During 2020 and 2021, Cuatrecasas advised on thirty-two private equity deals with transaction values greater than €10 million. Based on this experience, we can highlight some of the most relevant market trends in the Spanish private equity market.
In 2021, almost half the transactions reviewed were deals valued at over €100 million.
Investment was distributed among different sectors, but the food industry and technology, media, and telecom (TMT) sectors were particularly active.
In 2020, there was a clear change in trend from previous years, and investments (compared to exits or SBOs) were dominant with 82% of the transactions.
In recent years, an increasing number of private equity funds and financial sponsors have been adopting alternative investment strategies to buyouts. In this scenario, some traditional funds have sought to diversify their strategies and products. These alternative strategies often result in innovative structures and instruments such as minority investments, which are more flexible and can be adapted to the company’s needs and to the risk profile.
However, when a private equity fund invests, the most common transaction continues to be one in which it buys 100% of the target company’s capital stock or takes a majority shareholding through a pure share purchase deal.
Approximately one-quarter of transactions continue to be ones in which the private equity fund, instead of buying a majority shareholding directly, buys the target company through a special purpose vehicle (SPV), after which the seller reinvests in the SPV, usually through a capital increase. Although this happens for many reasons, tax, indebtedness and regulatory reasons are the most common.
In 2021, more than half the transactions reviewed were auctions with tighter deadlines due to the pandemic.
During the first year of the pandemic, there were fewer transactions with conditions precedent (47% in 2020) compared to previous years. Based on our experience, this is probably because, unless conditions precedent were strictly necessary, the uncertain circumstances made parties prefer fast transactions with simultaneous signing and closing.
In March 2020, Spain followed the trend of other European countries (e.g., France, Germany, and Italy) and implemented a prior authorization system for foreign direct investments (FDIs), either because the investment is made in a strategic sector or because of the investor’s profile. This was in line with Regulation (EU) 2019/452 (the “FDI Regulation”) and the EU Commission’s guidance—which called on all EU Member States to set up a full-fledged foreign direct investment (FDI) screening mechanism. This became the most remarkable aspect within the M&A market.
A transitional authorization system for EU investors also applies until December 31, 2022, but it only applies to investments in (i) Spanish listed companies that carry out their business in a strategic sector, and (ii) unlisted companies if the value of the investment exceeds €500 million and they also carry out their business in a strategic sector.
Despite the initial concern and uncertainty as to how the new regulation would affect the implementation of M&A deals (mainly owing to the regulation’s being unclear), in practice, it has not discouraged investment.
Due to funds’ interest in strategic sectors, an FDI analysis was needed in most transactions. Apart from this new condition precedent, which became increasingly regulated due to the pandemic, the negotiation and regulation of interim periods have not been as affected by the pandemic as was previously expected.
Unlike in previous years, when almost half the transactions requiring regulatory approval included a “hell or high water” clause, this was rarely the case in 2020 and 2021. Instead, the most common practice was to establish that the conditions the regulatory authorities could impose had to be assumed unless they were especially burdensome or exceeded certain limits.
Although the opposite could have been expected, there was a progressive decrease in the use of break-up fees in 2020 and 2021 in case the closing did not occur or there was a breach of the closing obligations. Also, the use of conditions subsequent was again scarce (less than 10% of transactions).
Consideration and pricing mechanisms
The locked-box mechanism consolidated its dominance in 2021 as the most used pricing mechanism (66% of transactions). Even though the locked-box mechanism has become the most used, the completion accounts mechanism was still used in 32% of the deals in which net debt and working capital were the most widely used financial parameters for the post-closing adjustment.
The use of equity tickers continues to grow, and structuring them as a fixed daily amount is more common than setting a fixed daily rate.
The seller’s liability under leakage compensation is either capped at the leakage amount effectively received, or expenses and taxes are added.
All transactions with deferred consideration were earn-outs or a combination of fixed deferred price and earn-outs. When an earn-out is agreed, there are sometimes covenants to protect the seller, but this is uncommon. Most earn-outs are linked to EBITDA or, in general, to the company’s benefits.
Warranties and indemnity undertaking
In 2020 and 2021, when there was more than one seller, their liability was usually joint or individual, or a combination of both (individual for the fundamental warranties and joint for the business warranties). Joint and several liability was hardly seen.
In 85% of transactions with a deferred closing, the seller was considered to repeat the representations and warranties (R&Ws) on completion.
Share purchase agreements (SPAs) are usually limited quantitatively and temporarily. However, those limits differ depending on whether there is an investment or an exit and whether warrant and indemnity (W&I) insurance is taken out. In Spain, the impact of a buyer’s actual or deemed knowledge on claims for breach of warranties is usually negotiated under SPAs.
In 2020 and 2021, an 18-month limitation period became the most used, abandoning the trend of longer periods in previous years. The most used liability cap for business and tax warranties has increased slightly and is now 20% to 30% of the purchase price.
During 2020, in all exit transactions, the private equity fund was not liable for the breach of business or tax warranties because a W&I insurance had been agreed. However, during 2021, this happened only in 40% of the transactions. However, as usual, in all transactions in which private equity funds invested, industrial sellers granted business and tax warranties, or W&I insurance was agreed. Specific indemnities were almost always included in transactions where W&I insurance was not agreed, and a private equity fund was investing.
Unless a W&I insurance was agreed, all deals had lower and upper limits. Regarding lower limits (and excluding W&I transactions), (i) the seller was not usually obliged to indemnify for losses if each loss, considered individually, was less than a certain amount (de minimis exclusion or de minimis amount), and (ii) all the deals included a basket. In these cases, the seller is not liable for damages unless the aggregate amount of the claim, together with all the claims (each over the de minimis amount), exceeds the basket amount. In cases where a basket is agreed, 77% took the form of tipping baskets and 23% of non-tipping baskets.
There have been more transactions with an anti-sandbagging clause than with a pro-sandbagging clause.
Buyer’s remedies against seller’s liability
In general, during 2021, funds have been less demanding in the seller’s guarantees, either because they were buying highly demanded assets or because the valuation was beneficial and there was no need for further guarantees.
Regarding classic buyer’s remedies, third-party guarantors were the most used, exceeding escrows, which were the most used in the past five years. This is probably because, as money was cheap, some escrow agreements were charging interest instead of giving it, discouraging parties. No transaction used a bank guarantee as a seller’s guarantee.
W&I insurance continues to be the most used buyer’s remedy, albeit less markedly so than in the past. Its use has become widespread, both when private equity funds are investing and disinvesting, and not only within the framework of an exit, though its use has focused on clean exits (90% of W&I transactions).
Parties opted for arbitration in 41% of transactions as the dispute resolution mechanism to resolve conflicts arising from the agreement.
The most common seat of arbitration was Madrid. Arbitration proceedings were mostly managed by the International Court of Arbitration of the International Chamber of Commerce (ICC), or by the Court of Arbitration of Madrid.