I GENERAL OVERVIEW
Fundraising activity in Portugal has increased significantly in recent years, in line with the general EU trend but also capitalising on favourable 2017 gross domestic product (GDP) growth figures, a strong export base and a relatively unexplored private equity market.
Although there are no publicly available detailed fundraising figures for 2017 or 2018, some data points support this claim. In particular, the increase in the number of private equity funds from 952 in 2017 to 121 currently.
According to information available on the website of the Portuguese Securities Market Commission (CMVM),3 there are currently 121 private equity funds, 45 private equity management companies below the alternative investment fund manager (AIFM) thresholds and three private equity management companies above the AIFM thresholds.
This increase was mainly due to the implementation by the Portuguese Development Finance Institution (IDF) in 2017 of the Line of Financing for Venture Capital Funds financial instrument.4 This call for tenders is intended to select and finance venture capital funds that will receive financial resources through this instrument from the Equity and Quasi-Equity Fund managed by IDF. There have also been several recent successful independent fundraisings by local private equity firms, such as Crest, Atena, Explorer and Indico, who were able to attract international limited partners (LPs), and these have also contributed to the increase in the number of private equity funds.
The value under management in the Portuguese private equity sector in 2017 amounted to around €4.5 billion (2.3 per cent of GDP).5 This represents a 1.2 per cent annual growth, which came primarily from an increase in private equity funds.
Private equity activity analysed by investment stages shows a concentration of investment activity in turnaround operations (including strategic reorientation and company recovery operations), representing around 33.8 per cent of the total investments carried out in 2017. Although less impressive in comparison with turnaround activity, expansion operations (representing 21.5 per cent of total investments) also have an important impact because of the considerable number of operations carried out and to the amounts invested.6
In contrast, the venture capital stage (seed capital, start-up and early stage) continues to represent a small share of the total private equity investment (19.8 per cent). In Portugal, the seed capital stage is very small, although the number of participations and amount invested has increased.7
Private equity investment activity continues to focus on non-financial sectors, amounting to approximately half of the total investment carried out by private equity funds.
The above-mentioned data relates to 2017, as no information was available for 2018 at the time of writing.
There is no official data on the duration that a fundraising process can take. However, according to the authors' experience, it may take six months to a year and a half.
iI LEGAL FRAMEWORK FOR FUNDRAISING
The implementation of the Alternative Investment Fund Managers Directive (AIFMD)8 changed the legal framework applicable to private equity activity, and this was transposed into the Portuguese legal framework by Law No. 18/2015 of 4 March 2015 (the Law), which is now the primary law governing private equity activity.
According to the Law, private equity activity consists in the investment in target companies (either through equity or debt capitalisation instruments) with a high potential for development and growth, to benefit in the future from this growth and development through the future sale of those target companies.
It is important to note that there is no accurate distinction in Portugal between the concepts of private equity and venture capital, with these concepts being used interchangeably. Therefore, unless stated otherwise, the term 'private equity' in this chapter refers to private equity activity in a broader sense, comprising private equity activity in all its forms, including venture capital.
The Law sets out two different legal regimes:
- a legal regime for those management entities whose value of assets under management falls within the following thresholds (i.e., that fall within the scope of the AIFMD): greater than €100 million, when the corresponding assets were acquired through the use of leverage, or of more than €500 million in unleveraged assets that do not grant investors redemption rights for an initial five-year period; and
- a legal regime for those management entities whose assets under management do not fall within the AIFMD thresholds, which reproduces the legal framework previously in force as set out in the former decree law, although with some amendments.
The legal regime referred to above at (b) is less stringeng than that at (a), as the provisions of the Law, with a view to protecting investors, set out tighter requirements regarding (1) authorisation and registration of management entities with the supervising authorities; (2) internal organisation; (3) conflicts of interest to be avoided, managed or disclosed; (4) risk management policies; (5) valuation rules; (6) remuneration policies; and (7) delegation and sub-delegation of functions to third parties.
However, the managing entities referred to above at (b) may opt to request authorisation to carry out activity as a managing entity above the AIFMD threshold (opt-in procedure) and be subject to the stricter legal framework but also able to benefit from the rights granted under the AIFMD (e.g., applicability of the EU Passport).
i Preferred jurisdictions for funds
As regards investors' preferred choice of jurisdiction, in the authors' experience, Portuguese investors tend to select Portuguese vehicles whenever the investment target is located primarily in Portugal.
