The 200708 economic and financial crisis, combined with a new set

of rules issued by European institutions, in particular the Alternative

Investment Fund Managers Directive (AIFMD) and the new
European Venture Capital Funds Regulation (EuVECA), has led to a
considerable evolution of the private equity and venture capital
market. While the international meltdown has certainly determined
the need for stricter regulations, these will in turn have a further
influence on the market, thus highlighting the reciprocal relationship
between them. The private equity and venture capital sector has
become very different from its previous incarnations, and is still
evolving, both in terms of data and behaviour of the players. The aim
of this book is therefore to describe the characteristics and trends of
the private equity and venture capital market by underlining these
changes and trying to identify likely future developments. As
private equity and venture capital have become a fundamental part
of the financial markets, it is very important to examine the features
and trends that have been a consequence of changes in this sector,
with a particular focus on the tax and legal issues relating to the new
regulations.
The European market did, in fact, grow significantly in the years
prior to the crisis, due to low interest rates and the availability of
credit, which produced an investment boom between 2004 and 2007.
However, the global crisis drastically changed the industry in many
respects. First, fundraising has become very challenging due to the
lack of liquidity and the so- called denominator effect: as the public
3
1
Introduction
Anna Gervasoni
AIFI Italian Private Equity and Venture Capital Association
and LIUC Universit Cattaneo
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markets have fallen and the prices of liquid assets have dropped, the
value of overall portfolios has decreased, thus making this asset class
less interesting for investors. On the investment side, the deal size
has reduced as a consequence of the credit crunch, which has made
debt both expensive and difficult to obtain, with the focus changing
from financial engineering to value creation through corporate
growth. The divestment activity has also experienced a slowdown
and the crisis has lengthened the holding period, due to the difficul-
ties in the main exit channels, especially in the initial public offering
(IPO) and the mergers and acquisitions (M&A) markets.
In this context, the AIFMD is the most important legislative
process ever experienced by the European private equity and
venture capital industry, representing one of the most significant
institutional reactions to the global financial crisis. However, this is
not the only sector to have become regulated, and it has often (inap-
propriately) been likened to other speculative markets that are, in
fact, very different. This aspect was underlined by Charlie
McCreevy, former European Commissioner for Internal Markets
and Services, who has stated that private equity is not central to the
traumas/difficulties surrounding the structured credit/asset backed
markets.
1
The worsening of the crisis, however, created significant
pressure in our industry in relation to the introduction of measures
aimed at increasing transparency, improving information disclosure
standards through appropriate reporting, and mapping of
investment-activity-related risks. Consequently, private equity was
included in the AIFMD, which will produce further changes to those
already generated by the market.
On the other hand, the EuVECA has been introduced in the
venture capital industry to support fundraising activities across
Europe, and to facilitate access to finance for the large number of
small and medium- sized enterprises (SMEs) that need to grow and
internationalise. The fact that institutions and regulators are now
interested in venture capital demonstrates that it is a crucial part of
the financial market, which has significantly matured and produced
positive effects on the whole economy. European markets have
historically focused on generalist funds investing in both new and
mature companies. In the US, however, the two kinds of investments
are clearly separate and industry players either focus on buy- outs or
on venture capital markets. The introduction of different regulations
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for venture capital and buy- outs highlight the fact that the two
markets are complementary but different. In the future, the
European model is likely to move towards the US model, with a
growing number of specialised firms.
If we consider the elements of private equity, fundraising appears
to be one of those most affected by the new regulations due to the
introduction of a passport that allows firms easier access to markets
within Europe. Accordingly, processes should become more trans-
parent and homogeneous and capital allocation decisions should no
longer be based on the fiscal and legal differences between countries,
but rather on the characteristics of the private equity firms.
Institutional investors will, therefore, focus on the track record, expe-
rience, capabilities and expertise of fund managers. In addition,
national governments will need to avoid using the gold- plating
practice when implementing European regulations in the context of
their national legal frameworks in order to maintain a competitive
landscape.
The harmonised European regulatory framework should also
increase the number of cross- border deals and permit the growth of
new multi- location private equity and venture capital players, based
and operating in different European countries. This may also have
positive effects on their portfolio companies, stimulating interactions
and synergies and, therefore, facilitating the processes of internation-
alisation. Looking at the bigger picture, private equity can help
Europe to attract overseas capital while consolidating European
capital.
