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Legal Aspects inthe Formation and Structuring of Search Funds

Tomás Barrilero

For some time now, the so-called Search Fund investment model has been gaining importance and entity, both in qualitative and quantitative terms, in Spanish territory, and as at today it has become an investment characterized by a structure which actually has not only an undeniable presence, but it has also increased in time, volume, and standardized presence.

At Bufete Barrilero y Asociados we approach each transaction with a multifaceted approach, thus assuming that -from a Tax Law perspective- there are multiple parties involved therein, and hence it is essential to ensure the full alignment of their interests.

As a starting point, the Search Fund ecosystem cannot be understood today without the coexistence of the different legal-tax regulations that coexist within the Spanish legal system (Common Territory, Bizkaia, Gipuzkoa, Alava and Navarre). This is due to the fact that, depending on both where the Search Fund is fi scally resident and where the Target is located, the legal-tax impact on both, investor partners and Searcher itself, will defer substantially.

By way of example, the tax treatment of company’s fi nancial goodwill, the qualifi cation of certain income sources, the exemptions in the particular case of taxes levied on the Searchers’ and investors’ assets, etc.

On the other hand, I do believe that the focus of legal-tax analysis must necessarily be on the Searcher, as the only common element throughout the life of the project (search phase, acquisition, management and eventual exit phase). Any kind whatsoever of a partial approach, which is focused exclusively on one of these overlooking the overall picture, shall qualify as a mistaken approach that will not allow structuring the full project in the most efficient possible way. For example, the interposition of an intermediate business entity that assumes the financial debt arising from the transaction which, by the way, may make sense in other types of structures, can be highly inefficient in the particular Search Fund structures because it adds unnecessary costs.

Just the same as these factors shall be present in any transaction, other material issues shall be taken into account, other transaction that constitute a nucleus, is company structure where the Seller of the Target when at the time where the transaction is tackled.

Although this is as a matter of fact an issue that, as a general rule, surpasses the more traditional advice in a Merger and Acquisition transaction (M&A), the specificities of the Search Fund model makes this analysis a material issue that, on many occasions, will result in successful acquisition and, at the same time, the full project. The legal tax impact of Seller shall be subject to, among many other factors, on whether or not the transferor is subject to Corporate Income tax (CIT, for short) or Personal Income Tax (PIT); whether or not Seller chooses to reinvest in the Search Fund structure; whether the transfer involves totally or partially the Target’s share capital; etc. In other words, the question is not of a trivial nature.

On the other hand, being fully aware of the fact that it is the main agent of any transaction, it is of paramount importance to order, analyze and face the tax impact that the different milestones will give rise to during the life of the Search Fund, and which shall the Searcher. That is to say, incentive legal-tax treatment, which is actually recognized as a consequence of being the most relevant participant of the Search Fund, and hence its legal-tax qualification, its valuation for tax purposes, and the moment of its accruals, among other.

Last but not least, as elements that make possible for the transaction to materialize, investment partners deserve being paid special attention. The financing of the relevant transaction by resorting to private debt or equity, the country or the territory where the investment partner has its residence for tax purposes, the Both nationally and internationally there is a significant tax saving due to the legislative specialties (both legal-tax and strictly regulatory) that surround this type of vehicle, the type of vehicle by means of which it is intended to provide the funds for the transaction, the percentage of participation in the share capital of Search Fund, the structure of the flow distributions, as well as many others, since they are in fact key factors to be taken into account when structuring the transaction resulting thereby.

Just as these factors must be present in any transaction, another of the core issues to be taken into account is the corporate structure of the Target seller at the time of the transaction.

This being the case, venture capital vehicles are beginning to take center stage as an investment channeling vehicle within the Search Fund ecosystem. There being no intention whatsoever to go into too much technical detail, this alternative can lead to significant tax savings for the investment partner -both nationally and internationally- due to the legislative specialties (both legal-tax and strictly regulatory) that surround this type of vehicle.

As referred to at the beginning of this brief article, the faces of the polyhedron that come into play in each transaction are multiple, and as far as possible the alignment of
all of them will result in the certain success of any transaction.