Distressed businesses create debt opportunities
By Olivier Jordant*, Ernst & Young, Luxembourg
Private Equity Europe
May 2010
In these tough conditions, many firms are facing real uncertainties regarding their market, clients and suppliers. Consequently, mapping companies’ positions on a “stress pendulum” can be a very useful exercise, helping to understand their situation and to highlight potential solutions and opportunities. At one end of the scale, businesses are burning cash and heading towards insolvency. These firms need to ensure survival by disposing of distressed assets and resolving other impairment issues so as to comply with debt covenants and regulatory ratios.
At the other end of the spectrum there are businesses with large cash reserves and it is here that one sees the potential for growth through acquisition and portfolio optimization.
Unsurprisingly, distressed investment opportunities abound in the current market – particularly in the area of distressed debt - and specialist distressed investors have again come to prominence. In addition, the potential to make investments at substantial discounts has attracted more traditional PE houses, which see the asset class as an attractive opportunity to invest some of their dry powder.
Luxembourg – a focus for distressed debt
For international funds investing in distressed debt, the main route for efficient tax planning is to use one of various Luxembourg Vehicles . Regulated funds such as the SIF and the SICAR may be appropriate, while Soparfis and Securitization vehicles may also work well. The choice of vehicle depends largely on who the investors are, where they are based and what distressed assets they are focusing on. The most efficient solution could also combine Luxembourg and foreign SPVs, so the use of advisors with international coverage is key to reducing the final tax burden of the ultimate investors.
The SICAR, a PE-specific vehicle created in Luxembourg, has the advantage of being a lightly-regulated onshore structure, as does the SIF, though this can be created in SICAV or FCP form.. The SIF differs from the SICAR in that it must satisfy diversification rules and is not restricted to private equity. Both variants can be incorporated with multiple sub-funds and are designed for qualified investors
From a tax point of view, the SICAR is a fully taxable company, though all revenues from its transferable securities are tax exempt; it can also access double tax treaties. In its most transparent form, the SICAR is exempt from corporate, municipal and wealth tax. At investor level, double tax treaty claims are accessible and the company will not qualify as Permanent Establishment for non-resident investors. Meanwhile, the SIF is only liable to subscription tax corresponding to 0.01% of NAV.
Securitization vehicles are another way to structure distressed debt activities, as loan portfolios fall under the definition of securitized assets. A common securitization structure is where assets acquired from the initial owner are financed through issuance of debt divided into tranches remunerated by the proceeds from the distressed assets. To date, this has been most commonly used for the internal restructuring of bank mortgage loans, but it is now also being used by international PE funds.
The current conditions are clearly going to create opportunities for distressed investments for some time to come and Luxembourg, with its established track record, international focus and pool of experienced human capital will ensure that the country will continue to be a focal point for the asset class.
Posted on 10 June 2010 