Moreover, new financial players will gain importance in this
scenario; sovereign wealth funds, in particular, will play a growing
role in our industry in terms of fundraising, providing resources to
the private equity players and investment activities, with a business
model that can be assimilated to theirs. From this point of view,
sovereign wealth funds have started to invest both directly, usually
buying well- known and international companies, and through joint
ventures with other private equity players.
2
The number of their
deals is increasing every year.
The geography of international capital flows has changed signifi-
cantly over the years, with the growth of new economies and the
decline of other traditional ones. Since 2000, the contribution of
emerging economies to world capital flows has grown very quickly,
INTRODUCTION
5
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as has their competitiveness; however, Europe collectively repre-
sents the largest economy in the world. International economic and
financial statistics demonstrate that the continent is the worlds
largest exporter and importer, and still attracts the majority of
foreign direct investments. In spite of problems with public finances,
the European debt- to- GDP ratio is still better than those of both the
US and Japan.
3
Europe also has leading research centres and excellent scientists
who are focusing on innovation in many fields although, from this
perspective, Europe still lags behind the US, Japan and South Korea.
The introduction of the European passport for venture capital funds
is one of the measures that was adopted to make the business envi-
ronment more innovation- friendly. Private equity and venture
capital provide the resources to bring innovative ideas to market,
turning them into new products, services or processes, and devel-
oping clusters in high- tech sectors. Studies have shown that private
equity makes a very high contribution to the total level of industrial
innovation in Europe,
4
and that more than 100,000 patents registered
between 2007 and 2011 were related to private equity and venture
capital- backed firms.
5
Consequently, the support provided for the
commercialisation process improves competitiveness and creates
growth and jobs.
Extensive research has also demonstrated that private equity and
venture capital make an important contribution to economic
growth.
6
Players in these areas increase revenues, productivity and
employment in target companies by introducing and promoting
strategic planning, operational improvements and further innova-
tion. In fact, research shows that the performance of portfolio
companies is better than for comparable non- backed firms.
A further critical issue for the industry is divestment activity:
private equity is only a small piece of the financial puzzle, which
performs well when the other markets are efficient. In particular, the
principal exit channels, such as trade sales and IPOs, depend on
M&A activity and on the stock exchanges. From this point of view,
despite the crisis and consequent recession, Europe remains the most
active area for M&A cross- border activity
7
and has three
8
of the
worlds leading stock exchanges by market capitalisation.
9
The European banking sector is also the largest in the world: it
accounts for 349% of European GDP, in comparison with 78% for the
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US and 174% for Japan.
10
The banking system plays a crucial role in
the international scenario: even if this sector cannot be considered as
the only cause of the problems, it has certainly been at the heart of the
crisis and is undergoing deep structural changes that have an influ-
ence on the private equity market. In this respect, another of the main
consequences of the financial crisis has been a decrease in the avail-
ability of bank financing, which has had an impact on a very large
number of companies, especially SMEs. In this particular area, the
private equity and venture capital industry can play a more impor-
tant role, by providing funds and know- how to high- potential
enterprises. Moreover, in the likely event that continental European
markets evolve following the US and Anglo- Saxon models, capital
markets will have more weight than credit markets. As a conse-
quence, new players will emerge that provide not only private
equity, but also private debt. Within the new unitary legal frame-
work, product synergies will arise from the common objective of
providing financing for growth. These players might represent new
points of reference for enterprises.
This book provides in- depth analysis and discussion of all these
topics interms of aninnovative approachtothe market: fromboththe
statistical and the regulatory points of view. It is comprised of five
main sections. In this first section, Chapter 2 by Giovanni Fusaro and
Alessia Muzio provides a description of the history of US and
European private equity and venture capital, fromits birth up to the
time of writing. The secondpart of the chapter offers some useful defi-
nitions of the mainactors andactivities that characterise the industry.
