France: Private Equity

Over the last 24 months (until November 2022), there has been a total of 2,250 M&A transactions in France, 1,256 of which (i.e. 55.8%) having involved a financial sponsor as a buyer or seller. Out of these 2,250 M&A transactions, 600 transactions were above €5M (i.e. 26.6% of the deals), representing an aggregate amount of €190.7bn. Out of these 600 transactions, 398 transactions (i.e. 66.3% of the number of deals) representing a total of €114.8bn (i.e. 60.2% in value) have involved a financial sponsor as a buyer or seller.

The representations and warranties provided by financial sponsors and management in a secondary LBO are generally limited to core warranties, i.e. title to shares, capacity, authority, absence of conflicts and insolvency, whereas the scope of the representations and warranties granted by trade sellers is substantially wider and will cover operational matters (e.g. compliance with laws, employment, taxes etc.). Almost all transactions involving financial sponsors are based on locked box mechanisms whereas trade sellers may continue to use completion accounts. However, the use of locked box mechanisms is more and more frequent in trade sales as well. Financial sponsors, unlike trade sellers, will also refuse non-compete or non-solicit undertakings so as to avoid any constraints in their future acquisitions. Finally, because they want to stream up the proceeds as soon as possible after completion of the transaction, financial sponsors tend to refuse to assume any residual liability vis-à-vis the purchasers. As a result, specific indemnities are quite rare. Financial sponsors will also be reluctant to put in place escrow accounts to guarantee the payment of any indemnification amount.

The process for effecting the transfer of the shares differs from one legal form of company to another. In the vast majority of cases, the transfer of the shares only requires a share transfer form to be signed by the seller together with an update of the share register and shareholders accounts of the target company. In such a case, the shares are recorded in the share register as owned by the purchaser. In other situations, which are very rare in practice, the transfer of the target’s shares will require an update of the bylaws of the company. Any transfer of shares in a French company (or any transfer of shares evidenced by an instrument executed in France) will trigger registration or stamp duties the amount of which depends on (i) the business and the legal form of the target company and (ii) the value of the transaction. The French société par actions simplifiée is the most common vehicle on the French market. Subject to certain exceptions (such as intragroup sales), the transfer of its shares should trigger a tax registration fee equal to 0.1% of the fair market value (if the company does not qualify as a real estate company).

In situations where the purchasing entity is a special purpose vehicle with no substance, the sellers will require the financial sponsors to provide, together with their binding offers, equity and debt commitment letters with certain funds commitments. Under the equity commitment letters, the financial sponsors irrevocably undertake to fund the bidding company if the bid is successful and, if not, to pay any damages awarded against the purchasing entity by a competent court in case of breach of the agreements entered into by this purchasing entity up to the amount of the equity commitment. This risk however is remote as French courts are reluctant to award significant damages.

When reviewing the offers, the sellers will make sure that (i) the funding obligations of the financial sponsors and/or their debt providers are subject to no or very limited documentary conditions and cover all amounts due by the purchasing entity at closing and (ii) the commitment letters can, upon closing, be enforced by the sellers themselves. It is worth noting that in highly competitive auction processes and even more so in recent times given the debt market, financial sponsors sometimes offer or accept to front 100% of the purchase price under the commitment letter.

Almost all transactions involving financial sponsors are now based on a locked box mechanism. On the other hand, closing/adjustment accounts are still used in certain trade sales although the use of locked box mechanism is more and more frequent. In certain – and rare – instances, hybrid mechanisms could be put in place. In those instances, the price is based on a set of historical accounts and there is a covenant that a certain amount of net debt or working capital is not exceeded at closing. This would typically be the case when revenues of the target group are highly seasonal and the cash flow forecast may not be relied upon or when a carve-out needs to be implemented.

Under a customarily structured share purchase agreement, the risks attached to the business of the target company are mainly dealt with through interim covenants and leakages protection. Purchase price mechanism, closing conditions, representations and warranties and specific indemnities are also used to reduce the risks attached to the transaction. Over the past years, due to the influence of private equity transactions, the French market has been increasingly seller friendly. This is particularly tangible when it comes to warranties and to risks attached to deal certainty and, in particular, closing conditions (that are limited to mandatory regulatory clearances). It is however worth noting that the French civil code now imposes to sellers an obligation to provide the purchasers with all key information relating to the object of the sale. However, professional purchasers such as private equity sponsors are supposed to perform reasonable due diligence in the context of a transaction. In this seller-friendly environment, the set of representations and warranties given by the buyer is often broader than the one given by the seller as the buyer is usually requested to represent and warrant that it has performed its due diligence, it has received all necessary information, it is fully financed and it has performed its regulatory analysis and does not expect any difficulty in obtaining the relevant clearance(s).

