Venture Capital

2021 Venture Capital Guide – Corporate/Commercial Law

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1) In your jurisdiction, which sectors do venture capital funds
typically invest in?

In 2018, the global amount of investment by venture capital
funds reached EUR 1,619 million1 in France.

The key sectors attracting venture capital investment in France
include the IT and digital sectors (EUR 836 million2),
healthcare and biotechnologies (EUR 413 million3),
industrial goods and services and the chemical sector (EUR 112
million4), as well as consumer goods and services (EUR
103 million)5.

2) Do venture capital funds require any approvals before
investing in your jurisdiction?

  1. With regard to venture capital funds established under
    French law, we distinguish between two main
    categories of vehicles depending on the type of investors to which
    they are open:

    1. the retail private equity funds, which are
      open to non-professional investors and include several types of
      funds, each of which has its own specific strategy:

      • Retail Private Equity Investment Funds (Fonds Communs de
        Placement à Risque
        or
        FCPRs“),

      • Retail Venture Capital Funds (Fonds Communs de Placement
        dans l’Innovation
        or
        FCPIs“),

      • Retail Local Investment Fund (Fonds d’Investissement de
        Proximité
        or “FIPs“),
        etc.

In terms of regulatory framework, the creation of retail private
equity funds requires the prior authorization of the French
Financial Market Authority (Autorité des Marchés
Financiers
or “AMF“) as these funds
are open to non-professional investors. The AMF also monitors these
funds throughout their lifetime.

  1. the professional private equity investment
    funds
    , which are dedicated to professional investors and
    include inter alia:

    • Professional Private Equity Investment Funds (Fonds
      Professionnels de Capital Investissement
      or
      FPCI“),

    • Venture Capital Firms (Sociétés de
      Capital-Risque
      or “SCR“).

In terms of regulatory framework, these professional private
equity investment funds, which are reserved for professional
investors (as defined by the AMF regulations) do not require any
prior authorization by the AMF. However, they must be declared to
the AMF within the month following their creation. The AMF also
monitors these funds throughout their lifetime.

  1. As for venture capital funds governed by a foreign
    law
    , they do not require any specific approvals for merely
    investing in France, except when investing in sensitive sectors, as
    detailed in question 3 below.

By contrast, the marketing and retail of these offshore venture
capital funds in France would be subject to the AMF regulations and
require necessary approvals.

3) Are there any legal limitations to an offshore venture
capital fund acquiring control or influencing the business,
operations, or governance of an investee entity?

As a general rule, foreign investments in France are
unrestricted.

However, foreign investments in sensitive sectors are subject to
specific authorizations from the Minister of Economy and Finance
prior to their completion.

In practice, foreign investments must be authorized by the
Minister of Economy and Finance if the following three conditions
are cumulatively met:

  1. condition relating to the origin of the considered
    investment
    : the investment comes from a country other than
    France, and

  2. condition relating to the nature of the considered
    investment
    : the forms of foreign investments subject to
    authorization are as follows:

    1. the acquisition of a controlling stake – within the
      meaning of Article L.233-3 of the French Commercial Code – in
      a company that has its registered office in France,

    2. the acquisition of all or part of a branch of activity of a
      company that has its registered office in France,

    3. the acquisition of 25%6 of the share capital or
      voting rights in a company that has its registered office in France
      (this sub-condition does not apply to Member States of the European
      Union), and

  3. condition relating to the nature of the target
    company’s activities: the French foreign investment control
    applies to business sectors related to public order, public
    authority, public security or the interests of national
    defense.

The authorization request shall be sent by the investor to the
Ministry of Economy and Finance prior to the closing of the
considered transaction, and a failure to comply may result in the
agreement giving rise to this foreign investment to be held null
and void, in addition to a potential civil fine on the foreign
investor (up to a maximum of EUR 5 million for legal entities and
EUR 1 million for natural persons) and possible criminal
sanctions.

4) Would an investor be required to undertake an antitrust
analysis prior to investment? When would such a requirement be
triggered?

Venture capital investments may be required to undergo an
antitrust analysis when they trigger a change of control of the
target company and provided certain turnover thresholds are met by
the parties to the concentration.