The second section, Overview and Effects of the Financial Crisis,
provides a general overview of the market, and describes the effects
of the global crisis from both a quantitative and a qualitative perspec-
tive. In particular, Chapter 3 by Giovanni Fusaro, Cornelius Mueller,
Alessia Muzio and Francesco Giordano, demonstrates the main
trends of the European market, illustrating both aggregated data
provided by the European Venture Capital Association (EVCA) and
single countries statistics, collected by the main national venture
capital associations, and details how the financial crisis has affected
the industry all over Europe. Chapter 4, by Tamara Laudisio and
James R. Noble, focuses on fundraising activity, describing the
changes that have characterised latterly the relationship between
private equity players and institutional investors, their sentiment in
INTRODUCTION
7
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this difficult environment and the most important challenges they
face. Strictly related to this, Chapter 5, a collaboration between
Quinn Moss, Richard Moudiotis, Pierre- Yves Denez, Anne- Sophie
Kerfant, Sven Greulich, Thomas Voss, Giovanni Carotenuto and
Peter J. Rooney, provides a deep analysis of the most common terms
and conditions used by private equity funds from a legal and
commercial point of view. Both European and US markets are exam-
ined in order to highlight the changes that occurred after the
financial crisis and the new regulatory environment. Investment
activity is the main topic of Chapter 6 by Harry Nicholson and
Umberto Nobile, which identifies the main levers through which
private equity players create value in target companies. The last part
of the section, Chapter 7 by Maximilian Fiani, Onno Sloterdijk and
Paul de Hek, focuses on divestment activity and performance,
describing the most common exit channels and their differences
across countries and size of the private-equity- backed companies.
The third section, Regulatory Developments, examines the
main regulatory developments of the private equity and venture
capital market. Two main aspects are taken into consideration: the
AIFMD and the EuVECA, which represent new market opportuni-
ties for European private equity and venture capital funds and their
managers.
As mentioned, the AIFMD represents one of the most significant
institutional reactions to the global financial crisis. Starting with the
aim of protecting investors, it will have a significant impact on the
compliance and reporting infrastructures of fund managers. It was
initially criticised by industry managers because it will add signifi-
cant costs to the private equity investment process; however, it has
also been acknowledged that the directive will open up new possibil-
ities for raising capital in Europe. The alternative investment
management world will be able to acquire a badge quality in the eyes
of institutional investors, the European passport, similar to the pass-
port for Undertakings for Collective Investment in Transferable
Securities (UCITS) asset managers. In order to take a real advantage
of this opportunity, the challenge for alternative asset managers will
be to find new investment strategies and to recruit the most talent
investment professionals.
More generally, levelling the legislative playing field among
different European countries is another desirable goal to improve the
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competitive arena. The EuVECA regulation was inspired by the aim
of pushing the venture capital industry to demonstrate its huge
hidden potential for sustaining high- tech innovative companies
across Europe. Again, thanks to the European passport, fundraising
should be easier. In this case, minimal adjustments of compliance
infrastructure will be requested of fund managers. On the other
hand, it is to be noticed that a real diffusion of venture capital will
also only be possible with a harmonisation of the contest at the fiscal
level through a mutual recognition of investment structures that can
avoid problems of double taxation.
Chapter 8, by Emidio Cacciapuoti, Simon Witney and Valentina
Lanfranchi, presents initially an historical background of the
AIFMDs legislative process, before providing in- depth analysis of
the main provisions of the AIFMD in the light of their main impact
on venture capital and private equity fund managers. The other set
of rules issued by the European Union for the industrys players,
EuVECA, is then explored by Andrea Arcangeli, David Williams
and Valentina Lanfranchi in Chapter 9. The chapter presents an
overview of its legislative process, reports and comments on the
principal dispositions of the EuVECA regulation, and illustrates an
overview of the venture capital legal framework in Germany, Italy,
Spain, the UK and France. The next chapter, by Fabio Pizzoccheri
and Paola Flora, details the impact of other regulations on private
equity and venture capital businesses in a material way. It first
outlines the Foreign Account Tax Compliance (FATCA) regime
before continuing the debate about the European directive that has
revolutionised the regulation of financial markets, the Markets in
Financial Instruments Directive (MiFID). The authors consider the
potential consequences for the private equity industry of these
legislative provisions. In the last chapter of the third section,
Alessandra Bechi and I discuss the most common publicprivate
models of intervention, with the aim of solving the financing prob-
lems of innovative companies, with a particular focus on the
approach of the European authorities to sustaining venture capital.
