Portugal: Private Equity

The Portuguese private equity industry continues to register steady growth both in terms of the number of players set up locally and organised under Portuguese law and, more importantly, in terms of assets under management. The industry is playing an increasingly significant role in the much-needed capitalisation of Portuguese companies across a broad number of industries. According to the Portuguese Securities Market Commission’s (“CMVM”) most recent report, there are currently 166 active private equity funds in Portugal and 56 private equity companies (three of which are above the EUR500 million legal threshold of assets under management). Moreover, the EUR5 billion mark of assets under management was reached in 2019. Although still a modest amount of assets under management, it confirms a continuous growth pattern registered over recent years. We have seen private equity and investment funds equally and strongly active in both acquisitions and divestments throughout the last year, and these have represented a considerable proportion of the entire volume of transactions. This situation could be seen as a natural outcome of the increased presence of private equity firms in the market.

One major difference is in their approach in terms of risk exposure and, hence, in terms of securities and liability. Transaction structures and schedules also tend to be different.

A transaction involving a selling company backed by a financial sponsor is typically carried out under very tight schedules. Sellers seek a quick negotiation process, with a swift due diligence process with a predefined timeline, especially considering that financial sponsors adopt a “buy to sell” approach when investing in a company, involving a thorough due diligence process and corrective measures. Sellers also seek an unconditional signing or short window of time between signing and closing in order to avoid deal uncertainty. Non-financial sponsors are, in principle, more receptive to negotiation and the process will generally be lengthier, with extended due diligence exercises.

Another key difference relates to price payment, with sponsors preferring one-off payments made in full, whereas other types of sellers are often more receptive to price retention and purchase price adjustment schemes or earn-out mechanisms (and increasingly so with the COVID-19 pandemic).

Financial sponsors will, in general, be more focused on ensuring a clean exit. Therefore, they will be seeking to have their liability limited to the greatest extent possible, with time barring and cap limitations, in order to reduce exposure both in terms of damage amounts and time. Indemnity clauses setting unlimited liability are rare, if accepted at all. Other types of sellers are more likely to take a wider liability exposure and accept conditions precedent to completion and indemnities brought into the agreement. Also, financial sponsors will typically resort to W&I insurance policies to mitigate their risk exposure under the transaction documents.

A transfer of shares (when the target company is a limited liability company by shares or “sociedade anónima“) becomes effective upon execution of a private agreement and no public registration or other form of publication is required. However, in the case of some types of companies (namely limited liability company by quotas or “sociedades por quotas“), the enforceability of a share transfer against third parties does depend on registration. In addition, effectiveness will be contingent on two key completion actions by seller – the endorsement of the shares representing target’s capital and registration in company’s ledger book.

A standard share deal process will then be covered under a private share purchase agreement. It will typically include a double stage of signing and closing, with conditions precedent to be met in the meantime, and conduct of business rules to deal with the interim governance of the target company between both stages. The deal is usually structured on the basis of the sale and purchase becoming effective upon completion, whenever all conditions are met. A less common structure would provide for effectiveness upon signing, with non-fulfilment of conditions by a given date leading to retroactive termination of the deal. This is more prevalent in transactions with price payments due only at completion.

The acquisition of shares does not, generally, trigger transfer tax in Portugal at the level of the purchaser. However, Real Estate Transfer tax will be payable at a 6.5% rate in case the purchaser becomes the shareholder of at least 75% of the share capital of a real estate trading entity and certain conditions regarding the qualification of the assets in the company’s accounts, apply.

A company seller entering into a share deal with a financial sponsor will be keen on receiving some sort of extra guarantee to cover for payment risk, especially in the context of a contractual framework with earn-out payments due over time or positive price adjustment mechanisms linked to post-closing mechanisms. This usually comes in the form of guarantees of a corporate or contractual nature involving the buyer’s parent company and the guarantees may take the form of parent company guarantees or comfort letters issued by group companies.

In some deals with sellers with a more conservative profile, the purchaser’s controlling shareholder is requested to join the deal as a party and assume liability as a principal co-debtor. The controlling shareholder may also be asked to give an undertaking that it will use its best endeavours to ensure that the purchaser complies with its price payment obligations or other financial liabilities of the purchaser towards the seller, if necessary, by funding the purchasing entity. Needless to say, buyers will try to ensure that the purchase price is one-off and earn-out or price retention mechanisms are avoided so that payment default risk may be controlled or mitigated to a greater degree.

