Private Equity Laws and Regulations Spain 2023-2024

1.1        What are the most common types of private equity transactions in your jurisdiction? What is the current state of the market for these transactions?

According to the Spanish Venture Capital & Private Equity Association (Asociación Española de Capital, Crecimiento e Inversión), (“SpainCap”), the Spanish Private Equity (“PE”) industry grew substantially in 2022.  In 2021, Spanish PE reached its second-best record of all times in terms of investment volume.  In 2022, investment continued to grow, remaining behind only the figures recorded in 2019.  Nine hundred and thirty-five transactions were reported, and companies received EUR 8.7 billion in equity, which represents a significant increase compared to 2021 (EUR 7.5 billion).  Middle-market transactions (between EUR 10 million and EUR 100 million) also marked a new record high for the fourth year in a row in terms of number of transactions (108) and in terms of investment volume (EUR 2.8 billion), representing an 18% increase over 2021.  The increase in large transactions (over EUR 100 million per transaction) where international PE funds have their sweet spot, together with an exceptional investment level in start-ups in mature stages, are some of the main reasons for such improvement.  With a total of 15 investments, high-end transactions were significantly relevant, accounting for more than half of the total volume invested.  Spanish investors, mainly family offices, also played a relevant role in 2022, with an increase of 15% in terms of investment volume (EUR 1.5 billion, compared to EUR 1.3 billion in 2021) with an increase in transactions from 554 in 2021 to 570 in 2022.

The most active sectors in terms of PE investment in 2022 were IT (24.5%), followed by industrial products and services (14%) and, closely, hospitality/leisure (13%).

In contrast, in 2022 there was a drop in fundraising from domestic private investors, showing a 36% decrease versus 2021.

1.2        What are the most significant factors currently encouraging or inhibiting private equity transactions in your jurisdiction?

Increased visibility of economic recovery in 2022, partly driven by the definitive overcoming of the COVID-19 crisis and the available liquidity, led to a strong reactivation of investments through 2022.  Unfortunately, 2022’s optimism was corrected based on the new geopolitical framework that began in the first quarter of 2022 and the corresponding effects on inflation and increase in interest rates.  Current uncertainty affects PE and all M&A markets across all industries, which may return to a situation in which a special focus will need to be made to portfolio companies, and such uncertainty and high interest rates will most likely reduce the number and volume of PE transactions in 2023.  However, the results for 2022 show that the geopolitical environment did not affect the number and volume of transactions ongoing, quite the contrary.

Likewise, following an extraordinary year in 2022, in which confidence in the economic recovery drove to a significant increase in activity, several factors will most probably have an adverse effect on the PE transactional market in 2023: (i) the costs in the investee portfolio have increased significantly in 2022 and are far from being corrected; (ii) penalties will certainly be imposed on valuations because of current general market uncertainty; (iii) PE funds’ average waiting times for divestitures will again increase; and (iv) interest rates will increase.

From a strictly legal standpoint, and as in most European Union Member States, the restrictions and control over essential freedoms, such as the freedom of movement of capitals and the limitations on foreign investments imposed in Spain will continue to substantially impact the way and timing of closing transactions.  Pursuant to this: (1) certain investments from foreign-controlled PE funds; and (2) exit strategies to certain third-party acquirers may need to complete a prior authorisation process.  To respond to the COVID-19 situation, the Spanish Government passed a new regulation, which suspended the general deregulation approach Spain enjoyed.  Since 2020, certain “Foreign Direct Investments” (“FDI”) made: (a) in specific “Strategic Sectors” of the Spanish economy affecting the national security, public policy and public health; and (b) by certain foreign investors that meet certain subjective conditions, as further explained in question 4.1 below, may require the prior authorisation of the Spanish Council of Ministers.

1.3        Are you seeing any types of investors other than traditional private equity firms executing private equity-style transactions in your jurisdiction? If so, please explain which investors, and briefly identify any significant points of difference between the deal terms offered, or approach taken, by this type of investor and that of traditional private equity firms.

Without yet representing a consistent trend, family offices or structures managing the capital of third parties as well as other funds, which in the past focused more on mezzanine financing or opportunistic transactions, are now engaging more in traditional PE style transactions.

Some large industrial companies with liquidity are investing in companies that develop new technologies linked to their core business.  Some differences between those kinds of transactions and traditional PE deals are: (i) more flexibility in the exit horizon; (ii) the investment is sometimes driven by the access to the information and/or technology, instead of pure financial return; and (iii) more difficulties in terms of corporate governance, remuneration/ratchets of the management team and willingness to retain access to the developed technology after exit.

2.1        What are the most common acquisition structures adopted for private equity transactions in your jurisdiction?

The most common structures are: (i) acquisition of companies in which a part of the purchase price is financed either by financial entities or through vendor loans (leveraged buyouts, or “LBOs”); (ii) financing of the growth of companies that are certainly consolidated or already have profits; (iii) replacement of part of the current shareholding structure (typically for family businesses and in succession situations); and (iv) investment for the restructuring or turnaround of certain troubled companies.

