PORTUGAL: An Introduction to Private Equity

General Overview of the Market 

The private equity market in Portugal comprises a variety of different realities and players.

There are very active private equity funds run by Portuguese management companies, but a significant part of Portuguese M&A activity is conducted by foreign-based private equity sponsors (PEs), in particular in Spain, the UK, France and the US.

M&A/PE databases evidence an increase in the last four years of cross-border transactions completed by foreign-based PEs.

It is also worth mentioning that national PE funds’ main focus will be mid-market transactions, while the fewer high-value deals are mostly undertaken by high-profile foreign PEs with an enhanced investment capacity.

The most attractive/dynamic sectors for investment are the renewable energy, real estate/tourism, health and TMT sectors.

Publicly available M&A/PE databases also reveal a slowdown in PE activity in the last quarter of 2022 continuing through the first quarter of 2023, in line with a global trend showing that in 2022 the amount of M&A deals involving private equity sponsors dropped by about a third (year-over-year).

The slowdown is expected to continue during 2023 taking into consideration the current macro-economic context of high interest rates, adversely affecting various phases of the PE investment cycle, namely:

fundraising ‒ fixed income (or lower risk) investments become a more attractive option for investors, making fundraising more challenging;investment ‒ leveraged buyouts, one of the most common investment strategies used by PEs, become more costly as interest rates rise, triggering the need to resort to other alternatives for value creation that is not chiefly debt-based; andexit ‒ rising interest rates weaken the value of a target’s assets and expected rate of return, as timing planned for the exit may be delayed while the market completes a price discovery phase, adjusting the price of a assets and businesses.

Trends  

Equity financing 

In addition to the typical M&A transaction structure used by PEs – acquisition of the target company’s control – other investment structure alternatives (more similar to those adopted in venture capital transactions) have been implemented in the past few years and are becoming more common and attractive to investors.

These include the previous owners maintaining control of the target company, while the investor provides funds for growth in exchange for a minority equity stake with a preferred return.

These transactions require a specific and more complex legal approach for the protection of the investor’s position as minority shareholder during the life of the investment and upon exit.

Most of these protections are typically used in common law (US/UK) companies and require some fine-tuning when used in continental law-based companies (such as Portuguese companies) with a more rigid legal framework. Nonetheless, a key objective in this type of structure is to ensure that these protection mechanisms set up for the benefit of the investor (particularly the exit mechanisms) do not cause the investment to be reclassified as debt financing.

(Re)allocation of risk: W&I insurance 

In the last few years, access to W&I insurance on M&A transactions in Portugal has improved significantly due to the simplification and acceleration of the contracting process and the availability of policies in good terms for competitive premia. We have witnessed a progressive growth in the use of W&I insurance, particularly when PEs are involved and take the position of seller in the deal. Taking into consideration the limited duration of funds (usually five to ten years), in an exit process (through a trade sale, either in an auction process or in a bilateral negotiation) the W&I insurance will be the ideal solution to ensure that the buyer enjoys protection against possible breaches of representations and warranties after the time the liquidation of the fund and provides certainty on price.

ESG 

Following the trend of the greater social and environmental awareness, ESG factors are more and more present in investors’ decision-making processes, including PEs. Depending on their investor base and regulatory scrutiny, sponsors are more or less attentive, but hardly any PE can nowadays overlook the alignment of their investment policies with ESG concerns. Also, the pressure and incentives for green financing are drivers of this change.

ESG provides very important business opportunities. It fosters investments in companies that operate in ESG sectors (such as renewable energy) and companies that operate in other sectors but that need to tackle ESG matters (such as the transports industry). It is also an important marketing tool to attract investors.

On the other side, this comes with an increased regulatory framework. In the financial sector, the key milestone was Regulation (EU) 2019/2088 (SFDR), which generally entered into force on 10 March 2021, but since 1 January 2023 a number of matters have been complemented by Delegated Regulation (EU) 2022/1288. This includes the terms of initial declaration and subsequent reporting of a (positive) consideration of principal adverse impacts of investment decisions on sustainability factors and pre-contractual and reporting duties regarding the “light green” funds (SFDR Article 8 funds, promoting ESG characteristics) and “dark green” funds (SFDR Article 9 funds, having as their objective making sustainable investments).

Regulators across the EU have been increasingly monitoring this and the Portuguese Securities Market Commission (CMVM) made an industry-wide supervision exercise in Q4 2022, which was reported earlier this year, and has announced further action during 2023.

Portuguese PE vehicles 

Where Portuguese PE vehicles are used, they usually take the form of a so-called “venture capital fund” (fundo de capital de risco), which is also the type of fund benefiting from the most competitive tax regime.

Despite its legal name hinting to venture capital strategies, the actual scope of application of this type of fund is very broad and they can be used essentially for any type of equity investment and strategy and for early stage, growth or mature companies. For instance, they have also been used significantly for turnaround and restructuring transactions.

Both the fund and the fund manager are subject to supervision by the CMVM, as opposed to Luxembourg, where alternative investment funds can under certain conditions experience very little or even no supervision, with only the fund manager being subject thereto. These Portuguese funds follow a unit trust format, as opposed to the corporate form more typical in Luxembourg.

The fund manager can be a fully licensed alternative investment funds manager (under Directive 2011/61/EU – AIFMD) or a sub-threshold alternative investment funds manager, with a lighter regulatory regime, but without the benefit of passporting its licence within the EU.

The key constitutive document of any such fund is the management regulation, which inter alia sets out the terms of subscription and capital calls, the duration of the fund and the investment policy. If the target investors comprise non-professional investors, a key information document (KID) has to be prepared and provided to investors in advance, following the rules applicable to key retail information documents. The concept of professional investors follows that of Directive 2014/65/EU (MiFID II). Thus, a high subscription ticket is not sufficient for the investor to be considered professional, nor is the investor having a high net estate.

Since 1 January 2023, the transitional regime providing for a light type of KID is no longer available, and the harsher regime under Regulation (EU) 1286/2014 (the “PRIIPS Regulation”) applies. This has brought about significant challenges to fund managers in Portugal and generally across the EU, as the template KID under the Regulation was not originally designed for this type of fund.