Private Equity 2021 Comparisons

Private equity (PE) activity in Spain has grown tremendously during the past few years, reaching its peak in 2019, in which the record for the highest M&A activity, both in terms of investment value and the number of transactions, was set.

It was envisaged that 2020 would be another positive year for PE activity, following the growth trend achieved in previous years. However, the economic effects of the COVID-19 pandemic severely disrupted M&A activity.

According to the Spanish Venture Capital and Private Equity Association (Asociación Española de Capital, Crecimiento e Inversión or ASCRI), Spanish private capital investment in 2020 fell by 35% with respect to 2019, especially due to the sharp decrease – from 19 to eight – of large transactions (for an amount greater than EUR100 million), with middle market operations maintaining the record numbers achieved in 2019. For its part, divestments fell 62% with respect to 2019, which is attributable to the great uncertainty that the pandemic caused in buyers and sellers alike.

It is expected that, once the pandemic is brought under control due to vaccination programmes during the second half of 2021 and uncertainty gradually eases, PE activity will bounce back to the record figures achieved in 2019, driven by growth in technology (such as e-commerce, cloud work and cybersecurity) and clean energy, which were growing strongly before the pandemic and whose growth the pandemic has only accelerated.

In terms of the transaction process, it is foreseeable that the pandemic will result in a lasting change in how PE M&A is carried out in Spain, in line with most other jurisdictions. Negotiations and interactions between the different players have now defaulted to Zoom or Teams, while the use of an electronic signature in private documents reflecting the terms of the deal has become standard.

During 2020, according to ASCRI, PE activity in Spain reached (in terms of volume) the third best figure on record, with an amount of approximately EUR6,275 million. This figure represents, nevertheless, a 26.4% fall from 2019 figures (totalling approximately EUR8,526 million), which stands as the current best figure on record.

The decrease in investment volume with respect to 2019 levels can be attributed to a sharp decrease in the number of large transactions (those for amounts greater than EUR100 million), while the middle market and venture capital segments remained strong, especially the latter.

In terms of sectors, communications and IT continued leading in terms of investment amounts, with major transactions to be highlighted including the purchase of MásMóvil by KKR, Providence and Cinven (which remains the largest equity transaction in the history of the sector), the purchase of Idealista by EQT, and the purchase of Signaturit Solutions by Providence, among others. These two sectors were followed in third place by the leisure sector, which climbed in the second half of 2020 with relevant transactions including the purchase of the Goiko chain of restaurants by L Catterton.

The most significant legal development impacting PE funds and transactions has been the authorisation regime set forth for certain foreign investments in 2020. This measure was implemented through Royal Decree 8/2020, by virtue of which, urgent and extraordinary measures were adopted to mitigate the impact of the COVID-19 outbreak, and it was clarified and complemented by Royal Decree 11/2020.

As a result of this new regulation, any investment into Spain carried out by residents of countries outside the European Union (EU) and the European Free Trade Association (EFTA), or carried out by residents of the EU or the EFTA whose ultimate beneficiary owner lies outside the EU or the EFTA, will need prior authorisation by the Spanish government if the investment:

• implies that the foreign investor holds a stake equal to or greater than 10% of the share capital of a Spanish company, or effectively controls a Spanish company;
• is directed into a “strategic sector”; and
• is greater than EUR1 million.

Transactions carried out without the required prior authorisation will have no legal effect whatsoever until legalised, and will entail an infringement punishable by law.

This new regulation considers as “strategic sectors” the following:

• critical physical or virtual infrastructures (energy, health, water, transport, communications, communications media, processing and data storage, aerospace, military, electoral and financial sectors), as well as lands and real estate needed for the use of such infrastructures;
• critical technology and dual-use items (including goods, software and technology, which can be used for both civil and military applications), as well as artificial intelligence, robotics, semiconductors, cybersecurity, aerospace or military technologies, technologies used for energy storage, nanotechnologies and biotechnologies;
• supply of essential commodities (in particular, energy) or those referred to as raw materials and "food safety";
• sectors with access to sensitive data; and
• the media.

