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1 Legal framework
1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?
Taxes are always relevant in the Swedish setting and this also applies within the private equity context, where acquisitions are generally structured on the basis of tax laws. As regards private equity transactions themselves, the primary sources of legislation are:
- the Contracts Act (1915:218);
- the Sale of Goods Act (1990:931); and
- the Companies Act (2005:551).
The Companies Act comes into play in several ways. For instance, Swedish private equity companies (as well as Swedish portfolio companies) must be mindful of the minimum capital requirement regulations set out in the act, as well as the general prohibition in the same statute against a corporation providing loans to its shareholders. Further, as in many jurisdictions, antitrust legislation and anti-money laundering legislation may affect how targets are selected and how business is conducted in certain circumstances. Also, if a transaction involves a target whose shares are listed on a Swedish regulated market, the Swedish takeover rules apply to the transaction.
1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?
The Swedish private equity market is mature and relatively large for a jurisdiction of Sweden’s size. There are several reasons for this:
- There are very few regulatory hurdles relating to the ownership of corporate assets, which provides structural support to the private equity market;
- There is no stamp duty on share transfers, which keeps transaction costs low; and
- Many Swedish companies are generally well run, resulting in a large number of potential targets.
2 Regulatory framework
2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?
The regulatory authorities often have limited relevance to Swedish private equity transactions. In general, no consents are required from the Swedish regulatory authorities, other than in relation to antitrust. If certain turnover thresholds are met, a merger filing with the Swedish Competition Authority may be required; and in certain industries – such as banking, insurance and infrastructure – there may be requirements for government permits and approvals (eg, from the Swedish Financial Supervisory Authority).
Please also see question 10.2.
2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?
The regulatory conditions will depend on the industry in which the portfolio company operates. Generally speaking, there are very few requirements in Sweden; and where there are requirements (eg, in the financial sector), the conditions are generally fairly straightforward and not arbitrary.
New legislation, due to enter into effect on 1 January 2021, on operators that undertake ‘security-sensitive activities’ (ie, activities which are important to Sweden’s national security), may have major implications for anyone contemplating selling or investing in such businesses. The new legislation, which is intended to meet the requirements of EU Regulation 2019/452 on establishing a framework for the screening of foreign direct investments into the European Union, aims to provide a framework for identifying transactions and issues which involve security-sensitive activities, and will oblige relevant sellers and operators involved to consult with an authority in order to have the proposed transaction scrutinised and cleared.
3 Structuring considerations
3.1 How are private equity transactions typically structured in your jurisdiction?
Assuming that the target is a Swedish limited liability company, the buyer often establishes a two or three-tier holding company structure (BidCo, HoldCo and in some cases a TopCo). BidCo is the buyer and usually takes up the external debt. Reinvestments by management (and sometimes by certain sellers) normally take place in HoldCo, in order to keep BidCo ‘clean’, with a single shareholder. Depending on the private equity buyer’s preference, reinvestment by management in HoldCo is often made via a ManCo, owned by management but controlled by TopCo. North of TopCo is the fund’s holding company, usually situated in a jurisdiction that is beneficial to the fund from a tax and distribution perspective.
3.2 What are the potential advantages and disadvantages of the available transaction structures?
Sweden recently enacted stricter regulations in relation to the possibility for Swedish corporations to deduct interest expenses. Since 2019, interest can be deducted only up to a maximum amount corresponding to 30% of a company’s earnings before interest, tax, depreciation and amortisation (EBITDA). While we have not yet seen the full effect of these changes, they are expected to affect the appetite for highly leveraged transactions going forward, and thus potentially the prices payable on the Swedish private equity market in general.
In addition, and more generally, structuring acquisitions must also cater for the future – that is, actions and issues that may arise during the holding period of the portfolio company. These will normally include considerations surrounding:
- restructurings (at both holding company and portfolio company group levels);
- limited partner co-investments;
- exit strategies (including by way of an initial public offering); and
- the winding down of the holding structure post-exit.
3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?
BidCo will usually take up external debt and pledge the shares and valuable assets of the target as security therefor. Depending on the size of the transaction, bank debt can be provided by a single Nordic bank, a club of Nordic banks or a larger syndicate of international banks and debt funds. Equity will be made available from the fund and reach BidCo through a combination of shareholder contributions or an intra-group loan structure from TopCo or HoldCo and newly issued shares in BidCo. Alternatively, if the bond markets are open, some deals are debt financed via bonds. Depending on the size of the deal, it can be funded by Nordic bonds or, for larger transactions, Euro bonds.
3.4 What are the potential advantages and disadvantages of the available funding structures?
Bank debt provided by Nordic banks will generally have more conservative terms than those seen on the international market, including maintenance covenants.