Price adjustment provisions are still prevalent when compared to locked box mechanisms. However, we have seen locked box pricing mechanisms being increasingly adopted in recent times and favored over completion accounts or other pricing structures, mostly driven by the interest of more conservative sellers in locking up a certain balance sheet (typically at previous year end) and mitigating or preventing cash leaks prior to closing mostly.

In a traditional M&A transaction, risks are typically allocated between buyers and sellers at several levels under a standard share deal. This usually comes in the form of representations and warranties/specific indemnities (tax and otherwise) and liability limitations. Trade sellers normally accept liability caps for breach of representations and warranties of up to 20% of the transaction price, being further limited by the typical de minimis and basket provisions.

One layer involves the due diligence exercise performed in virtually all M&A transactions in the country. This exercise creates a risk allocation structure between the buyer and the seller designed around the concepts of “due diligence” and “disclosed information”. At this level, the contractual package will burden the seller with the risk of violation of any representations and warranties provided, typically in an objective manner, although this is, in some cases, mitigated through W&I insurances. However, any such liability will usually also be mitigated or even fully excluded to the extent the buyer’s knowledge is acquired under the due diligence exercise in a fairly disclosed manner (anti-sandbagging). All in all, a liability line will usually be traced in accordance with at least the disclosed information.

On the flipside, the buyer will find protection through specific indemnity provisions, whereby the seller will take up the risk (on a euro-per-euro basis) of certain identified or disclosed contingencies materialising in the future, with a certain degree of likelihood, and leading to a loss in the company.

On another level, a share purchase agreement will normally contain liability limitation clauses, either in the form of de minimis, deductibles and basket provisions, along with monetary caps and time barring provisions. These provisions usually set different limitation time limits according to the matters involved and the statutes of limitations applicable to them. This results in a clear-cut separation of default risk both in terms of damage amount and liability expiry.

Furthermore, because of the Covid-19 outbreak, market players are now more focused on providing contractual mechanisms to control and allocate the risks of unpredictable and abnormal changes of circumstances that may impact transactions in the period between the signing and closing, through introduction of MAC or MAE clauses. As it is a risk allocation mechanism, the most common type of MAC clause allows the buyer to terminate the agreement, or simply not to complete the transaction, if, between the signing and closing, a circumstance arises which has, or may reasonably have in the future, an MAE. These clauses also frequently provide for a price adjustment if an MAE occurs in this period.

The risk allocation dynamics tend to be considerably different in a distressed M&A, with seller taking up more risk compared to non-distressed deals.

W&I insurance is still a growing market. It has been an increasing trend in the last 2-3 years, but it is still far from being an established market practice. The late rise of this type of insurances in Portugal is mainly due to low-cap transactions, lack of sophisticated players and associated W&I costs.

Nevertheless, W&I has been increasingly put on the table by sophisticated investors and international players, prevalently on the buy-side. The aim of this is to speed-up negotiations, thus lowering transaction and advisory costs, and as a route to find middle-ground and compromise solutions between players. W&I has been challenging more traditional buyer indemnity provisions, subject to caps, exclusions and other limitations, for breaches of the seller’s R&Ws and collateral agreements (e.g., escrow).

A similar trend has been observed with regard to known indemnity insurance policies.

Generally, financial sponsors have not been very active in recent time in the acquisition of infrastructure assets in the country. However, there are a few exceptions – the main ones being highway concessions and energy projects, especially PV solar.

Takeover of companies listed in the small-size Portuguese Stock Index have been virtually non-existent in recent years and this arena has been left practically unexplored by private equity firms so far.

Almost all foreign investment in Portugal remains unregulated and this makes the country one of the most inviting in Europe to non-EU investors. Some recent efforts at the European level due to the Covid-19 outbreak have recommended countries to set up a suitable screening mechanism (e.g., FDI Screening Regulation) and this has led several Member States to strengthen their powers in relation to foreign investments. However, Portugal is still to follow suit and it is to be expected expect that the county will at least scrutinise foreigner investments in the future in more detail. Nonetheless, to date, there is no news of Portugal strengthening its legal powers to monitor foreigner investment.

Other than anti-trust and regulated sectors – such as airlines, telecommunications, transportation, energy, insurance, and credit institutions – no governmental consents are required to be made by financial sponsors when acquiring businesses in the country.

The CMVM is the regulatory authority responsible for private equity funds, including oversight of registration and incorporation and monitoring of governance, activities and financial standing.

Additionally, pursuant to Instruction no. 27/2012, of 17 September, of the Bank of Portugal, as amended, all legal persons residing or operating in Portugal must communicate to the Bank of Portugal foreign transactions exceeding the total annual amount of EUR 100,000. This will apply to any Portuguese company receiving a transfer of funds from a foreign investor exceeding that amount.

