Malta: Private Equity 2018

Overview

2 Structuring Matters

2.1 What are the most common acquisition structures adopted for private equity transactions in your jurisdiction? Have new structures increasingly developed (e.g. minority investments)?

The most common structure consists of a new shareholder buying out the current shareholder, by purchasing the majority of the shares in the entity and retaining control. The parties then embark on a negotiation to discuss reserved matters and veto rights for the minority. It is also customary for the (new) majority shareholder to retain call options and to purchase the shares from the minority over a period of time. It is also common for the minority shareholder to retain a put option against the new majority shareholder which would require the latter to buy out the former if certain performance indicators are achieved. We have also seen several cases where it is agreed that ownership of the entity would pass, however the price is divided into an upfront payment (typically making up at least 50% of the total price) and a number of staggered payments over the subsequent years, which are sometimes linked to performance indicators and sometimes to the occurrence or otherwise of specific events (such as where an issue is identified during the due diligence process which is factored into the price). It has also become customary for the management team to be offered part of the company by the new owners also as a talent retention mechanism. One of the primary dangers of an acquisition in Malta is the resignation of key people within the organisation. This could be particularly debilitating especially where the targets are service companies which are dependent on certain key people. Maltese companies also tend to be small- to medium-sized enterprises so the departure of top ranking management would negatively impact the business.

2.2 What are the main drivers for these acquisition structures?

The main driver could be unrelated to the Maltese business itself where this is part of a bigger organisation and decisions are being taken at a much higher level. That said, we have come across several cases where the value was intrinsically linked to the local business either because of its management team, regulatory considerations, client base or in view of particular products. Particularly in media and gaming, the market is going through innovation where new products are being created on the ground by Maltese entities and where research and development are given a lot of weight.

2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)?

Institutional investment is mostly made through offshore private equity funds based in a number of offshore jurisdictions. These types of investors would expect control over management, introduction of personnel at management and at times also executive level. On the other hand, when the investors are venture capitalists or business angels these insist less on control over the management structures and are satisfied with an equity stake. We have seen Maltese domiciled private equity funds – of which there are several – discounting their management fees and instead focusing more on carried interest, which could be higher than the traditional 20% encountered as performance fees in hedge funds.

2.4 What are the main drivers for these equity structures?

Control over management decisions is normally the main driver. Acquisitions can have various triggers. Where the trigger is consolidation of businesses in order to reduce competition and expand the client base, there is invariably a shift towards new management taking over within a few months. It is rare that the old management team remains in place in its entirety and it is nearly expected that a new team will take over shortly after the acquisition. On the flipside, where the acquisition is more of the nature of a strategic investment one would normally expect the management team to remain in place and to be given leeway to take the business to further success.

2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions?

Performance linked to EBITDA, or some other indicator is one of the triggers which we have come across for vesting. We would also see good leaver and bad leaver provisions either embedded in senior employee contracts or else forming part of the terms and conditions of issue of the vested shares.

2.6 If a private equity investor is taking a minority position, are there different structuring considerations?

In case of minority shareholdings, it would be normal to have a number of reserved matters requiring the vote of the minority such as on change of business, changes to the articles, indebtedness, guarantees and loans above certain amounts, setting up in other jurisdictions, acquisitions, etc.

3 Governance Matters

3.1 What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction?

Governance could have various meanings and means different things to different people. In Malta the Companies Act requires the publication of financial statements audited by a Maltese auditor in accordance with International Accounting Standards. Such financial statements are also filed with the Registry of Companies and are available for public inspection and scrutiny upon issuance. There are no exemptions on the audit and filing requirement although there is the possibility of filing abridged accounts in case of small- to medium-sized enterprises. Secondly the identities, addresses and passport or registration numbers of the directors and shareholders are also disclosed to the public and any changes to the board or the shareholders need to be notified to the Registry of Companies. Maltese companies are required to have a company secretary which can either be an individual or a corporate entity, although in the latter case the entity would need to be subject to certain regulatory standards as a corporate services provider. There are also requirements on share capital and the detail which should be included in the Memorandum and Articles of Association of the company (which is also a public document). Additional requirements apply if the company is listed or if it is regulated.

3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy?

It is quite normal for veto rights to be retained by the minority shareholder. There is also a tendency for the minority to retain the right to appoint at least one director and for certain actions to be taken only if such a director is in agreement. Quorum requirements are sometimes imposed at the level of the board of directors. It is customary for the shareholders to pre-agree a business plan and if there is any material variation to this business plan then the approval of all shareholders would be required, thus amounting to a veto right. Veto rights/prior approval on litigation (subject to thresholds), indebtedness (also normally subject to thresholds) and on acquisitions and disposals is standard.

3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed?