Nordic bonds are generally made with incurrence covenants and very flexible terms. Placing a bond between signing and closing may be burdensome for the target management (road show); and in a volatile market, it can also involve a lack of certainty. For sellers seeking to ensure that the buyer already has funding in place on signing of the deal, this could also require that the buyer have a bridge facility in place as a back-up.
3.5 What specific issues should be borne in mind when structuring cross-border private equity transactions?
Tax considerations – in particular, as they relate to the non-deductibility of interest (limited at 30% of EBITDA and further limited in relation to intra-group debt).
3.6 What specific issues should be borne in mind when a private equity transaction involves multiple investors?
Most important is alignment on governance, regulatory and exit triggering rights. In addition, the parties must take into account the various limited partner requirements that may exist in relation to the different funds.
4 Investment process
4.1 How does the investment process typically unfold? What are the key milestones?
The process is generally relatively standard and does not differ from that in most other jurisdictions.
Auction processes are often preferred by the seller. In such processes, following negotiations of the non-disclosure agreements, the potential buyers get a chance to review high-level information such as an investment or information memo and limited financials, before indicative offers are due. In the second round, following the seller’s review of the bids, a handful of bidders get the chance to conduct full due diligence of the target. During the diligence phase, the bidders are also provided with the seller’s proposed transaction agreements, which must be turned by the bidder and subsequently negotiated between the parties. Bidders are also offered restricted access to management of the target at this point. Such access is also necessary for the private equity bidder to present its management reinvestment offer, which is a crucial milestone in the transaction.
Warranty and indemnity (W&I) insurance is the norm, so sellers tend to have a stapled insurance solution prepared, which also means that the warranties provided in the transaction documents are usually fully covered by the insurance. Following review of the final bids and the selection of a winner, there is a short timeframe (usually no more than 72 hours; often less) during which the W&I process is finalised before the transaction is executed.
On occasion, bidders will try to pre-empt the auction process by offering to acquire the target on a very short exclusivity period, thus creating a bilateral process. This is particularly prevalent in situations where the target is highly desirable and a particular sponsor is eager to acquire the target quickly. Bilateral processes are also often used in situations where:
- the target is regarded as less desirable and an auction process therefor is less likely to yield a higher price than that offered by the pre-empting bidder; and
- the enterprise value of the target, relatively speaking, is lower.
Management is often invited to reinvest in the transaction. The management shareholders’ agreement and reinvestment documents are usually negotiated in conjunction with the negotiation of the main transaction documents. Management is usually represented by separate counsel, so as to avoid conflicts of interest.
4.2 What level of due diligence does the private equity firm typically conduct into the target?
It obviously depends on the target, but certain focus areas are generally given specific attention. Tax and accounting diligence is normally very detailed. Legal can vary, but every document offered to the bidder in due diligence must be reviewed, as the norm in sale and purchases governed by Swedish law is that every piece of information offered in due diligence is deemed disclosed to the bidder (and thus qualifies the warranties).
Reporting has become more professional and to the point (materiality thresholds for findings are often linked, if possible, to de minimis thresholds in the sale and purchase agreement and deductible in the W&I policy), Most sponsors try to avoid receiving lengthy, descriptive reports in favour of red flag reports reporting only on deviations from the norm.
4.3 What disclosure requirements and restrictions may apply throughout the investment process, for both the private equity firm and the target?
As market practice dictates that the entire data room be disclosed under the purchase agreement, sellers generally tend to include a lot of information in the data room. This obviously does not apply where the potential buyer is a competitor, in which case it is not unusual to have the advisers to the bidder set up clean teams which can review the information, but not disclose sensitive information to the bidder.
Both W&I underwriters and loan provides require relatively comprehensive diligence reports, or at least evidence that the diligence review has been thorough, in order to support a transaction.
4.4 What advisers and other stakeholders are involved in the investment process?
- Fund representatives, advisory team, legal, financial and other due diligence advisers (eg, environmental, commercial);
- Debt providers and their advisers;
- The target’s debt provider and its advisers;
- The seller’s representatives, investment bank, financial and legal advisers;
- Target management and their legal adviser; and
- The W&I insurance broker and legal adviser (possibly also accountants).
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?
The locked box remains the preferred mechanism, as it provides certainty and does not require post-closing activities from the parties. Depending on the target’s cash-flow fluctuations and the negotiation strength of the seller, we also sometimes see a ticker interest adding to the locked box purchase price on a daily basis. This will require the buyer to feel confident about the amount of time it will need to satisfy any conditions precedent (eg, antitrust and other regulatory filings).
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 permitted in Sweden. The trigger is normally the buyer’s failure to meet conditions precedent within its control within a specific timeframe or by the long-stop date. The level of the break fee should not be set too high, as it risks being set aside if unreasonable. The break fee language and triggers must also be carefully considered for the same reasons. However, break fees are relatively unusual in the Swedish setting.
