PRACTICAL LAW PRIVATE EQUITY MULTI-JURISDICTIONAL GUIDE The law and leading lawyers worldwide

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1 PRACTICAL LAW MULTI-JURISDICTIONAL GUIDE 2012 The law and leading lawyers worldwide Essential legal questions answered in 20 key jurisdictions Rankings and recommended lawyers in 38 jurisdictions Analysis of critical legal issues AVAILABLE ONLINE AT

2 Luxembourg Marie-Béatrice Noble, Katia Scheidecker, Arnaud Peraire and Raquel Guevara MNKS MARKET OVERVIEW 1. How do private equity funds typically obtain their funding? Institutional investors were the most important source of private equity funding in Europe in 2010 (2010 figures published by the European Venture Capital Association (EVCA)). Pension funds contributed 12% of the total and funds of funds 11%, while the contribution by banks was significantly lower than in 2009 at only 9%. The remaining contribution was by European private equity houses, which raised 13% more funds in 2010 than in Funds raised in Europe break down as 83% from buyout and growth funds and 17% from venture funds. Most of the investors were European (with the UK providing over one-third, France 21% and Germany 7%). Non-EU LPs contributed 12%. Of European investors, French investors initiated the most sociétés d investissement en capital à risque (SICARs) (the Luxembourgdedicated vehicle for private equity and venture capital) with 18%, followed by Swiss, German and Luxembourg investors. US-based private equity houses set up the most non-european SICARs with 8%. In total, investors came from 32 different countries. As of December 2011, Luxembourg private equity vehicles included: 15 pension funds (pension savings associations (Associations d Épargne Pension) (ASSEPS) or pension savings companies with variable capital (sociétés d épargnepension à capital variable) (SEPCAVs)). 274 SICARS. 27 securitisation vehicles specialised investment companies (fonds d investissement specialisés) (SIFs). Unlike SICARs, SIFs can in principle be used for any type of investment. However, as of December 2010, 79 SIFs invested in non-listed assets and high-risk assets. See Question 3. against offshore centres. In recent years more than 300 private equity and venture capital funds have been incorporated as SICARs and SIFs. In the last decade, the industry has seen increasing use of non-regulated vehicles by private equity houses to structure their European acquisitions, such as the unregulated Société de Participations Financières (Soparfi) structure (see Question 6), of which there are now more than 25,000. It is estimated that Luxembourg has around US$40 billion in private equity assets under administration. (As at 1 November 2011, US$1 was about EUR0.7.) In 2010, SICARs either limited their investment policy to a particular strategy (such as, buy, build and sell, buyouts, mezzanine financing or risk capital funds) or adopted a combination of these strategies. The growing number of SIFs demonstrates that this vehicle is also suitable for private equity investors. SIFs structured as umbrella funds generally offer a compartment dedicated to private equity alongside sub-funds investing in real estate, hedge funds and listed securities. More recently, many of the world s leading private equity houses have established sizable operations in Luxembourg and service providers such as banks, fund administrators, lawyers and accountants have set up specialised private equity teams. A major trend resulting from the recent economic downturn has been the growth of regulation in the private equity industry. Investor concerns have led fund managers to seek wellregulated jurisdictions such as Luxembourg to domicile their funds. Luxembourg s regulatory environment and legislative framework has therefore allowed the private equity industry to remain strong despite the global economic climate. Similarly, Luxembourg s network of over 60 double taxation treaties has added to the Luxembourg s attractiveness as an EU on-shore location. The Luxembourg Private Equity Association was established in February 2010, which now has more than 70 members and aims to promote the private equity industry in Luxembourg (see box, Private equity/venture capital associations). 2. What are the current major trends in the private equity market? Luxembourg remains the second largest global leader for domiciled funds, behind the US, and is gaining significant ground In addition to the regulations at European level (such as Directive 2011/61/EU on alternative investment funds managers (AIFM Directive)), the authorities are working on various changes to the legal and financial regime (see Question 4). This article was first published in the Private Equity multi-jurisdictional guide 2012 and is reproduced with the permission of the publisher, Practical Law Company.