Transactions may be executed by regulated funds (“entidades de capital riesgo”) through direct investment in the target companies or through holding vehicles (“BidCos”) – the acquiring entities – whose shareholders are the PE funds, jointly with its shareholders and the fund management team, when applicable.  A BidCo structure is more commonly used to channel acquisition financing, in part to avoid financial assistance restrictions and to benefit – when financing is needed – from the ability to collateralise target group’s shares and assets.

Transaction structures for foreign PE investments focus, in general, on certain tax aspects (mainly the acquisition structure, its financing and the tax treatment of dividends and capital gains at the exit).  International PE companies sometimes channel the investment through Spanish companies subject to the ETVE regime (“entidad tenedora de valores extranjeros”) to invest in most Latin American countries, considering the wide net of the bilateral Double Tax Treaties signed by Spain and Latin American countries.  Alternatively, subject to the tax residency of the investors, another frequently used structure consists of the incorporation of a vehicle in the European Union on top of the Spanish target, which are commonly incorporated in Luxembourg or the Netherlands (provided that valid economic reasons and sufficient substance following OECD’s BEPS regulations are met).

2.2        What are the main drivers for these acquisition structures?

The main drivers for PE transactions essentially relate to: (i) financial considerations and the ability to grant sufficient warranties to the financial entities; and (ii) tax reasons, not only looking for tax-efficiencies but also due to the requirements imposed by the country of origin or by Spanish tax regulations for tax deductibility.

Other drivers are: (a) the expected returns for the investor; (b) the role and incentives of the management team and PE sponsors; (c) the economic and operational costs related to the post-closing restructuring of the company; and (d) the rules and costs of exit.

In relation to driver (c) mentioned above, special attention is usually paid to minimise the costs arising as a consequence of the acquisition, organising the group existing after the acquisition for the taxation to be as efficient as possible (which usually requires tax consolidation), and taking into account the rules and costs that might apply upon exit.

2.3        How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)?

As described above, PE transactions can be executed directly in the target company or channelled through BidCos.

The equity investment of the management team is often financed (partially) through loans that can be provided by PE sponsors and are repayable as management bonus compensation, or even at exit.  This financing could also be provided by the target company, if not restricted by financial assistance provisions under Spanish or other applicable laws.  It is also customary that management invests only in equity, whilst the PE sponsor provides both equity (common shares) and subordinated financing (through profit participating loans or preferred shares).

However, the management team – other than the top manager(s) of the target – is not always required to invest in equity, but is, on many occasions, provided with sweet equity or a ratchet that vests upon exit, provided that a minimum internal rate of return (“IRR”) is obtained and/or certain investment multiples are achieved.  The usual thresholds would be an IRR of 18–20% and return multiples in the range of 2× to 3.5× (with intermediate levels vesting a portion of the marginal gain obtained at exit).  The managers’ rights under the ratchet arrangements are usually vested throughout agreed vesting periods (typically four to five years) and subject to good-leaver (as further explained in questions 2.5 and 2.6 below) and bad-leaver events.  Carried interests paid to managers typically include a hurdle rate or cumulative compounded rate of return (usually 8% p.a.) once all the capital invested is distributed to all investors pro rata to their respective investments.  Thereafter, a full catch-up is usually distributed to management until they recover the amounts not received up until that moment, and then the amounts are distributed equally to both investors and management, pro rata, until that distributed to investors equals around 20–25% and/or a certain multiple of aggregate capital invested by them.  From that moment onwards, there has been a split of all distributions, in which amounts received by management are substantially higher than would correspond to them according to their investment.

2.4        If a private equity investor is taking a minority position, are there different structuring considerations?

Majority or minority positions do not usually affect the investment structuring unless they entail “control”, as such term is defined in the Spanish Competition Laws.

In Spain, PE funds usually acquire majority stakes, unless their investment policies require otherwise or they agree to hold non-controlling positions alone or in combination with other partners; either other strategic investors, PE sponsors, or founding families.  In such cases where the PE sponsor will have limited control or influence over the management of the portfolio company and probably a reduced market to sell the shares and realise the investment, the negotiation of the shareholders’ agreement becomes a key aspect of the transaction.  The PE sponsor will usually focus on ensuring that adequate protections of its investment are put in place, such as corporate governance arrangements (e.g., veto rights and/or reinforced majorities for certain matters, a seat at the managing body, etc.), exit provisions (tag-along rights, put options against majority shareholders upon certain milestones, etc.) and key management retention schemes.

2.5        In relation to management equity, what is the typical range of equity allocated to the management, and what are the typical vesting and compulsory acquisition provisions?

Management teams usually take 5–10% of the share capital of BidCos or 15–20% in secondary PE deals.

