The Private Equity Review: Spain
I General overview
Despite the impact of the pandemic, the Spanish private equity market has remained very dynamic providing attractive investment opportunities to national and international managers and reaching record figures in terms of investment and fundraising.
In absolute terms, after the 2020 drop in deal activity, in 2021 total investment increased by 19 per cent (€7.494 billion) and total divestment remain stable with a decrease of just 8 per cent (€1.490 billion).2 Large transactions increased by 44 per cent (€4.140 billion) and middle market transactions remained around the same level as the previous all-time record of 2020 and, again, an all-time record in number and volume was reached in venture capital investments.3
In terms of fundraising by Spanish GPs, a total amount of €2.583 billion was raised in 2021 according to ASCRI estimates. This represents an increase of 21 per cent if compared to the 2020 figures, and the dry powder of Spanish GPs stands at around and €5 billion.4 This year it was especially remarkable that the total amount fundraised by venture represented 40 per cent of the total fundraising volume, though the average size of Spanish venture funds is still below international venture funds.
According to the information available at the public register of the Spanish National Securities Commission (CNMV), a total of 47 private equity funds, 51 private equity companies, 12 closed-ended funds, 13 European Venture Capital Funds (EuVECA) and seven management companies have been incorporated into the register of the CNMV in 2021.5
In terms of limited partners (LPs), according to data provided by ASCRI, there has been a very relevant increase in the commitments subscribed by family offices and high net-worth individuals (HNWIs) supported by the ongoing low interest rate scenario and lack of appealing yields in traditional assets. Additionally, public institutions, such as Fond-ICO, have continued their contribution to the fundraising market by providing funding to new private equity funds and putting more emphasis on venture capital and growth strategies.
In essence, the fundraising market is continuing the trend of previous years and becoming more mature with the entry of new players as a consequence of the spin-off of teams from historical private equity firms, the creation of new business lines by Spanish private equity firms and the launch of new teams focusing on less common investment strategies in the Spanish private equity market (private debt, special situations, social impact and funds of funds with exposure to niche strategies).
During these atypical years, renewable energy and infrastructure funds have attracted great interest because of their greater resilience to covid-19 side effects and, in similar terms, venture funds as investment in technology and digitalisation is increasing in the wake of the many opportunities and challenges brought by remote working and e-commerce.
Finally, there has been a noteworthy increase in the number of continuation funds and GP-led transactions that occurred in 2021 to provide additional funding for expansion or potential add-on opportunities that may arise in the coming years.
II Legal framework for fundraising
The great majority of private equity funds in Spain are structured as domestic private equity funds (FCRs) or private equity companies (SCRs), incorporated under Law 22/2014 of November 12 on Venture Capital Entities.
FCRs are separate pools of assets without legal personality, represented by units, which are held by investors or unitholders. SCRs are Spanish public limited liability companies subject to a particular regulatory and tax regime pursuant to Law 22/2014 and also subject to the provisions of the Spanish Corporate Law.6 FCRs and SCRs (collectively, ECRs) must be registered with the Spanish Securities Exchange Commission (CNMV).
FCRs are not subject to legal requirements generally applicable to corporations that give shareholders substantial rights to participate in, or to control, a board of directors (as is the case for SCRs). The role of investors in FCRs is generally passive, which makes FCRs more appropriate for investment funds managed independently.
Private equity funds organised as ECRs invest mainly in equity instruments issued by non-financial, non-real estate, unlisted target companies. They may also grant 'profit-sharing loans' to companies, subject to certain requirements and limitations. Likewise, ECRs may extend their main purpose to the investment in: (1) securities issued by companies whose assets comprise more than 50 per cent of real estate (provided that the real estate representing at least 85 per cent of the total book value of the target entity's real estate is ancillary to the development of an economic activity);7 and (2) in other ECRs subject to the diversification requirements established in Law 22/2014.
There is no minimum number of investors or minimum investment requirements (although marketing to certain categories of investors may require a minimum commitment) and, as they are closed-ended vehicles, ECRs are not subject to redemption requirements or liquidity coverage ratios. ECRs are subject to diversification requirements (i.e., they may not invest more than 25 per cent of their assets in a single target company (or 35 per cent in target companies belonging to the same group)). ECRs may have different classes of units or shares, which may help to set up a more tax-efficient carried interest structure for founders and promoters.