3 3. What has been the level of private equity activity in recent years? Fundraising The global financial crisis has significantly affected fundraising in the private equity sector. The figures for the first half of 2011 globally showed that private equity fundraising remained at a fraction of pre-crisis levels. During the same period, on the investment side, private equity activity continued to steadily increase but this trend is likely to have slowed due to the debt crisis in the second half of Investment The level of activity in relation to investments by regulated vehicles (see Question 6, Regulated vehicles) is as follows: SICARs. Based on the provisional figures as at 31 December 2010, the capital commitments of investors in SICARs totalled about EUR16.6 billion. The SICARs balance sheets (unpaid subscribed capital excepted) totalled EUR25.1 billion. Investment in risk capital totalled EUR22.2 billion. SICARs are principally financed by their investors and the total financing of SICARs by banks only amounted to EUR0.7 million, representing 2.78% of the SICARs balance sheet total (CSSF s annual activities report 2010). Undertakings for Collective Investments (UCIs) (including SIFs). Net assets in non-listed transferable securities and venture capital totalled EUR9.348 billion and EUR0.766 billion respectively as at November Transactions There were seven big deals involving Luxembourg private equity houses from January 2010 to November 2011 in the domestic mergers and acquisitions market. Exits At a global level, the first half of 2011 saw a rebound from 2010 with 455 private equity-backed exits and an aggregate transaction size of US$162 billion. Global aggregate transactions realised in the second quarter of 2011 constituted a 5% increase from the post-crisis record seen in the fourth quarter of In addition, private equity-backed companies executed some of the largest sponsored IPOs in history in the first half of REFORM 4. Are there any proposals for regulatory or other reforms affecting private equity in your jurisdiction? SIF Law A draft law was adopted by the Luxembourg Government Council on 1 July 2011 and submitted on 12 August 2011 to the Luxembourg Parliament, which if passed will modify the Law of 13 February 2007 relating to SIF (SIF Law) to implement the AIFM Directive and make other changes. The draft law covers the authorisation process, delegation of specific tasks and functions to third parties, risk management, and conflicts of interest. It also permits cross investment between compartments of SIFs and modifies reporting and general meeting requirements. There are presently no global statistics relating to the volume of activity of non-regulated funds (see Question 6, Non-regulated vehicles). The investment strategies followed by SICARs as at 31 December 2010 were as follows (CSSF Annual Activities Report 2010): Buy, build and sell investments: 144. Investments through buyout instruments: 35. Investments through mezzanine instruments: 18. Investments by risk capital funds in early stage investments: 50. In practice, combined strategies are generally used in the area of risk capital. The use of buyout and mezzanine strategies grew by 30% compared to the previous year. SICARs net assets, according to the main investment policy, were as follows (CSSF s annual activities report 2010): Private equity: EUR13,863 million. Private equity and venture capital: EUR4,181 million. Venture capital: EUR2,159 million. Mezzanine: EUR368 million. In addition, SIFs include a considerable number of vehicles investing in clean technologies, infrastructure projects and tangible assets such as art, wine, jewellery and similar assets. Limited partnership regime (association en commandite simple) A possible future development, though still at the discussion stage, is the introduction of a corporate vehicle modelled on the Anglo-Saxon common law concept of the limited partnership. Though a Luxembourg vehicle similar to the UK partnership already exists (the société en commandite simple) it is not marketed as such and not seen by international investors as being sufficiently comparable. Therefore, with the introduction of a partnership vehicle, Luxembourg would be able to provide the full spectrum of legal structures for private equity structuring. AIFM Directive EU member states are required to adopt, publish and apply the laws, regulations and administrative provisions necessary to comply with the AIFM Directive by 22 July Existing AIFMs will have one additional year to comply with the new regime. In anticipation of the entry into force of the AIFM Directive, private equity fund managers will have to analyse the impact it will have on their business model. In addition, Luxembourg private equity funds service providers (depositaries, asset managers, investment advisors, administrators, transfer agents, and so on) must also comply with the AIFM Directive. The existing regulated private equity vehicles (SICARs and SIFs) already display many of the features that will become standard, such as light and flexible supervision, a depositary bank, sophisticated reporting, standards relating to service providers and parent passporting of AIFMs and AIFs.

4 Consultation on venture capital regime In December 2011, the European Commission presented its action plan, further to a consultation launched in June 2011, with the goal of creating an internal market for venture capital. The project includes a proposal to introduce a European passport for venture capital funds to raise capital from professional investors freely throughout the EU and to invest in small and medium-sized enterprises (SMEs). The consultation paper focused on two options to create an internal market for venture capital in the EU: Re-examining the suitability of the AIFM Directive in relation to certain venture capital funds. Creating a tailor-made system, as a standalone initiative. TAX INCENTIVE SCHEMES 5. What tax incentive schemes exist to encourage investment in unlisted companies? At whom are the schemes directed? What conditions must be met? Liquidation proceeds. Liquidation proceeds received by a fully taxable Luxembourg resident company are generally also exempt from corporate income and municipal business tax under the same conditions as above. Capital duty. A fixed registration duty of EUR75 applies to transactions involving Luxembourg entities (that is, incorporation, amendments to the articles of association and transfers of the head office to Luxembourg). In addition, proportionate registration duties may also apply in certain cases. Distribution to foreign investors. Interest paid by a Luxembourg company is not subject to withholding tax if it is transaction made at arm s-length. However, Directive 2003/48/EC on taxation of savings income in the form of interest payments (Savings Directive) imposes a withholding tax of 35% from 1 July 2011 on interest paid to individuals or residual entities that reside in the EU (or territories with similar measures to the Directive and/ or that have entered into bilateral agreements for the application of the Directive.) As an alternative to the withholding tax, the recipient of the interest can opt for the exchange of information procedure, in which case no withholding tax is imposed. Incentive schemes Luxembourg non-regulated vehicles benefit from a number of tax incentives. These are generally available to all Luxembourg resident corporations (irrespective of their underlying investment(s) or the nature of their shareholders). Dividends and capital gains. Dividends received and capital gains realised by a fully taxable Luxembourg resident company are exempt from corporate income and municipal business tax if all of the following conditions are fulfilled: The distributing company or the disposed participation is: a fully taxable Luxembourg resident company; a company resident in another EU member state that is covered by Article 2 of Directive 90/435/EEC on the taxation of parent companies and subsidiaries (Parent- Subsidiary Directive); a non-resident company that is fully liable to a foreign tax comparable to Luxembourg corporate income tax (it is generally accepted that a foreign corporate income tax is comparable if it leads at least to an effective tax rate of approximately the half of the Luxembourg corporate income tax, that is, approximately 10.5%). At the date of realisation of the income (dividend and/or capital gain), the Luxembourg company has been holding (or undertakes to hold) the participation for at least an uninterrupted period of 12 months. During this 12-month period, the participation does not fall below 10% or the acquisition price does not fall below EUR1.2 million (for dividends) or EUR6 million (for capital gains). Where the above requirements are not met, under certain circumstances it is possible to apply for a tax relief of 50% of the dividend income in the hands of a Luxembourg tax payer. Dividends are generally subject to 15% withholding tax, unless an exemption (such as under the Parent-Subsidiary Directive) or reduced rates (arising from the investor s domestic tax law or any applicable double tax treaty) apply. Except under limited circumstances, capital gains realised by foreign investors on the sale of Luxembourg corporations (see below) are not subject to tax in Luxembourg. Double tax treaties. As of December 2011, Luxembourg has 64 double tax treaties in force. in addition, 15 additional double tax treaties have been signed and await ratification. Talks have also been initiated with at least five additional countries. Tax grouping rules. Fiscal unity is applicable to municipal business tax and corporate income tax on a written request to the tax authorities. The companies commit to apply this regime for a period of at least five years. Fiscal unity means that there is only one sole taxpayer for the companies belonging to the group. The head of the group must be either a: Luxembourg fully taxable corporation. Luxembourg permanent establishment of a foreign company, if the foreign company is fully subject to a tax comparable to the Luxembourg one. The companies that can belong to the group are Luxembourg fully taxable corporations that are owned, directly or indirectly, at least 95% by the head of the group from the beginning of the financial year when the request for the application of this regime is made. Under special circumstances the Ministry of Finance can grant the fiscal unity regime to a company that is owned at a lower percentage than 95%, but at least 75%, if the participation and/or the group would be of special relevance to the Luxembourg economy. There is no fiscal unity for net-worth tax purposes.