W&I insurance policies become more and more common on the French market, although France remains a jurisdiction with significant M&A volumes (c. 60%) that are not using insurance. This situation could be explained by the fact that financial sponsors generally do not provide representations and warranties and by the fact that the PE market is highly competitive and most of the transactions are secured in a few weeks. This situation is reinforced by the fact that managers of French companies under LBO are generally treated pari passu with the financial sponsor. However, financial sponsors and managers may accept to provide a set of business representations and warranties (with a €0 or €1 cap), to the extent a W&I insurance entirely covers their risk such that they have no skin in the game (save for fraud). Other exceptions may be seen in trade sales. However, more and more clients are considering, at some point in a transaction, the opportunity to use an M&A insurance, in particular when they are sellers in a primary LBO or in an exit with trade buyers and want to staple a buy-side W&I insurance policy to the share purchase agreement.

Regarding publicly listed companies, out of 50 tender offers – which were cleared by the French AMF – over the last 24 months (until November 2022), 18 tender offers have been submitted by private equity players with the intention to implement a squeeze-out. Although financial sponsors have expressed more interest for publicly listed companies, these figures can be explained, in part, by the fact that French market authority will reject any offer that is conditional upon reaching the squeeze-out threshold. In 2019, this threshold was reduced from 95% of the share capital and voting rights of the listed target to 90%. This change has encouraged bids from PE funds, although the fact that activist funds may acquire blocking minorities is still perceived as a risk. In 2021 and 2022, there was an increase in the number of public-to-private transactions although the squeeze-out threshold is generally still not reached immediately after the tender offer: precedents show that this threshold is usually reached within a 12-month period after the tender offer. This increase is also due to a larger number of opportunities on listed companies whose valuation are lower than non-listed assets.

In France, investment is in principle unrestricted. However, by way of exception, foreign investments carried out in business sectors deemed to be sensitive are subject to prior authorization from the services of French Minister for the Economy (“DGT”). In the beginning, foreign investment control was limited to a small number of specific activities, such as gambling, cryptology, weapons and warfare equipment. This list has grown considerably over time and the system has been profoundly overhauled, in particular by a Decree dated 14 May 2014 on foreign investments subject to prior authorization. This list has been further extended in 2018 to cover certain technologies including artificial intelligence, robotic or space activities. Powers of the authorities and sanctions have also been strengthened through the Pacte Law. Since 2019, in case of breach of the applicable regulation, the DGT is entitled to, inter alia, force a foreign investor to either file an application for authorization, restore the situation preceding its investment at its own expense, and/or modify the investment. The DGT is also subject to a higher scrutiny from the Parliament and, as from October 2020, is now required to coordinate with other EU countries in the implementation of foreign investment controls. This may result in a stricter enforcement of the French rules with a longer clearance process. In 2020 and in 2021, the scope of the foreign investment control was successively expanded: the list of the sensitive business sectors was expanded to biotechnologies and then to renewable technologies. Further, in 2020, certain shareholding thresholds triggering the foreign investment screening on companies operating in a sensitive business sector have been lowered (some permanently and others only in theory temporarily as a result of the sanitary crisis although this new mechanism has been extended several times and is now supposed to terminate only at the end of 2022). As a result of the foregoing, sellers tend to see the foreign investment rules as a risk similar to merger controls risk. Purchasers are more and more requested to make hell or high water commitment in connection with the issuance of foreign investment clearances, especially as the clearances are increasingly conditional upon foreign investors undertaking certain commitments vis-à-vis the French State, the scope and the nature of which depends on the sensitivity of the business sector (e.g. maintaining jobs and industrial capabilities in France, etc.).

