Merger Control Issues and Private Equity Transactions

Merger Control Issues and Private Equity Transactions

Further information If you would like further information on any aspect of Merger Control and Private Equity Transactions please contact a person mentioned below or the person with whom you usually deal. Contact Lesley Ainsworth T +44 (20) 7296-2181 lesley.ainsworth@lovells.com Gianluca Belotti T +39 (06) 675823-02 gianluca.belotti@lovells.com Jacques Derenne T +32 (2) 62 69-261 jacques.derenne@lovells.com Pierre de Montalembert T +33 (1) 5367-1800 pierre.demontalembert@lovells.com Martin Sura T +49 (211) 1368-390 martin.sura@lovells.com This note is written as a general guide only. It should not be relied upon as a substitute for specific legal advice.

Contents Introduction 1 International merger control - key points 1 Particular issues for private equity transactions 1 Acquiring control 1 Transactions caught by merger control 2 Turnover calculation 2 Timing 2 Risks 3 Annex 4

Lovells 1 Merger Control Issues and Private Equity Transactions INTRODUCTION Even for private equity transactions, which often do not raise any substantive competition concerns, the need to notify acquisitions and obtain regulatory clearance from merger control authorities can have a material impact on the structure and timing of the transaction. Failure to notify a transaction to relevant authorities could result in severe penalties for the parties. Discovering the need to make clearance applications at a late stage can cause unnecessary delays in closing, and cause additional costs. This note provides an overview of international merger control regimes and highlights key issues that private equity investors need to bear in mind when structuring acquisitions. INTERNATIONAL MERGER CONTROL - KEY POINTS Merger clearance may be needed even if the transaction raises no competition concerns It is important to distinguish between the two different questions: the jurisdictional analysis: does the transaction have to be notified to (and cleared by) any competition authority(ies) before closing can take place?; and the competition analysis: is any competition authority likely to object to the proposed transaction? The jurisdictional analysis involves two further questions: is the control threshold met? - i.e. is anyone acquiring influence/control over another business to bring the merger control rules into play?; and, if so are the notification thresholds met? These are typically related to the turnover of the parties or market shares/asset value of the parties. The details of merger control regimes vary between jurisdictions The details of the jurisdictional thresholds and substantive test by which transactions are judged vary between countries, as do the procedural requirements. In the EU, in addition to the national merger control regimes of the 27 Member States, there is a pan-eu merger control regime under the EC Merger Regulation ("ECMR") which applies to larger transactions, in place of the national regimes. For transactions subject to the ECMR a single filing to, and clearance by, the European Commission replaces the need for clearances from individual Member States. 1 The comments below reflect mainly the ECMR regime and the national regimes which are based on the ECMR regime. It is always necessary to check the details of the national regime at issue because there are many variations between national regimes. PARTICULAR ISSUES FOR PRIVATE EQUITY TRANSACTIONS Although acquisitions by private equity funds are primarily made for investment purposes, they are treated in the same way as trade acquisitions by the merger control authorities, most of which now have mandatory regimes (i.e. a transaction that meets the jurisdictional thresholds must be notified and, in most cases, get cleared before completion). There are, however, some particular features of the way in which merger control regimes impact on private equity transactions: the private equity house (and not the investing funds or the limited partners) is generally treated as the acquiring party (see Acquiring Control section below); an acquisition of a minority interest may also trigger the need to file for merger control clearance (see Transactions Caught by Merger Control section below); when co-investing in a target, the choice of co-investor can affect both the issue of where clearances are needed and whether the transaction gives rise to competition concerns (see Transactions Caught by Merger Control section below); when calculating a private equity buyer's turnover, it is often necessary to include the turnover of the group to which the private equity firm belongs and the turnover of all portfolio businesses controlled by the various funds managed by that private equity house (see Turnover Calculation section below); and in assessing whether an acquisition gives rise to competition issues, the merger control authorities will usually take into account the activities of all portfolio companies controlled by the private equity house through its funds and those controlled by any coinvestors who will be sharing control over the target. ACQUIRING CONTROL In a typical private equity transaction: a newly incorporated vehicle ("NewCo") acquires all the shares in the target; shares in the NewCo are acquired by one or more limited partnerships which together comprise a fund (or in some cases more than one fund); and the investors are the limited partners in the limited partnership and subsidiaries of the private equity house act as general partners of the limited partnerships. On the acquirer side, under the ECMR and in most European jurisdictions, it is the private equity house (or its