5 Thin capitalisation rules. There are no thin capitalisation rules. Administrative practice requires a debt-to-equity ratio of 85:15 for holding activities. Liabilities involved in the financing activity are generally excluded. Under certain circumstances and subject to confirmation from the tax authorities, the ratio can be extended to 99:1. Foreign controlled corporations. There is no list of foreign-controlled corporations. Foreign companies that are not resident in the EU or in a country with whom Luxembourg has concluded a double tax treaty, and that are not taxed under a corporate tax comparable to the Luxembourg one, cannot benefit from the participation exemption (see above). IP box regime. Luxembourg taxpayers holding an intellectual property right can benefit under certain circumstances from both: An exemption from 80% of the net income generated by the right. An exemption from 80% of the capital gain on the disposal of the right. The intellectual property right must have been either acquired or constituted by the Luxembourg taxpayer after 31 December At whom is it directed These tax incentives are directed at Luxembourg corporations (Soparfis) and are available irrespective of the nature of the investors and the underlying investments. Conditions See above, Incentive schemes. Public limited companies (société anonyme) (SA). This is more regulated than the SARL and can be listed. Regulated vehicles The following vehicles are supervised and authorised by the regulatory authority the Commission de Surveillance du Secteur Financier (CSSF) (see website, SICARs. The SICAR was implemented to offer a new lightly regulated vehicle for investment in private equity to well-informed investors (see Question 12, Type of investors). It combines a flexible corporate structure for investing in risk capital with the benefits of light supervision by the CSSF and a neutral tax regime. SICAR is an optional regime, and must be formalised in the object clause of the company s articles of association. SICARs can be incorporated as one of the following companies: Limited partnership (société en commandite simple) (SCS). SCA. Co-operative in the form of a public limited company (société cooperative organisée sous forme de société anonyme) (co-operative). SARL. SA. These various possibilities offer significant contractual freedom. While general corporate law provisions apply to SICARs, they have substantial flexibility in determining their articles of association. FUND STRUCTURING 6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction? Non-regulated vehicles Soparfis are non-regulated vehicles that have the object of holding and financing participations in portfolio companies. Soparfis benefit from the Parent-Subsidiary Directive and double tax treaties signed by Luxembourg. The most commonly used forms of non-regulated vehicles are the: Private limited company (société à responsabilité limitée) (SARL). This is commonly used for investing in private equity since it offers significant flexibility. There are restrictions on the transfer of SARL shares (for example, they cannot be offered to the public). Partnership limited by shares (société en commandite par action) (SCA). This has two types of shareholders. Some have an unlimited liability and manage the SCA (commandités) and the others have limited liability (commanditaires). The rules applicable to public limited companies (société anonyme) (SA) (see below) are generally also applicable to the SCA. The share capital of the SICAR must be at least EUR1 million. This minimum must be subscribed to within one year of incorporation, and paid up in principle at least up to 5% of the capital, including share premium. It is also possible to opt for variable capital, whatever the corporate form, since the introduction of the SICAR Amendment Law. This new development should attract more foreign investors familiar with the tax incentive vehicles of common law limited partnerships. Although SICARs are supervised by the CSSF (see Question 10), their monitoring obligations are lighter than those of the UCIs, although they must prepare and publish annual accounts, and update the prospectus on the issue of additional shares. An independent auditor (approved by the CSSF) must audit the annual accounts. However, a SICAR is not required to publish a bi-annual report. Since the SICAR Amendment Law, there is no mandatory legal requirement to calculate the net asset value on a compulsory bi-annual basis. The net asset value must be based on the principle of fair value (similar to the SIF regime). SICARs must invest in risk capital and have no obligation of investment diversification (unlike UCIs). Therefore, SICARs can invest all of their funds in a single company or project. A SICAR can also be structured as an umbrella vehicle with separate compartments enabling it to run different investment policies in each compartment.