Depending on these thresholds, the transaction may fall under
the scope of either French or European Union merger control
mechanisms, as described hereafter.

a. French merger control

Venture capital investments resulting in a change of control of
the target company must be notified to the French Competition
Authority (Autorité de la Concurrence) when the
following three conditions are cumulatively met:

  1. the aggregate worldwide pre-tax turnover (achieved during the
    previous financial year) of all the parties to the concentration
    exceeds EUR 150 million, and

  2. at least two of the parties to the concentration each achieved
    individually, during the previous financial year, a pre-tax
    turnover in France exceeding EUR 50 million, and

  3. the transaction does not fall under the European
    Commission’s jurisdiction (normally described as not having a
    so-called “EU dimension“).

Reduced thresholds will apply wherever:

  • at least two of the parties are active in the retail trade
    sector, or

  • at least one of the parties run(s) its/their activity or part
    of it in one or more French overseas departments or French overseas
    territories.

There are specific rules for calculating the turnover in sectors
such as banking and finance, insurance, leasing, travelling,
advertising, franchising, and for state-owned companies.

b. European Union merger control

The European Commission only examines larger mergers with an EU
dimension, meaning that the concerned parties reach certain
turnover thresholds. In a nutshell, one of the minimum thresholds
to be met is a worldwide turnover of all the parties to the
concentration over EUR 2.5 billion.

5) What are the preferred structures for investment in venture
capital deals? What are the primary drivers for each of these
structures?

Venture capital funds usually invest in venture capital deals by
way of subscribing for ordinary shares (actions
ordinaires
) and/or preferred shares (actions de
préférence
). Preferred shares, which can grant
their owners specific rights (such as multiple voting rights, prior
access to information, priority dividend rights, etc.), are widely
used in practice. However, the issuance of preferred shares can
prove (i) costly, as an independent statutory auditor will have to
be appointed, and (ii) complex insofar as special meetings of
preferred shares’ holders shall be convened to approve any
modifications related to the preferred shares.

It is also common for venture capital investors to subscribe to
hybrid securities of the target company in addition to ordinary
and/or preferred shares. Hybrid securities have developed
considerably over the last years in France.

In addition to subscriptions for ordinary or preferred shares,
investments often also take the form of subscriptions for
convertible bonds (obligations convertibles) or bonds
redeemable in shares (obligations remboursables en
actions
).

6) Is there any restriction on rights available to venture
capital investors in public companies?

The primary purpose of venture capital funds in France is not to
invest in listed companies but to finance the creation or start-up
phase of technology-intensive companies.

In this respect, it should be recalled that the venture capital
activity is carried out mainly through dedicated investment
vehicles such as FCPRs, FCPIs, FIPs, etc. (see question 2 above)
that benefit from preferential tax regimes in return for
restrictive investment rules, mainly regarding of the structure of
their asset portfolio and in particular with regard to unlisted
securities. For example, at least 50% of the assets of a FCPR must
be made up of unlisted companies. This percentage is set at 70%
minimum in FCPIs and FIPs and non-compliance with these thresholds
entails a tax penalty.

As such, restrictions on investment in listed companies by
venture capital investors take primarily the form of investment
quotas.

7) What protections are generally available to venture capital
investors in your jurisdiction?

Venture capital investors usually rely on the protection granted
by the articles of association of the target company and the
transactional documents, including inter alia the share
transfer agreement and the shareholders’ agreement.

Venture capital investors are also granted representations and
warranties (garantie d’actif et de passif) in
connection with the shares being sold, and related indemnity
protection.

To secure its indemnification obligations under the
representations and warranties agreement, the seller is usually
required to provide a guarantee, in the form of a first demand bank
guarantee or joint guarantees provided by the seller or a bank.
Apart from these guarantees, an alternative solution usually
consists of placing a portion of the sale price in an escrow
account.

8) Is warranty and indemnity insurance common in your
jurisdiction? Are there any legal or practical challenges
associated with obtaining such insurance?

Although the use of warranty and indemnity insurance
(“W&I insurance“) has significantly
developed over the last years, this type of insurance is not as
widely used as other guarantees implemented to secure
representations and warranties agreements, as detailed in question
7 above (first demand guarantee, joint and several guarantee,
etc.). W&I insurance may either be effected by the buyer
(typically) or the seller, or cumulatively effected by both of
them. Given its specificities, W&I insurance is generally
considered by the investor as a tool to complement the guarantees
mentioned in question 7 above, not as a substitute for them.