Merger clearance is typically included as a key closing condition. This means the deal will only go through if the transaction is cleared by a given longstop date (or the imposed remedies are deemed acceptable by the parties) and completion will not take place if no clearance is issued. Therefore, although the way this risk is managed between the parties mainly depends on the bargaining power of the parties, in principle, the clearance risk is equally shared between the parties (no deal). Nevertheless, a standard share purchase agreement will include a set of collaboration duties of the parties throughout the procedure.

The process is normally kicked-off by the purchaser, as the entity that is legally bound to notify the antitrust authorities and seek approval. The purchaser must also agree to comply with any conditions which may be set out by the antitrust authorities. Besides this, the purchaser must undertake to keep seller informed along the process, for example, by disclosing any relevant information required by the authorities. However, a common provision will impose a duty on the seller to cooperate with and assist the buyer as necessary and use reasonable efforts to achieve clearance. Therefore, while the clearance risk and associated costs are primarily borne by the buyer, there is some risk allocation between the parties whenever the seller’s cooperation is needed, and parties will undertake to collaborate in good faith in order to achieve the merger condition.

Equity investment in companies through buying common or preferred shares is still the most common investment structure in Portugal. Financial sponsors acquire a minority stake and seek governance protection through a shareholder, investment or joint venture agreement with the other shareholders. This protection can include veto rights through reserved matters, rights to appoint directors and members of a remuneration committee, pre-emption rights and dividend/financing/business policies.

Nevertheless, we have seen an increase in debt investments by private lenders, especially through convertible bonds issuances, coupled with strong security.

A wide range of incentive packages have been used to remunerate management and incentivise performance for directors, as well as managers and key employees. These packages vary mainly in accordance with a legal and commercial evaluation, but they also depend on a tax and social security assessment.

Typically, remuneration policies comprise fixed and variable remuneration and a fringe benefits package. Among other incentives, this type of packages may include personal use of company car, health and life insurance and contributions to pensions funds.

Generally, there is plenty of flexibility when structuring the variable remuneration incentive schemes, so private companies are free to have packages tailored to their specific corporate goals. This is less true for financial institutions and publicly listed companies where some key regulation is found, which defines some principles on remuneration structure, approval, disclosure and payment deferral.

The main decision for companies on incentive plans is usually between awarding an equity participation with associated vesting provisions (either directly in shares or through stock option plans or other financial instruments) or a cash premium based variable remuneration (even if mirrors stock remuneration, as in phantom share schemes or other company performance indicators). In both cases, the calculation of variable remuneration is usually based on previously defined KPIs and an annual assessment. There is an increasing trend to include ESG related KPIs, particularly in listed companies, financial institutions and other big corps. This is driven particularly by recent EU regulation on these matters, ESG Indexes and pressure from international investors.

Big corps, listed companies and settled financial institutions are looking to ensure their management is strongly committed to the corporate goals by linking compensation to ongoing and long-term performance. However, startups are typically more focused on incentives at exit stage in order to align their collaborators and employees with the vision of the management team and accelerate growth and a successful sale.

Indeed, different tax frameworks apply to different incentive schemes. In general terms, remuneration and bonuses paid to managers and directors are subject to social security. The rate of social security is 34.75%, with 11% being paid by the manager or director and the remaining amount by the employer. Remuneration and bonuses are also subject to personal income tax, with progressive rates up to 48% depending on the total amount paid. As an alternative, market practice is for the managers/directors to have a carried interest in the fund through the subscription of a special class of participation units – with distribution of profits being subject to a flat 10% rate.

Yes, it is common for buyers to devote some effort to securing a strong non-compete commitment from seller in the context of a transaction. This is intended to afford the former some level of protection against competition from the latter, thus ensuring the transfer of the full value of the business.

Non-compete obligations are generally imposed on the seller’s top executives and managers, and possibly even on key employees. However, non-competes cannot prevent those individuals from purchasing or holding shares in competing companies purely for financial investment purposes, provided they do not grant them any management functions or material influence over the company.

Non-competes must have a reasonable duration to allow for the legitimate objective of implementing the transaction. Non-compete and exclusivity clauses usually last for up to 2 years and, in specific cases, up to 3 years. The general rule is that they may not exceed 3 years. A non-compete with a duration beyond that time-period is no longer considered justified to achieve the legitimate objective and is instead considered an anticompetitive agreement.