6 In addition, the duty of the custodian is the same as for SIFs (that is, its monitoring duty is restricted to the general safekeeping of the assets) (SICAR Amendment Law). SIFs. UCIs created under the Law of 19 July 1991 concerning UCIs that did not offer their securities to the public, and invested into venture capital undertakings that were exclusively reserved to a limited number of institutional investors, have been superseded by the SIF. These UCIs automatically became SIFs as of 13 February SIFs are subject to lighter statutory rules than the other UCIs. The following can create and/or invest in a SIF (see Question 12, Type of investors): Institutional investors. Professional investors. The subscribed share capital (including share premium) must total EUR1.25 million within 12 months of the date of CSSF approval. The shares need only be paid up to a minimum of 5%. SIF supervision and its monitoring obligations are the same as for a SICAR, as well as the issuing document requirements (that is, information necessary for the investors to form their view on the investments proposed and its related risks). The SIF s issuing document must provide for the quantifiable limits to be complied with (CSSF s circular 07/309 relating to the risk-spreading principle for the SIF) (see Questions 10, 11 and 13). A SIF can be organised with several segregated sub-funds. 7. Are these structures taxed, tax exempt or fiscally transparent for domestic and foreign investors? Other well-informed investors (whether legal or physical persons). The SIF aims to be an attractive vehicle through its flexible functioning rules, and the extensive scope of assets open to investment (the SIF can be used to invest in any kind of assets without limitation, to the extent it complies with the general risk spreading rules (see Question 13)). It is authorised and supervised by the CSSF and has a neutral tax regime. A SIF can be created as: A common fund (fonds commun de placement) (FCP), which is a contractually drawn up set of jointly owned assets with no legal personality, managed by a Luxembourg management company. An investment company with a variable share capital (société d investissement à capital variable) (SICAV) incorporated as any of the following: SCA; co-operative; SARL; SA. A company with a fixed share capital (société d investissement à capital fixe) (SICAF), which is incorporated as any of the following: SCS; SCA; co-operative; SARL; SA; SNC (société en nom collectif) (unlimited company); Société civile (civil company). The legal provisions and types of companies under which a SIF can be incorporated allow investors to set up their own corporate governance rules in a flexible manner. SICAR The tax status of SICARs depends on the legal form chosen: SCS. SCSs are tax transparent and therefore not subject to tax in Luxembourg. Tax is levied at the level of the investor depending on and according to the law of their tax residency. Double tax treaties or EU directives may apply in the country of the investor and the country of the portfolio company, depending on the relevant regulations. SICARs under the form of a corporation. All other SICARs are in principle fully taxable in Luxembourg at 28.80%, including contribution to the employment fund and municipal business tax for the city of Luxembourg (this can slightly vary for other municipalities) and should, in principle, benefit from double tax treaties and the Parent-Subsidiary Directive at least from a Luxembourg perspective. Where a country does not recognise the SICAR, alternative structuring is available. The tax regime applicable to SICARs incorporated under the form of a corporation is as follows: gains or income from transferable securities are not subject to tax; income from cash arising from investment in risk capital is not subject to tax, subject to certain conditions; SICARs are not subject to net-wealth tax; SICARs are not eligible for the application of the tax group regime; distributions made by SICARs are free of withholding tax; there is generally no taxation in Luxembourg on the disposal of an interest in a SICAR by non-resident investors; SICARs are considered as VAT persons but their activities are exempt from VAT. They therefore cannot deduct input VAT. Management services for these vehicles are also exempt from VAT. Management

7 SIF services for these purposes include accounting services, monitoring compliance with regulatory requirements, record keeping and investment advice services. EU case law excludes custody services from being classed as management services (and would therefore be subject to a 12% rate). As a result, SICARs are generally not obliged to register for VAT purposes (unless they receive intangible services from outside Luxembourg). SICARs are subject to a fixed annual fee of EUR1,500 and a registration fee of EUR1,500 (EUR2,650 for umbrella SICARs) payable to the CSSF. The tax regime applicable to SIFs is as follows: SIFs are not subject to corporate income tax, municipal business tax and net-wealth tax. They are subject to a subscription tax on the net asset value (0.01%) which is calculated quarterly. The law allows some specific exemptions. Distributions made by SIFs to their investors are not generally subject to withholding tax except under: the law dated 21 July 2005 implementing the Savings Directive; and several other agreements with third countries implementing similar measures to the Savings Directive. SIFs are subject to either: an annual fee of EUR1,500 (EUR2,650 for umbrella structures); a registration fee of EUR1,500 (EUR2,650 for umbrella structures). SIFs formed as investment companies (SICAVs) can benefit from double tax treaties (there are currently 36 double tax treaties applicable to these vehicles). SIFs formed as FCPs generally do not benefit from double tax treaties. SIFs are considered as VAT persons but their activities are exempt from VAT. They therefore cannot deduct input VAT. Management services for these vehicles are also exempt from VAT. Management services for these purposes include accounting services, monitoring compliance with regulatory requirements, record keeping and investment advice services. EU case law excludes custody services from being classed as management services (and they would therefore be subject to a 12% rate). As a result, such vehicles are generally not obliged to register for VAT purposes (unless they receive intangible services from outside Luxembourg). The following tax treatments apply: Domestic investors. Income received by both individuals and corporate domestic investors from SIFs are taxable under the usual Luxembourg tax rules. Capital gains realised by individual investors are taxable if the sale occurs less than six months following the purchase of the units and the seller holds more than 10% of the SIF. Foreign investors. No Luxembourg taxation and income derived from a SIF to be taxed in the respective country of the investors according to the relevant law in force. For non-regulated vehicles (Soparfis), see Question What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as not being tax transparent (in so far as they invest in companies in your jurisdiction)? What parallel domestic structures are typically used in these circumstances? The use of a foreign structure is unlikely, as Luxembourg is typically used as a platform for holding and acquisition vehicles in operating groups, either in Luxembourg itself or abroad. The features of Luxembourg as a holding location are equally strong for Luxembourg targets as for foreign targets and therefore it would be unlikely that foreign holding vehicles would be set up to acquire a Luxembourg group. From a Luxembourg perspective, there is no particular foreign investment vehicle commonly used for private equity funds in other jurisdictions that would not receive tax transparency in Luxembourg. INVESTMENT OBJECTIVES 9. What are the most common investment objectives of private equity funds? The main objective of private equity funds is to have the highest return on capital possible at the time of the exit (capital gain) and a seamless repatriation without tax leakage. For mezzanine funds, the main objective is to distribute a regular return to their investors. The average duration of private equity funds is between seven and ten years. FUND REGULATION AND LICENSING 10. Do a private equity fund s promoter, principals and manager require licences? Whether the management organs require CSSF approval depends on the type of investment vehicle used. Soparfi Soparfis do not require CSSF approval (see Question 6, Nonregulated vehicles). SICAR/SIF The CSSF is the competent authority for approving SICARs and SIFs, and specifically requires the following: SICAR or SIF directors and managers must prove their ability to perform their duties. Under the AIFM Directive, the managers of SICARs or SIFs must be approved by the CSSF. Constitutive documents to be produced (prospectus, issuing documentation, management regulations or articles of incorporation), which must comply with the applicable laws. The appointment of a custodian with whom the SICAR s or SIF s assets are deposited. The appointment of an independent auditor (for monitoring obligations, see Question 6). There is no requirement for a promoter.

