Recently effected reforms to Spanish dividend protections for minority shareholders should cause European dealmakers to review deal terms more closely in 2017. Outright acquisition of businesses is unusual in Spain, 83% of Spanish private equity transactions completed since January 2016 involve the acquisition of less than 100% of the target. In our view, the reforms could significantly affect buyout firms that invest alongside minority shareholders or management in Spain.
What Is New?
Effective from the start of 2017, any shareholder in a Spanish company can demand a dividend distribution of a minimum of a third of the company’s operating profits obtained during the previous financial year, and which are legally distributable. If the company declines to declare such a dividend, any minority shareholder who had voted in favour of the dividend can exercise a “separation right”, requiring that the company acquires their shares at a “reasonable value”. If parties disagree on valuation, the Spanish Commercial Registry will appoint an independent expert to carry out a binding valuation. The reform applies to all private companies registered for five years or more, so captures completed deals as well as prospective deals.
The rationale of the reform was to prevent majority shareholders from systematically refusing to distribute dividends, instead exercising majority control to withdraw value via director remuneration, employment arrangements or via the provision of other services, which a minority shareholder would not typically benefit from. While the reform was not intended to directly target private equity deals, buyout transactions will be caught.
Why Does It Matter and What Should Deal Teams Do?
While acquisition structures vary, international private equity funds investing in Spanish businesses frequently use a Spanish incorporated topco. The new law will directly impact these deals. Buyout firms can mitigate the impact of the legal changes by acquiring 100% of the existing Spanish holding company, with managers rolling over at topco level into a non-Spanish entity. In our view, such structures have historically been less common in Spain than in other European jurisdictions, although this may change as the implications of the reform are felt.
For affected deals, the reform will impact negotiation of new deal terms and should cause deal teams to review existing deals. The separation right should be factored into management incentive plans. It is foreseeable that a nonperforming manager may trigger the separation right as an alternative to being treated as a “bad leaver”, seeking reasonable value rather than the lower of cost and market value. Deal teams should seek separation right waivers from managers in shareholders’ documents and target bylaws, although the effectiveness of such waivers has yet to be tested. Firms should consider using different classes of shares for minority shareholders, excluding the separation right from certain classes. Alternatively, buyout firms may consider full equity ownership, incentivising management by way of a phantom share plan without actual share ownership. However, potential tax inefficiency may make such structures unappealing.
Deal teams must also consider the implications of the new law on new and existing financing structures, as well as any target financing. For instance, there may be implications for covenants restricting dividend distributions, use of cash, distribution waterfalls and compliance with ratios.
Further, the meaning of terminology used in the legislation has been subject to debate. Deal teams should factor in the need for additional accounting information in order to determine what is legally distributable, within the definition of the new law.
Although Spain remains an attractive and buoyant buyout market, in our view, deal teams should be factoring the separation rights of minority shareholders into deal structures and monitoring the interpretation of the reform to ensure that commercial objectives are not compromised.