Netherlands: Locusts or worker bees?

Arne Grimme
De Brauw Blackstone Westbroek
Amsterdam

Public opinion versus facts, figures and developments in the Dutch private equity market

The Netherlands features as the world's ninth most attractive country for private equity investments in the 2010 Global Venture Capital and Private Equity Country Attractiveness Index developed by the International Center for Finance Research of IESE Business School and Ernst & Young. Despite this, private equity has not yet captured the hearts and minds of the Dutch public. 'Locusts' is one of friendlier terms used by the Dutch media to typify private equity firms. And many fear just that: swarms of private equity firms zeroing in on domestic companies, only to extract value and take off, leaving empty shells behind.

Research conducted by the Dutch Private Equity & Venture Capital Association and PriceWaterhouseCoopers contradicts those fears. The research shows that private equity firms have in fact acted as worker bees and played a positive role during the economic downturn of 2009 and early 2010. Private equity firms in the Netherlands invested heavily in companies (mostly SMEs) already in their portfolios, increasing their investments compared to 2008. As a result, and despite the near impossibility of attracting debt capital, these companies "were able to strengthen their balance sheets in times of economic uncertainty and attract capital for growth and acquisition" (Dutch Private Equity Market 2009).

Private equity has also played a crucial role in promoting innovation in the Netherlands. In 2009, by far the most investments were undertaken in innovative sectors such as healthcare, biotechnology and ICT. These investments accounted for approximately 40 percent of the overall amount invested by private equity firms in 2009. 2010 shows a continuation of this trend with Philips Healthcare's cornerstone investment in the Gilde Healthcare Partners III Fund this August.

Case Law Highlight

The Dutch public's fears may be partially explained by the LBO of the prominent Dutch publishing house PCM by Apax Partners in the period 2004-2007. The LBO had disastrous consequences for PCM: interest payments increased nearly six-fold, no strategic investments were undertaken, and, at Apax's exit, management cashed out at more than ten times their contributed stake and PCM was left an empty shell.

Following Apax's exit, PCM was successfully sued for mismanagement. In May this year, the Dutch Enterprise Chamber rendered a landmark decision in the PCM case in which it formulated a number of investment guidelines for both management and private equity firms. The lessons for private equity firms from PCM are that it is in the interest of the private equity firm to:

• supply the target's managing and supervisory boards with a reasoned justification for an LBO.
• formulate a clear strategy to be achieved by means of the LBO and to ensure correspondence between strategy and available means. If a growth strategy is formulated, financial means must be secured and debt push down options may be limited.
• ensure that management participation schemes not only serve the interests of the private equity firm, but also those of the target.
• assume responsibility for interests of the target in case supervisory directors related to the private equity are appointed to the target's supervisory board.

In the post-PCM era, private equity investors may also find themselves faced with pro-active managing boards and close scrutiny of their proposals.

Regulatory and Self Regulation

Recent developments in the regulatory field focus on addressing the perceived problem of the lack of transparency of private equity firms. As early as 2005, the European private equity sector initiated self-regulatory efforts geared towards more transparency in terms of the operating methods and professionalisation of the private equity sector. These self-regulatory efforts resulted in a European code of conduct in 2005 and a Dutch code of conduct in 2007.

However, European regulators felt that the financial crisis and economic downturn called for a shift from soft law mechanisms to hard and fast regulation. In 2009, this led to a Commission proposal for an EU Directive for managers of alternative investment funds (AIFM Directive).

Labeled by Ernst &Young as "perhaps the most contro-versial and far-ranging regu-latory proposal" in its 2010 Global Private Equity Watch, the proposed AIFM Directive originally applied a one size fits all approach subjecting private equity firms to the same regulations as hedge funds. Heavy lobbying by market representatives such as the Dutch Private Equity & Venture Capital Association and its European counterpart have led to a more tailor-made approach.

The AIFM Directive would introduce licence requirements as well as a European passport for AIFMs. Additionally, disclosure and capital requirements would become more stringent and the amount of leverage allowed would be capped. Most contentious are the third-country rules which would make access of non-EU based firms to the European capital markets dependent on the fulfilment of stiff criteria by the home country. Such criteria must be laid down in bilateral cooperation agreements between the respective EU member state and the home country.

The proposed AIFM Directive has been subject to many amendments of the European Parliament and the Council of the European Union in a dual track process, which resulted in two substantially different texts. Negotiations between the Council and the Parliament are ongoing. The envisaged outcome of the negotiations is a compromise text which may be put to vote in the Parliament. Voting is scheduled for September 2010, but further delays are expected.