase at the target.
Sometimes an asset deal structure may be advantageous in comparison to a share deal structure; this might particularly be the case if an asset deal presents the opportunity to generate a higher potential for future depreciation of the acquired target.
If the target is to be sold by a very limited number of individual shareholders, it may be interesting for all parties involved to minimise the sellers' tax exposure by considering the tax benefits which are granted under German income tax law to the once-a-lifetime sale of an entire business by a person who is aged 55 or over, if certain additional conditions are met. This will have a direct impact on the purchase price, as the sellers will enjoy significant taxation benefits.
9.3 What preferred tax strategies are typically adopted in private equity transactions in your jurisdiction?
In addition to the points discussed in question 9.2, international private equity funds should look carefully at the benefits of using double tax treaties to avoid or at least mitigate the tax on capital gains when repatriating funds allocated into German investments. This may result in the use of intermediate holding vehicles domiciled in jurisdictions where some tax benefits might be realised (eg, Luxembourg, Cyprus or Malta). The details should be evaluated carefully as they will vary depending on various issues, such as:
- the domicile of the funding entities/shareholders;
- the corporate structure of the private equity fund; and
- the duration of the investment in a German target.
In many cases, the parties to a transaction attempt to avoid the transaction becoming subject to trade tax in Germany. This can basically be achieved if the acquisition is being considered as the sale of an entire business. Certain qualification criteria must be met in order to fall within this category, which will result in a trade tax-free acquisition. The parties may provide for fall-back solutions if the tax authorities do not agree with the assessment of the parties and treat the transaction as a trade tax event, which will result in an additional trade tax of 19% of the net purchase price, to be paid by the purchaser. This risk should always be addressed in the respective transaction documentation, in order to avoid unpleasant discussions afterwards.
10 Trends and predictions
10.1 How would you describe the current private equity landscape and prevailing trends in your jurisdiction? What are regarded as the key opportunities and main challenges for the coming 12 months?
The market remained rather seller-friendly in 2020, though investments slowed down in the second half of the year due to the COVID-19 pandemic. The pandemic and its challenges to the economy are likely to continue to dominate the next 12 months and investors will choose their exposures even more cautiously. We continue to see particular opportunities for forward-looking investments, especially in the areas of healthcare and telemedicine, as well as in the increased digitalisation of work.
10.2 Are any developments anticipated in the next 12 months, including any proposed legislative reforms in the legal or tax framework?
11 Tips and traps
11.1 What are your tips to maximise the opportunities that private equity presents in your jurisdiction, for both investors and targets, and what potential issues or limitations would you highlight?
In order to increase the chances of successful transactions in the German market, private equity investors should be prepared to take only a minority stake as an "entry" into a company in individual cases. This is based on the currently emerging discrepancies in the valuation of potential target companies: The shareholders (and the target companies) still have high expectations in terms of valuation while - objectively - the market figures are increasingly coming under pressure, also as a result of the coronavirus crisis. In view of this situation, a strategy may be to initially acquire only a minority stake (at a higher valuation) and then to increase this stake at a later stage.
For the same reason as discrepancies in valuation expectations, another strategic option could be to put a stronger focus on flexible purchase price elements such as earn-out models. Also for target companies and their shareholders, this deferred and future success orientated form of purchase price can be a viable solution to come to a deal with a private equity investor after all.
Given the current developments, it does not seem advisable for investors to wait (only) for a market of distressed opportunities in Germany as we see only very few businesses that go into crisis and become distressed as sustainable in terms of their business model. For target companies and their owners, a pre-investment restructuring of the business carried out, i.e. separation of the sustainable business segments from those that are (no longer) sustainable, can be a good way to become more attractive to private equity investors to make their investment.
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.