5.3 How is risk typically allocated between the parties?
The seller is rarely willing to take any risk with regard to closing certainty and will assume ordinary course covenants up to closing.
The buyer will expect the seller to give warranties at signing and at closing, with a right to put forward claims under those warranties for a period of 12 to 24 months after closing. W&I insurance is commonly used (and thereby the need for traditional escrows has very much diminished).
5.4 What representations and warranties will typically be made and what are the consequences of breach? Is warranty and indemnity insurance commonly used?
The warranty package is usually relatively well developed, as transactions are normally covered by warranty and indemnity insurance. Consequently, most operational warranties are provided, as well as customary fundamental warranties such as authority, ownership and so on.
The remedy in the event of a breach of a warranty is damages – that is, compensation for the loss caused by the breach. There is no right to terminate the purchase agreement as a result of a breach of warranties.
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?
Management often gets to participate in the incentive programme through one or two management HoldCos, through which each manager gets to choose the allocation between common stock and preferred stock (within certain boundaries, such as 80/20 or 70/20). All shares are acquired at market value, as the transaction would otherwise be taxable for both the employer and the manager. Management is normally subject to good leaver/bad leaver provisions, and most sponsors tend to acquire all securities when a manager leaves his or her position.
6.2 What are the tax implications of these different structures? What strategies are available to mitigate tax exposure?
Since the Swedish tax system generally taxes capital income at a substantially lower level than salary income, it is important that any profit made from the management incentive programme be taxed as capital income. Consequently, it is imperative that any programme consist of securities, and that such securities be acquired at market value.
As a result of the foregoing, a tax assessment of the management incentive programme is often part of the structure paper/straw man report prepared by the buyer’s tax structuring adviser.
6.3 What rights are typically granted and what restrictions typically apply to manager shareholders?
Managers are usually bound by general transfer restrictions, with a right of first refusal for the lead investor if sales are at all permitted. Good and bad leaver provisions are standard, and the managers usually provide a power of attorney to the lead investor to represent the manager’s shares at all general meetings and so on.
6.4 What leaver provisions typically apply to manager shareholders and how are ‘good’ and ‘bad’ leavers typically defined?
A manager shareholder who leaves on the grounds of retirement, long-term illness, death or termination of employment by the employer without cause is generally considered a good leaver. Good leaver status will normally lead to the manager receiving market value for the shares (should the lead investor decide to acquire them).
A manager shareholder who leaves on the grounds of material breach of the management shareholders’ agreement or the employment agreement, or termination of employment by the employee or by the employer with cause, is generally considered a bad leaver – triggering a right for the lead investor to acquire (or designate someone to acquire) his or her shares for the lower of the acquisition price and 50% to 70% of the market value.
7 Governance and oversight
7.1 What are the typical governance arrangements of private equity portfolio companies?
The ‘real board’ will normally be set up in the BidCo, with the boards of the underlying group companies staffed by smaller management boards (ie, the chief executive officer (CEO) and/or chief financial officer of the group).
CEO instructions and board procedure documentation will normally be put in place, even though generally these are not legally required. In the operating companies in the group’s jurisdictions, the private equity owner will want to ensure that some control is exercised indirectly via limitations in management’s authorisations.
7.2 What considerations should a private equity firm take into account when putting forward nominees to the board of the portfolio company?
At least half of the board members (and the substitute board members) must be residents of the European Economic Area. This applies to all (Swedish) entities throughout the structure.
Aside from getting the relevant competences in place, the private equity firm will often have (under its umbrella) a ‘pool’ of operating chairpersons that can be used.
There are also tax considerations to be taken into account
7.3 Can the private equity firm and/or its nominated directors typically veto significant corporate decisions of the portfolio company?
Yes, control of the main board of directors is key for the private equity firm.
7.4 What other tools and strategies are available to the private equity firm to monitor and influence the performance of the portfolio company?
- Reporting procedures;
- Limitations in authorisations for the boards and managers in the portfolio group;
- Bonus programmes and incentive programmes; and
- A new business plan.
8.1 What exit strategies are typically negotiated by private equity firms in your jurisdiction?
Bilateral discussions are the preferred route for buyers and have become more common during the last few years. From a sell-side point of view, bilateral discussions may be interesting if the price is right and the buyer is willing to commit to a fast process. If not, the obvious choices are controlled auction processes and, at times when the stock market valuation is attractive, an initial public offering (for the right portfolio company).
Buyers that are very keen on a target will often try to pre-empt an auction sale.
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?
Other than the process yet to be established for transactions involving security-sensitive activities (see question 2.2), there are no specific legal or regulatory consideration to bear in mind.