Lovells 2 ultimate parent entity if it is part of a wider group) that is deemed to acquire control of the target through the subsidiaries acting as the general partners of the various limited partnerships. It is the general partner (not the limited partnership) that has the power to vote shares held by the limited partnership and that gives them control over the NewCo's and, through them, the target. Consequently, although the limited partners are the investors who have financed the purchase, and for whose benefit the target's shares are held, it is the private equity house that is regarded as acquiring control of the various portfolio companies held by its various funds. TRANSACTIONS CAUGHT BY MERGER CONTROL Merger control not only applies to mergers and acquisitions of entire businesses but may also include acquisitions of minority interests. For merger control purposes the key issue is whether the transaction causes a change of control. In many jurisdictions, including under the ECMR, it is sufficient if the minority interest allows the holder to exercise decisive influence over the target's strategic business decisions. Co-investing: Where control is based on veto rights, it is possible for there to be more than one party acquiring control over the target. In private equity transactions this may happen if two or more private equity firms are coinvesting or where the original shareholder is retaining a substantial interest. The question of how many parties will be regarded as sharing control of the target is vital since the turnover and activities of each party with joint control will decide whether notification thresholds are met, and whether competition issues arise. Syndication: If a private equity house decides to syndicate an investment after closing, this may trigger the need for a second round of merger clearances. If the new co-investor acquires a sufficient stake for them to be deemed to be acquiring joint control for merger clearance purposes and the notification thresholds are met, this will be treated as a second transaction for which clearances have to be obtained. Completion of the syndication will have to be conditional on obtaining those clearances. In contrast, if syndication is to take place before the closing of the original purchase (or in some cases where the syndication is agreed before closing of the initial deal but is to take place slightly later) then the involvement of the second investor should be factored into the original merger analysis and clearance applications. TURNOVER CALCULATION Which countries have jurisdiction over a transaction is generally determined by whether the parties' combined turnover (and/or assets/market shares) exceeds certain thresholds. On the seller's side, the turnover, assets or market share to take into account is generally that attributable to the target. 2 On the buyer's side, it is normal to take into account the group turnover of all the acquisition vehicle's shareholders that will have a sufficient interest to be deemed to be acquiring "control" over the target under the relevant national rules. In complex transactions with a number of minority shareholders, each with veto rights over strategic issues, there may be a number of parties to take into account. Where the buyer is a private equity house, under the ECMR (and in most EU countries), the following turnover should be included: the turnover of the private equity house itself (which will typically comprise fee income); where the private equity house is part of a larger financial institution (e.g. a bank or insurance group), that group's turnover needs to be included; and the turnover of the other portfolio companies controlled by the private equity group. It is the private equity house (not the limited partners) which is deemed to acquire control of the target. Consequently, in Figure 1 of the Annex, all entities (other than the limited partners themselves and the management) would be considered as undertakings whose turnover should be included. If a private equity house jointly controls one of its portfolio companies with a third party, part of that turnover should be included. How much of the turnover should be included in such cases is decided by the number of controlling companies and not the percentage shareholding. E.g., in Figure 2 of the Annex, private equity house PE1 proposes to acquire Target via NewCo. Assuming PE1 jointly controls Company X through a 40% shareholding with two other controlling companies, PE2 and PE3, having shares of 30% and 30% respectively and each private equity house having veto rights over changes to X's budgets/business plans, a third of X's turnover will be attributed to PE1, not 40%. TIMING Concentrations that require merger filings must, generally, be notified and cleared pre-completion. Normally the clearance application is submitted once the acquisition agreement has been signed but in some jurisdictions it is possible to file before signing has taken place. The time taken to obtain clearance varies considerably from country to country. Most merger control systems have a two-phase process with most transactions being cleared in Phase 1 (typically 1-3 months) and only deals raising serious competition concerns being subjected to a Phase 2 investigation (these timetables vary widely but an additional 4-6 months or longer is not unusual).

Lovells 3 RISKS Jumping the gun: Where mandatory clearances are required it is essential that the buyer does not attempt to exercise control or influence over the target until all necessary clearances have been obtained and completion has taken place. In order to avoid this, care should be taken in drafting any provisions in the transaction documentation that specify how the business is to be run in the period between signing and completion. Generally, the acquirer should not have the right to appoint nominees to the target's board before clearance. Failure to file/closing without clearance: Where a mandatory filing is not made or completion takes place before mandatory clearance is given, the parties face the risk of penalties even if the transaction does not raise competition concerns. This may include fines; the transaction being void; and/or criminal sanctions. Penalties can also be imposed where certain filing deadlines are breached. January 2009 1 2 Where a transaction does not meet the ECMR thresholds but falls within the jurisdiction of at least three Member States, the parties can request the Commission to take jurisdiction under the ECMR. However, in some jurisdictions the entire seller group's turnover or assets has to be considered.

Lovells 4 Annex Figure 1 Rest of Group Limited Partners PE House LP 1 LP 2 Fund Other portfolio companies controlled by PE House GP 1 GP 2 45% % NewCo 45% % 10% % Management Target. Figure 2 PE3 PE2 30% 30% PE1 Management 40% X 90% 10% NewCo Target

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