Looking across borders for financing and deal flow is certainly not a new phenomenon. Indeed, calendar year 2000 saw a record amount of global private equity and venture capital transactions close US $177 billion. Nevertheless, as the wind left the sails of the private equity markets in 2001, global venturing saw an equally precipitous decline. Fewer than 35% of the amount of venture deals of calendar year 2000 were successfully closed in 2001. This dramatic decline raises the interesting question of whether, in this market environment, there is still a place for global venture capital and private equity. The answer, as one might gather from looking at the increased number of foreign listings in the most recent issue of Pratt's Guide, remains an unqualified yes.
As investors have focused more intently on accretive investments with more diverse liquidity options, foreign targets have become more attractive. In fact, many larger private equity and venture investors report anecdotally that a majority of their recent transactions involve more than one jurisdiction. Foreign markets, while often tracking the US markets, have traditionally had independent drivers and thus may still offer attractive liquidity options. The large number of middle-market, privately owned companies in Europe and Asia facing succession issues and the competitive pressures of an increasingly global marketplace, provides an active market for buyout opportunities and majority-control investments. The globalization of technology has also accelerated the trend to cross border venture capital investments, even at the earliest stages. These facts have not gone unnoticed by US and foreign private equity and venture capital institutions which, in response, have significantly increased their on-the-ground presence in a wide variety of global regions, and have expanded the reach of their fund raising efforts across multiple borders. Moreover, the deployment of capital resident in the large family houses, banks, corporations and keiretsus of Asia and Europe has increasingly moved across borders and oceans. The need and desire to hedge risk by looking to outside markets, as well as the limited deal flow of local economies, has meant that more often than not a U.S. or European startup or buyout candidate will see a term sheet originate from a foreign-based fund.
As a result, an understanding of the issues and complexities involved in cross-border private equity and venture capital becomes required reading. In this article several top partners at Baker McKenzie, the global law firm, attempt to give a brief, high-level summary of some of the key distinctions, issues and complexities involved in a cross-border private equity and venture capital practice. Clearly, there is no limit to the universe of issues that arise with each new foray into a foreign market and thus we note that, for specific advice on a cross-border transaction, you are well advised to consult legal and tax advisers with specific international expertise in both your home jurisdiction and your target markets.
While the nature and function of legal documentation in a cross-border transaction is generally the same as with a domestic transaction, specific agreements and provisions will vary based upon the countries and funds involved. The principal operative investment document will be structured to provide for a subscription to equity with representations and warranties, rights, remedies and other covenants appropriate to the transaction. Other documentation will, based upon the corporation law of the country in question, address board representation, shareholder rights, liquidity and exit mechanisms and information rights. One key issue or element particular to a foreign transaction that will generally require attention is the ability to enforce covenants and rights, especially in jurisdictions where reliance upon court based legal systems may be questionable. Often, the best motivator for continued compliance is control of funds and thus staged disbursements or equity combined with debt can operate to limit the risk of abuses.
An additional logistical issue faced relates to language requirements for documentation as well as specific notarial, license and permit requirements and filing obligations. Many jurisdictions will not recognize the enforceability of an agreement if it is not in the local language or if it has not been appropriately filed or stamped. Thus, provisions relating not only to governing law but governing language (and the role of translated versions) are quite important. Other clauses that also require attention include arbitration provisions and clauses involving agreements among shareholders in many jurisdictions, special privledges of shares or similar actions or guarantees are necessary to give meaning to covenants that are viewed as typical under U.S. form shareholder agreements. In the end, most of the rights and remedies that are traditionally granted in U.S. and European deals can be obtained by investors in foreign transactions provided that there is an understanding of the particular limitations and requirements of the local jurisdiction and a reasonable amount of patience for the explanation that will undoubtedly be required by the local target company.
Another recent trend is the increasing adoption of "U.S. style" documentation in cross border transactions. In many countries, the legal relationships between and among investors, shareholders, lenders and other transaction constituencies are codified, and not subject to modification by contract. In yet other countries, the level of detail contained in typical U.S. documentation may offend cultural and business norms. While most will allow that the specificity of this style of documentation brings greater clarity and certainty to a transaction, investors should prepare for and carefully weigh those benefits against the cultural and legal detriments that may adversely affect the conduct and success of negotiations in certain countries.
In addition to form requirements such as notarial deeds, issues relating to limitations on the percentage of foreign direct investment, competition laws, enforceability of proposed structures and regulatory approvals will typically arise. Specifically, there are several types of approvals, clearances, consents, filings, notifications and registrations which may be applicable to any given private equity transaction:
Many of these issues must be addressed in the due diligence process, as they will often have a substantive impact on the potential returns to investors. The consequences of noncompliance vary significantly from country to country and from agency to agency, and can seriously delay or prevent the consummation of a transaction. The consequences may also include civil (and even criminal) fines or penalties, imprisonment, invalidity of the transaction, and vulnerability to attack by third parties. Compliance failures in some countries may also limit the types of business in which a target company may engage, or the manner in which that business may be conducted. Venture capital and private equity transactions involving highly regulated and other sensitive sectors and industries require special attention as more restrictive rules and complex processes are applicable.