However, the transposition of the AIFMD into Portuguese law led to a harmonised regime governing private equity activity in Europe, avoiding asymmetries between the jurisdictions and making Portugal a more competitive jurisdiction.
Moreover, the Law sets out two new types of private equity investment vehicle that will place Portugal on a more competitive level and these are outlined below.
ii Legal forms of private equity vehicles
The Law provides for a broad range of private equity regulated vehicles, which may be set up in several legal forms.
The Law provides for different regulated vehicles, depending on whether they fall within or outside the scope of the AIFMD, and these are outlined below.
The activities carried out by these vehicles are not considered to be financial intermediation activities.
As noted above, the dynamic activity of private equity in recent years has been mainly supported by the growth of private equity funds rather than by private equity companies. This is evident in the number of private equity funds compared with the number of private equity companies registered in Portugal (121 compared with 45).9 It should also be noted that the value of assets managed by private equity funds is much higher than the value of assets managed by private equity companies.
Private equity vehicles outside the scope of the AIFMD
Private equity companies
- can be incorporated to directly own a portfolio of investments;
- can be incorporated with the sole purpose of managing private equity funds; or
- can combine both activities (i.e., they can directly own a portfolio of investments and manage private equity funds).
Private equity funds
Private equity funds12 are contractual funds managed by entities that surpass the thresholds set in the AIFMD: autonomous sets of assets without legal personality that may be managed by private equity companies, regional development entities and entities legally qualified to manage closed-end securities investment funds. Private equity funds are not responsible whatsoever for the debts of the investors, or for the debt of the entities that undertake the fund's management, deposits and marketing, or for the debts of other private equity funds. This legal form corresponds to the more commonly known 'contractual funds'. Private equity funds have a minimum subscribed capital of €1 million. The minimum subscription amount required per investor is €50,000, with the exception of the directors of the management entity who are not subject to this minimum threshold.
Private equity investors
Private equity investors are special private equity companies mandatorily incorporated as a single shareholder limited company. Only individuals may be a sole member of private equity investors. The registration of private equity investors with the CMVM is not made public.
Private equity vehicles within the scope of the AIFMD
Private equity fund management companies
Private equity fund management companies13 are limited liability companies, incorporated with a minimum share capital of €125,000, whose scope is the management of private equity funds that fall within the scope of the AIFMD. Following that, these companies are subject to more demanding legal requirements, namely as regards the access necessary to carry out this activity and the companies' operating conditions.
Private equity investment companies
Private equity investment companies14 are funds of a corporate nature whose purpose is direct investment in private equity, and in having their own portfolio. These companies may be externally or self-managed. If externally managed, they are managed by private equity fund management companies or by securities investment fund management companies. If self-managed they must have a minimum share capital of €300,000.
Private equity collective investment undertakings
Private equity collective investment undertakings15 are contractual funds managed by entities above the threshold set in the AIFMD, namely private equity fund management companies or securities investment fund management companies. The legal provisions concerning the above-mentioned private equity funds that fall outside the scope of the AIFMD are also applicable to these funds, along with more specific and demanding provisions regarding liquidity management, asset evaluation, and disclosure of information to the investors and to the CMVM.
iii Key legal terms
The relationship between investors and the private equity vehicles (i.e, the functioning and operating rules of the private equity funds) is governed by a set of rules negotiated with the investors, which in addition to the applicable legal and regulatory provisions will constitute the fund's rules as the fund's primary constitutive documentation.
Certain legal terms are imposed by mandatory provisions set out in the Law (to be provided in the private equity fund's rules) and others that, although not mandatory, are typically negotiated between the investors and the private equity management entities.
The following typical key terms are worth highlighting:
- Key-man provisions: these are applicable to certain key members of the private equity fund's management company, who are expected to devote their business time to the management of the private equity fund or the private equity company concerned; should this not be the case, several consequences may be triggered, such as the replacement of those key members or the immediate suspension of new investments, follow-on investments or divestments for which there were no binding commitments prior to the event.
- Borrowing limits of the private equity fund: according to the Law, the borrowing limits shall be set out in the fund's rules. This is an important item decided between the investors and the management entities.
- Portfolio diversification: provisions that impose investment diversification criteria more stringent than those imposed by the Law.
- Investment restrictions: geographic limitations, and limitations regarding the type of industry (e.g., prohibited industry sectors).