Vesting provisions for ratchets and other incentives may be structured, depending on the relevant PE sponsor, based upon: (i) the time elapsed from the investment or commencement of the relationship of the manager with the company to the time of the departure of the relevant manager; and (ii) the time from the termination of the manager’s relationship with the target and the exit.

In this regard, good-leaver and bad-leaver provisions (see question 2.6 below) play an important role in management incentives, as they encourage the management team to remain in the company and to properly carry out its duties.  These provisions allow the sponsor (and usually also the other shareholders) and/or, subsidiarily the company, to purchase the equity that a manager leaving the company held at a pre-agreed purchase price.  Share transfer conditions usually vary depending on whether it is a good-leaver (where the shares’ price is commonly the market price, or it is sometimes allowed that the leaving manager keeps the shares) or bad-leaver situation.  Outstanding financing at the moment of exit initially granted to the managers for the acquisition of their stake is commonly compensated with the shares’ price and any other compensation that the manager might be entitled to as a result of the exit.

Call options may also be granted to ensure effectiveness of the transfer obligation, which, on some occasions, are reinforced with irrevocable powers of attorney granted by the managers in favour of the PE sponsor (or the representative of the other shareholders, as applicable).  Put options in favour of the managers are sometimes contemplated, but PE sponsors generally try to avoid them.

2.6        For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your jurisdiction?

“Good leaver” usually refers to the cessation of a management equity holder for a reason they cannot control, such as: (i) death; (ii) retirement; (iii) permanent illness or physical disability that renders them incapable of continued employment in their current position; and (iv) voluntary non-justified termination by the company.

“Bad leaver” situations include, amongst others: (i) disciplinary dismissal based on misbehaviour in the workplace; (ii) being found guilty by a court of a criminal offence jeopardising the company; (iii) voluntary resignation of the management equity holder (except if as a “good leaver”); and (iv) termination by the company with fair cause based on a material breach of which they are liable.

Good leavers may be granted the right to keep their shares of the company and certain vested rights under the ratchet, if applicable.  Bad leavers, however, are usually forced to transfer their shares, which are distributed proportionally amongst the remaining equity holders or by the company.

It may also be the case that both good and bad leavers may be obliged to transfer their shares.  Thereupon, it is common to include a clause in the by-laws that states the sale price of the good leaver’s shares shall be the greater amount between the acquisition cost and the market value of such shares.  Conversely, in a bad-leaver situation, the sale price of the manager’s shares is the lower amount between the market value and the acquisition cost.

3.1        What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction?

PE investors usually have the right to appoint members of the managing body of their portfolio companies, even when their representation in such body is higher than in the share capital.  They control the decision-making process and are involved with the company’s business and day-to-day operations.  However, in cases where the PE investor holds a minority stake or for any other reason is not allowed to appoint a director, PE investors usually reserve the right to appoint an observer, who can participate in the managing body’s meetings without voting rights.

PE investors can usually impose super-majority voting requirements for the passing of certain key decisions of the company, both in general shareholders’ meetings and managing body’s meetings, as well as impose to the company and managers to provide information to shareholders that might not otherwise be entitled by law.

The most common type of managing body is a board of directors.  In this regard, the composition of the board is public as the appointment of directors shall be registered at the Mercantile Register.  Agreed super-majorities and veto rights are usually reflected in the by-laws and, as such, registered and public.  Incorporation in the by-laws and registration grants more certainty on enforceability of such provisions.  In any case, shareholders’ agreements, which are usually private and confidential documents, also include these provisions, as well as any other governance matters, such as the structure and role of the management group, the limitation to the powers of attorney of some directors and managers, etc.  Additionally, shareholders’ agreements often contain rules of preference between their provisions and the by-laws, granting priority to the former in cases of contradictions or inaccuracies.

3.2        Do private equity investors and/or their director nominees typically enjoy veto rights over major corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy?

PE investors with a majority stake may have influence over the decisions (as they are entitled to appoint the majority or a wide number of members of the board), except over those decisions subject to veto rights for minority shareholders.  When a minority stake is held and the PE investor does not have enough director nominees representing its interests, veto rights and reinforced majorities are usually negotiated and granted in their favour, generally in respect of increases/reductions of capital, mergers, spin-offs, liquidation, engagement in new activities, relevant acquisition and disposals, capex above a certain threshold, level of indebtedness, related party transactions, approval of the business plan, etc.

Veto rights and reinforced majorities not only apply to decisions to be adopted in board of directors’ meetings but also in general shareholders’ meetings.  These provisions are usually included in the by-laws of the company and/or in the corresponding shareholders’ agreements, with the rules of preference mentioned in question 3.1 above.

3.3        Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed?

The Spanish Capital Companies Act (“LSC”) sets forth some binding minimum and maximum majorities to vote on certain matters (such as the removal of directors, amendment of the company’s by-laws or corporate restructurings, to name a few) or on some matters restricting the rights of certain shareholders with the express consent of the affected shareholder.  These limitations can be modified or agreed differently between the parties in the shareholders’ agreement but may not be included in the by-laws of the company or registered and, therefore, they become private agreements amongst the shareholders enforceable amongst them but not against any third parties.

