[co-authors: Adrian Aldinger, Alexander Olliges, Laurent Schummer]*
World Law Group member firms recently collaborated on a Global Venture Capital Guide that covers more than 30 jurisdictions on investment approval processes, typical investment sectors and investment structures on Venture Capital deals (and more!).
The guide does not claim to be comprehensive, and laws in this area are quickly evolving. In particular, it does not replace professional and detailed legal advice, as facts and circumstances vary on a case-by-case basis and country-specific regulations may change.
This chapter covers Luxembourg. View the full guide.
Arendt & Medernach
- In your jurisdiction, which sectors do venture capital funds typically invest in?
Sectors in which venture capital funds invest in the Luxembourg market are often related to development and integration of new technologies in the financial center in Luxembourg, which serves as catalyst for developments in this sector and is supported by several public and private innovation hubs. Notably, fund services and related support for the asset management industry, as well as payment services and related activities have been a focus of development. Others include blockchain applications in various sectors.
However, certain major VC investments have also occurred in big data, small data, and in the logistics sector.
- Do venture capital funds require any approvals before investing in your jurisdiction?
Venture capital funds do not require an approval before investing in Luxembourg subject to any compliance requirements that apply to them or their managers pursuant to the laws of establishment of the fund vehicle. Venture capital funds established in Luxembourg may, for example, opt in to the SICAR or EuVECA regimes which would require prior approval or notification to the local regulator, CSSF, before commencing operations.
- Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations, or governance of an investee entity?
Offshore venture capital funds that have registered for marketing in one or more European Member States pursuant to Art. 42 of Directive 2011/61/EU of the European Parliament and of the Council of June 8, 2011 on Alternative Investment Fund Managers (AIFMD), will need to proceed with an acquisition of control-filing and ensure compliance with Art. 26 AIFMD seqq. under certain circumstances. These circumstances include where controlling stakes (331/3 % or 50% of voting rights depending on whether the entities are listed or not) are acquired and the investee entity does not qualify as a small and medium-sized enterprise within the meaning of Article 2(1) of the Annex to Commission Recommendation 2003/361/EC of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises (i.e., enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding EUR 50 million, and/or an annual balance sheet total not exceeding EUR 43 million). When an AIF acquires (or subsequently increases) a non-controlling stake (starting with a 10%-stake) in a non-listed company, it will need to inform the regulator pursuant to Art. 27 AIFMD.
Stemming from EU legislation, Luxembourg is subject to the rules set forth in Regulation (EU) 2019/452 of the European Parliament and of the Council of March 19, 2019 establishing a framework for the screening of foreign direct investments into the Union (the “FDI Regulation”) which entered into force on April 10, 2019 and applies to transactions as of October 11, 2020 in all EU Member States directly. The FDI Regulation does not require an EU-wide control mechanism of foreign direct investments, but instead leaves the final decision thereon to EU Member States. The FDI Regulation does not require EU Member States to put foreign direct investment controls in place either, but it foresees coordination and cooperation between the EU Member States.
Luxembourg has not established foreign direct investment controls in its national legislation, but it has followed the strong recommendations of the EU Commission to all EU Member States to introduce a regime with a proposed bill of law (bill n°7578 of May 19, 2020). The bill is still subject to change, but aims in its current form to introduce a foreign direct investment control regime in accordance with the provisions of the FDI Regulation, notably a requirement that an investor wanting to acquire at least 10% of the shares/voting rights in a Luxembourg-based enterprise submit a prior notification for authorization. If the appropriate authorities are not of the opinion that a foreign direct investment may affect security or public order, or essential national or European interests, they should authorize the transaction in a period not exceeding three months (which can be extended to four) from the date of receipt of the notification of planned investment.
- Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
Luxembourg law does not provide for a prior merger control regime for investments in a Luxembourg company unless EU merger control is triggered. However, the law on competition of October 23, 2011 prohibits agreements between undertakings or associations of undertakings, and concerted actions between undertakings, made with the aim of or having the effect of distorting competition or the abuse of a dominant position. A transaction may therefore subsequently become subject to scrutiny of the Luxembourg competition council.
- What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
Investments not using a fund vehicle are often made through private limited companies (S.à r.l.) or public limited companies (S.A.), which offer flexibility to accommodate the typical venture capital contractual terms (see under 7) and is largely used in international transactions. Both can accommodate foreign investors without restrictions. Additional authorizations that may be required for the business of the investee company (if any) can be obtained for both.
- Is there any restriction on rights available to venture capital investors in public companies?
Luxembourg law does not provide for specific restrictions for venture capital investors in public companies.
- What protections are generally available to venture capital investors in your jurisdiction?
Luxembourg formed an economic union with Belgium in 1925, which has been adapted several times (the Belgium–Luxembourg Economic Union or “BLEU”) with the purpose of setting up regional economic integration primarily based on a common external trade investment policy, customs and excises union. While the European Union achieves many of the objectives of BLEU, Luxembourg has, through BLEU together with Belgium, entered into over 100 bilateral investment treaties, which foresee protections of foreign investments on the basis of the model agreement (https://investmentpolicy.unctad.org/international-investment-agreements/countries/122/luxembourg).
Typical contractual protection mechanisms for the investment of a venture capital investor can also be found in Luxembourg investee companies: An investor can typically require observer seats, or, if desired, a board seat (no requirements of qualification or nationality to the extent the investee company is not subject to regulatory oversight). Important matters (including budget approvals, large expenditures, mergers and acquisitions, control rights in relation to an exit) are usually made subject to approval by investors.
The vesting timeline of founder shares to are regularly an important part of the investments, which would include typically a 48-month vesting, with a one-year cliff and possible accelerated vesting in case of exit. Both participating and non-participating liquidation preferences are common. Anti-dilution protections through subscription rights for new financing rounds and down round protections in early-stage investments have been common recently. Given financing needs and the rather difficult environment through the COVID-19 crisis, one could observe a larger portion of financing through convertible bond pre-funding rounds, as well as the
granting of significant discounts on future pre-money valuations, and bridge financing up to a subsequent financing round. Regular and extensive reporting on financial and non-financial KPI is typically foreseen in investment agreements.
- Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
Warranty and indemnity insurance is frequently used in transactions exceeding a certain size, but remains rare in the Luxembourg VC context.
- What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
Exit mechanisms include notably the sale or a combination transaction with a strategic investor (such as banks or financial institutions), the operator of an investment exchange, or a competitor in the framework of an international expansion.
Secondary transactions have also been available, mostly for targets having reached greater maturity, but also through specialized secondary fund investors.
Finally, in the current market environment, an exit through the listing on a public market has become more frequent.
- Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
IPOs are not the usual exit route in a Luxembourg VC context.
*Arendt & Medernach