Apart from the FCRs and SCRs, Law 22/2014 contemplates a third type of private equity fund: venture capital entities for small and medium-sized investments (ECRs-Pyme). ECRs-Pyme may adopt the form of FCR or SCR. ECRs-Pyme must generally invest at least 75 per cent of their assets in equity or equity-related instruments in non-listed, non-financial and non-real estate entities, having less than 250 employees and with annual assets not exceeding €43 million or turnover not exceeding €50 million. Diversification thresholds are raised to 40 per cent, both per target company and per group.
ECRs can be marketed to both professional and non-professional investors and enjoy a special tax regime as described in Section III below.
Due to their lack of legal personality, FCRs must by externally managed, while SCRs may elect between self-management (through their board of directors), and external management (i.e., to delegate the management of their assets to a fund manager).
The principal vehicles for managers in Spain are the management companies of collective investment schemes (SGIICs)8 and the management companies of closed-ended collective investment schemes (SGEIC).9 Any company whose main activity is the management of private equity structures must obtain authorisation to qualify as a management company from the CNMV under Law 22/2014 (which transposes the AIFM Directive10 into Spanish law) and are subject to the supervision of the CNMV. European Union (EU) management companies authorised under the AIFM Directive may also manage Spanish ECRs, ECR-Pymes and EICCs (as referred to below) directly (freedom to provide services) or through a Spanish branch.
In addition to ECRs, the Spanish Law on Venture Capital Entities, regulates two types of close-ended collective investment entities (EICCs):11 (1) close-ended collective investment companies (SIICC) and (2) close-ended collective investment funds (FICC). EICCs are financial or non-financial closed-ended collective investment schemes with the ability to generally carry out any defined investment policy. They also have no minimum capital or assets. Otherwise, the rules on ECRs are applicable on a subsidiary basis to EICCs. EICCs can only be marketed to professional investors and they do not have a special tax regime (they are subject to the ordinary 25 per cent corporate income tax rate).
In line with the AIFM Directive, externally managed ECRs, ECR-Pymes and EICCs are not subject to prior authorisation requirements, but they must be registered with the CNMV before they can commence their activity. On the other hand, self-managed SCRs, SCR-Pymes and SICCs require authorisation by the CNMV prior to their incorporation.
Finally, the following close-ended fund vehicles are less frequently used in Spain, but are also available:12 (1) European Venture Capital Funds (EuVECA); (2) European Social Entrepreneurship Funds (EuSEF); and (3) European Long Term Investment Funds (ELTIF).
Spanish managers focused on certain investment strategies, such as venture capital or direct lending, may find EuVECAs and ELTIFs an interesting alternative for structuring their funds and, in fact, the use of EuVECAs has increased in Spain during the last two years. Spanish managers have incorporated ELTIFs, particularly in Biscay, where they enjoy a special tax regime for Biscay tax residents.
i Key items for disclosure
Disclosure requirements to potential investors when raising funds are outlined in Law 22/2014, of 12 November, on Venture Capital Entities. These requirements purport to ensure prospective investors adopt an informed investment decision.
There are two types of disclosure documents: the prospectus and the management regulations (FCRs) or corporate by-laws (SCR). The prospectus contains a description of the following items:
- information related to the ECR's investment policy and strategy and related risk factors;
- the procedures under which the ECR may amend its investment policy and strategy;
- the main legal effects arising from the contractual relationship entered into between investors and the ECR for the purposes of the investment;
- identification of the ECR's depository entity where applicable, ECR auditors and other service providers, together with a description of their obligations and investors' rights;
- a description of how the management company covers its professional liability risk;
- information on delegation arrangements of investment management functions by the management company and depository functions by the depository entity, including a description of potential conflicts of interest arising therefrom;
- valuation procedures and pricing methodology;
- the ECR's liquidity risk management including redemption rights;
- description of fees, costs and expenses that may be directly or indirectly borne by investors and the maximum limit thereto;
- a description of how the management company ensures fair treatment of its investors and information on any preferential treatment received by an investor (e.g., through bilateral agreements);
- the procedures and conditions for the issuance and sales of units and shares;
- historical performance where available;
- any prime brokerage arrangements where applicable and a description of how potential conflicts of interest are managed;
- a description of whether the depository or a sub-custodian may re-use and transfer the ECR's assets and the conditions upon which such practices are to be made;
- a description of any contractual arrangements made by the depository to discharge itself of liability; and
- a description of how and when periodic disclosure will be made to investors (leverage, risk profile, assets that are subject to special arrangements arising from their illiquid nature).
