An insight into the legal environment in France

01 November 2008

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The relationship between private equity and a country's legal structure is a complex one, yet the rapport between the two plays an important part in influencing investors' actions within a certain country. According to the European Private Equity and Venture Capital Association's (EVCA) league table, France has the best regulatory legal environments with regard to the interests of private equity and venture capital. But what does this mean to GPs?

France's top ranking in the EVCA European chart takes into account favourable government action with regards to pension funds, insurance companies, fund structures and tax incentives for investors and fund managers, all of which are attractive jurisdictions for private equity. The French government's incentivisation, tax brakes in FIP and FCPI incentives, which were updated last year and record investment from government-backed funds, have indeed contributed to this position.

Increased flexibility

The government reinforced its support by proposing of Loi de Modernisation de l'Economie (LME) in August. This latest change to the legal environment covers corporate law and, more importantly, private equity's FCPR funds making investments more conducive (as well as tax, real estate and anti-trust).

The LME offers a new degree of flexibility that benefits both the private equity and venture houses. The law, which comes into effect in January, will also allow for more flexibility in French corporate vehicles.

The new regulations will see the removal of the requirement to own minimum share capital in a "societe par actions simplifiee" (SAS). For entrepreneurs this translates to a reduction of costs; they will be able to establish a company first and subsequently raise the capital. The new legislation also removes the requirement for a director to be a shareholder in the company, although such an obligation may still be required by the company's by-laws.

Adding to this smaller "societe anonyme" (SA), the main type of French public company vehicle, and the SAS companies will be able to chose to be taxed on personal income tax regime instead of corporate tax. This will only be applicable to companies under five years old, with specific turnover and staffing figures, and to businesses where more than 50% of the company's share capital is held by individuals.

Ultimately, the management team of young companies may use the company's losses to reduce personal income tax. It will also mean that the company has no carry forward tax losses to offset against future profits.

The new legislation will also allow SAS companies to issue shares to employees as rewards and bonuses. The shares to be issued must be non-transferable, and only yield dividends and a share of the distribution while the individual is employed by the company.

The reform has also upgraded other schemes that are of interest to the industry, including founders' warrants (a particularly effective incentive scheme for young innovative companies), the issuance of preferred shares and tax credits for research.

All is not well

Unfortunately all isn't as rosy as it seems for French private equity and the EVCA's benchmark may not be an accurate reflection of private equity sentiment. For instance, the position at the top of the charts came from research conducted by KPMG's M&A Tax Services in which they questioned the adviser to private equity rather than private equity houses themselves. In regards to the LME legislation, for instance, the incentives offered by the government are more oriented towards smaller businesses than large ones as well as bringing with it increased registration duties on the transfer of shares from 1.1% to 3%.

The research also comes at a precarious time for larger private equity following the Converteam fallout and the potential legal ramifications. The French private equity association, AFIC, has also been lobbying the French Ministry of Finance to avoid aggressive initiatives against buyouts put forward by certain politicians. Some of the proposed motions include a ban on the use of debt as leverage and to raise the carried interest tax rate from 30% to 60%. LBO France and Barclays Private Equity, the investors involved in the Converteam deal, have since taken the initiative to split some of their buyouts' capital gains with employees to appease the situation. Should strong measures be implemented by the government it would severely hinder private equity and potentially result in some investors heading for new pastures.

Providing the AFIC and its lobbyists manage to stave off any drastic action by the government which would hinder private equity, the positive legal reforms which are expected to increase in the next couple of years are defiantly a step in the right direction, especially for smaller developing companies.