The creation of a partnership between the public sector and private
players has been proven to be one of the most effective ways to
attract private foreign institutional investors in particular.
Finally, we come to the fourth section, Tax and Legal
Developments. The five chapters in this section deal with a variety
INTRODUCTION
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of topics, starting with Chapter 12 by Davide Mencacci and Pietro
Belloni, who investigate the principal structures used by private
equity and venture capital players. It analyses the key considerations
to keep in mind when assessing proposed structures, concluding
with a look at some of the principal steps required to implement the
agreed structure. The following chapter, by Maurizio Bernardi and
Pierluigi De Biasi, focuses on the main legal topics of a private equity
or venture capital investment and divestment process in order to
provide a practical guide to the basic legal issues to be taken into
account when conducting investment operations. In Chapter 14,
Claudio Cerabolini analyses the most commonly used route
followed by entrepreneurs and private equity players as share-
holders of the same target company. Chapter 15, by Alessandro
Corno, describes the corporate and legal structuring of a typical seed
investment made in a start- up or in a recently formed company, and
details the documents that regulate the execution, governance, oper-
ation and exit strategy of these transactions. The last chapter of this
section, by Fulvia Astolfi and Serena Pietrosanti, discusses the tax-
related aspects of the world of venture capitalist and private equity
players. It discusses the investment structures offered by English,
Luxembourg and Dutch law, and contains an appendix that details a
comparative analysis of the main tax issues to be taken into account
in the implementation of private equity and venture capital invest-
ment in various European countries.
Finally, we include a glossary of the most important terminology
used to describe the private equity and venture capital industry.
I would like to thank all the private equity professionals that enthusi-
astically agreed to dedicate their time and effort to writing the
different parts of this book. I also wish to thank Alice Levick,
Associate Editor at Risk Books, for her invaluable professional
support and patience in coordinating the project. Last, but not least, I
would like to express my gratitude to my team, and especially to
Giovanni Fusaro, Valentina Lanfranchi and Alessia Muzio, who
supported me in this project and shared the editorial burden. Finally,
a special thanks to Alastair Robertson for his perfect English.
1 Speech by Charlie McCreevy, European Commissioner for Internal Market and Services,
Private Equity, Allied Irish Banks, London, February 7, 2008.
2 For example, IQ Made in Italy Venture is the joint venture by Fondo Strategico Italiano, the
holding company controlled by the Cassa Depositi e Prestiti, and Qatar Holding LLC, which
will invest in the most important Italian sectors.
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3 For further details, see The World Economic Outlook (WEO) database, created by the
International Monetary Fund (available at http://www.imf.org/external/data.htm).
4 Popov, A. and P. Roosenboom, 2009, Does Private Equity Investment Spur Innovation?
Evidence from Europe, European Central Bank, Working Paper series No. 1063, June.
Analysis based on data on private equity investments and patent activity from 21 European
countries in the period 19912004 highlights that private equity contribution is equal to 12%
of the total industrial innovation in Europe.
5 Frontier Economics, 2013, Exploring the Impact of Private Equity on Economic Growth in
Europe, a report prepared for EVCA, May. Based on Popov and Roosenboom (2009),
Gambardella, A., D. Harhoff and B. Verspagen, 2008, The Value of European Patents,
European Management Review, and the World Intellectual Property Organisation (WIPO), it is
estimated that 116,000 patents worth up to 350 billion were attributable to private equity-
backed firms between 2007 and 2011.
6 See, for example, Colombo, M. G. et al, 2011, Venture Capital: Policy Lessons from the
VICO project, PwC, 2013, LImpatto Economico del Private Equity e Venture Capital in
Italia; Ernst & Young, 2012, Annual Report on the Performance of Portfolio Companies
IV, BVCA; ASCRI, 2011, Economic and Social Impact of the Private Equity Activity 2011.
7 KPMG Corporate Finance, 2013, Rapporto Mergers & Acquisitions 2012.
8 London Stock Exchange, Euronext and the Frankfurt Stock Exchange.
9 World Federation of Exchanges, 2013, Market Highlights, January.
10 High- level Expert Group on reforming the structure of the EU banking sector, chaired by
Erkki Liikanen, 2012, Final Report, October.
INTRODUCTION
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