Nevertheless, post-contractual non-compete clauses do not provide buyers with an effective protection. In fact:

1. The former employer cannot object and prevent the employee from working for a competitor in breach of the agreement;
2. The competitor that hires the worker is not liable towards the previous employer for any losses caused by the breach;
3. The worker is liable for any losses caused, but the burden is on the company has the burden of alleging, quantify and prove the damages caused.

In order to strengthen the enforceability of the clause, the inclusion of a penalty clause that is paid on top of the damages is generally recommended. This acts as a more effective breach deterrent and mitigates the risks of the employer not being able to prove significant losses.

A financial sponsor typically looks for a shareholder or other form of investment agreement that binds all (or the majority of) the target’s shareholders in order to retain some level of negative control and ensure a minimum level of involvement in the decision-making process. The most typical control tools are found in the form of (i) rights of appointment of one or more directors, (ii) appointment of delegated or managing directors or proxies to conduct the ongoing business, and (iii) veto rights over reserved matters (structural decisions with a material impact in the company or the business) at the level of general meeting and board of directors.

The use of management pooling vehicles in this context is still far from being common in Portugal.

Traditional bank loans remain common in Portugal. However, bonds issuances are also very commonly used to structure corporate direct lending transactions, as they represent very efficient structures. This is commonly used by non-Portuguese lenders investing in Portugal.

Larger and more sophisticated companies also look at regulated markets and/or multilateral trading facilities for funding by issuing bonds under a public offer and admitting bonds to trading under such infrastructures, i.e., here the purpose is no longer to obtain funding from a specific lender.

Portuguese sophisticated bond issuers are already paying attention to the relevance of green bonds and there have already been cases in Portugal of issues seeking to fall under this label.

Portuguese company law bans private companies from providing any type of financial assistance (funding, loans or guarantees) in order to enable a third-party to acquire its own shares, under penalty of the whole transaction being null and void (and the directors of the companies participating in such transaction being punishable with criminal penalties). This applies to all sorts of financing arrangements, debt and equity alike, and it becomes particularly tricky in leveraged buyouts. This limitation should instead not apply where the funding to be secured and/or guaranteed by the Portuguese company in question is to be used for purposes other than the acquisition of its shares, including to refinance existing debt of the company or the group, or to fund working capital and future capital expenditures.

It is discussed among scholars as to the real extent of the prohibition rule, because doubts may be raised as to whether certain funding schemes are really covered by the rule and even as to whether it applies to all types of limited liability companies. However, players have been taking a conservative or preventive approach as to the understanding of this rule.

In addition, Portuguese law allows an upstream personal guarantee to the extent that guarantee is in the best interest of the guarantor. As a practical matter, the existence of the justified own interest is typically to be determined by the guarantor itself and properly resolved and documented by its Board of Directors/General Meeting. It is also common for personal guarantees granted by subsidiaries to include guarantee limitation wording taking as reference the value of that company’s assets.

No standard form for credit agreements is available in the market, but a great alignment on the content of the credit facilities is noticeable across the board. Nonetheless, negotiation is common depending on the risk profile of the borrower and the transaction at issue.

Some of the elements at the centre of negotiations between borrowers and lenders over the last few years have been (i) the definition of cash flow cascade, cash flow available for distribution and, in general, the allowed distributions scenarios, (ii) the definition of conditions precedent for each drawdown and the formalities entailed, (iii) a list of events of default and their consequences (which lead to acceleration and which result in termination), (iv) material adverse effect clauses (especially due to the pandemic), (v) the set of reserved discretions requiring prior notice or consent from the lender, (vi) the extent of the borrower’s positive and negative covenants, (vii) the provisions around financial information and requirements as to financial statements, which measures the level of the lender’s control.

Credits funds are a relatively new investment product in our jurisdiction. They are framed as a specific type of alternative investment fund allowed to grant loans, and to acquire performing and non-performing loans held by financial institutions. Loan funds can be established as self-managed corporate entities or as contractual collective investment schemes.

This was an important development in the Portuguese financial legal framework, because there were several restrictions on both lending and the acquisition of performing loans, which could be deemed as triggering licensing requirements when carried out on a professional basis.

Although it is expected that this new framework will contribute to the diversification of financing solutions available to the Portuguese economy, both through the granting of credit to companies and through the acquisition of credits generated by financial institutions (namely NPLs), the unclear tax regime has not permitted this investment scheme to develop as expected.

In any case, private equity funds in Portugal also provide alternative forms of debt capital, particularly through mezzanine type of transaction structures.