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 Switzerland. View the full guide.
CMS von Erlach Poncet
1) In your jurisdiction, which sectors do venture capital funds typically invest in?
In Switzerland, investments in almost all sectors and during all stages have clearly increased in the last couple of years. The information technology sector (including FinTech) attracts most venture capital funds. Besides that, the life sciences sector (including biotech, MedTech and healthcare) is quite attractive for venture capital investments as well. Partly, this can be explained by the success and dynamism of the Swiss polytechnic universities as well as by the historically strong pharmaceutical and biotechnical industry in Switzerland.
2) Do venture capital funds require any approvals before investing in your jurisdiction?
Depending on how a venture capital fund is structured and how it conducts its business (i.e., incorporating or running permanent business operations in Switzerland vs. conducting investments on a cross-border basis), prior authorization from the Swiss Financial Market Supervisory Authority (FINMA) may be required.
On the transactional level, in the event certain turnover thresholds are met, the regulations of the Federal Act on Cartels and other Restraints of Competition need to be considered (see question 4 below). Further, for transactions in certain industries (e.g., banks, telecom, real estate, etc.), governmental approvals may be required.
3) Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations or governance of an investee entity?
Currently, there are no specific restrictions on investments in a Swiss company's equity securities by foreign venture capital funds. Consequently, the latter can acquire control and thereby influence a company, its operations or governance.
However, it should be noted that anyone who alone or in concert with third parties acquires shares in a company whose equity securities are not listed on a stock exchange (as regards listed companies, see question 6 below), and thus reaches or exceeds the threshold of ownership of 25% of the share capital or voting rights must, within one month from exceeding such threshold, give notice to the company of the beneficial owner(s) for whom it is ultimately acting. Non-compliance with such obligation has severe consequences: the membership rights (in particular voting rights) are suspended for as long as the shareholder has not made the required notification. Financial rights (in particular the right to receive dividends) may only be exercised once disclosure has been made and are forfeited for the period until disclosure is made. In addition, failure to comply with the obligation to disclose the beneficial owner(s) is subject to a fine.
Further, despite the Swiss government's resistance, in March 2020 the Swiss Parliament instructed the government to propose legislation regarding the introduction of a foreign direct investment control regime. The legislative process is expected to take months or even years, and the final outcome cannot yet be predicted, especially given the strengths of promoters and opponents within the Swiss Parliament and the possibility of a potential public referendum.
4) Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
Generally, any direct or indirect acquisition of control over a previously independent entity or parts thereof, including through the acquisition of equity interest or the conclusion of a corresponding agreement, must be reported to the Swiss Competition Commission in the event the following thresholds are cumulatively met in the last business year preceding such transaction: (i) the entities concerned must have reported an aggregate turnover of at least CHF 2 billion worldwide or an aggregate turnover in Switzerland of at least CHF 500 million, and (ii) at least two of the entities involved in the transaction must have reported individual turnovers in Switzerland of at least CHF 100 million.
Irrespective of the turnover achieved, a transaction is subject to the notification requirement if (a) one of the entities concerned has in a final decision been held to be dominant in a market in Switzerland, and (b) the transaction concerns either that market, an adjacent market, or a market upstream or downstream thereof.
Given that the notification must be submitted prior to the completion of a transaction, it is usually filed after the relevant agreements have been signed but prior to completion (typically, merger clearance is structured as a condition precedent to closing). Unless the Competition Commission decides to initiate a four-month phase II investigation, clearance is granted within one month (phase I) after filing the complete application.
5) What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
The vast majority of venture capital investee companies receive financing through equity capital, i.e., by venture capital investors subscribing for newly issued shares in the context of a capital increase. Usually, the issued shares provide for preferential rights, for example relating to dividends and liquidation proceeds. Such preferential rights may be of contractual nature only or be implemented into the investee company's articles of incorporation.
Sometimes, these equity investments are combined with convertible loans or alike instruments, i.e., debt that, provided certain conditions are met, can (or must) be converted into genuine equity participation (mezzanine capital financing). In this context, the convertible lender typically waives most of its security interests by agreeing to a subordination. As a result, the corresponding loan liability does not have to be covered by the investee company's assets when calculating whether or not insolvency proceedings must be initiated. On the other hand, the convertible lender benefits from a right to convert the loan into equity capital of the company at a reduced rate in the next financing round or at the latest at the end of the term (discount). Often, this type of investment/financing is used to bridge finance the investee company until the next equity financing round, when the loan is converted into shares.
6) Is there any restriction on rights available to venture capital investors in public companies?
There is no specific restriction on rights available to venture capital investors in listed companies; securities regulations in Switzerland apply uniformly to all shareholders of a listed company.
In this context, it should be noted that anyone who acquires equity securities which, together with the equity securities already held, exceed the threshold of 331/3 % of the voting rights of a Swiss listed company is obliged to make an offer for all listed equity securities of the company (mandatory tender offer), unless the Swiss Takeover Board grants an exemption or the respective company has either increased the threshold to a maximum of 49% of the voting rights (opting-up) or completely excluded the obligation to make an offer (opting-out).
Furthermore, anyone who exceeds certain thresholds of the voting rights in a Swiss listed company (the lowest threshold being 3%) is obliged to notify the respective company and the stock exchange (disclosure obligation).
7) What protections are generally available to venture capital investors in your jurisdiction?