The ECR's management regulation and corporate by-laws are included as an exhibit to the prospectus.
Additionally, the management company is required to make available to investors, prior to the adoption of the investment decision, the ECR's latest annual report, net asset value according to the latest calculation and any investment delegation agreement, if any.
Further, given that shares of SCRs and units of FCRs qualify as packaged retail investment products (PRIP) under Regulation (EU) No. 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs), management companies are required to make available to retail investors the Key Information Document (KID) to assist investors to understand the performance and mechanics of ECRs (as investment products) and to compare the investment with other similar investment products.
The most common method of solicitation is by way of investor presentations, teasers and fact sheets to test investor appetite.
While institutional investors may request to conduct a comprehensive financial, commercial and legal due diligence concerning the investment and the fund management team, private wealth investors rely on their investment advisers' analysis and on the fact that the management company is a regulated entity subject to prudential and conduct of business supervision.
The management company may also appoint distributors, typically wealth management firms to solicit potential investors. Distributors must ensure that they comply with the applicable disclosure obligations under Law 22/2014 and PRIIPs as explained above, and their own disclosure obligations under the Spanish Securities Exchange Act and implementing rules and regulations.
iii Fiduciary duties
The management of ECRs is legally reserved to authorised management companies (SGEIC and SGIIC). Management companies are liable to investors for all damages suffered by investors as a consequence of the Management Company's breach of its obligations under Law 22/2014 and the provisions of the management regulations and corporate by-laws of the relevant ECRs.
Furthermore, management companies, their directors and managers (including de facto directors and managers) and senior officials are administratively liable for violations of the provisions of Law 22/2014 and subject to the sanctions stipulated under said law.
III Regulatory developments
The CNMV is the competent authority for the supervision of management companies, ECRs and depository entities in Spain. The CNMV performs its supervisory activities both through on-site visits and remote supervision on the basis of information reported and submitted to it.
With respect to management companies, the CNMV performs its oversight duties by controlling their financial situation and solvency through periodic information (reporting obligations to competent authorities); controlling compliance with organisational requirements, means and functions; and controlling that public information requirements are complied with.
With respect to ECRs, the CNMV performs its oversight duties by controlling their financial situation and investment coefficients and restrictions through periodic information (reporting obligations to competent authorities) and controlling that public information requirements are fulfilled.
Lastly, the CNMV is the competent authority for the supervision of ECR depository entities. The CNMV performs its supervisory duties of depository entities by controlling compliance with its obligations relating to custody, recording of assets and the supervision and control of the management company's activities.
ECRs are not subject to authorisation by the CNMV provided they are managed by a management company. However, they are subject to registration in the CNMV's Official Registries of ECRs.
ECR sponsors are not required to be registered with the CNMV.
ii General tax overview
The Spanish private equity funds set up as ECRs pursuant to Law 22/2014 are non-transparent entities and, therefore, their income is subject to Spanish corporate income tax (CIT) and are entitled, if they meet the applicable requirements, to the tax regimes, deductions, exemptions, treaties and incentives generally applicable to Spanish CIT payers.
In general terms, pursuant to the Spanish CIT general tax regime, entities subject to CIT will benefit from a 95 per cent exemption on dividends and gains (the General CIT Exemption)13 obtained from their participation in resident and non-resident companies (except tax haven companies), when the following requirements are met:
- that the participation is held for at least one year and represents at least 5 per cent of the share capital of the investee company; and
- in the case of stakes in non-resident investee companies, that such companies be subject to a CIT that applies at least a 10 per cent tax rate (this is presumed to be the case for residents in a country that has a double tax treaty with Spain with an information exchange clause).14
If the investee company receives dividends or gains from participating companies that represent more than 70 per cent of its income, to benefit from this exemption for the income received attributable to such indirectly held company, the indirect holding in such entity must also comply with the above-mentioned requirements; in particular, if such dividend or gain was not subject to taxation in the directly held company or came from a tax haven jurisdiction.
Notwithstanding the above, pursuant to Article 50 of the CIT Act, ECRs do enjoy a privileged tax regime on dividends and gains derived from 'typical' or 'qualified investments' (as set out in the Law 22/2014), and also with respect to distributions made to Spanish corporate investors and non-resident investors (except tax haven investors) as described below.
