Do you manage or advise an alternative investment fund (AIF) in the EU? The EU Alternative Investment Fund Managers Directive (AIFMD) comes into force on 22 July 2013, although businesses will have up to one year to comply, depending on their circumstances. Are you well placed to ensure compliance with the new regulatory framework?
What does the AIFMD mean for private equity houses?
An AIF is any collective investment undertaking which raises capital from a number of investors and makes investments in accordance with a defined investment policy, excluding retail funds that are regulated by the UCITS Directive. Most private equity funds will fall within the scope of the AIFMD.
The AIFMD imposes a number of new obligations and restrictions on AIF managers (AIFMs) that either manage an EU AIF or market a non-EU AIF within the EU. This article focuses on:
- two of the key issues affecting AIFMs who make private equity investments: (i) the significant notification obligations and (ii) the restrictions on asset-stripping
- the practical steps that the new rules require AIFMs to take.
Private equity houses may wish to revisit their standard form equity investment documents to ensure that they adequately support the AIFM’s compliance with the AIFMD.
Care needs to be taken to ensure that the notification and information obligations and asset-stripping restrictions are not accidentally triggered where the AIF’s voting rights are temporarily enhanced or when they revert to their usual level.
Notification of voting rights in a portfolio company
An AIFM will have to notify the Financial Conduct Authority (FCA) when the voting rights of its AIF in a portfolio company (Newco) reach, exceed or fall below 10%, 20%, 30%, 50% or 75%. AIFMs will need to monitor these thresholds – for example, in connection with further share issues or capital reorganisations.
Notification following acquisition of control
Where an AIF acquires control of Newco, by holding more than 50% of the voting rights (whether directly or indirectly through other undertakings controlled by the AIF), the AIFM will be required to:
- notify the FCA, Newco and its shareholders that it has control, provide information relating to such control (including the date of acquisition of control and the resulting situation in terms of voting rights) and use its best efforts to ensure that the board makes the information available to Newco’s employee representatives without undue delay (the employee notification obligation) unless to do so would seriously harm the functioning of Newco or would be seriously prejudicial to it
- provide the FCA, Newco and its shareholders with information about the AIFM, its conflict management and communications policies relating to Newco and the safeguards in place to ensure arms’ length dealing between Newco and the AIF/AIFM and comply with the employee notification obligation in relation to such information unless to do so would seriously harm the functioning of Newco or would be seriously prejudicial to it
- inform Newco and its shareholders of the AIFM’s future intentions regarding the business and the likely repercussions on employment and comply with the employee notification obligation in relation to such information unless to do so would seriously harm the functioning of Newco or be seriously prejudicial to it
- provide the FCA and the AIF’s investors with information relating to the financing of the acquisition
- ensure that Newco’s annual report contains certain information and comply with the employee notification obligation in relation to such information
These control provisions also apply to indirectly controlled companies, and consequently will extend to all EU subsidiaries of Newco – including companies acquired on an MBO/MBI, or subsequently acquired as part of a ‘buy and build’ strategy.
Disclosures relating to repercussions on employment and the business as a whole are likely to be sensitive in the context of a private M&A transaction. Disclosure of this sort has been required under public company acquisitions for some years now and it remains to be seen whether the private market will follow the lead of the public market in terms of the level of disclosure that will be given in practice.
Asset-stripping following acquisition of control
Once an AIF has acquired control of a company (either directly or indirectly), the so-called ‘asset-stripping’ rules will apply. Unless an exemption is available, the AIFM must not during the next two years facilitate, instruct or vote for, and must use its best efforts to prevent, the company from effecting:
- distributions that would reduce the net assets below the level of subscribed capital plus undistributable reserves or exceed the distributable profits, as determined by the last audited accounts (and regardless of the position in any later management accounts)
- capital reductions, unless the purpose is to offset losses incurred or to credit an amount of up to 10% of the reduced subscribed capital to a non-distributable reserve of the company
- share redemptions
- purchases of its own shares where they would reduce the net assets as above.
AIFMs and their advisers will need to consider carefully the structure of acquisitions, the projected cash flows for the target businesses (including potential refinancings), and the process for subsequent follow-on investments to avoid inadvertently trapping cash in portfolio companies for the two-year period.
AIFMs should also consider amending their equity investment documents to make it easier to comply with the asset-stripping rules when the control threshold has been met.