As stated above, this regime only applies to investments carried out by residents/beneficiaries of countries outside the EU or the EFTA. However, by virtue of Royal Decree 34/2020, this regime was extended to residents of EU and EFTA countries, albeit with certain differences and only temporarily (as of July 2021, this regime has been extended and applies until 31 December 2021). In this regard, investments made by residents of EU and EFTA countries will require the prior approval of the Spanish government if the investment meets all three of the followingrequirements:

• it implies that the EU or EFTA-residing foreign investor holds a stake equal to or greater than 10% of the share capital of a Spanish company or effectively controls a Spanish company;
• it is directed into a “strategic sector”; and
• it is directed into a Spanish listed company or, if not listed, the value of the investment is greater than EUR500 million.

In general terms, M&A transactions and foreign investments are not subject to restrictions or regulatory scrutiny in Spain. There is no distinct specificity in terms of primary regulators and regulatory issues applicable to PE deals with respect to general M&A activity.

However, merger control regulations as well as the new regulation established in 2020 in relation to foreign investments, see 2.1 Impact on Funds and Transactions, must be taken into consideration. Likewise, certain tightly regulated sectors (eg, banking, insurance and utilities) are subject to regulatory oversight from the relevant supervisory authority.

PE funds require regulatory authorisation from the Spanish National Securities Market Commission (CNMV) to operate, and are subject to specific disclosure obligations before the CNMV. However, such legal regime does not provide for regulatory oversight over the PE fund’s M&A activity.

Merger Control Regulations

There is no distinction between PE deals and other M&A transactions in terms of merger control. Any transaction leading to a concentration must be subject to prior approval from the Spanish antitrust authority if any of the following alternative thresholds are met:

• as a consequence of the transaction, the undertakings obtain a market share of at least 30% in a national market or a substantial part of it regarding a certain product or service; the market share threshold increases to 50% if the target's aggregate turnover in Spain was less than EUR10 million in the previous financial year; or
• the combined turnover of the undertakings concerned in Spain in the previous financial year was at least EUR240 million, provided that at least two of the undertakings achieved an individual turnover of at least EUR60 million in Spain during the same period.

Until antitrust clearance is granted, a stand-still obligation to suspend the execution of the transaction applies. Penalties for not complying with this obligation and premature implementation (gun jumping) are foreseen and imposed regularly.

Under the so-called “one-stop-shop principle”, prior antitrust approval from the Spanish antitrust authority is not necessary if the concentration falls under the scope of applicable EU regulations (ie, it has a “community dimension”) and is thus notifiable to the European Commission.

The scope of the due diligence usually depends on the size and industry of the target as well as the type of buyer, ranging from quite narrow-scoped due diligences to full and comprehensive ones. PE players in Spain (both national and foreign) generally request full due diligence scopes focusing on the following four areas:

• financial due diligence;
• legal due diligence (including corporate, commercial and financing agreements, regulatory, industrial and intellectual property, data protection and real estate – other scopes such as compliance, corporate social responsibility and cybersecurity are increasingly being included);
• tax due diligence; and
• labour due diligence.

Contingencies

Contingencies identified in financial, tax and labour due diligence are typically addressed through valuation adjustments and/or guarantee mechanisms (escrows, bank guarantees, etc), in so far as they typically include an estimated amount per contingency. However, contingencies in legal due diligence are often of a qualitative nature for which remedies should be adopted before or after the transaction. A prime example of this are change of control clauses included in the main agreements, which may entail the seller’s obligation to obtain a waiver before the closing of the transaction as a condition precedent.

Contingencies detected in the legal due diligence process may be addressed through:

• remedies carried out by the seller before closing;
• remedy obligations for the seller included in the private share sale and purchase agreement (SPA), which shall be carried out thereby after closing;
• general representations and warranties included in the SPA; and
• specific indemnities included in the SPA.

Due Diligence Findings

With respect to due diligence findings, major bones of contention between the parties typically revolve around:

• whether specific contingencies identified in the course of the due diligence should be included in the SPA as specific indemnities; and
• whether the seller should limit its liability on the basis of the buyer's knowledge of the matters disclosed in the due diligence.

Due diligences are usually carried out through a virtual data room (VDR) into which the relevant requested documentation is uploaded. Due diligence processes also imply a constant question-and-answer process with the management of the target company, carried out via conference calls or physically at the premises of the target. It is usual for due diligence processes to be co-ordinated by a corporate finance team hired by the buyer or the seller.

Due diligence reports frequently contain an executive summary section, which highlights the identified contingencies, followed by a more descriptive section focusing on a more in-detail description of each area.