In all medium or large sized transaction, the closing will be subject to the issuance of merger clearances by the relevant competition authorities. It is common for sellers to require financial sponsors to agree to a “hell or high water undertaking” pursuant to which the purchaser will carry out any action that is required by competition authorities to obtain the merger clearance. However, given their fiduciary duties vis-à-vis their investors, financial sponsors will generally refuse any provisions pursuant to which they may be under the obligation to take constraining actions vis-à-vis, or impose undertakings to, their portfolio companies or affiliated funds.

We see more and more financial investor trying to make minority investments and family offices are becoming more and more present on the French private equity market. However, the market is extremely competitive and the bargaining power lies on the seller and management side. To protect their investment, in addition to customary minority protections (e.g. tag along right, anti-dilution right), financial sponsors will seek a right to trigger and implement an exit after a certain period of time. Financial sponsors may also subscribe hybrid instruments with downside protection in case of under-performance of the business.

The French market is familiar with the use of continuation funds by sponsors as new path to liquidity. Certain customary provisions of the transaction documents (notably tag along and drag along clauses) have been adjusted to cover risks associated with the use of continuation funds and conflicts of interests that may arise in connection thereof.

The management incentive schemes aim at aligning the managers and the financial sponsor’s interests. To do so, the financial sponsor will request the key managers to make a significant investment in the target company, on a pari passu basis with the sponsor. In practice, the amount to be invested by top managers could represent 6 to 12 months of the manager’s gross salary. For less senior managers, the investment will generally represent between 3 to 6 months of their salary. In a secondary LBO, the financial sponsor will request the top managers to reinvest around 50% of their net proceeds or 30% to 40% of their gross proceeds. The managers may generally invest into ordinary shares and, as the case may be, fixed-rate instruments depending on the nature of the transaction. It is now common for managers to benefit from free share programs that benefit from a specific tax and social regime (under certain conditions) in addition to a pari passu investment. The vesting of these free shares will generally be subject to certain conditions including an obligation for the beneficiary to remain a manager/employee of the company during the vesting period that must be at least equal to one year.

Gains realized by French resident managers investing in shares should, in principle, qualify for the French capital gains tax regime, provided that certain conditions are met. The capital gains tax regime generally results in taxation at a rate of 30% to 34% (including social security contributions on capital gains). It is worth noting, however, that management incentive/investment schemes are subject to high scrutiny by the French Tax Authorities, which may try to requalify such gains as salary. In this respect, the French Administrative Supreme Court rendered some much-discussed decisions in July and November 2021 (which were further confirmed since then) setting forth principles pursuant to which gains on the sale of shares held in management incentive schemes should be taxable as a salary whenever the capital gain can be considered as having been acquired by the beneficiary in consideration for his/her functions as an employee or corporate officer and not because of his/her status as an investor. In the event of a reassessment of the gains as salary, such gains would be subject to the progressive income tax scale (i.e., up to 45% or 49%), plus social security contributions on activity income, late payment interest and, as the case may be, penalties (under certain conditions, tax penalties may be as much as 80% and may also trigger the automatic transfer of the matter to the public prosecutor). As regards French social security contributions, it is also worth noting that in a recent case, the French Supreme Court also considered that gains realized by the managers should be considered as salary because the instruments in question (warrants) only benefited the managers and were closely linked with their employment contracts. Other equity schemes, such as free share plans, can benefit from specific preferential regimes, provided that they are granted in compliance with the conditions set forth in the French Commercial Code and the Tax Authorities’ official guidelines. Considering the recent decisions from the French Supreme Courts, free shares plans tend to become commonly used, and particular attention should be paid to management incentive plans in place at the target level, particularly when structured with paid ratchet instruments (which used to be fairly common in the French private equity market before July 2021) as part of the due diligence and negotiation of the transaction. Buying sponsors should also carefully structure new management incentive plans.

It is market practice for senior managers to be subject to exclusivity, non-solicitation and noncompete obligations included in their employment agreement or in their corporate office agreement. The length of the non-solicitation and non-compete obligations varies from 12 to 24 months as from the departure of the manager, it being specified that managers shall receive a compensation in exchange for their non-compete undertaking unless they only had a corporate office and no employee position. However, even in the latter case, these managers will request to be granted such compensation.