Likewise, the requirement of the unanimous favourable vote for the adoption of certain matters at the board of directors’ level can be included in the shareholders’ agreement but not in the by-laws, as such provisions are rendered void and, therefore, not enforceable with third parties.  If the parties want to include this unanimous favourable vote, it is accepted to set a high majority, which only can be achieved if all the members vote in favour.

3.4        Are there any duties owed by a private equity investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed?

PE investors have no specific duties towards minority shareholders, unless voluntarily assumed by the PE investor.  Nonetheless, pursuant to the LSC, resolutions of the company may be challenged when they are contrary to the Law, the by-laws or the company’s meeting regulation, or may damage the interest of the company to the benefit of one or more shareholders or third parties.  Also, directors shall refrain from voting in respect of resolutions where they may incur in a conflict of interest.

Damage to the interest of the company also occurs when the resolution, although not causing damage to the company’s assets, is imposed in an abusive manner by the majority (that is, when, without being in response to a reasonable need of the company, it is adopted by the majority in its own interest to the unjustified detriment of the other shareholders).

3.5        Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?

As mentioned in question 3.3 above, shareholders’ agreements are private and only enforceable against the parties who have signed them, while by-laws and other corporate documents are public and thus enforceable against not only the company and its shareholders but also against third parties.

There are no limitations or restrictions on the contents of shareholders’ agreements other than the observance of law.  In Spanish PE deals, the parties usually agree to subject the shareholders’ agreement to Spanish law and to submit any disputes to arbitration, to ensure confidentiality and a fast process as opposed to slower, public Spanish courts.  It is also common to incorporate them into public deed in order to ensure enforceability between the signing parties.

3.6        Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards of portfolio companies?

A PE investor should be aware of the fiduciary duties it may have as director or as member of the board of directors, or those of its appointed directors.  Directors may not be subject to any ground of prohibition or incompatibility to discharge their office and, in particular, to any of those established in the Law 3/2015, of March 30, 2015 and other related legislation or any statutory prohibition and, in particular, those established in the LSC.

Directors’ duties are, among others, diligence, loyalty, avoiding conflict of interest situations and secrecy.  Directors are held personally accountable for any damage caused by their acts performed without diligence or against the law or the company’s by-laws.  Directors are liable to the company, its shareholders and the creditors of the company for any damage they may cause through acts (or omissions) contrary to the law or the by-laws or carried out in violation of the duties inherent to their office, provided that there has been intentional misconduct or negligence.

Additionally, it is also important to consider that these duties of directors and the related liability resulting from a breach of these duties are also extended to those persons or entities acting as “shadow” directors or “de facto” directors.  This is the main risk applicable to PE investors that nominate directors to boards of portfolio companies.

Most directors of PE-invested companies in Spain usually contract D&O insurance to cover their civil liability to a certain extent.

3.7        How do directors nominated by private equity investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies?

Directors must refrain from discussing and voting on resolutions or passing decisions in which the director or a related person may have a direct or indirect conflict of interest.  Excluded from the foregoing prohibition are the resolutions or decisions that affect the director in its condition as such, such as the director’s appointment or removal from positions on the administration body or others similar.

In any event, directors have the duty to adopt the necessary measures to avoid situations in which their personal interests, or those on behalf of others, can conflict with the company’s interests and their duties to it.  Therefore, directors must also refrain from, among others, engaging in activities on their own behalf or on behalf of others that involve effective competition (whether actual or potential) with the company or that in any other way place it in permanent conflict with the interests of the company.  Notwithstanding the above, the LSC allows, in certain cases, the general meeting of shareholders to exempt directors from the prohibition to compete with the company or to exempt them from the duty of loyalty for singular and extraordinary situations.

4.1        What are the major issues impacting the timetable for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval requirements, disclosure obligations and financing issues?

In general terms, PE transactions do not usually require prior authorisation, except for those undertaken in regulated sectors such as, but not limited to, gaming, financing, telecom, public concessions, energy, air transport, sports, media sectors and tour operators.  Authorisations can be at the European Union, national or local levels depending on the applicable regulation.

In addition, as explained above, the new article 7-bis of Spanish Law 19/2003, of July 4, subjects FDI in strategic sectors (critical physical or virtual infrastructures, critical technology and dual-use items, essential commodities, in particular, energy, sectors with access to sensitive data and media), made by residents (or which beneficial owner is resident) of countries outside the European Union and the EFTA, to prior administrative authorisation by the Spanish Government (Council of Ministers) if, as a consequence of such investments, the investor holds a stake equal to or greater than 10% of the capital stock of the Spanish company or effectively participates in the management of the Spanish company or in its control.

As of March 18, 2020, FDI is also restricted (and may be subject to prior authorisation) to foreign investors that are directly or indirectly controlled by a third-country government (including public agencies, the military or armed forces), amongst others.  This subjective condition may impact sovereign wealth and certain pension funds and other institutional investors who are natural investors in PE funds.