Vendor due diligences are not standard for most transactions, except for competitive auctioning processes for medium and large cap targets, in which case, they are fairly common.

In such cases, advisers typically provide credence to the vendor due diligence reports, although it is common for the buyer to additionally perform a buy-side “confirmatory due diligence” on the vendors’ due diligence provided.

The scope of “confirmatory due diligence” is narrower than a typical buyer’s due diligence, mainly focusing on areas which are not adequately covered in the vendors’ due diligence.

Private Purchase Agreements

The vast majority of PE deals are carried out through private purchase agreements between the seller and the buyer. Court-approved schemes are reserved for liquidation procedures and tender offers for listed companies, so they are not generally part of a PE transaction.

Most private purchase agreements are granted before public notaries. Public notaries in Spain are civil servants who, among other functions entrusted to them, advise clients in order to guarantee that transactions are carried out in accordance with the law. In particular, notaries are in charge of drafting the deed of transfer (which in PE deals will commonly imply the granting into public deed of the SPA) and of ensuring that both parties understand and agree to the undertakings foreseen in the transaction. In some deals their presence is mandatory (such as the acquisition of shares of limited liability companies) but, in any case, they are typically involved in a PE deal, as the legal certainty that they provide to the transaction benefits both buyer and seller. After the closing of the transaction, the deeds granted before the notary acquire probative value, and the parties may request copies of said deeds at any time.

Share Deals

Share deals are far more frequent than asset deals. This is mainly due to the fact that, whereas in share deals the acquisition of the shares of a company entails the indirect acquisition of all its assets and liabilities, in asset deals there is a need to:

• precisely detail in the asset purchase agreement each and every asset that is being transferred (as assets which are not detailed will remain with the seller); and
• depending on the transfer regime of the specific asset, obtain the consent of the counterparties to the agreements that are being transferred or the consent of the public authorities.

Typically, transactions involve the execution of a SPA in addition to a shareholders' agreement between the PE fund special-purpose vehicle (SPV) and the manager shareholders. In cases where the equity fund not only acquires the target company but also injects funds, it is common for the shareholders' agreement to be included within a broader investment agreement, which, in addition to the relationship between the parties post-acquisition, also regulates the investment undertakings of the parties in relation to the target company.

Competitive Auctions

Competitive auction processes are standard for medium and large cap companies, while in the case of small cap companies, the transaction usually entails a bilateral negotiation between the seller and the PE fund. The terms of the transaction in the case of competitive auction processes tend to slightly favour the seller, although this will vary immensely, depending on the characteristics of the transaction (industry, type of parties involved, etc).

Acquisitions are typically carried out through SPVs incorporated in Spain as limited liability companies (SL companies). Usually, SPVs are directly controlled by a PE fund (if the fund is located in Spain) or by a foreign holding entity ultimately controlled by a fund located in a tax and investment-friendly country with which Spain has a favourable double-taxation treaty (if the fund is not located in Spain).

It is unusual for a PE fund to be a party to the transaction documents except for the equity commitment letter agreeing to fund the target.

PE funds are highly involved throughout all stages of a transaction, from market prospection, signing of initial non-disclosure agreements and letters of intent, and performance of due diligence through to closing of the transaction.

PE funds are always assisted by an advisory services firm that typically provides, at least, legal advisory services in relation to the transaction.

Transactions commonly involve a PE fund taking a majority stake in the target company, with the key managers remaining as minority manager-shareholders. PE deals involving a minority stake are quite rare.

Most PE transactions are financially leveraged, involving a combination of equity and debt (usually, with banks as lenders). It is customary for the due diligence report to be shared with and analysed by the lending banks as part of the approval process for financing. The lending banks may require reliance on the due diligence report.

Deals involving a consortium of PE sponsors are not typical in Spain, except for in transactions involving large cap companies.

Certain PE transactions involve other investors alongside the PE fund, but this does not happen very frequently (although it is common in venture capital deals), and it is normally driven by the modus operandi of the PE fund rather than being a general feature of PE transactions.

In PE transactions, it could be said that the predominant consideration mechanism, and still the preferred mechanism for PE sellers, is the locked-box mechanism. As a general rule of thumb, it could be argued that locked-box mechanisms are preferred over completion account mechanisms, especially for PE sellers, given the price certainty granted by the former.

