On 5 April 2006, the CSSF issued a circular letter (06/41) (the “Circular”) containing guidelines and clarifications on the criteria applied by the CSSF when assessing whether a project is eligible under the SICAR law or not.
We refer to the section client memorandums on our website for an outline of the SICAR law, which you can receive upon request.

Concept of risk capital

The purpose of the SICAR law is to favour the collection, in a vehicle specialized in risk capital, of funds contributed by well-informed investors accepting with full awareness and in expectation of a better return the increased risks most often associated with risk capital, i.e. lower liquidity, higher price volatility and lower credit quality.
Risk capital is defined in the SICAR law in a broad manner as to include any direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange. The Circular reminds that SICAR application files submitted for CSSF approval require the simultaneous combination of two elements i.e. (i) a high risk associated with the investment in the target company and (ii) the intention to develop the target company, which is broadly construed as the “creation of value” at the level of the target companies.

In general

The creation of value may take different forms:

  • The type of financingFinancing may be through bond issuance, bridge financing, share capital, mezzanine loans, convertible loans, etc.
  • Different investment typesIt may take the form of buy-offs, LBO’s, MBO’s, and management buy-ins, etc.
  • No restrictions as to the exit of investorsThe exit of the investors in the target company can be structured in the most efficient way from a legal and tax perspective (i.e. via a trade sale of assets or via an initial public offering).
  • Risk repartitionThe SICAR law does not impose any risk repartition with respect to the selected investments and it is thus possible that certain SICARs limit their investments to one or several companies active for example in a niche market or in extremely specialized sectors.
  • Holding periodThe CSSF stressed that the contemplated holding period of an investment is an important criterion in determining whether it is eligible to be considered risk capital. Therefore, the declared intention of the SICAR must be in general to acquire financial assets with a view of a resale at a profit.

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–          the type of financing
Financing may be through bond issuance, bridge financing, share capital, mezzanine loans, convertible loans, etc…
–          different investment types
It may take the form of buy-offs, LBO’s, MBO’s, and management buy-ins, etc.
–          No restrictions as to the exit of investors
The exit of the investors in the target company can be structured in the most efficient way from a legal and tax perspective (i.e. via a trade sale of assets or via an initial public offering)
–          Risk repartition
The SICAR law does not impose any risk repartition with respect to the selected investments and it is thus possible that certain SICARs limit their investments to one or several companies active for example in a niche market or in extremely specialized sectors.
–          Holding period
The CSSF stressed that the contemplated holding period of an investment is an important criterion in determining whether it is eligible to be considered risk capital. Therefore, the declared intention of the SICAR must be in general to acquire financial assets with a view of a resale at a profit.

Special case for real estate investments

Whereas the SICAR law does not allow SICARs to directly hold real estate properties, the indirect investments via entities which hold real estate properties is permitted. The Circular gives criteria of eligibility of investments in private equity real estate under the SICAR law.
The CSSF has confirmed that private equity real estate investments must be made for the purpose of creating value, which can be understood as a change to the existing conditions such as the enhancing of the valuation of the real estate by renegotiation of contracts, renewal of tenants and refurbishment of the properties. Furthermore it is necessary to demonstrate that the relevant real estate represents a specific risk, beyond the normal real estate risk attached to such real estate in a given market.  Such specific risk can lay for example in the fact that it is difficult to find tenants or that the real estate is located in an unfavourable zone.
The CSSF has set out a series of criteria which will be taken into account when assessing whether a private equity real estate investment is eligible to fall within the scope of the SICAR law.

  • The potential for significant profit due to the specific risks attached to the property;
  • High risk/ expected return ratio;
  • Identity of the management, the nature of their remuneration and procedure for selecting real estate property;
  • Financial participation of the managers;
  • Active development of property, limited holding period ;
  • Nature of financing: significant leverage, mezzanine type of financing.

Indirect investments

The Circular clarifies the types of companies that can be used in a structure of indirect investment in risk capital. The indirect investment via an UCI (undertaking for collective investment) or another private equity vehicle is acceptable provided the investments policy of the UCI restricts them to investing in assets that are eligible under the SICAR law. However, the investments into hedge funds are not eligible as hedge funds do not pursue the creation of value for its own investments.

Political risk

The geographical localization of investments in countries where there is a political risk can be taken into account when assessing whether a given investment constitutes a given risk. However, it is possible that it may be necessary to demonstrate the existence of additional risk factors so that creation value at the level of the target company can be proven.

Mezzanine loan

Mezzanine financing is an eligible form of financing insofar as the financing is made to a non-listed company or to a listed company if the financing is given in view of a specific development project.

Investment in listed securities

A SICAR may invest in listed securities when associated to a specific development project or if aimed at a delisting.

Conclusion

The CSSF has provided some guidelines on the concept of risk capital without setting hard rules on what does or does not qualify as a SICAR. At the end, each investment will be reviewed on a case-by-case basis.