9) What are common exit mechanisms adopted in venture capital
transactions, and what, if any, are the risks or challenges
associated with such exits?

In venture capital transactions, investors are expected to exit
in the short or medium term. Several exit routes are available to
venture capital investors:

  • trade sale,

  • transfer to the management team (known as “management
    buy-out” or “MBO“),

  • sale to another investment fund (known as secondary
    “leveraged buy-out” or
    LBO“),

  • initial public offering
    (“IPO“).

Trade sale is the most common exit channel. The main issue in
this type of exit is the proper alignment of the financial
interests of the venture capital investor and those of the other
selling shareholders so that none of them are adversely affected by
the sale.

The second most common exit channel is the transfer of the
company to the management team. The main challenge is to raise the
necessary financing to pay the purchase price. In addition to
obtaining a bank loan, the purchasing manager(s) often applies to
an investment fund that will participate in the acquisition
alongside while remaining a minority shareholder.

A third option is for the venture capital investors to sell
their shares to another investment fund via a secondary LBO. One of
the main difficulties arises from the divergence of financial
interests that may exist between the venture capital investors, who
wish to maximize the value of their investment when exiting the
company, and the remaining shareholder(s), who seek(s) a new
financial partner who shares the same vision for the development of
the company.

Finally, an IPO is a well-known exit strategy. In practice,
however, it is rarely implemented. This is partly due to the fact
that the holdings of venture capital investors in France are almost
exclusively made up of start-ups and small- and medium-sized
businesses. The complexity, constraints and costs associated with
an IPO are often difficult to reconcile with the profile of these
companies.

10) Do investors typically opt for a public market exit via an
IPO? Are there any specific public market challenges that need to
be addressed?

IPO exits only accounted for 4% of the amounts related to the
main divested businesses in the venture capital sector between 2009
and 20187. This type of exit strategy is therefore not
(yet) very common in practice. IPO exits are also highly regulated
as they are subject to the control of the AMF.

When considering an IPO exit strategy in France, the investors
shall first identify the listing venue for share trading: Euronext
Paris regulated market or multilateral trading facilities
(systèmes multilatéraux de
négociation
or “SMNs“).

a. Euronext Paris regulated market

The Euronext Paris regulated market is divided into four
capitalization segments organized according to market
capitalization: Compartment A for companies with capitalization
over EUR 1 billion / Compartment B for companies valued between EUR
150 million and EUR 1 billion / Compartment C for companies valued
below EUR 150 million / A professional Compartment (for admissions
by French or foreign companies without a prior public offering of
securities).

Rules for admission on Euronext Paris regulated market require
that the following conditions to be met:

  • a minimum distribution of at least 25% of the issuer’s
    capital, or 5% if this represents at least EUR 5 million,

  • three years of audited accounts and the most recent reviewed
    half-yearly accounts if admission takes place more than nine months
    after the close of the financial year,

  • the use of IFRS accounting standards, and

  • a prospectus previously approved by AMF.

IPOs are subject to strict transparency requirements covering
inter alia performance, financial positions, and major
changes to the shareholding structure. Listed companies are also
required to publish without delay any information that may have a
material impact on their share price.

b. Multilateral trading facilities

Alongside the regulated market, there exist multilateral trading
systems which include inter alia Euronext Growth, an
organized SMN dedicated to small and medium-sized businesses.

Rules for admission on Euronext Growth are less stringent than
those applicable to the Euronext Paris regulated market.

Footnotes

1. 2018 Key figures, French Venture
Capital Guide (Chiffres clés 2018, Capital-Innovation
français), published by France Invest.

2. Ibid.

3. Ibid.

4. Ibid.

5. Ibid.

6. In the wake of COVID-19 pandemic,
Decree no. 2020-892 dated July 22, 2020 temporarily (until December
31, 2020) lowered the threshold triggering the foreign direct
investment screening mechanism to 10% of the voting rights of
French listed companies operating in sensitive sectors.

7. 2018 Key figures, French Venture
Capital Guide (Chiffres clés 2018, Capital-Innovation
français), published by France Invest.

Originally published by World Law Group 2021 Venture Capital
Guide
.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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