On the other hand, completion account mechanisms are seen as well, but this is perhaps more generalised and spread over mid-sized deals.

Regarding the protection provided by a PE buyer, although the PE buyer is usually quite reluctant to provide any sort of protection, the most common one would be an equity commitment letter, by virtue of which the fund commits to funding the acquisition vehicle at the closing of the transaction.

The COVID-19 health crisis has resulted in earn-outs being more frequently agreed. Lockdown and the subsequent restrictions on several activities have resulted in a temporary reduction of target values (and consequently, lower considerations), mitigated with earn-out structures if the target returns to higher values after a certain period of time.

Where locked-box consideration structures are agreed, it is quite common for the seller to try to charge interest on the price since the date of opening of the locked-box account. However, such interest is heavily negotiated, and it is common for the parties to agree that no interest will apply.

As regards any interest charged on leakages, the usual provisions to be negotiated would be to directly reduce the purchase price on a euro-for-euro basis when any such leakages arise, prior to closing. If any leakages arise post-closing, interest could be charged.

Specific dispute resolution mechanisms are usually included. The parties would first agree to negotiate in good faith and find an amicable solution within a short period of time. Where this proves to be impossible, the parties agree to defer the decision to be adopted by an independent expert appointed by both parties in accordance with the conditions set out in the SPA.

It is highly uncommon to apply the general dispute resolution agreed by the parties and governing the SPA.

The most common condition is notification of the acquisition to the Spanish antitrust authorities (Comisión Nacional de los Mercados y la Competencia) and where applicable, to the antitrust authorities in other countries, especially in large deals.

Moreover, applicable Spanish legislation sets out that if the assets being transferred represent a significant percentage of the seller's assets, approval of the transaction by the GSM of the seller is required, and therefore, such condition usually finds its way into the SPA.

Other conditions, although less common, would include financing of the acquisition by the buyer, third-party consents to be obtained for major agreements of the target containing change-of-control provisions (termination of which would have a significant impact on the business being acquired) or any carve-out or reorganisation that might need to take place before closing the transaction.

Interim period limitations on the way the seller conducts the business have increased and therefore, PE buyers have gained more control over the target during the interim period. These additional interim period limitations have been justified considering the very unstable context, such as the current one caused by the COVID-19 health crisis.

PE buyers are very reluctant to accept any “hell or high water” undertakings. Therefore, it is not very common to include such undertakings in PE transactions, although an upward trend towards sellers trying to push the execution risk onto the purchaser through such clauses is becoming apparent.

Break fees or reverse break fees are rarely seen in any PE transactions in Spain. Sellers are highly reluctant to accept any walk-out rights in an SPA (other than any condition precedent previously negotiated and agreed by the parties).

It is very unusual for a signed SPA to be terminated prior to closing. The only scenario would be a case where any of the conditions precedent set out in the SPA are not met. In such a scenario, the parties would usually find an amicable way to proceed with closing and, given that such conditions precedent (if not regulatory) can be waived by the parties, this makes it very uncommon for either party to terminate or walk away from a signed SPA.

Material adverse change (MAC) clauses are not common. Any PE seller will be very reluctant to accept any MAC clauses as these significantly reduce the certainty of the deal.

Despite these clauses being uncommon, in some cases, “soft” MAC clauses have been introduced in an SPA. These refer to macroeconomic situations which are unlikely to materialise. However, specific business-related MAC clauses are very rare.

Notwithstanding the above, negotiations on MAC clauses have increased to regulate the impact of COVID-19. The exclusion of the pandemic from MAC clauses has been common (a fact that is well known and assumed by the purchaser). Only a limited number of deals have taken certain effects of the pandemic into consideration as part of MAC events, consequently, precluding the closing of the transaction.

Risk allocation varies and would need to be analysed on a case-by-case basis. In general terms, risk allocation favours the seller.

In competitive auction processes, especially where a PE seller is involved, SPAs are drafted in a seller-friendly manner, meaning that the scope of representations and warranties (R&W) insurance is narrowed, and the quantum is also limited.

In the case of a PE seller, R&W insurance would basically refer to capacity, title to the shares being sold and the absence of liens or encumbrances over the shares. In the case of a trade seller, a more complete set of R&W is usually agreed (including business-related R&W).

The most common limitation on liability for a seller would include full disclosure of the data room. On some occasions, known issues as a consequence of the due diligence exercise also limit the liability of the seller.

