As from 12 May 2004 an innovative and flexible fund structure is available in Luxembourg for investments in private equity.
The new structure was created through the vote by the Parliament of the law relating to the "Société d'Investissement en Capital à Risque" ("SICAR") (the "Law").
The Law refers to a wide definition of private equity and includes all type of financial assets (shares, loans, bonds, hybrids instruments) representing interests in non-quoted companies.
This new law creates a private equity investment vehicle that:
• Is more flexible than existing regulated UCITS;
• Introduces flexibility to common company law;
• Benefits from an attractive tax regime;
• Is regulated by the CSSF; and
• Can be listed on the stock exchange.
Given the high level of flexibility attributed to the SICAR, it is targeted at qualified or informed investors.
These "informed" investors have been identified as "professional" investors and these other investors knowing the risks attached to and familiar with "Private Equity" business. Such a definition is wide enough to encompass all types of investors who can commonly be found in venture capital investments from specialized High Net Worth Individuals to traditional institutional investors.
Which investments for the SICAR?
While the definition of the Law is very broad when defining what asset classes qualify for eligible investments for the SICAR, the commentaries of the Law illustrate that the SICAR may invest directly or indirectly (i.e. through SPV's) in all categories of assets representing interest in a non-quoted company. Therefore, besides the traditional investments in private equity, it is possible that a SICAR be a Fund of (private equity) Fund, a Mezzanine Fund, a Buy Out Fund, etc.
Most importantly is that there is no legal investment restriction that applies to the SICAR where in other existing UCI's some risk spreading ratios needed to be complied with.
Which Investors for the SICAR?
The definition given by article 2 of the Law is sufficiently wide to ensure that none of the typical private equity investors will be ruled out of the SICAR. Eligible investors include institutional investors of the Law of 19 July 19911, and professional investors or informed investors as defined by the CESR2. This definition includes credit institutions, other professionals of the financial sector ("PFS"), insurance and reinsurance companies, pension funds, industrial and financial groups and the structures they put in place for the management of funds.
Further to professional investors, investors will be qualified as "informed" if they meet the following conditions: declare that they complied with the expertise and knowledge expected from a professional investor, and either invest a minimum of EUR 125.000; or, deliver a written confirmation by a PFS that they have the expertise and knowledge to apprehend investment in venture capital. This will be applicable for example within the frame of a discretionary management mandate.
The PFS giving such confirmation must be a credit institution or an investment company3 benefiting from an ISD passport. Management companies of UCITS, as defined and regulated by directive 2001/107/EEC, will also be eligible to provide such confirmation.
Regulated but flexible
Although there is now a new terminology in the Luxembourg funds lexicon, the law has not created a new legal form. SICARs will be set up in the forms of Public Company (Société Anonyme), Partnership Limited by Shares (Société en Commandite par Actions), Limited Liability Company (Société à responsabilité limitée), Cooperative incorporated as a public company (Société cooperative organisée en société anonyme) and as a Limited Partnership (Société en Commandite simple), all subject to the common rules of the law on commercial companies dated 10 August 1915.
These companies will be able to benefit from the variable capital rule, which gives flexibility to their redemption and dividend policy. This is a critical point for venture capital funds that must be able to redeem and distribute without constraints, as soon as the investments matured and/or are sold.
Also, motivated by the specificity of venture capital funds, there is no rule relating to the subscription mechanism, these will be disclosed in the by-laws. SICARs will be able to tailor their commitments and drawback mechanisms to their needs, which should make this point easier to deal with for promoters and lawyers.
The minimum capital is set at EUR 1 million and has to be reached within a 12 month period after incorporation; which should give enough time to the promoter to collect the seed money an potentially make their first investment. Also, an interesting feature is that the subscribed capital must only be paid in at a ratio of at least 5%.