Finally, authorisations are also required for those acquisitions that result in a business concentration that exceeds certain antitrust thresholds (supervised by both Spanish and European Union competition authorities).

These restrictions were originally introduced in the framework of the COVID-19 crisis, but with the new Royal Decree 571/2023 of July 4, 2023, the Spanish government has shown its intention to continue with these policies.  The new Royal Decree establishes the types of foreign companies and operations that do or do not need to request an investment authorisation from the administration, which improves the predictability of the rule and a series of exemptions to the prior authorisation regime are established.  Among other measures, administrative deadlines for foreign investors are also improved and shortened.  In this regard, the resolution period is reduced from the current six months to three months.  In addition, the possibility of voluntary consultation, binding on the administration and with a response period of 30 working days, is provided for.

4.2        Have there been any discernible trends in transaction terms over recent years?

In recent years, auctions and initial public offerings (“IPOs”) have gained special prominence with respect to bilateral transactions.  Recent trends include the increasing use of locked-box and earn-out structures in lieu of post-closing adjustments of the purchase price, and vendors’ loans replacing (on occasion) financial entities financing, as well as the use of representations and warranties insurance.

5.1        What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with?

Spanish takeover regulations establish that PE investors shall detail the full control chain of the funds into the takeover prospectus and that all documentation must be submitted in Spanish as it will be addressed to all potential or actual shareholders.

5.2        What deal protections are available to private equity investors in your jurisdiction in relation to public acquisitions?

PE investors are usually requested to accept break-up fees when entering into auctions or competitive bids.  However, these fees do not usually exceed 1% of the total transaction costs.  The board of directors of the target company must have approved such fee, a favourable report by the target’s financial advisors must be submitted, and the terms and conditions of the break-up fee must be described in the takeover prospectus.

6.1        What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction?

Irrespective of the transaction side, PE investors usually prefer locked-box structures due to the certainty they provide (as there are no adjustments) and the simplicity and cost-efficiency in setting the price (using the latest approved financial statements).  In this regard, for proper buyer protection under this structure, the seller will have to warrant the non-existence of undisclosed leakage in the financial statements until the closing date, and respect the strict, ordinary course of business provisions from the reference date of the financial statements until the closing date.

Earn-out structures are still used, enabling the buyer to maximise the price if the seller keeps control over the company’s management and allow the buyer to reduce overpayment risks.  Most of the time, earn-outs are conflictive and easily lead to arbitration/litigation.

6.2        What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) the management team to a buyer? 

PE sellers commonly have to offer a set of representations about the target company and the shares, although the scope and time are limited.  Escrow deposits are still the most common warranty granted by PE sellers, in which a percentage of the purchase price is deposited in a bank account for a period of time and partial releases can be agreed.  Escrow deposits are used much more frequently than price retentions, set-offs or on-demand bank guarantees.  Management team members do not usually offer representations to the buyer, except for those that might correspond to them as selling shareholders in proportion to their stake.

6.3        What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer? 

Covenants, undertakings and indemnities are avoided as much as possible by PE sellers.  The most typically requested and controversial covenant is non-compete, which is usually provided by the management team but generally not by the PE seller.

6.4        To what extent is representation & warranty insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such insurance policies, and what is the typical cost of such insurance?

The use of representations and warranties insurance is significantly increasing in Spain, particularly in auctions or competitive bid acquisition processes, and affects both PE and regular M&A.

Any parameter of the insurance policies is determined by each insurance company considering the coverage needed, the characteristics of the transaction and the target company.  However, to provide an estimated average of the market, the policy limit ranges between 10% and 20% of the target’s enterprise value, the deductible is fixed between 0.5% and 1% and the recovery policy period is generally seven years.

Insurance premiums vary depending on the target company, the insurer’s associated costs, the coverage requested and the timing of the transaction among other factors, but usually range between 0.5% and 2% of the policy limit.

6.5        What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings?

PE sellers usually cap their liability at a percentage of the price (between 5% and 20%) and for a period of up to two years from closing, except for matters such as tax, labour, social security, personal data protection or environmental matters, which are usually subject to their relevant statutory limitation periods (e.g., four to five years).

Warranties are usually provided for specifically identified potential and relevant liabilities or to cover any potential damages arising from the breach of the representations and warranties or any covenant agreed in the share and purchase agreement.  The extension of the definition of damages is also negotiated and limited to the item provided for in the Spanish Civil Code.

6.6        Do (i) private equity sellers provide security (e.g., escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)?

As mentioned, escrow accounts are the most common warranties granted by PE sellers.  These warranties are usually requested by buyers to cover certain potential liabilities and ensure retention and faster access to the seller’s money, although they are monetarily limited to a percentage of the purchase price, limited to a period of time, and partial releases of the amount deposited are usually agreed between the parties.