Customary R&W granted by a PE seller would usually include those referring to the valid existence of a target, title to the shares, and the absence of lines or encumbrances over the shares being sold. For these R&W, liability would only be capped at the purchase price.

In certain deals, whether granted by a PE seller or by management, business-related R&W are also granted. The most common representations in this sense would include those relating to the accounts, main contracts or agreements to which the target is a party; compliance with tax obligations; litigation; employees or the conducting of business.

Limitations

Regarding business-related R&W, certain limitations would apply. Mainly, a time limitation usually ranging from 12 to 24 months after the closing of the transaction (except for any tax or employee-related warranties which are usually limited to a four-year term).

Specific indemnities are also included for known issues arising from the due diligence exercise, the importance of which make specific protection necessary.

In most cases, liability for known issues is excluded and general disclosure of the data room against the R&W is very common (particularly in competitive auction processes).

As stated in 6.8 Allocation of Risk, full disclosure of the content of the data room to limit the seller’s liability is generally accepted.

W&I insurance is becoming increasingly common, although it still cannot be considered common practice. The product is not well known to trade sellers and the need for additional due diligence to be conducted by the W&I insurer, the exclusions of certain known issues (namely, known tax issues) and the impact on timing, prevent W&I insurance from being highly common as yet.

PE sellers are usually unwilling to accept escrow or any sort of price retentions, especially in auction processes.

Litigation proceedings in respect of PE transactions are not common in Spain. Although the usual applicable jurisdiction provisions are always introduced in the SPA, PE buyers or sellers usually prefer to settle any situations amicably and try to avoid initiating any litigation proceedings.

As regards any consideration mechanisms or earn-out discussions, PE transactions usually agree to defer these to an external expert to be appointed by the parties in accordance with the provisions previously set out in the SPA.

Apart from those referring to consideration mechanisms or earn-outs, the most commonly litigated provisions would refer to any sort of R&W being granted by the sellers, or specific indemnities.

Public-to-private (P2P) transactions are not very common in Spain since, in comparison with other jurisdictions such as the UK or the USA, the number of listed companies in Spain is comparatively low.

P2P transactions in Spain are mainly carried out by:

• direct or indirect competitors;
• private investors holding large equity stakes in a listed company as a result of consecutive acquisitions over time; and
• in what seems to be a future trend in the market, PE investors (acting both individually and as a pool of different PE investors).

The rationale behind these P2P transactions is usually:

• lowering the management costs of the listed company by not having to comply with all the obligations imposed on listed companies by the law and market regulations; and
• valuation reasons (when the prices of unlisted companies begin to surpass those of listed ones).

Any “transaction” by virtue of which a “shareholder” reaches, exceeds or falls below a voting right stake threshold of 3%, 5%, 10%, 15%, 20%, 25%, 30%, 35%, 40%, 45%, 50%, 60%, 70%, 75%, 80% and 90% in a listed company (both in the Spanish secondary market or another EU-regulated market), must notify the listed company and the CNMV (ie, the market regulator).

When the shareholder is a tax haven resident, the above-mentioned percentages are lowered to multiples of 1% (eg, 1%, 2%, 3%, etc).

Under certain requirements, the listed company must also notify the CNMV when it acquires, directly or indirectly, a stake in its own shares exceeding 1% of the voting rights of the company

For the purpose of this section:

• “transaction” means:
1. any acquisition or transfer of shares assigning voting rights;
2. execution of any financial instrument which:
1. at maturity, confers an unconditional right or discretion to acquire, exclusively at the holder's own initiative, shares assigning voting rights; or
2. is linked to these shares and which confers to its holder similar economic rights; and
3. execution of any type of agreement by virtue of which voting rights are conferred to a particular shareholder; granting of a usufruct/use right or pledge conferring voting rights; or concerned actions;
• “shareholder” means any person (whether legal or natural) who owns, directly or indirectly through a controlled entity:
1. shares of the listed company in its own name and on its own account;
2. shares of the listed company in its own name, but on behalf of another person; or
3. certificates representing the shares of the listed company, in which case, the holder of such certificates will be the holder of the underlying shares represented by the certificates.