8 11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions? Regulation SIFs and SICARs are regulated entities, and are therefore subject to prior approval by the CSSF before launch. These vehicles must issue a prospectus or issuing document, which is examined and/ or approved by the CSSF (see Question 14). The central administration of the fund (bookkeeping, share registrar and transfer agent services) must be located in Luxembourg. Soparfis are non-regulated vehicles and therefore do not require regulatory approval. However, if Soparfi shares (under the corporate forms of SA or SCA) are offered to the public (that is, marketed in any manner) then a prospectus complying with the rules of the Law dated 10 July 2005 implementing Directive 2003/71/ EC on the prospectus to be published when securities are offered to the public or admitted to trading (Prospectus Directive) must be approved by the CSSF. Exemptions Soparfis under the corporate forms of SCA and SA can be offered to the public (see Question 6) and, if so, may be exempt from publishing a prospectus in some circumstances (for example, if the shares are offered to fewer than 100 persons). 12. Are there any restrictions on investors in private equity funds? Managers and other persons who are involved in the management of a SICAR or a SIF are no longer required to certify their status as a well-informed investor to be an eligible investor. 13. Are there any statutory or other limits on maximum or minimum investment periods, amounts or transfers of investments in private equity funds? SICAR There are no specific limits on maximum or minimum investment periods, amounts or transfers of investments in the SICAR. Any limits are subject to the contractual terms agreed by the parties themselves. The investment(s) in a SICAR must be made for a certain period of time with the intention of a later sale at a profit. SIF The risk-spreading principle applies for a SIF fund. A SIF cannot invest more than 30% of its net assets in the same investment, subject to certain exceptions (CSSF circular 07/309). In practice, on CSSF approval, this spreading rule can be reached within 12 months following the SIF s launch. The CSSF may also give some additional requirements for a specific investment policy. INVESTOR PROTECTION 14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek? Number of investors A SARL must have a minimum of one shareholder and a maximum of 40. An SCA must have a minimum of two shareholders (at least one general partner and two limited partners) with no maximum limit. The minimum required for an SA is one shareholder. Nationality of investors There are no nationality restrictions. Age Generally, there are no age restrictions except for minors (under 18 years old). The prospectus or issuing document and the articles of association or management regulations regulate the relationship between the investors and the fund. The main aim of the prospectus or issuing document is to protect the investors by giving them information on the nature of the investments to be made. Among other provisions, the prospectus states the rules relating to: Dividends. Commitments required from investors. The investment s policy. Draw-downs. Type of investors The investors of SICARs and SIFs must be well-informed investors, which are any of the following: An institutional investor. A professional investor. Any other investor which: confirms in writing that it adheres to the status of a well-informed investor; and invests a minimum of EUR125,000; or is certified by another professional of the financial sector as having experience and knowledge in risk investment or area of investment made by the SIF or the SICAR. Subscription or redemption rights. Protections sought by investors include: Establishing an investors committee within the fund with the right of information and consultation. Veto rights for certain matters or actions. Conflict of interests and corporate governance rules. Information rights (a minimum reporting obligation is required for regulated vehicles). An obligation to disclose the agreements to the other investors where co-investment agreements are entered into with the managers or with some investors. Exit clauses.

9 INTERESTS IN PORTFOLIO COMPANIES 15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? What are the relative advantages and disadvantages of each? Are there any restrictions on the issue or transfer of shares by law? Common forms Private equity funds commonly take securities or financial instruments in a portfolio company, which may carry specific financial or voting rights (such as preferred dividend rights). More complex and hybrid instruments may be used depending on the ultimate tax planning (tracking stocks, preferred equity certificates (PECs), convertible preferred equity certificates (CPECs), profit participating loans and credit linked notes, and so on) enabling profit repatriation, capital gains or dividend flows in a tax efficient manner (for information on debt interests, see Question 23). A pure Soparfi can be financed up to 85% by debt, provided shareholder funds represent the remaining 15% of the company s total financing. However, for mixed Soparfis (companies conducting certain other activities in addition to holding participations) the 85/15 ratio generally only applies to their holding company vehicles. BUYOUTS 16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply? Although auctions of private companies exist, they are not common in Luxembourg. 17. Are buyouts of listed companies (public to private transactions) common? If so, which legislation and rules apply? Buyouts of listed companies in Luxembourg are not common, since the number of companies listed at the Luxembourg stock exchange is not significant. Until recently, Luxembourg did not have specific legislation regulating takeover bids. The hostile takeover bid by Rotterdam-based Mittal Steel for steel producer Arcelor prompted the Luxembourg government to implement Directive 2004/25/EC on takeover bids. As a result, security holders are now protected, and have enough time and information to allow them to reach a properly informed decision on the bid. In addition, new principles of mandatory offer, squeeze out, sell out and right of withdrawal regulate takeover bids and better secure this kind of transaction. The issue or transfer of shares is subject to statutory legal requirements and the specific provisions of the company s articles of association. Generally, transfers or issues require approval by an extraordinary general meeting of shareholders (general meeting), or by the board for authorised capital. Advantages and disadvantages The issue of shares in exchange for contributions in kind in an SA and an SCA requires the issue of a special report by an independent auditor. These rules are much more flexible for a SICAR or a SIF. Restrictions The legal restrictions on the transfer of shares depend on the type of company: SARL. A SARL s shares can be transferred to non-shareholders if the current shareholder(s), representing at least three-quarters of the corporate capital, agree to this in a general meeting. In addition, specific clauses can be included in the articles of association relating to preemptions and rights of first refusal for the benefit of the remaining shareholders. SCA and SA. The general partner s and limited partner(s) shares of an SCA are freely transferable. An SA s shares are also freely transferable. Other clauses relating to restrictions on transfers, pre-emption and first-refusal rights are generally allowed, but are subject to certain restrictions given that a shareholder of an SA or SCA cannot be fully restricted from selling its shares. Principal documentation 18. What are the principal documents produced in a buyout? Due diligence phase The documents usually provided in relation to the target include: Documents containing financial information. Corporate documentation authorisation(s) relating to the company s activity. Employment or insurance contracts. Documents relating to the guarantees granted by the company (pledge and mortgages). IT contracts. Other material contracts. Implementing the buyout The documents usually produced relating to the implementation of the buyout include the: Placement memorandum. Term sheet. Letter of intent. Confidentiality agreement. Exclusivity agreement. Share purchase agreement. Shareholder agreement.