Warranties in PE transactions are rarely granted, except where the management team are also selling shareholders.

6.7        How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the buyer (e.g., equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)?

In Spain, the most common scenario is the buyer providing the seller with an equity commitment letter, which sets forth the availability of debt and/or equity finance.  Staple financing or a pre- arranged financing package offered to potential bidders for an acquisition and arranged by an investment bank is not yet common.

Where equity finance is required, the commitment letter is usually provided by the PE funds controlling the companies.  Where debt financing is required, such letters (usually of a soft nature) are issued by financial entities, although they are, in general, subject to the fulfilment of certain conditions: confirmatory due diligence; final agreement on contractual terms and conditions; and no material adverse change occurrence.

In the absence of compliance by the buying entity, sellers have the right to request specific performance of obligations under the commitment letter and/or to be indemnified for the damages caused.  However, due to the soft nature of the letters and since they are commonly subject to certain conditions precedent, it may be difficult to obtain their enforcement.  As a consequence, the reputational risk of non-performing PE funds is also valued by sellers when considering assuming such risk.

6.8        Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical?

Reverse break fees are relatively unusual in PE transactions in Spain because they are difficult to negotiate and enforce in case of breach.  Notwithstanding the above, article 42.4 of the Royal Decree 1066/2007 of July 27, 2007 expressly allows a target to grant a break fee to an initial bidder (although not to any subsequent bidder) as compensation for the bidder’s expenses in preparation of the offer.  The break fee is payable if a competing bid is launched and, as a result, the initial bid does not succeed.  In addition, the break fee to be paid by the target is subject to four conditions: (i) its amount must not be greater than 1% of the total value of the bid; (ii) it must be approved by the target’s board of directors; (iii) the target’s financial adviser must provide a report in favour of the fee; and (iv) it must be disclosed in the offer document.

7.1        What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit?

No particular features and/or challenges shall concern PE sellers in considering an IPO exit, further than those applicable by law to any other seller.

7.2        What customary lock-ups would be imposed on private equity sellers on an IPO exit?

Lock-ups are imposed for 180 days, with a possibility of being increased up to 360 days depending on the participation that the PE investor might still have remaining in the target company after the IPO exit.

7.3        Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO?

Dual-track exit processes are not implemented in all transactions but can be seen, particularly, in large deals and when the IPO market is favourable.

PE sellers can continue to run the dual-track exit process until pricing, but it usually depends on the particularities of each transaction.  In Spain, both sales and IPOs have turned out to be successful, so both structures have the same possibilities to be ultimately realised.

Stock exchange markets’ instability and geopolitical environment may have a material impact on the use of dual-track transaction structures in 2023 and beyond as price optimisation may advise those following both tracks.

8.1        Please outline the most common sources of debt finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (including the syndicated loan market, private credit market and the high-yield bond market).

The most common source of debt is bank financing.  However, alternative financing tools have arisen, especially since the last global crisis where banks were not providing liquidity enough, such as in direct lending (vendor’s loans or direct financing at the target company) and financing obtained from some mezzanine debt funds.

The combination of both banking financing and alternative financing has proved interesting since it allows for far more complex and flexible structures, with higher returns.  This is typically applied in hybrid structures where debt funds not only provide equity but also debt.

Despite the high dependence on financing from traditional banks, the trend for Spanish corporates is to actively source alternative financing.  This trend has been reinforced in post-COVID-19 transactions and in the present geopolitical framework, which has raised the rate interests and the finance associated costs.

Regarding syndicated loan structures, rising interest rates have increased their funding costs and the pricing differential between private debt players and banks has narrowed.  Private debt funds, which hold loans on their balance sheets, can also close deals faster than banks.

8.2        Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions?

Financial assistance (that is, to advance funds, extend credits or loans, grant security, or provide financial assistance for the acquisition of its own quotas or shares) is the main legal restriction under the LSC.

Additionally, there are some tax limitations imposed to tax deductibility of interests (as further explained in section 10 below).

8.3        What recent trends have there been in the debt-financing market in your jurisdiction?

Despite the fact that, in past years, financial entities and banks were offering high liquidity and lower interest rates in the Spanish market, driven by a macroeconomic positive environment and a record of PE transactions, a significant increase in direct lending from funds has been observed.  Thus, both bank financing and direct lending have co-existed providing investors and companies with a diversified menu of debt structures.  Nevertheless, the perceived increasing economic uncertainty (e.g., rising inflation, the economic effects of the Ukraine war, rising interest rates and the associated regulatory developments intending to mitigate them) slowed down debt-financing activity during the last quarter of 2022.

9.1        How prevalent is the use of continuation fund vehicles or GP-led secondary transactions as a deal type in your jurisdiction?

The PE secondary market has grown and become significantly sophisticated.  The use of continuation fund vehicles aims, on the one hand, to provide liquidity to existing investors and, on the other hand, to extend the holding period of assets, which, with more time and capital, can generate attractive additional returns.  The rise and growth of the secondary market is also explained by its flexible liquidity solutions that allow for the renewal or replacement of part of the investor base.