Mandatory takeover bids are required when a person acquires “control” of a listed company. In such event, the shareholder acquiring control must make a bid for 100% of the issued shares of the listed company at a fair price (ie, a price not lower than the highest price that the offeror has paid or agreed to pay for the same shares during the 12 months prior to the announcement of the bid).

For the purpose of this section, a person shall be deemed to have "control" when that person (directly or indirectly):

• achieves a percentage of voting rights equal to or greater than 30%; and
• appoints, within 24 months following the date of acquisition of the listed company shares, more than half of the members of the board of directors of the listed company (even if it has a holding stake lower than 30%).

Control may be achieved not only voluntarily but also in a supervening way (eg, by way of a share capital decrease of the listed company). In those particular cases, Spanish law allows the person achieving control to sell the number of shares exceeding the above-mentioned thresholds for a period of three months (as long as it doesn’t make use of the control achieved).

The CNMV may also waive, in very limited scenarios, the obligation to make a mandatory offer.

The consideration in most takeovers is paid in cash.

However, it is not unusual for some takeovers to provide other securities as total or partial consideration.

The conditions to be established in an offer of a takeover bid depend on the nature of the takeover bid.

In this sense:

• mandatory takeover bids might only be conditioned to the approval of the competition authorities and other supervisory bodies; and
• voluntary bids might be subject to the following additional conditions:
1. approval of by-laws or structural modifications or adoption of other resolutions by the general shareholders’ meeting of the listed company;
2. acceptance of the bid by a certain minimum number of shares;
3. approval of the bid by the general shareholders’ meeting of the listed company; and
4. any other condition which complies with applicable law at the discretion of the CNMV.

For these purposes, the CNMV considers a condition to be acceptable when it meets the following requirements:

• its fulfilment depends on events outside the control of the offeror;
• it is sufficiently precise, in terms of its configuration or definition, to make its verification feasible and simple;
• its fulfilment can be verified before the end of the acceptance period of the bid; and
• it is reasonable and proportionate so as not to conflict with the principle of irrevocability of takeover bids.

In accordance with the above, the condition consisting of obtaining the required financing for the bid is not admissible under Spanish law as it would go against the principle of irrevocability of the bid and would be contrary to:

• the obligation of the bidder to ensure that it is able to cover any cash consideration in full; and
• the obligation of the bidder to provide a guarantee, or constitute a cash deposit, to guarantee payment for the shares that have been sold within the framework of the takeover bid.

Two Competitive Takeover Bids

In the event that there are two competitive takeover bids, the listed company and the first offeror may agree a break-up fee by virtue of which the latter is compensated for the expenses incurred in preparing the bid. This break-up fee is subject to the following four conditions:

• such fee will not exceed 1% of the total amount of the bid;
• the fee will be approved by the board of directors of the listed company;
• the financial advisers of the listed company will issue a favourable report regarding the break-up fee; and
• the fee will be detailed in the corresponding prospectus of the bid.

Any bidder who has acquired at least a 90% stake of the share capital with voting rights of the listed company, as a result of a takeover bid, is entitled to require the remaining shareholders to sell its holding stake in the listed company at a fair price (ie, the consideration of the bid).

The offeror must indicate in the prospectus its intention of executing its squeeze-out right in the event of acquisition of at least a 90% stake of the share capital with voting rights of the listed company. Three days after the announcement of the result of the offer, the offeror must communicate its intention to exercise or not exercise its squeeze-out rights, which decision is irrevocable.

The squeeze-out must be executed within three months of the date of expiry of the acceptance period of the takeover bid.

It should be pointed out that the remaining shareholders also have a sell-out right which must be executed under similar terms and conditions to the squeeze-out right.

It is relatively common to reach irrevocable commitments with significant shareholders prior to issuing a takeover bid, in order to ensure the success of the same.

These commitments often include not only an irrevocable right to sell, but also a commitment to exercise their voting rights in such a way as to facilitate the success of the bid (both at a shareholder level and, as far as legally possible, at the board of directors' level).

Hostile takeovers are legally possible, but are less common than non-hostile takeovers in Spain.

Unlike in other jurisdictions (eg, the USA, which has the "poison pill" mechanism), the target listed company has no other protection mechanism to persuade its shareholders to reject the offer or find another bidder.

Hostile takeovers usually take place among competitors or private investors and not between PE investors.

Equity incentivisation of the management team is a very common feature of PE transactions. Management equity ownership often ranges between 5% and 10%. The previously mentioned equity ownership stake may be increased up to a 15% and 20% range in secondary buyouts.

