Compared to other investment models, buyout funds face a tougher test in returning investors' cash as a result of “asset stripping” rules contained within the EU's Alternative Investment Fund Managers Directive.
Under the directive each EU member state will have to implement certain restrictions on distributions to shareholders where a company is “controlled” by a fund (or by funds acting together) to prevent financial sponsors from breaking up a company for its most prized assets too early in an acquisition.
For example firms will be unable to distribute dividends to shareholders and make certain capital reductions within the first two years of owning a controlled entity. The directive defines “control” as holding more than 50 percent of an unlisted company's voting rights.
Legal sources said the rules may create unintended and arbitrary consequences for portfolio companies. For instance a company owned by a sovereign wealth fund or a GP fundraising outside of Europe would be subject to a different set of legal standards than a financial sponsor touched by the directive.
That could “be discriminatory against [GPs] who are either operating in or raising money in Europe, said one London-based lawyer familiar with the directive.
There is also concern surrounding the directive's language which currently provides a grey area for member states to interpret the rule. “Currently the drafting of the rules is unclear and a lot will depend on the national implementation”, said Simon Witney, partner at international law firm SJ Berwin.
Depending on how each member state interprets the rules, which they must do by July 2013, certain states may adopt harsher asset stripping rules relative to others.