Venture capital investors essentially receive the following contractual protections, some of which may also be included in the investee company's corporate documents:
· Right to be represented on the board.
· Reporting, information and inspection rights.
· Veto rights in relation to certain matters falling within the competence of either the shareholders or the board.
· Representations, warranties and indemnities typically granted by all or some of the existing shareholders.
· Pre-emption rights relating to the issuance of new shares are provided for by Swiss law and can only be withdrawn from a shareholder under certain specific circumstances (the resolution to withdraw the pre-emption right from existing shareholders is usually subject to the investors' consent).
· Restrictions on the transfer of existing shares, such as a general lock-up for a certain period of time, a right of first refusal/preemptive rights, and call-options. Moreover, the investee company's articles of incorporation usually provide for transfer restrictions enabling the board to refuse a transfer in certain situations.
· Anti-dilution protection.
· Preference relating to dividends, sales and liquidation proceeds.
· Agreement of the key employees to a minimum duration of their employment with the investee company.
· Incentivizing key employees by way of implementing good/bad leaver provisions.
· (Post-contractual) non-compete and non-solicitation undertakings of the founders, which, under mandatory Swiss law, however, are subject to various limitations and entail uncertainties regarding their enforceability.
· Mandatory accession to the shareholders' agreement for any new shareholder.
· Exit rights such as drag-along and tag-along rights, put and call options, as well as certain rights relating to initiating an IPO or a trade sale.
8) Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
Historically, warranty and indemnity insurance was only rarely agreed upon in Switzerland. However, as a result of more attractive insurance solutions (lower premiums, a more efficient process for the conclusion of an insurance policy, increasingly flexible insurance packages, etc.) and due to the current sellers' market, the number of warranty insurance policies has increased significantly in recent years. Investors generally prefer it in high value transactions.
From a legal perspective, it should be noted that, in principle, liabilities arising from known matters, facts identified in the due diligence or information otherwise disclosed by the seller(s) cannot be covered by warranty and indemnity insurance. In addition, the following risks are typically excluded by the insurance policies as standard and are, therefore, not insurable with a customary warranty and indemnity insurance: (i) fines or penalties, (ii) product liability, (iii) pension underfunding, (iv) certain environmental matters, (v) forward-looking warranties, (vi) certain tax matters, (vii) fraud, corruption or bribery and (viii) purchase price adjustments as well as non-leakage covenants in locked-box deals.
As the underwriting process is running in parallel to the investment transaction process, the insurance policy must be negotiated with selected insurers while negotiating the transaction contracts, which makes the transaction process, from a practical point of view, even more demanding. In addition, although the insurers are able to quickly and professionally push ahead with the conclusion of a warranty and indemnity insurance policy, at least two to three weeks should be scheduled for this.
9) What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
The investment period of venture capital funds typically is about three to five years. Depending on the situation of the investee company and the other shareholders' perspectives, an exit may take various forms: (i) sale of the entire company to a third party (trade sale), (ii) sale of the venture capital investor's shares to a third party (typically a larger corporation or a financial investor) while the remaining shareholders keep their shares (partial trade sale), (iii) sale of the venture capital investor's shares to other shareholders or managers (buy-out), (iv) listing of the investee company and sale of the shares on the public market (IPO, cf. below question 10), or (v) liquidation of the investee company.
Provided the investee company is successful, trade sales represent the most common exit route for venture capital investors in Switzerland. The advantages of a trade sale are that it usually can be achieved within a short time frame and involves lower transaction costs (compared to the transaction costs of an IPO). In addition, such approach allows the selling investor to get a control premium and to exit completely. Further, the respective transaction may remain confidential. Disadvantages, on the other hand, include that a change of control may have an adverse effect on the business partners and the employees. Additionally, even if a trade sale may be performed fairly rapidly, potential deferred purchase price components, such as earn-outs or escrows, might delay and reduce the venture capital investor's final pay out.
10) Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
Public market exits via an IPO are not very frequent in Switzerland. This might be related to the fact that the process of an IPO consumes considerably more time and causes higher transaction costs compared to a trade sale. Other reasons might be that the investee company as well as the remaining investors become subject to additional obligations and restrictions under Swiss securities laws and exchange regulations (e.g., financial reporting, compensation of the board, ad-hoc publicity, disclosure of major shareholdings, etc.). Moreover, underwriters typically require important shareholders as well as members of the board of directors and the executive management to commit to lock-up undertakings for a period of 6 to 18 months after the IPO. Nevertheless, an IPO also includes advantages: first, an IPO is an attractive financing option for companies seeking to raise a large amount of money while retaining control over at least a portion of the voting rights. Further, investors who do not sell their entire participation may benefit from an increase in the value of the investee company's shares following the IPO. Finally, the management is likely to support an IPO given the fact that they usually remain in control of the company's business.
CMS von Erlach Poncet
Dr. Stephan Werlen, LL.M.
Want to Learn More?
The objective of this publication is to serve as a Q&A-style multi-jurisdictional guide to venture capital law in countries where WLG member firms have offices. The guide intends to provide a high level overview of the venture capital market, including key sectors, preferred investment structures, regulatory approval requirements, limitations on acquisition of control in portfolio companies, restrictions on investment, investor protection, and exits; and hopes to provide readers the benefit of the shared global knowledge and local insights among the WLG member firms.