10 Amended and restated employment and service contracts. Documents relating to the guarantees concerning the purchase price payment and the satisfaction of potential liabilities (for example, in case of breach of a representation and warranty). Debt financing documents. Certain documents are often produced to meet the conditions precedent to the closing, for example, documents providing information on the: Executed guarantees. Board of directors. Updated shares register. Buyer protection 19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management? 20. What non-contractual duties do the portfolio company managers owe and to whom? Non-contractual duties, such as duties of confidentiality and loyalty to the portfolio company, derive from general civil law obligations to act in good faith in the execution of any contract. These obligations are also usually set out contractually (common for employment contracts, less common in the corporate mandate between the company s management body (managers or directors) and the company). In addition to these duties, managers with a corporate mandate must exercise their mandate in line with the principles of good management, and act in the company s interest. If not, the managers are liable to third parties and the company under the corporate law and common law (Articles 1382 and 1383, Civil Code). 21. What terms of employment are typically imposed on management by the private equity investor in an MBO? Representations and warranties The buyer typically requires the seller (and sometimes the managers) to give representations and warranties in the share purchase agreement in relation to various matters relating to the seller s business, for example: The seller s capacity to enter into the share purchase agreement. The target s shares. Compliance with corporate and tax law. The target s financial position (particularly the accuracy of the accounts on which the purchase price is based). The seller provides the buyer with indemnification guarantees for breach of the representations and warranties. In addition, guarantees are often provided to secure the payment of the indemnity. Purchase price adjustment The transaction documents typically provide for an adjustment of the purchase price on the target s post-closing financial results. Conditions precedent The transaction documents can also provide for conditions to be fulfilled for the acquisition to take effect, for example: Evidence of the seller granting the guarantees. Managers letters of resignation. Covenants The share purchase agreement usually provides: A non-compete clause. An obligation to properly manage the company before closing. Management continuity The fund may also require an undertaking from the target s management to remain in office for a minimum duration. Some service contracts (such as IT and accounting) can be extended for an agreed duration. A private equity investor typically imposes the following terms on management in an MBO: Exclusivity. This restricts the manager from carrying out other professional activities (such as, other employment, self-employed activity or another corporate mandate) during the course of employment. Non-solicitation. This prevents the manager, during or after termination of the employment contract, from: contacting the company s clients for his own interest or the interest of another company; approaching the company s employees with alternative employment. Confidentiality. The employee undertakes, both during the performance of his contract and at any time after its termination, to keep confidential and not disclose confidential information or data collected during the employment relationship to third parties, unless specifically authorised. Ownership. This gives the exclusive ownership to the company of all documents and equipment that are used by the manager or put at his disposal during employment. Copyright. The literary and artistic works a manager creates in the course of their employment belong to the manager. The employer can, therefore, require an assignment of the patrimonial rights on any works created during the period of employment. Non-competition clause. This prevents the employee from competing with the employer after termination of the employment contract. Communication. This prevents the management from speaking in public on behalf of the company, unless expressly authorised to do so.

11 22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders agreement or company bye-laws? This depends on the outcome of negotiations between the fund and its management, and the legal rules regulating the target. However, a fund typically requires from its portfolio company: Shareholder approval of some major decisions, stricter rules of quorum, majority voting for some decisions and rights of veto. The right to submit a list of candidates from which the shareholder meeting must choose a manager. Stricter rules of quorum and majority requirements for board resolutions. The right to receive certain relevant information. The creation of internal committees in the portfolio company (right of information and consultation). Whether these protections should be inserted in the articles of association or in a shareholder agreement is considered on a case-by-case basis. DEBT FINANCING Security Pledge of assets (contrat de gage). This is the most common way of taking security over Luxembourg assets. The pledge is usually granted over (present and/or future) bank accounts, financial instruments (which include all type of securities) and/or receivables of the pledgor. Luxembourg law provides for efficient and effective methods of enforcing a pledge. On default, the pledgee can: Take ownership of the pledged assets at the price determined in accordance with the rules of valuation agreed between the parties. Sell the pledged assets through legally permitted means (for example, through an arm s-length sale). Obtain a court decision stating that the pledged assets will be transferred to the pledgee as payment up to the amount of the debt owed, as estimated by an expert. Transfer of ownership by way of security interest (transfert de propriété à titre de garantie). This transfer can apply to the same assets as for a pledge of assets (see above, Pledge of assets). On default, the transferor does not need to transfer ownership back in accordance with the terms and conditions agreed in advance by the parties. Contractual and structural mechanisms Contractual subordination, acceleration and netting mechanisms are frequently used to secure investments. 23. What percentage of finance is typically provided by debt and what form does that debt financing usually take? Financing by debt can come either from the investors (to benefit from the deduction of interest) or from third parties. Investors debt financing can take several forms, ranging from straightforward shareholder loans to hybrid, convertible or subordinated instruments. Interest paid to investors must be at arm s length. In addition, an 85:15 debt-to-equity ratio is generally regarded in practice as acceptable (other ratios may be acceptable provided the overall interest is not excessive). Excessive interest is regarded as deemed dividends (subject to withholding tax, if applicable) and as such, may not be tax deductible. Financial assistance 25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions? Rules In principle, an SA or SCA cannot advance funds, make loans or provide security with a view to the acquisition of its shares by a third party. However, this rule does not apply to the acquisition of shares by, or for, the company s employees. Third-party financings usually take the form of senior or mezzanine loans (syndicated or otherwise). Bond issues are also an option (parties enjoy a large degree of freedom in their terms and conditions). Lender protection 24. What forms of protection do debt providers typically use to protect their investments? Protection for debt providers is regulated by the Law of 5 August 2005 on collateral arrangements implementing the Directive 2002/47/EC on financial collateral arrangements. The law remains silent on the rules applicable to SARLs. Although there are arguments to conclude there is no prohibition applicable to SARLs, it is open to interpretation. Exemptions The Law of 10 June 2009 has set out exemptions to this rule, and financial assistance for the purpose of assisting a purchase of shares in an SA or SCA is now allowed. For example: Transactions must take place under the responsibility of the board of directors or the management board, and gain prior approval at a general meeting of shareholders. The transaction must be at fair market value, particularly in relation to interest received by the company and in relation to security provided to the company for the loans and advances.