- Removal of the fund's management company: provisions regarding the removal of the fund's management company either with or without cause. Typically, 'cause' will include fraud, wilful misconduct, gross negligence, material breach of the fund's legal documentation, or any unauthorised change of control. As cause may be difficult to prove, the negotiations tend to focus on the relevant terms that will trigger removal 'without cause', notably regarding relevant voting majorities, implications for management fees and the right of the management entity to eventual compensation.
- Exclusivity: provisions regulating the setting up of other funds by the managing entities.
- Early termination: provisions allowing for the early termination of the investment period (this is an investor protection provision). This is one of the negotiable terms that has given rise to more detailed provisions.
- LP advisory committee: an advisory board composed of nominees of the investors. Their typical functions are the monitoring of conflicts of interest and taking relevant resolutions on these matters.
- Change of control: provisions aiming to prevent change of control in the management entities, establishing that, in the event of an unauthorised change, an early termination of the fund may occur, or replacement of the management entities.
- Most-favoured-nation clause: provisions set out in the fund's rules to ensure the principle of equal treatment of the investors. Those provision entitle investors to receive the same benefits as any arising for other investors through side letters.
iv Key disclosure items
Private equity entities shall submit information biannually to the CMVM regarding their investment portfolios, capital, performance, commissions, investors, the acquisition and disposal of assets, and the balance sheet and financial statements.16
Private equity entities must also disclose information to the CMVM, on a regular basis, on such matters as: the main instruments in which it is trading, main risk positions, most important concentrations of risk, total value of assets under management, and a general description of the investment strategy.
They shall also submit the following documents to the CMVM annually: annual report, balance sheet, financial statements, cash-flow statement, report issued by an auditor registered with the CMVM, and other accounting documents required by law or regulatory regime.17
The provision of this information is integral to the CMVM's supervisory function and important for statistical purposes.
The information to be provided to the investors on an ongoing basis is usually regulated by the fund rules, which usually stipulate that the information shall be reported quarterly. These reports usually contain consolidated information on variations in the net asset value, an overview of each of the key figures in the portfolio companies, and market comparisons.
Note that the Law, following the AIFMD provisions, sets out more onerous disclosure requirements that must be made to investors before they invest in private equity activity, namely regarding the investment strategy and objectives, leverage, how changes in strategy may be implemented, service providers, valuation procedures, fees and expenses, risk profile, remuneration practices and policies, and a historical outline of the financial results obtained by the fund.
Other key disclosure items
Private equity fund management entities shall annually submit for approval by the general meeting a statement regarding the remuneration policy of the members of their respective administrative and supervisory boards, which shall be disclosed in their annual financial statements together with information regarding the total and individual annual remuneration received by the above-mentioned directors.18 It is worth noting that the requirement to set remuneration policies and practices applicable to these entities falling within the scope of the AIFMD has been further strengthened by the introduction to the Law of an additional provision.
v Solicitation of investors
Most commonly, solicitation is made by way of initial contact with the key investors, which is followed by a distribution of the draft of the fund rules that will govern the private equity fund. The fund rules are the primary constitutive document to be negotiated with the potential investors.
As a matter of fact, the Law expressly states that the subscription or acquisition of a private equity fund's investment units is conditional upon being subject to that fund's rules. As such, whenever there is a subscription, the investor must at the same time accept and agree to be subject to the fund's rules.
Where the vehicle is a private equity fund (whether of a corporate or a contractual nature), a solicitation process by private subscription includes the negotiation of the fund's rules and, in the case of a vehicle of a corporate nature, also the negotiation of the articles of association, between the investors and the fund's management entity. Similarly, a solicitation process by public offer entails the negotiation of the prospectus.
It is also worth mentioning that Portugal has been witnessing a recourse to international placement management to allow access to international LPs. However, if the solicitation is made by public offer, the general rules set out in the Portuguese Securities Code apply.
vi Fiduciary duties of management entities
When performing their management activities, the directors of management entities shall comply with the fundamental fiduciary duties set out in the applicable company law – the Portuguese Companies Code – which include the duty of care and the duty of loyalty. Portuguese law defines the duty of care standards to be observed by directors as that of a wise and orderly manager, with an understanding of the company's business appropriate to their role. In addition, directors must have the availability and the proper technical capacity and skills to perform their relevant functions.
Furthermore, the duty of loyalty includes an obligation to act in the best interests of the company and to consider the long-term interests of the shareholders, as well as those of the company's stakeholders who are relevant for the company's sustainability. Additionally, this duty entails a non-competition obligation towards the company, which requires directors to place the interest of the company and its shareholders above their own. These general rules are applicable to private equity participants.