Regarding capital duty or stamp taxes, at present, there is no capital duty applicable on the establishment or capital increase of ECRs or any other Spanish company. However, capital duty may be due in the case of a share capital reduction or winding-up of a private equity company that results in distributions to its investors (generally, 1 per cent over the amount obtained by investors). Notwithstanding the above, the use of adequate tax planning may help to reduce such capital duty.
As regards VAT, management fees paid by the ECR to its management company are specifically exempt from VAT. If, apart from the ECR management company, there are other sponsors or third parties that provide administration or advisory services to the ECR, such services may be subject to VAT depending on the nature of the services provided, which may result in tax inefficiencies.
Finally, the registration of the ECRs in the CNMV registries is currently subject to registration fees.
ECR CIT special tax regime
Dividends and gains obtained by an ECR from 'typical investments' in accordance with the Spanish ECR Law (generally, investments in non-listed companies – other than public-to-private transactions – that do not qualify as financial or real estate entities) will be subject to the ECR special tax regime, which, briefly, provides the following.15
Gains that do not qualify for the general CIT Act 95 per cent exemption that are obtained by the ECR from the transfer of securities representing a participation in the share capital of the investee company (considered as an ECR typical investment) will, nonetheless, benefit from a 99 per cent CIT exemption at the level of the ECR, provided that the investment holding period is longer than one year and does not exceed 15 years (subject to the approval of the Spanish tax authorities, this term may be extended to up to 20 years in certain cases). However, this 99 per cent exemption will not be applicable in the following cases:
- if the acquirer is resident in a tax haven jurisdiction or the gain is obtained through a tax haven;
- if the acquirer is to be considered related to the ECR pursuant to the CIT Act (unless it is another ECR); or
- if the participation was acquired by the ECR from a related person or entity pursuant to the CIT Act; and
- dividends obtained by the ECR from such investee companies (except if obtained through a tax haven) will benefit at the recipient ECR level from the 95 per cent general tax exemption contained in Article 21.1 of the CIT Act, regardless of the investment holding period and the percentage stake held in the company paying out the dividend.
When the investments executed by the ECR are not considered as ECR typical investments, the gains and dividends obtained from them will be taxed at the level of the ECR in accordance with the general tax regime established in the CIT Act. Therefore, although the ECR will not benefit with respect to such investments from the above-mentioned ECR privileged tax regime, the ECR may be able to benefit from the general tax credits and exemptions applicable pursuant to the CIT Act (e.g., Article 21 of the CIT Act). Similarly, interest, royalties and any other income that do not qualify as dividends, distribution of profits or gains from ECR's typical investments will be subject to the CIT general regime at the ECR level.
Special tax regime for ECR non-resident investors
Income obtained by non-resident entities or individuals (without a permanent establishment in Spain for these purposes), deriving from their participation in the ECR (i.e., dividends, distribution of profits or capital gains from the reimbursement or transfer of their stake in the ECR, but excluding interest or other types of income) will not be considered to have been obtained in Spain for Spanish tax purposes and, consequently, will not be subject to taxation in Spain.16
Notwithstanding the above, if the income or gains received by the non-resident investor are attributable to income obtained by the ECR through a tax haven jurisdiction, this special tax regime may not be applicable and the relevant domestic rules and international tax treaties shall apply. Likewise, if the non-resident receives income from the ECR through a tax haven jurisdiction or when the acquirer is a tax haven resident, this special tax treatment shall not apply.
Pursuant to the above, non-resident investors may have to provide the ECR with a tax residence certificate regarding their specific non-resident status.
Special tax regime for ECR Spanish-resident investors
Spanish resident companies subject to CIT investing in ECRs will benefit from the ECR special tax regime as follows:17
- for gains obtained from the transfer or redemption of ECRs' shares or units – the Spanish CIT investor will benefit from the 95 per cent general CIT exemption regardless of the holding period and the percentage stake held in the ECR; and
- for dividends and profits distribution, the Spanish CIT investor will benefit from the General CIT exemption, regardless of the holding period and the percentage stake held in the ECR.
Notwithstanding the above, if the income or gains received by the Spanish resident company are attributable to income obtained by the ECR through a tax haven jurisdiction, this special tax regime may not be applicable and the CIT general regime may apply.
Finally, regarding Spanish resident individuals investing in ECRs, no particular tax regime applies, so the dividends and gains obtained will be fully subject to the general Spanish personal income tax regime.