The board could proceed irrespective of any veto used by one of its members if its action or inaction would amount to a breach of fiduciary duty. This is effectively where the interests of the company would be supreme to those of the shareholders. Veto rights can also be dispensed with by the court in case of unfair prejudice to any of the shareholders. There is also a requirement that a director can be removed by the ordinary resolution of the shareholders in spite of any agreement to the contrary.

3.4 Are there any duties owed by a private equity investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed?

Under Maltese company law a shareholder does not have any duty of care to the other shareholders of the same company. A shareholder cannot use his influence over the company in order to induce the company to behave in such a manner as to cause unfair prejudice to the other shareholders. Minority shareholders have certain rights embedded within the Companies Act which would allow them to, for instance, requisition meetings and contest changes to the terms and conditions of their shares; and in some cases, their approval would be required for the adoption of extraordinary resolutions depending on the majority thresholds provided for in the statute of the company.

3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?

The only limitation would be that the shareholder agreement cannot provide for matters which would put the particular company in breach of Maltese law. However, the parties to the shareholders' agreement can agree on several matters between them. It is required that the memorandum of association of the company discloses the rights of shareholders, so it is typically advisable for the contents of the shareholders' agreement to be reflected in the memorandum and articles of association of the company. The governing law of the shareholders' agreement could be any law as may be agreed upon between the parties. The agreement has the force of law between the parties thereto, however it is not binding on third parties particularly if it is not disclosed.

3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards of portfolio companies under corporate law and also more generally under other applicable laws (see section 10 below)?

The concept of a 'nominee' director does not exist in law and accordingly any person appointed as a director of a Maltese company owes a duty of care to the company and not to its shareholders, not even to the shareholder who appointed him. Directors could be personally liable in terms of a number of different laws, particularly those relating to income tax, employment, value-added tax and health and safety, to mention a few.

3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies?

Conflicts of interest need to be disclosed in all cases. At law a director can vote on any matter even where he is conflicted so long as he obtains the necessary approvals by the company, however it is customary for conflicted directors not to be for quorum purposes and not to vote on any matter on which they are conflicted.

4 Transaction Terms: General

4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval requirements, disclosure obligations and financing issues?

Timing of a transaction is particularly impacted when the approval of the competition or other regulatory authorities is required in order for the transaction to proceed. Such approvals could take as much as six months or more to be granted depending on the type of business which is being acquired.

4.2 Have there been any discernible trends in transaction terms over recent years?

One could highlight the increasing importance which is being given to management teams with skin in the game. In a number of cases management teams are expected to reinvest a portion of their employment income into the business, particularly if this is in the form of performance bonuses.

5 Transaction Terms: Public Acquisitions

5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with?

So-called privatisations tend to be subject to a very high level of scrutiny by independent public authorities and also attract a lot of media attention. Most of the public-to-private transactions in Malta have been contested, in court or out of it by the media, causing delays to the closing of the transaction and in some cases negative consumer sentiment.

5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees?

These arrangements are not customary in Malta.

6 Transaction Terms: Private Acquisitions

6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction?

The sell-side would be amenable to receive payments over time even after the acquisition closes which are linked to the performance of the company in the future. The buy-side tends to look more at historical performance and negotiate the price on that basis.

6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer?

Typical warranties would be in no breach of laws or regulations other than those which are specifically disclosed, payments of tax liabilities, health and safety standards are complied with, no litigation, no encumbrance over assets, protection of intellectual property in place, and financial statements which provide a fair view of the business.

6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer?

There is normally a de minimis threshold, a change in law clause, a time bar to warranties and a subject to disclosure clause whereby the seller would provide a disclosure letter in utmost good faith to the buyer, highlighting what the seller considers to be material issues.

6.4 Is warranty and indemnity insurance used to "bridge the gap" where only limited warranties are given by the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies?

No, it is not.

6.5 What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings?

Please see question 6.3.

6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)?

This depends on the transaction; however, there have been cases where payments are placed in escrow with an independent trustee or third party, otherwise the parties could negotiate the staggered payment of the consideration with rights of set-off in case claims come through within a certain defined period.

6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)?

Sellers could ask for collateral such as a pledge over receivables or other assets, or a pledge over bank accounts. These would be the more easily enforceable mechanisms. Alternatively, or in addition, commitment letters and undertakings are also provided supported by personal guarantees.

6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers' exposure? If so, what terms are typical?

No, they are not.

7 Transaction Terms: IPOs

7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit?

Listing rules on takeovers and mergers and large exposures as well as rules on market manipulation and insider dealing could be challenging.

7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit?

No custom has evolved as such on IPO exits in Malta.

7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO?

No custom has evolved as such on dual-track exit processes; if any such processes have been pursued, then these would be one-offs.

8 Financing

8.1 Please outline the most common sources of debt finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds).

Straight bond issues sold to retail investors and listed on the Malta Stock exchange are probably the most common. A new market was launched some time ago called The Prospects Market which is a multi-lateral trading facility operated by the Malta Stock Exchange, available to SMEs. Bond yields in Malta are not particularly high although one would expect high yield bonds to be listed in the Prospects Market in view of the higher risks involved.