It should be noted that the Law particularises the following duties for management entities:
- to refrain from entering into arrangements that may lead to a clash of interests with investors;
- to set an organisational structure and internal procedures proportional to the size and complexity of their activity;
- to perform their activities to safeguard the legitimate interests of the investors; and
- the board members of these entities must be reputable and experienced, to ensure sound and prudent management.
Moreover, in many cases the fiduciary duties are expressly set out in the constitutive documents (e.g., the fund's rules), thereby ensuring higher standards.
III REGULATORY DEVELOPMENTS
i Regulatory oversight by the national authorities
The prudential and market conduct of the above-mentioned private equity vehicles are subject to the CMVM's supervision. The CMVM is an independent public institution with administrative and financial autonomy.
Pursuant to the aforementioned powers of supervision granted to it, the CMVM has decision-making powers regarding the granting, or refusal, of registry or authorisation, as applicable, as well as powers to demand of private equity management entities the presentation of documents and the provision of all necessary information for compliance with the legal framework of access to and pursuit of private equity activity.
Investors are not necessarily subject to CMVM supervision simply because they are private equity investors. In fact, an investor may be subject to supervision by any national authority as a result of its functions, but not merely as a result of being a private equity investor (e.g., if the investor is a bank or any other credit institution, it is subject to the supervision of the Bank of Portugal).
However, the Law provides that holders of qualifying holdings in all private equity companies should comply with the conditions that ensure the sound and prudent management of those companies.
ii Registration and authorisation requirements
As previously mentioned, the Law creates two different legal regimes, one applicable to managing entities that fall outside the scope of the AIFMD and the to those that fall within the scope of the AIFMD.
Each legal regime has different registration requirements, with the registration procedure applicable to managing entities that fall outside the scope of the AIFMD being swifter than the one applicable to entities outside the scope of the AIFMD (which require authorisation in advance), as summarised below.
Registration requirements applicable to managing entities that fall ouside the scope of the AIFMD
The setting-up of private equity funds and commencement of activities by private equity investors and private equity companies (regardless of whether they directly own a portfolio of investments or have the sole purpose of managing private equity funds, or a combination of both activities) is conditional on having previously registered the activity with the CMVM.
However, whenever the capital is not offered to the public and the investors are qualified investors or, regardless of the type, when the minimum capital subscribed by these investors is equal to or greater than €500,000 for each investor, the setting up of a private equity fund and the commencement of activity of private equity companies and private equity investors is subject only to a requirement to notify the CMVM of the activity.
Authorisation requirements applicable to managing entities that fall within the scope of the AIFMD
The Law sets out stricter registration requirements for those management entities that fall within the scope of the AIFMD.
The incorporation of such management entities is subject to a requirement for prior authorisation by the CMVM.
The standard of information required for this authorisation request is, in this particular case, rather extensive, requiring significant support documentation, since these managing entities raise more concerns from the Community and national legislators on account of their size.
If the CMVM fails to reply to the application request within the prescribed time frame, the application is considered to have been rejected.
iii Tax regime
At the level of the funds
Private equity funds set up and operating under Portuguese law are exempt from Portuguese corporate income tax (CIT) on capital gains, dividends, interest and any other sort of income received either from Portuguese or foreign sources. This CIT exemption means private equity funds will not be able to claim foreign tax credits that might be levied on investments made abroad.
The simple reimbursement of the capital invested by the investors is not taxed.
The setting-up of a private equity fund and subsequent capital increases do not trigger stamp duty or any other sort of taxation. Depending on the type of commission charged to private equity funds, indirect taxation could be levied.
At the level of Portuguese tax-resident investors (individuals or corporations) or non-resident investors with a permanent establishment in Portugal
Income paid or made available by private equity funds (by means of distributions, redemption of fund units or by virtue of liquidation) to investors that are Portuguese tax residents, or to non-residents with a permanent establishment located in Portugal to which the units are allocated, is subject to a 10 per cent withholding tax, except in the case of investors that benefit from a general tax exemption.
Withholding tax (if any) constitutes definitive taxation of Portuguese tax resident individual investors acting outside the scope of a commercial, industrial or agricultural activity, unless they opt to aggregate the income deriving from the participation units to global income, which is then subject to progressive personal income tax at rates of up to 48 per cent.19 If this were the case, if income distributed included dividends, only 50 per cent of the dividends would be considered for personal income tax assessment purposes.20
For other investors, withholding tax constitutes a payment on account of the final tax liability and is levied at the following rates: (1) standard corporate income tax rate of 21 per cent, in relation to corporate entities;21 and (2) the general progressive personal income tax rates of up to 48 per cent,22 applicable to individual investors acting within the scope of a commercial, industrial or agricultural activity.
