Sweet equity always sweet for managers?
Yes, this may well be the case, and not only if the manager is offered to acquire the investment at a purchase price that is lower than its fair market value. Any arrangements that limit the economic risk of a manager’s investment may result in the tax authorities questioning the acquisition of beneficial ownership of the investment. This applies, among other things, to “non-recourse” purchase price deferrals, i.e. agreements that a deferred portion of the purchase price is only payable to the extent that the future exit proceeds are sufficient.
Until recently, at least a risk note was indicated if the investor and management invested disproportionately in different equity instruments in order to increase management’s return.
In the case of the disproportionate investment of private equity house and manager, the BFH has helped us with a long-awaited and recently published decision: The disproportionate allocation of the capital investment of private equity house and manager to different investment vehicles has no impact on the taxation of the exit proceeds as capital income. In principle, managers can thus be offered, without any tax risk, to use their capital exclusively for the acquisition of shares and not to invest in shareholder loans or, in the case of different share classes, to acquire only shares of the share class with the highest yield.
I generally advise against non-recourse purchase price deferrals. In addition to the tax risk that the tax authorities will deny the manager’s assumption of entrepreneurial risk due to the capital loss limitation and will not treat the capital gain — at least in part — as a capital gain, the right incentive is not set here. Other legal options for limiting personal liability are, of course, available.
Absolutely. Especially if the management is already involved and has to provide its own purchase contract guarantees on the seller side. If a guarantee issued by management turns out to be incorrect, a claim for damages against management will severely disrupt the shareholder relationship with the private equity investor. Purchasing S&I insurance mitigates management’s handling of a breach of warranty.
For the subsequent exit, it facilitates the assumption of purchase agreement guarantees by management and can lead to the always desired — but previously often non-negotiable — result that the private equity investor can focus on the acquisition of legal title guarantees and the buyer has a recourse debtor for the guarantees issued by management for the operating business with the S&I insurer. Wealth Conference 2021
About Dr. Gabriele Fontane
Gabriele Fontane has been advising on M&A/private equity and corporate law since the mid-1990s, with a focus on MBO/LBO transactions. Her practice also includes advising on acquisition financing and management equity investments. Gabriele Fontane acts for financial investors/private equity funds, managers interested in investing, strategic buyers as well as entrepreneurs considering the sale of their company.