9 Tax considerations
9.1 What are the key tax considerations for private equity transactions in your jurisdiction?
In general, acquisition structures for private equity transactions are tax driven. The most common tax considerations in such structures are the deductibility of interest expenses and withholding tax implications for the repatriation of profits.
With respect to interest expenses, Sweden applies a general earnings before interest, tax, depreciation and amortisation (EBITDA) based limitation regime to all interest expenses. This applies as from financial year 2019 and allows for a maximum deduction corresponding to 30% of taxable EBITDA.
Interest expenses paid to affiliated companies may also be subject to additional specific anti-avoidance rules. There are various specific interest limitation rules in place. The most important rule provides that interest expenses paid to affiliated companies are not deductible for tax purposes, unless the beneficial owner of the interest income is resident within the European Economic Area or a tax treaty jurisdiction, or a jurisdiction that applies a nominal corporate income tax rate of at least 10%. However, if the debt arrangement has been constructed exclusively to achieve a tax benefit for the group, the interest expenses may not be deducted.
Sweden does not apply withholding tax on interest. However, dividends paid to non-Swedish shareholders are generally subject to 30% withholding tax. Relief from withholding tax may be available under applicable double tax treaties or under the participation exemption regime in domestic tax law. Withholding tax implications play a key role in shaping acquisition and exit structures in relation to private equity transactions.
9.2 What indirect tax risks and opportunities can arise from private equity transactions in your jurisdiction?
The indirect tax risks that arise from private equity transactions generally relate to a company’s possibility to deduct value added tax from transaction costs and related questions (eg, the set-up of a management fee structure).
9.3 What preferred tax strategies are typically adopted in private equity transactions in your jurisdiction?
If both BidCo and TargetCo are Swedish limited companies, any deductible interest expenses or other expenses in BidCo may be offset against profits in TargetCo through group contributions. However, this can be achieved only the year after the acquisition of TargetCo. If BidCo and TargetCo are merged in the year that the acquisition takes place, tax consolidation between these two entities will effectively be achieved a year earlier than through group contributions. Such a merger can generally be carried out without triggering any taxation.
Other strategies include management incentive programmes where the acquired instruments (eg, shares or warrants) are taxed as income from capital rather than earned income. If management participates in such programmes, all shares are acquired at market value,as the acquisition would otherwise be taxable for both the employer and the managers. As management investment is generally made in a debt financed entity, the market value of the acquired shares may be reduced.
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?
With plenty of equity to be deployed by private equity firms active in Sweden and in the Nordics, Q3 2020 has shown signs of increased activity following an almost complete standstill in Q2. The digitalisation trend continues, so we expect to see a lot of activity in that space (eg, tech, IT, payments and software). Private equity-backed companies that have continued to show strength during the pandemic could certainly head for initial public offerings during 2021, as long as the stock markets remain high.
10.2 Are any developments anticipated in the next 12 months, including any proposed legislative reforms in the legal or tax framework?
International private equity groups have been able to insert so-called ‘portability language’ into loan documentation in recent deals.
The Swedish government recently decided to refer a proposal to the Council on Legislation with the aim of strengthening efforts against foreign direct investments that threaten Swedish security and public order. This action is based on EU Regulation 2019/452 on establishing a framework for the screening of foreign direct investments into the Union adopted by the EU in 2019, which entered into force on 11 October 2020. The Swedish Inspectorate of Strategic Products and the Swedish Defence Research Agency have been given assignments to further develop these efforts under the proposal. It is proposed that new legislation will come into force in Sweden on 1 December 2020, but the effects thereof are still very uncertain. To the extent that a target conducts business or owns assets that are of importance for Sweden’s national security – a term which can be interpreted very broadly – the regulations will apply (other than in relation to acquisitions of public companies and real estate); and we do not know as yet exactly what the process and the timing will be. Transactions which have commenced prior to the new legislation entering into effect will not be affected it.
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?
The Swedish private equity market is, and has for many years been, very strong and is one of the most active in Europe (based on its share of national gross domestic product), in particular as it relates to small and medium-sized targets. As such, both early-stage companies and more mature companies can often find suitors for a potential sale, making the Swedish market very attractive to entrepreneurs. Similarly, private equity sponsors will find that many Swedish targets are both suitable targets – being well managed and with an attractive potential future – and willing participants in transactions.
As a consequence of the foregoing, however, the price-to-earnings ratio in private equity transactions in Sweden is relatively high and there is plenty of competition for good assets. This means that in order for sponsors to be able to meet their internal rate of return requirements, there must be exit possibilities – either through an attractive initial public offering market or through secondary sales on the international market. Consequently, the Swedish private equity market is highly dependent on international stock markets and the availability of international private equity. If these exit possibilities were to disappear – as was the case in early/mid-2020, when COVID-19 hit – the Swedish private equity market would be significantly affected.
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