Upon closing, a supervisory board is generally set up with the majority of its members being appointed by the financial sponsor. Certain material decisions, including the decisions affecting the business of the group, shall be approved by the supervisory board before they are decided or implemented by the managers or the shareholders. The list of decisions that requires the prior approval of the supervisory board is set out in a shareholders’ agreement entered into between the financial sponsors and the managers of the target group. This agreement will contain further details on the governance of the portfolio company and will also describe, among others, the liquidity rights of the shareholders. In order to ensure that the provisions of the shareholders’ agreement will be enforceable under French laws, its main terms will generally be reflected in the bylaws of the holding companies.

It was fairly common to use specific entities in order to regroup the manager / employee shareholders within one investment vehicle usually referred to as “Manco”. This structure aims at simplifying the implementation of an exit. The financial sponsor will generally hold a preferred share in the share capital of Manco. By using this preferred share, the financial sponsor will have veto rights on certain material decisions regarding Manco and, more importantly, will be entitled to force Manco to sell its interest in the target group in the event a manager / employee shareholder opposes the sale or is unable to consent to the sale.

Note however that Manco cannot receive free shares, but Manco can issue free shares in certain circumstances. As a result and if Manco cannot issue free shares, managers holding free shares would be direct shareholders of the top holding company

If the incentive scheme benefits to a wider group than the senior management team, corporate mutual funds (fonds commun de placement d’entreprise) may also be implemented to the benefit of all employees of the target group.

General Bank loans remain the most prevalent source of financing for French acquisitions, either through syndication or club deals. Such financing is often combined with a refinancing of the target company’s existing debt, typically with a term loan (usually a term loan B) and a revolving credit facility. As an alternative source of funding, acquisition financing has been carried out through private placements and high yield issuances (associated with a bridge financing) thus allowing them to access institutional investors and diversify their financing sources. Certain borrowers also finance acquisitions by unitranche structures. Small caps The French finance market in relation to small cap transactions mainly consists of bank loans.

Under the French Commercial Code, it is prohibited for acquired French limited liability companies and for their subsidiaries, to provide any financing to acquire the shares of the target or to give any guarantees or grant security interests over their assets to secure the amounts used to acquire them. Financial assistance issues must also be considered when merging the acquisition vehicle and the target or when implementing debt pushdowns. Hence, the acquiring entity will typically provide security only over its own assets, the shares of the acquired company and downstream guarantees. In addition, the target group may provide upstream guarantees to secure a revolving credit facility and/or a CAPEX line but provisions limiting the amount of such upstream guarantees must be provided with corporate benefit rules.

For large and mid-cap transactions involving syndicated loans, the most widely used standard form is based on the French law Loan Market Association’s template, with adjustments for leveraged acquisition finance transactions. The resulting documents is subject to negotiations. For large and mid-cap transactions, inhouse precedents from private equity funds are widely used.

For large and mid-cap transactions, there is a general trend in the acquisition finance market to only put in place a Term Loan B to take into account the weakening of banking monopoly prohibitions and covenant lite documentation. In addition, sponsors often obtain provisions of a springing covenant whereby the financial ratios are tested only when a certain percentage of the revolving credit facility is drawn. In very limited cases, we have seen a structure whereby junior PIK notes were combined with a Term Loan B to improve leverage. However, for small and mid-cap transactions, acquisition amortizable term loans are still widely used. For all type of financings, there also has been an increase in negotiations relating to the following items: – sanctions, which became subject to more negotiation due to the consequences of the conflict in Ukraine and especially the sanctions against the Russian Federation, and anti-money laundering provisions; – transfer provisions, with negotiations resulting in restrictions as to (i) any free transfer by a lender of its participation under a facility, such free transfer being now usually limited to the occurrence of limited events of default (i.e. payment default, insolvency and breach of covenants) and (ii) an express prohibition of transfer to “Loan to own” distressed funds; – Key Performance Indicators and sustainability goals in relation to ESG-linked credit facility and – due to the recent changes with respect to the reference rates transition, the insertion of replacement screen rate provisions. The impact of Brexit is still being processed by market participants and will lead to new areas of negotiation.

The weakening of banking monopoly prohibitions has led to more and more private equity funds creating a lending entity in France. This phenomenon could grow in the near future. Indeed, it should be noted that the access of the banking debt market became more expensive, mainly due to the raise by the European Central Bank of the three key interest rates (the main refinancing operations, the marginal lending facility and the deposit facility) by 75 basis points up to 1,25%, 1,50% and 0,75% as of 14 September 2022.