Tax regime on ECR management companies
The ECR management company is subject to the general CIT regime and therefore its annual profits are taxed under Spanish CIT regular tax rates (25 per cent being the standard tax rate).
The management fees obtained from the management services provided to an ECR are exempt from VAT. Therefore, generally, VAT borne by an ECR management company will not be deductible (or may be partially deductible only), depending on the VAT pro rata applicable to the ECR management company, taking into account the services provided to other parties subject to VAT.
Other relevant tax considerations
With regard to carried interest, depending on the circumstances, it may be structured either as a success fee payable to the ECR management company (taxable under the CIT) or as a return from the investment made by the management company or other company or individuals, sponsors or promoters of the ECR. However, because of the lack of clear rules on this, and particularly following recent tax rulings, depending on the specific characteristics and conditions set out in each case, carried interest structured as a capital gain from investments may be contested by the Spanish tax authorities, who may regard such income rather than as a capital gain, as consideration for a service subject to taxation as such under the CIT or, if applicable, under personal income tax rules. As an exception to the above, a different set of tax rules have been set out for ECRs resident in Basque Country regions for resident individuals, under which carried interest may be considered as a capital gain.
Finally, the Spanish general or special tax regime applicable to ECRs contains a number of anti-abuse rules applicable to transactions made by ECRs with related entities, and to transfers to tax-haven residents and potential hybrid mismatch investments in line with the EU Anti-Tax Avoidance Directives (ATAD), which may result in the non-application of the ECR's special tax regime to certain transactions or the application of specific tax rules. Therefore, such rules must be considered when planning a transaction with related parties or involving tax haven residents, parties or accounts, as well as investments that may incur in hybrid mismatches.
iii Recent tax and regulatory developments
As set out above, in 2021 certain amendments were introduced into the Spanish CIT; among others, its participation exemption regime, reducing the previously full exemption on dividends and gains to 95 per cent.
Recently, the Spanish tax authorities issued a resolution clarifying the criteria to determine when a foreign entity should be considered tax transparent for Spanish tax purposes.
Finally, from a regulatory perspective, the approval of Regulation 2018/2088 and 2020/852 on sustainability-related disclosures in the financial sectors, is directly applicable to ECRs and their management companies; therefore, establishing certain new disclosure obligations in relation to environmental, social and governance matters towards their investors and regulators for the upcoming years.
Despite the effect that low attendance in offices, businesses and retail stores is continuing to have on the Spanish economy, private equity activity has the potential to remain robust in Spain during 2022, depending on various factors, including: (1) if the current level of liquidity in the market endures; (2) if the Spanish authorities involve the private equity sector in the deployment of EU covid-19 funds; (3) if Fond-ICO continues to actively deploy its investment mandate; and (4) if the new legislation promoting venture capital investment and amending the Spanish private equity legal framework, which will be debated in Spanish Parliament in the coming months, is approved.
1 Carlos de Cárdenas, Alejandra Font and Manuel García-Riestra are partners at Alter Legal SL.
2 2021 estimate figures published by the Spanish private equity association ASCRI on 21 January 2022.
3 ASCRI, 21 January 2022.
4 ASCRI, 21 January 2022.
6 Spanish Companies Act (Legislative Royal Decree 1/2010 of 2 July).
7 Pursuant to Law 35/2006, 28 November on Personal Income Tax and the partial amendment of the laws of Corporate Tax, Non-Resident Income Tax and over Property.
8 Collective Investment Schemes Act (Act 35/2003, of 4 November) and its implementing regulation (Royal Decree 1082/2012, of 13 July).
9 Venture Capital and Closed-Ended Collective Investment Schemes Act (Act 22/2014, of 12 November).
10 Directive 2011/61/UE, of 8 June on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No. 1060/2009 and (EU) No. 1095/2010.
11 Article 38 of the Venture Capital and Closed-Ended Collective Investment Schemes Act (Act 22/2014, of 12 November).
12 Articles 39 and 40 of the Venture Capital and Closed-Ended Collective Investment Schemes Act (Act 22/2014, of 12 November), Regulation (EU) 345/2013 on European venture capital funds, Regulation (EU) 346/2013 on European social entrepreneurship funds and Regulation (EU) 2015/760 on European long-term investment funds.
13 Article 21 Law 27/14, of 27 November, del Impuesto de Sociedades (the CIT Act).
14 Spain has a very wide tax treaty network, covering over 90 different countries.
15 Article 50 of the CIT Act.