Capital gains obtained by Portuguese-resident investors through the sale of units in private equity funds are subject to taxation at the following rates: (1) standard corporate income tax rate of 21 per cent23 for corporate entities; (2) the general progressive personal income tax rates up to a maximum rate of 48 per cent24 for individual investors acting within the scope of a commercial, industrial or agricultural activity; and (3) a flat-rate personal income tax of 10 per cent for individual investors acting outside the scope of a commercial, industrial or agricultural activity, unless they exercise the option for aggregation.
At the level of non-resident investors (individuals or corporations) without a permanent establishment in Portugal
Income paid or made available by private equity funds (by means of distributions, redemption of fund units or by virtue of liquidation) to non-resident investors without a permanent establishment in Portugal, and the capital gains obtained by the investors from the sale of their units, shall not be subject to withholding taxes, to the extent that (1) the unitholders are not resident in clearly more favourable tax jurisdictions,25 and (2) in the case of corporate entities, Portuguese residents do not hold share capital in the entity, directly or indirectly, of more than 25 per cent. When these conditions are not met, Portuguese taxation is levied at a rate of 10 per cent on both the income distributed by private equity funds and the capital gains derived from the sale of the corresponding units, except where a double-tax treaty has been entered into between Portugal and the unitholders' state of residence granting exclusive right to tax this type of income and gains to the beneficiaries' state of residence, in which case no Portuguese taxation is due.
Finally, it should be noted that investors will not be considered to have a permanent establishment in Portugal simply by virtue of having invested in the fund.
Market observers anticipate a slowdown of the recent fundraising activity from international LPs given the current grim economic outlook and the more balanced supply and demand of private equity that exists currently in Portugal. However, several announcements from governmental bodies point towards the continuation of a policy directed at fostering the private equity market in general, so it is likely that public funds will continue to be deployed in the near future.
From a legal perspective, Portugal is witnessing the market adopting some of the innovations created by the Law, such as the capacity to set up a fund with different sub-funds where each sub-fund corresponds to a distinct portfolio of the fund's assets and liabilities.
1 André Luiz Gomes is a partner, Catarina Correia da Silva is a counsel and Vera Figueiredo is associate coordinator at Luiz Gomes & Associados – Sociedade de Advogados SP, RL.
2 CMVM Annual Report of Private Equity Activity 2017, page 8.
3 Information from the CMVM website: https://web3.cmvm.pt/sdi/capitalrisco/pesquisa_nome_fcr.cfm.
4 Line of Financing for Venture Capital Funds IFD-FC&QC-FCR-01/16 (http://www.ifd.pt/en/products/esif/equity-and-quasi-equity/lineoffinancing-vcf/).
5 CMVM Annual Report of Private Equity Activity 2017, page 6.
6 CMVM Annual Report of Private Equity Activity 2017, page 13.
8 Directive 2011/61/EU of the European Parliament and of the Council on Alternative Investment Fund Managers.
9 Information from the CMVM website: https://web3.cmvm.pt/sdi/capitalrisco/pesquisa_nome_fcr.cfm.
10 Sociedades de capital de risco.
11 Sociedades anónimas.
12 Fundos de capital de risco.
13 Sociedades gestoras de fundos de capital de risco.
14 Sociedades de investimento em capital de risco.
15 Organismos de investimento em capital de risco.
16 CMVM Regulation No. 3/2015.
18 Law No. 28/2009, of 19 June 2009.
19 The maximum rate of 48 per cent is applicable to income up to €80,640, plus an additional solidarity rate of 2.5 per cent imposed on income exceeding €80,640 and up to €250,000, and of 5 per cent on income exceeding €250,000.
20 Fifty per cent of the amount of dividends included in income paid or made available by private equity funds to Portuguese tax-resident individual unitholders acting within the scope of a commercial, industrial or agricultural activity shall also be considered, provided they are included in the organised accounting regime.
21 Plus municipal and state surcharges, if applicable.
22 See footnote 13 above.
23 See footnote 15 above.
24 See footnote 13 above.
25 As listed by Ministerial Order No. 150/2004, dated 13 February 2004, and subsequent amendments.