In addition, or as an alternative to equity incentivisation, management incentives may also be structured through:

• salary incentives, such as a variable extraordinary bonus (ratchet) linked to a determined internal rate of return (IRR) ratio and subject to the fulfilment of certain obligations and/or conditions (eg, good/bad leaver provisions);
• phantom stock or stock appreciation plans; and
• debt instruments, such as bonds acquired or loans granted by the managers to the target company, which interest is linked to a determined IRR ratio and subject to the fulfilment of certain obligations or conditions (eg, good/bad leaver provisions).

Depending on the structure of the management incentivisation, the rights and obligations of the management team and the PE investor may be regulated through the by-laws of the company, a shareholders' agreement, a management incentive/equity plan and/or an employer/director agreement.

Management participation is typically structured through:

• the managers holding sweet equity of the company; and
• the PE investor holding preferred shares of the company.

Other forms of equity investment, eg, stock options, are not common in PE transactions in Spain.

Under this structure, PE investors hold preferred shares which give them decision-making control of the company by holding either or both the majority of the voting rights of the company and/or certain veto rights over certain decisions.

Managers often obtain financing from the PE investors for the execution of their investment (especially if the investors were not among the former shareholders of the company and therefore did not obtain their funds from the PE investment in the same).

Management equity plans in Spain usually provide for "good leaver", "early (good) leaver" and "bad leaver" options.

Generally speaking, managers are considered:

• good leavers, when they remain in the company at the time the liquidity event takes place, or, at least, for a certain previously agreed period of time (around five years);
• an early (good) leaver is a manager who leaves the company prior to the liquidity event but for a reason previously agreed between the PE investor and the manager as "reasonable", such as:
1. death;
2. severe/permanent disability;
3. retirement at the legal age;
4. dismissal by the company without cause; and
5. resignation by the manager for good cause; and
• a bad leaver is a manager who leaves the company prior to the liquidity event for any reason other than a good/early leaver reason.

In these early (good) leaver scenarios, the percentage of the agreed ratchet will depend on the vesting period agreed by the parties and when the early (good) leaver cause of departure takes place.

Vesting periods in Spain usually range between four to five years, accruing more of the ratchet by the end of the same (eg, 5% during the first year, 10% during the second year, 40% during the third year, 80% during the fourth year and 100% during the fifth year).

Restrictive covenants such as non-compete, non-hiring/non-solicitation are customary for manager shareholders (as well as for management with no equity interest in the company). These restrictive covenants are limited to two or three years under Spanish law. When the manager is also an employee of the company, these non-compete covenants must be remunerated.

A non-disparagement covenant is not that common in Spain, but it can be agreed between the parties.

PE investors usually require manager shareholders (as well as management with no equity interest in the company that are part of a management incentive plan) to assume the following obligations:

• to stay as a manager in the company for a certain period of time (between two to four years) after the exit of the PE investor (in order to facilitate an exit with other PE investors), provided that the new investor offers them similar working/salary/incentive conditions as those they already have; and
• to make the representations and warranties in the PE investor's exit (since these managers have knowledge of the day-to-day operations of the company).

All these restrictive covenants and obligations are usually regulated both in the shareholders' agreement, the employment/director contract with the company and the corresponding management equity/incentive plan.

Manager shareholders usually obtain two types of protection in their investment:

• exit/divestment protection; and
• anti-dilution protection.

In this sense, it is common for manager shareholders to obtain a tag-along right so they can divest in the company at the same time as the PE investor.

Regarding anti-dilution protection, it is also common to guarantee to manager shareholders either that they can maintain their percentage of sweet equity in the company during the investment period of the PE investors or to grant them the required financing for the subscription to additional shares.

On the other hand, veto rights are generally reserved to the PE investors through their preferred shares, either by having a direct veto right in certain decisions or by keeping control over the majority of the voting rights of the company (sometimes, the sweet equity has no direct voting rights). However, some veto rights may also be granted to the manager shareholders.

As a general rule, the management team of the portfolio company is entrusted with the day-to-day management activities related to the business.

Provisions related to the control of the PE fund over the portfolio company are usually incorporated into a shareholders’ agreement, which is typically executed by the PE fund SPV with the minority manager shareholders upon closing of the acquisition of the portfolio company.