12 Luxembourg Private Equity and Venture Capital Association (LPEA) W Status. The LPEA is a non-profit organisation. Membership. Full members include: PE or venture capital management companies. Organisations that directly or indirectly invest in private equity and venture capital funds. The credit standing of the third party must be duly investigated. The aggregate financial assistance granted must at no point result in the reduction of the net assets below the amount specified in the law. The company must include in the liabilities in the balance sheet, a reserve, unavailable for distribution, of the amount of the aggregate financial assistance. Insolvent liquidation 26. What is the order of priority on insolvent liquidation? The rules regulating the insolvency procedure are a matter of law (notably Commercial and Civil Codes, the Law dated 24 May 1989 relating to the employment contract, the law of 5 August 2005 on collateral arrangements and Regulation (EC) No 1346/2000 on insolvency proceedings). All creditors, other than secured and privileged creditors, must be treated equally. Payments to secured and privileged creditors are made in the following order: /VENTURE CAPITAL ASSOCIATIONS Organisations that act as intermediaries (for example, fund of funds and secondary private equity funds). Associate members include organisations or persons who provide ancillary services to the private equity and venture capital industry, or who represent special interest groups. Principal activities. These include: Representing and promoting the interests of Luxembourg private equity and venture capital players. Supporting government and private initiatives to enhance the attractiveness, competitiveness and efficiency of the Luxembourg economic, legal, regulatory and operational framework as an international hub for carrying out private equity and venture capital business and/or servicing the industry. Representing the interests of LPEA members towards the European Venture Capital and Private Equity Association and other relevant international industry bodies. Association of the Luxembourg Fund Industry (ALFI) W Status. The ALFI is a non-profit organisation. Membership. The following may be full members, provided that they are established and authorised to carry out their activities in Luxembourg, and regardless of their legal form: Undertakings for collective investment and other regulated investment vehicles. Service providers to the Luxembourg collective investment management industry. Associate members include fund industry players established abroad, provided that they offer services to full members. Principal activities. The five key objectives set out in ALFI s mission statement are to: Ensure UCITS remains the best-in-its-class for investor protection Help fund managers and institutional investors to leverage the development of regulated European alternative funds, with AIFMD. Stimulate innovation within the funds industry. Facilitate cross-border fund distribution. Ensure Luxembourg remains the partner of choice for the asset management industry. The receiver s fees and the liquidation expenses. Privileged claims, for example, money owed to employees, certain social security contributions and outstanding taxes. Payment of the lower ranking privileges and secured creditors. However, the following security interests remain valid and fully enforceable despite the commencement of insolvency proceedings against the grantor: Pledges. Transfers of ownership by way of security interest (to the extent these pledges or transfers apply to financial instruments (including all types of securities) and/or receivables (including those resulting from bank accounts), as well as netting arrangements). Secured assets covered by the security interests listed above are, therefore, not included in the assets available for distribution to the general pool of creditors. Shareholders capital contributions are only repaid if and when all other creditors have been fully satisfied.