Clearly one of the most significant aspects of any cross-border private equity and venture capital transaction is the tax effect on the investor(s) and the target company. From the fund perspective, the use of vehicles in various jurisdictions, involving both fiscally transparent and non transparent jurisdictions with beneficial tax treaties, may be necessary to achieve a more favorable tax result. Dutch BVs or CVs, or Caymans or Channel Islands LPs, may be necessary to implement a desired tax result.
The overall aim is ultimately to minimize any tax leakage from target companies through to the investors and to ensure that the fund and its limited partners are not subject to adverse taxation in the fund's jurisdiction or in any target company jurisdiction. From the target company perspective, the principal concerns will center on ensuring that any structure proposed by the investors does not involve unnecessary or undue withholding or similar taxes that would decrease the return to all equity holders, including management. These issues are no less critical in pan-regional fund formation activities, and must be carefully considered by fund organizers together with issues of limited partner liability, investment return repatriation, and the suitability of the chosen investment vehicle for targeted investor groups.
As the title of this article suggests, at a minimum, language differences can pose problems with a cross-border transaction. Add to the mix cultural differences and distinctions and a transaction may resolve to chaos without appropriate advance preparation. Depending on the country involved, for example, deal structures involving information rights, veto rights and the desire for control provisions considered typical in one jurisdiction may result in broken transactions and wasted hours unless the issues are addressed within the context of the cultural norms involved. Cultural formalities in many cases will assume great importance and attention (even though they may appear to outsiders to be unnecessary or awkward) and can often mean the difference between a successful transaction and an offended group of investees. To the extent that an investor does not have an on-the-ground presence or intimate knowledge of a country or locale, experienced professional advisers can be of invaluable assistance in navigating the minefield of cultural norms, negotiation styles and courtship rituals that can significantly effect the ability to win and ultimately profit from an investment transaction.
Ultimately, the convergence of global interests and opportunities means that investors and target companies alike will find themselves exposed to more and more transnationalv transactions. The world is at once both a much smaller and much larger place, and with the periodic appearance and disappearance of regional markets at various times, savvy investors increasingly hedge their bets by deploying capital across regions. The key to a successful international strategy, however, rests with a good deal of homework regarding the target company and an understanding of the varied business, legal, tax and cultural issues that arise in connection with such a cross-border deal. With the right preparation, venturing abroad presents truly promising prospects.
About the Authors:
Kanwar Singh, Partner
Practice Group: Corporate & Securities
Education: Northwestern University (B.A.) (1989); Boston University (J.D.) (1993)
Mr. Singh specializes in domestic and international/cross-border private equity and venture capital fund information and investments as well as international/cross-border commercial and information technology transactions. Mr. Singh has represented a number of prominent companies in industries such as manufacturing, electronics, investment banking, communications, high-tech, and software.
Marc R. Paul, Partner
Office: Washington, D.C.
Practice Group: Corporate & Securities
Education: Harvard Univ. (A.B.) (1982); Univ. of London (M.A.) (1983); Harvard Univ. (J.D.) (1986)
Marc Paul's practice involves venture capital transactions, public and private offerings of debt and equity securities, mergers and acquisitions, joint ventures, licensing arrangements, and complex commercial transactions, both internationally and domestically. Mr. Paul acts as outside general counsel to numerous business entities, from large multinational corporations to domestic start-up companies. He specializes in legal issues relating to technology oriented companies, particularly in the Internet, software, telecommunications, media and aerospace industries.
Bruce A. Zivian, Partner
Practice Group: Corporate & Securities
Education: Stanford University (A.B.) (1981); University of Michigan (J.D.) (1984)
Mr. Zivian is a Partner in the Corporate and Securities Department of the Chicago Office of Baker & McKenzie, and serves as the Coordinator of the Firm's Global and North American Venture Capital and Private Equity Practice Groups. Mr. Zivian regularly represents corporate strategic venture investors, traditional venture capital and private equity funds, and angel investors in their investment activities. A significant portion of Mr. Zivian's work in this area focuses on the strategic investment and business activities of both brick and mortar and technology companies.
Marwan Al-Turki, Partner
Practice Group: Banking/Financing
Education: Oxford University (B.A.) (1983), (M.A.) (1993); College of Law at Guilford (L.S.F.) (1985)
Marwan Al-Turki is a Partner in the London office of Baker & McKenzie, where he specializes in advising on structuring cross-border venture capital and private equity funds and on matters flowing from an investment in such funds. Marwan has expertise in advising funds on structuring parallel and feeder investment vehicles. He acts for a number of venture capital and private equity funds, as well as funds of funds.
Kien Keong Wong, Partner
Practice Group: Tax
Education: Massachusetts Inst. of Technology (S.B./Management) (1975); Massachusetts Inst. of Technology (S.B. and S.M.) (1976); Oxford Univ. (Brasenose College) (B.A./Law) (1984); Univ. of London (Imperial College) (Ph.D.) (1987)
Kien Keong Wong has had extensive experience in corporate, commercial and tax law, including tax planning and controversies. He is also actively involved in corporate and securities, mergers and acquisitions, competition law, information technology, telecommunications, electronic commerce and private equity/venture capital work. Wong has written several articles in journals and edited books on a range of subjects in tax, corporate and commercial areas. In addition, Dr. Wong has spoken widely in conferences, seminars and symposia in the Asia Pacific, North America, Europe and Australia.
*This article originally appeared in the 2002 issue of Pratt's Guide to VC Sources.