In this regard, it is expected that over the next few years that the presence of this type of transaction will increase due to the advantages it brings to certain PE investors.  In any case, the future evolution and consolidation of the secondary market in Spain will depend, to a large extent, on the ability of portfolio companies to maintain growth.

9.2        Are there any particular legal requirements or restrictions impacting their use?

At a Spanish level, for the time being, there are no different restrictions or legal requirements defined for this type of transaction (beyond the regulations explained above applicable to all PE transactions).  However, this is an issue that may change in the coming years, as in jurisdictions such as the U.S., where the Securities Exchange Commission (“SEC”) has already expressed its willingness to focus on this type of transactions and regulate certain matters associated with them.

10.1      What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common?

Unless the investor is resident in a tax haven, income obtained by non-resident investors in Spanish PE-regulated vehicles (both dividends and capital gains derived from the transfer of shares in the Spanish PE) is not usually subject to taxation in Spain.

Subject to the investor tax residency, interest income obtained by non-resident investors could be subject to Withholding Tax (except if the lender is the beneficial owner of the interest and they are a European Union resident).  Other types of vehicles require careful analysis to facilitate efficient cash-back channels to investors.

Off-shore structures are also common in Spanish PE deals for international Funds.  However, it is important to undertake a particular analysis of certain tax issues like the tax deductibility of the interest expense incurred by the Spanish entity acquiring the target and the option for the tax consolidation regime.  A 95% participation exemption regime (a 100% participation exemption until 2020) also applies to domestic investments when the shareholding in the target is higher than 5%, that is, dividends obtained by Spanish entities from Spanish subsidiaries are 95%-exempt from Corporate Income Tax (“CIT”).  Likewise, capital gains obtained by Spanish entities from the transfer of Spanish subsidiaries are also entitled to the 95% exemption to the extent that certain requirements are met.

The standard CIT rate is 25%, so the 95% participation exemption leads to an effective 1.25% (25% × 5%) taxation on qualifying dividends and capital gains.

10.2      What are the key tax-efficient arrangements that are typically considered by management teams in private equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)?

It is common practice for the management team to receive incentive packages based on risk-sharing principles and the maximisation of value at exit.  Considering tax-efficiency reasons, management teams usually focus their attention on: (i) sweet equity or ratchets; (ii) payments of deferred bonus (which may enjoy certain reductions for tax purposes if generated over more than two years); or (iii) stock appreciation or similar rights (“SAR”).  

If the management team also holds a minority stake in share capital of the target company, capital gains upon exit would be generated in the same way as the financial investors and would be subject to a maximum 28% Personal Income Tax general rate (depending on the Autonomous Community), which is lower than the taxation of the income received as employment remuneration (which, depending on the Autonomous Community, may reach a 50% marginal rate).  Likewise, ratchet payments upon exit up to EUR 300,000 may benefit from a 30% tax reduction provided for gains accrued in periods longer than two years.

Nevertheless, there is a certain discussion about the taxation of these instruments and their risk of re-classification, due to the wide definition of “salary” or “work-related income” for tax purposes, and the already existing anti-avoidance rules (e.g., any assets, including securities or derivatives, acquired by an employee below market price are deemed to be “salary” from a Personal Income Tax point of view).  

Starting to apply on January 1, 2023, new personal income tax rules have been introduced regulating taxation of the on carried interest.  Previously, only the territories of the Basque Country and Navarra had rules on this topic. 

The new rules apply to income obtained from the successful management of PE entities: (a) closed-ended alternative investment funds, as defined in Directive 2011/61/EU, falling into any of the following categories (i) PE entities as defined in article 3 of Law 22/2014 of November 12, 2014, (ii) European venture capital funds, (iii) European social entrepreneurship funds, and (iv) European long-term investment funds; and (b) other similar investment schemes to those mentioned.

The specific provisions are as follows: (a) carried interest is defined expressly in the law as salary income; (b) a 50% portion of this income will be included without applying any exemption or reduction whatsoever, provided the following requirements are fulfilled (i) the economic rights will have to be conditional on the other investors at the entity obtaining a minimum level of profitability defined in the entity’s regulations or bylaws, and (ii) the shares or rights must be held for at least five years, unless a transfer following death occurs, or they are liquidated earlier or become null and void due to a change of management entity.

This last requirement will be laid down, as applicable, for the entities owning the shares or rights.

This tax treatment will not be applicable where the special economic rights come directly or indirectly from an entity resident in a country or territory considered as a non-cooperative jurisdiction or with which there is legislation on mutual assistance regarding the exchange of tax information.

10.3      What are the key tax considerations for management teams that are selling and/or rolling over part of their investment into a new acquisition structure?

As mentioned in question 10.2 above, capital gains at exit are generally subject to Personal Income Tax at a 28% maximum marginal tax rate (depending on the Autonomous Community).

