German buyout fund uses AG structure

Barlage, Knoth & Cie has unveiled details of a E175m mid cap buyout fund designed to protect investors from uncertainty over potential changes to German tax law.

Barlage, Knoth & Cie, a private equity fund manager recently set up in Munich, has launched a E175m mid-market buyout fund to invest primarily in underperforming German Mittelstand companies operating in electrical engineering, automotive supply and mechanical engineering.


Instead of setting up the new fund as a limited partnership, the firm is using a German stock corporation (AG) structure. Under the scheme, investors can buy shares in initially up to three separate AGs serving as acquisition vehicles for the fund, paying a contractual premium of E5 per share in addition to the nominal value of E1. An average management fee of 1.6 per cent is charged for each AG which is tax deductible and incurs value added tax that qualifies for a refund. According to Barlage, Knoth & Cie, these benefits will result in a performance improvement of 1 per cent per per annum for shareholders.  


Historically management fees of German limited partnerships were not subject to VAT, but in a recent court ruling Germany's highest tax court, BFH, said fees for management services provided by a GmbH to a limited partnership in which it is at the same time a shareholder will fall under VAT. 


The fund structure is also designed to eliminate any uncertainty over whether or not the German tax authorities will proceed with plans to tax private equity managers making majority investments no longer as asset managers but as operational companies, a move that if triggered would result in significant tax-related consequences for the managers and their investors. The uncertain tax status of limited partnerships in Germany has long been a concern for investors. 


According to Frank Hock, managing director of Barlage, Knoth & Cie, the structure will be benefitial to investors even if no changes to the tax treatment of German limited partnerships should come into effect. 'From a taxation point of view, investing in our concept is like investing in Daimler Benz or Siemens shares. Investors get better terms on carry and fees, the product is more transparent than limited partnerships, and it will be easier to access by foreign investors such as fund of funds, which won't require complex feeder vehicles or parallel investment structures in order to comply with German foreign fund investment law. Instead there is very clear treatment according to double tax treaties.' 


Once the fund is raised, it is intended that there will be a total of seven individual AGs, each capitalised at E25m and making one core investment in one of the firm's target sectors. Follow-on investments in a portfolio company will be made by the same AG that funded the initial acquisition. Investors in the initial seven stock corporations will be given first right of refusal once Barlage, Knoth & Cie raises capital for additional AGs. 


Freshfields Bruckhaus Deringer, led by Rolf Füger, acts as legal advisor to Barlage, Knoth & Cie and worked on the establishment of the new fund.


Hypovereinsbank has already made a commitment to supply 20 per cent of the fund’s capital, with Klaus Murmann, a former president of the Federal Association of German Employers, another cornerstone investor in the fund.


The founders of Barlage, Knoth & Cie will also invest 3 per cent of total funds raised and provide an additional E1.8m to the fund manager’s complementary limited structure, which will effectively assume the role of the general partner in traditional funds.


The founders will be buying their shares at par. To align interests, investors are entitled to a refund in case the fund should fail to reach its performance target of an annual internal rate of return of 15 per cent. This is set at 80 per cent of the value of the initiators’ shares at the time of exit for an IRR of 5 per cent and below, at 50 per cent for an IRR of 5-10 per cent, and at 20 per cent for an IRR between 10-15 per cent.   


Barlage, Knoth & Cie was set up by a group of individuals including Hans Albrecht, who founded the German arm of the The Carlyle Group before establishing his own private equity company, Nordwind, and raising a German turnaround fund. Nordwind has adopted the same fund structure as Barlage, Knoth & Cie.


Other members of the group include Tonio Barlage, a former COO at Sauer Danfoss, Rainer Knoth, a leveraged financier and former member of the board of Bayerische Hypo und Vereinsbank, and Bernhard Heiss, managing partner at the Munich office of Freshfields Bruckhaus Deringer.


The fund is targeting established companies where it can generate value by way of focusing on operational improvements, without relying on top line growth, technical innovation or financial engineering. Barlage intends to spend the first two years of an investment to improve profitability, two years to stabilise it and  another two years to exit.