13 Equity appreciation 27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options? It is possible, and common in some circumstances, for debt holders to achieve equity appreciation through the use of conversion features such as convertibles, debt instruments, warrants and options. PORTFOLIO COMPANY MANAGEMENT 28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction? There is no specific legislation regulating management incentives, and therefore the standard labour, corporate and financial law provisions apply. Capital gains are tax free if the options or shares are sold at least six months after their purchase, and the transferor does not own a major shareholding interest in the company (10%). If the employee is subject to Luxembourg social security, social contributions are due under the same conditions and on the same base as income taxes. Capital gains are subject to a 1.4% dependence contribution. 30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors? Dividends require the existence of distributable reserves and Soparfis must retain a legal reserve of 5% of the yearly profit up to an amount of 10% of the share capital of the company. This also applies to interim dividends distributions. There are no restrictions on interim dividend distributions for limited liability companies or SARLs. SAs and SCAs can distribute interim dividends only under certain circumstances and if their articles of association allow this. Share options are most commonly granted to encourage management to become involved in the company s development (since they are subject to a favourable tax treatment under certain circumstances) (see Question 29). Share purchase plans, phantom share plans or other types of bonus schemes linked to the company s results are also used. In addition, ratchets are used in practice and their mechanism is defined contractually, since they are not regulated and can take different forms. 29. Are any tax reliefs or incentives available to portfolio company managers investing in their company? A special tax regime deriving from a circular from the Director of the Direct Tax Authorities (LIR No 104/2, 11 January 2002 relating to share option plans) applies to share options granted to employees. If the share options can be traded freely (a pre-emption right can, however, be provided in favour of the company), tax is levied at the time of grant. The tax base is equal to the market value of the option on the grant date, less the price paid by the employee to acquire the options, if any, and is subject to the progressive income tax rate (currently from 0% to 38.95%). The gain earned when the option is exercised is not taxed as salary. If the options are subject to trading restrictions, taxation is levied when the options are exercised and the benefits are taxable at the progressive income tax rate. The tax base is equal to the stock market value on exercise of the option, less the strike price. If the shares obtained further to the exercise of the option are subject to trading restrictions (lock-up period), the taxable gain is calculated by applying a discount to the stock market value of 5% per year of lock-up (maximum 20%). EXIT STRATEGIES 31. What forms of exit are typically used to realise a private equity fund s investment in a successful company? What are the relative advantages and disadvantages of each? Forms of exit Trade sales and secondary buyouts are the most common form of exit. The form of exit used principally depends on where the portfolio company is located and on the contractual and commercial reasons for the exit. Advantages and disadvantages There are no particular advantages/disadvantages to the different methods. If the structure has been correctly implemented the exit should not trigger any adverse legal or tax consequences (see Question 5). 32. What forms of exit are typically used to end the private equity fund s investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each? Forms of exit In most cases, the form of exit from an unsuccessful portfolio company depends on the foreign law applicable to that company. Unsuccessful companies are often written off in the balance sheet of the private equity funds. A voluntary winding-up will most likely be the preferred exit of the Luxembourg holding vehicle. In some cases, the bankruptcy rules can also apply. Advantages and disadvantages There are no particular advantages/disadvantages to the different methods. The liquidation should not trigger any adverse legal and, more concretely, tax consequences (see Question 5).

14 CONTRIBUTOR DETAILS MARIE-BÉATRICE NOBLE MNKS (formerly Noble & Scheidecker) T F E noble@mnks.com W ARNAUD PERAIRE MNKS (formerly Noble & Scheidecker) T F E peraire@mnks.com W Qualified. Luxembourg, 1995 Areas of practice. Corporate structuring; private equity; M&A; corporate real estate; incentives; commercial contracts; litigation. Recent transactins Assisting a major private equity fund in the partial acquisition and refinancing of a top domiciliation company operating in Luxembourg. Assisting in the restructuring of a media group, involving the negotiated exit of existing shareholders and the entrance of new venture capitalist investors. Assisting the management of an industrial group in connection with a management incentive scheme negotiated with the private equity house majority shareholder. Regularly assists private equity funds in their Luxembourg activities, for example, structuring the carried interest system for their investment managers. KATIA SCHEIDECKER MNKS (formerly Noble & Scheidecker) T F E scheidecker@mnks.com W Qualified. France, 2008 Areas of practice. Investment funds (private equity, real estate and hedge funds); banking and financial services. Recent transactions Assisting a SICAR investing in the secondary market with its constitutive documents; cornerstone investors and related side letters and legal opinion; key funds terms and conditions; fundraising and regulatory aspects. Assisting a French management company in setting up an umbrella SIF real estate fund and negotiating with the CSSF for approval of its strategy (raising money by issuing convertible bonds alongside shares). Assisting an SIF in listing bonds on the Luxembourg Stock Exchange s Euro-MTF market. Assisting in the setting up of a hybrid hedge fund as an umbrella SIF focusing on proprietary event-driven strategies with a bottom-up approach and the GP s structuring and executive incentives. RAQUEL GUEVARA MNKS (formerly Noble & Scheidecker) T F E guevara@mnks.com W Qualified. Luxembourg, 1995 Areas of practice. Banking and finance; investment funds; private equity; corporate structuring; regulatory; financing transactions; commercial contracts; technology and IP. Recent transactions Acting for a global financial group traded on the NYSE in the acquisition of an additional stake in a joint venture bank in Luxembourg. Advising one of the leading real estate companies in Austria on the implementation of an international joint venture. Assisting a fund management company in relation to the setting up of a Luxembourg private equity fund, the fundraising process and the drafting of the relevant documentation. Advising a management company in the setting of a hedge fund as a specialised investment fund established as an openended umbrella structure, consisting of various sub-funds. Qualified. Spain, 1999 Areas of practice. International corporate taxation in particular in the private equity sector. Recent transactions Advises on international Private Equity Fund structures and the alternative investment industry focused on the structuring of Luxembourg intermediate holding structures between the PE House, including Management schemes and mainly but not limited to continental European Targets. Development of tax effective structures including hybrid instruments designed for different kinds of (US) investors and tailor-made management equity programmes for top tier management.

15 VERY DEPENDABLE HIGH QUALITY SERVICE SEAMLESSLY DELIVERING EFFECTIVE SOLUTIONS What makes us different is our unwavering commitment to our clients. Building strong relationships and a culture of excellent service remains our guiding compass. We offer our clients an extensive range of legal services, not only in the typical areas of law for a Luxembourg law firm, i.e. corporate law (corporate structuring, private equity, M&A), financial law (including setting up alternative investment funds) and tax law, but also have top-tier expertise in a broader range of areas such as employment law, litigation, Information Technology and IP law. Our strong international vision and excellent working relationships with international law firms, consultants and service providers, allow us also to provide global coordination and integrated advice to clients whose business activities reach beyond Luxembourg. Visit to find out more about our people, work and transactions and to learn more about our services and how we can help you. MNKS. Vertigo Polaris Building. 2-4 rue Eugène Ruppert. L-2453 Luxembourg T: F: E: info@mnks.com.