The main tax consideration in the reinvestment of part of the management team’s investment into a new acquisition structure is that the exchange of shares is qualified as tax-neutral.  However, recent tax audits and court resolutions have denied the application of the tax neutrality regime to exchanges of shares in certain cases (e.g., when “coexisting” an exchange of shares and a transfer of shares, under certain conditions).  To apply for the tax neutrality regime in share-for-share exchanges, the issuer of the new shares (i) should hold more than 50% of the share capital in the target company as a result of the shares’ exchange, and (ii) cannot pay more than 10% in cash.

10.4      Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any anticipated?

The last legal reform operated in the tax area with a significant impact in the PE industry and structures was carried out in 2014, with effect as of January 1, 2015 (mainly due to the amendments on interest deductibility – specific limits for LBO transactions – and tax consolidation).  As explained in question 10.2 above, Spain has enacted certain regulations on carried interest (previously, only the territories of the Basque Country and Navarra had specific regulations on this topic).  In 2020, a reform, effective as of January 1, 2021 has brought certain additional tax reforms that may have an impact on the traditional PE structures, such as the reduction to 95% of the participation exemption on dividends and capital gains. 

As to the approach of the tax authorities, interest deduction in PE structures has been the main area of discussion over the last few years (especially in intra-group indebtedness), together with the remuneration of the management team (see question 10.2 above) and the analysis of the rationale and substance of structures as a whole (following OECD/BEPS approach).  This has been reinforced with the implementation into Spanish regulations of the provisions of ATAD 2 Directive, covering all types of hybrid situations and hybrid mismatches.  

Tax rulings aimed at providing legal security to particular situations or transactions may be more difficult to obtain, as the Directorate General of Taxes is focusing on the technical interpretation of the rules, rather than on its application to particular transactions.  

Furthermore, there is recent ECJ case-law (known as the Danish cases) and domestic case-law, where the Danish cases have already been transferred to the Spanish context, which refers to the “beneficial ownership” clause as an autonomous anti-abuse provision, potentially leading to the denial of the benefits of the European Union Directives in terms of exemption on withholding taxes on dividends and interest paid to European Union residents.

11.1      Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any anticipated?

The regulatory framework for PE investors has remained stable since the Spanish Law 22/2014 on regulated PE vehicles and close-ended collective investment (the “PE Law”) transposed the AIFM directive for Spanish PE vehicles.  Since then, the PE Law has granted a stable regulatory framework for PE vehicles.

11.2      Are private equity investors or particular transactions subject to enhanced regulatory scrutiny in your jurisdiction (e.g., on national security grounds)?

PE transactions are not subject to any prior authorisation unless, as stated in question 4.1 above, the company is engaged in a regulated sector, the transaction results in a concentration of companies that exceeds certain antitrust thresholds, or the transaction requires prior FDI authorisation.

Further, any foreign investments or divestments in Spanish companies (no matter who the final foreign investor is) must, however, be communicated to Spanish authorities once executed, for statistical purposes only.

11.3      Are impact investments subject to any additional legal or regulatory requirements?

Impact investments are not subject to any additional requirements unless, as stated in question 4.1 above, the company is engaged in a regulated sector, the transaction results in a concentration of companies that exceeds certain antitrust thresholds, or the transaction requires prior FDI authorisation.

11.4      How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g., typical timeframes, materiality, scope, etc.)?

Due diligence work is a process to be performed thoroughly, since the report usually covers an extensive analysis of the potential investment from several perspectives, including legal, financial, commercial, tax, technical, regulatory and compliance.  However, red-flag reports, sample-based due diligence and materiality thresholds are common as well.  The scope and detail of the analysis are also adjusted depending on the insurance requirements and limitations of coverage.

It is generally conducted by outside advisors specialised in each area.  The usual timeframe covers between two to four weeks, depending on the information available, the commitment, the resources devoted by each party and the technology used in the process.  Publicly traded companies are normally exempt from due diligence work.

11.5      Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ approach to private equity transactions (e.g., diligence, contractual protection, etc.)?

PE houses have one or more compliance-dedicated officers taking care, among other tasks, of conducting (at least) certain preliminary due diligence when approaching a potential investment.  Additionally, certain compliance provisions and covenants are usually seen in investment and/or shareholders’ agreements.

11.6      Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the liabilities of another portfolio company?

A PE investor may be held accountable for the liabilities of the underlying portfolio companies: (i) if the PE investor is considered a company “shadow director”; or (ii) if the court lifts the corporate veil of the portfolio company and, consequently, the action or omission for which a liability has risen is attributed to the PE investor.

Otherwise, a portfolio company (or its directors, officers or employees) cannot be held accountable for the liabilities of another portfolio company.

12.1      What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?

Most of the relevant factors that a potential PE investor must consider when approaching a Spanish investment have already been addressed in the previous sections.  As in any other economy, legal certainty, political stability, foreign exchange rates, labour and union regulations, and other rights become major considerations to investment in our jurisdiction.