8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions?

To the extent that the structure is in line with basic legal principles and, where listed on a regulated market, complies with the rules of that market and those of the regulator then there are no specific legal requirements to highlight.

9 Tax Matters

9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common?

Offshore structures are common; however, Maltese tax law provides for the same set of rules independently of the domicile of the investor since Maltese companies are taxed at 35% on their distributable profits.

9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure?

The main considerations would be tax on any capital gains made by management teams selling their shares as well as stamp duty which could be applicable unless there are certain exemptions in place.

9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private equity portfolio companies (such as growth shares, deferred / vesting arrangements, "entrepreneurs' relief" or "employee shareholder status" in the UK)?

Maltese tax law does not contain or provide for the intricate tax-efficient arrangements which apply in the UK. There are some tax efficiencies which could be achieved but these are not sector-specific.

9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any anticipated?

Tax laws are being constantly updated to reflect local and international realities and obligations, however none of these updates are specifically relevant.

10 Legal and Regulatory Matters

10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity transactions differently to other types of transaction?

The main law is the Companies Act which establishes the basic legal framework on how a company should operate, and which also provides for fiduciary duties of directors and an insolvency regime. Other laws would then apply depending on the particular sector in which the target is operating, and of which investors should be aware in view of the regulatory due diligence which might have to be conducted, not to mention any regulatory approval which may be required prior to the acquisition coming into full force and effect. Of relevance one could mention the Insurance Business Act (insurance principles), the Investment Services Act (investment services providers such as assets managers, broker-dealers, brokers, custodians, depositaries and nominees, investment advisors and fund managers), the Financial Institutions Act (payment services providers, e-money institutions, entities providing factoring, forfaiting, lending, money broking services), the Insurance Intermediaries Act, the Banking Act, the Trust and Trustees Act, the Corporate Services Providers Act and the Gaming Act. The Competition Act is also relevant as a law which could impact acquisitions from a competition law perspective, seeing as it regulates monopolies and dominant positions.

10.2 Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any anticipated?

We would highlight as a main regulatory development the intervention of and approval required from the European Central Bank in case of acquisitions of banks domiciled in Malta and, as of a few years ago, the approval process with the local financial services regulator (the MFSA) for acquisitions of certain companies operating in financial services has become a more complex exercise, which could take several months following more detailed rules on acquisitions which were introduced at a European Union level through directives and regulations. There are also detailed rules which apply in case of takeovers of listed companies even if not regulated as such.

10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house?

It is customary for professionals to be engaged to perform a due diligence. The detail of the due diligence depends on several factors such as the familiarity of the investor with the business, whether the negotiations protracted over a long time as that would have enabled the investor to get a better understanding of the target. Due diligence could be a red flag exercise where the lawyers are asked to only highlight what they would consider to be material issues or else it could be a full due diligence where the investor would then assess what is material. The due diligence normally spans legal, financial and (where relevant) regulatory issues. An environmental or technical due diligence could be conducted depending on the business of the target company.

10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors' approach to private equity transactions (e.g. diligence, contractual protection, etc.)?

Bribery and corruption, even by private persons and not only public figures, could amount to a criminal offence under the Maltese Criminal Code. That said, the anti-bribery and anti-corruption laws prevailing in other countries such as the USA or the UK have had a bigger impact on private equity transactions since these laws tend to have extra territorial application which could also indirectly impact the acquisition in Malta.

10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the liabilities of another portfolio company?

To the extent that each entity has separate legal personality, the patrimonies of each company are segregated and none of the companies are liable for the obligations of any other company within the group. The corporate veil has been lifted very rarely by the Maltese courts and only in cases of fraud or intentionally wrongful acts where the separate legal personality was being used as a front to defraud creditors.

11 Other Useful Facts

11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?

An important consideration is the impact of competition law on the particular transactions. In a number of cases the acquisition or disposal could be subject to notification to the Malta Competition and Consumer Affairs Authority, which would review a transaction to ensure that competition in the particular sector is safeguarded in spite of the transaction. Furthermore, private equity investors should be aware that the acquisition of companies operating in certain specific sectors is also subject to approval by different authorities; so for example the acquisitions of a bank, an insurance company, an asset management firm, a trust or corporate services firm are subject to approval by the Malta Financial Services Authority, and in case of banks, also by the European Central Bank, whereas the acquisition of a company active in the field of telecommunications is subject to approval by the Malta Communications Authority, and the acquisition of a gaming company to that of the Malta Gaming Authority. The same applies to companies involved in manufacturing where, in some cases, the approval of Malta Enterprise might be necessary.

GANADO Advocates has contributed the Malta chapter in the fourth edition of The International Comparative Legal Guide to: Private Equity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.