Valuation of the assets
The valuation of the investments must be based on the foreseeable realization value of the assets estimated in good faith by the directors of the SICAR. The procedure of such a valuation method should be detailed in the by-laws. It is to be expected that by-laws will refer in general to valuation principles such as defined by professional associations such as the European Venture Capital Association (EVCA).
The SICAR is a regulated vehicle and as such it is placed under the supervision of the CSSF. The approval procedure is much lighter than for other UCI (requirements limited to submitting the incorporating documents, the name of the directors of the SICAR and the name of the custodian for approval). On this basis, the CSSF will not require the support of a promoter and will not need to approve the Investment Manager to whom the directors may have delegated the asset management. The motivation supporting this lighter approval process by the CSSF is that the investors in the SICAR will be qualified investors.
The SICAR must publish an offering circular containing the required information for the investor to form his view on the risk and rewards of the proposed scheme. On a yearly basis the SICAR must publish its annual account that must be audited by an independent auditor.
A tax efficient vehicle
The SICAR will benefit from an attractive Luxembourg tax regime. Contributions to a SICAR (as well as certain corporate restructurings of the company itself) will in principle be subject to a one-shot Euro 1.250 capital duty due upon incorporation.
A SICAR is not subject to any Luxembourg tax on the income derived from the holding or the disposal of securities and is also exempt from Luxembourg wealth tax. No annual subscription tax applies to a SICAR. No Luxembourg withholding tax will be levied on distributions to resident and non-resident investors. Also, income derived from the investment of its treasury is tax exempt, provided certain conditions are met.
Nevertheless, the SICAR is not per se a tax-exempt vehicle and might thus claim treaty protection (or application of the EC Directives).
Services related to the day-to-day management of the SICAR (including the management fees) will be exempt from Luxembourg VAT.
The tax efficiency of the SICAR, however, will also depend on the recognition of tax treatment applicable to this vehicle by the jurisdiction(s) of residence of the investors as well as in the jurisdiction(s) where the target companies are established.
The impact for Luxembourg custodians
The SICAR must appoint a custodian for the safekeeping of its assets. As is the case for other Luxembourg UCIs, the custodian needs to be a bank or a credit institution as defined in the law 5 April 19934.
In addition to the safekeeping duty, the custodian of a SICAR must:
- ensure that the subscription price has been paid according to the prospectus,
- control that when assets are bought or sold, a counterpart has been effectively delivered,
- ensure the correct allocation of the income derived from the underlying assets.
The role of the custodian will be somewhat different from its role for other UCI's. Indeed, safekeeping assets representing interests in non-quoted companies located in different countries is different from safekeeping listed shares or bonds.
Similarly, the follow-up of the investment activity of the SICAR will require the custodian to dedicate specialist teams to service these vehicles.
The custodian is not responsible for controlling the compliance of the investment decisions with the investment policy of the SICAR.
The SICAR could potentially become the vehicle of choice for professional investors and compete against vehicles such as the UK or Jersey Limited Partnerships and Delaware Partnerships both on the tax (i.e., no taxation at SICAR level and investor level from income on securities investments) and structuring side, which allow maximum flexibility. The SICAR seeks to allow the same flexibility but within a regulated vehicle and emphasis has been put on both the supervision of the SICAR by the CSSF and the appointment of a custodian bank.
This should contribute to create a quality-label for the SICAR that is today of paramount importance to certain investors.
1Law concerning undertakings for collective investment, the securities of which are not intended to be placed with the public and CSSF Guidance note relating to the same law.
2 recommendations note issued by the Committee of European Securities Regulators ("CESR") in November 1999 relating to "The implementation of article 11 of the ISD: categorization of the investors for the purpose of conduct of business rules".
3 Companies following rules of conduct of article 11 of ISD 93/22/EEC of 10 May 1993 relating to investment services in transferable securities.
4 Law of 5 April 1993 relating to the supervision of the financial sector.
This brief was prepared by the Luxembourg office of PricewaterhouseCoopers. For further details please contact Laurent de La Mettrie at [email protected]