The following measures are customarily included in the shareholders’ agreement for the exercise of control over the portfolio company:

• reserved matters in respect of which decisions may be vetoed or may be passed with the affirmative vote of the PE fund – among others, amendment to the by-laws, a merger, spin-off, transformation or winding-up, distribution of dividends, share capital increase or decrease, drafting and approval of the annual accounts, execution of transactions exceeding a pre-determined monetary amount, and the granting of charges or encumbrances over the portfolio company’s shares or assets;
• right of the PE fund to appoint all or a number of the directors of the portfolio company (in particular, the right to appoint the chairperson and secretary of the board of directors; it is common for the chairperson of the board of directors to hold the casting vote when there is an odd number of directors);
• reporting obligations for the managers of the portfolio company to the PE fund;
• drag-along rights in favour of the PE fund in the case of a transaction involving the portfolio company;
• lock-up mechanisms for the manager shareholders; and
• non-competition covenants for the manager shareholders.

Spanish corporate law establishes as a matter of principle the liability system, according to which shareholders limit their liability to the amount of their contributions to the company.

However, Spanish corporate law also envisages the possibility, in certain exceptional circumstances, for shareholders to be held personally liable through the application of the "corporate veil" doctrine, based on which courts can declare shareholders liable for damages caused to the company and/or third parties where they have profited fraudulently by benefiting from the fact that the company has its own separate legal personality and independent assets.

In addition, de facto directors (ie, those who carry out the functions of director of a company without a title, with a void or extinguished title or other kind of title, and those on whose instructions the directors act) are also liable for damages caused to the company and/or third parties and/or shareholders for acts or omissions carried out illegally or in breach of their duties.

In recent years, there has been a notable growth in compliance and corporate social responsibility (CSR) or environmental, social and governance (ESG) obligations for portfolio companies. In fact, portfolio companies should have their own compliance management systems and should act in compliance with the CSR or ESG standards and policies of the PE fund.

This trend has also been reflected in the scope of due diligences carried out by PE funds, which increasingly include a review of the target’s criminal risks, compliance systems and ESG policies.

Additionally, it is increasingly common for portfolio companies to periodically report on the evolution and management of their risks and the application and effectiveness of their policies in the PE fund.

The usual holding period for a PE fund before a divestment takes place varies, but is usually from four to six years. In some cases, PE sellers have sold their interest in a business as soon as two years after its acquisition, although this is uncommon.

Dual tracks are quite common in large deals. In this scenario, it is not unusual for the sale process to derail a potential IPO if the PE sellers find there is appetite in the market for the assets they are selling.

All in all, auction sales have been the most common form of PE exit, although bilateral sales either to a PE buyer in a secondary buyout or to a trade seller are also common.

In PE deals there is sometimes reinvestment in certain secondary buyouts, but this is not common. On the other hand, reinvestment of any kind is seldom seen in trade deals.

PE transactions usually include drag-along rights in favour of the PE investors in the relevant shareholders’ agreement to ensure that such investors can implement at all times both partial or total divestments.

Depending on the majority held by the PE investor, this would apply to any other co-investor regardless of its nature. However, it is more common and easier to enforce in respect of minority shareholders (managers or other).

If the co-investor is another PE entity, the lock-up period and exit by either of the investors is heavily negotiated and introduced into the shareholders’ agreement.

As a general rule, the management team does not usually enjoy any sort of tag-along rights, but PE shareholders usually do in the rare event that they hold a minority stake.

In these scenarios, such tag rights would not typically be triggered until a change of control occurs.

Although an IPO is still the preferred exit route for PEs in larger deals, this has been quite uncommon, especially given the severe economic crisis resulting from the 2007–2008 financial crisis before and today, because of the COVID-19 pandemic. For illustrative purposes, during 2020, only one company (Soltec, manufacturer and supplier of solar trackers) IPO-ed on the computerised trading system (continuous market) of the Spanish stock exchanges. IPOs to the BME Growth (a stock exchange for smaller companies with a more flexible regulatory system, similar to the Alternative Investment Market of the London Stock Exchange) have been far more common.

Lock-up arrangements would be in the region of 18 months.

In an IPO scenario, any existing shareholders’ agreement would usually be terminated. Otherwise, where there is a new shareholders’ agreement in place, this should be disclosed to the regulator.