Expert Views: Shareholding as a Service: A New Way for Lenders to Maximize Value as German M&A Market Falters

Editor’s Note: In the latest installment of the Expert Views series, Octus’ Reporter Sidney Watson speaks to Tobias Moser, founder and partner at MR Corporate Solutions, on how German lenders are using shareholding as a service to operationally restructure companies they have enforced on and secure better recoveries while M&A remains weak.

As Germany’s economy struggles and distress levels climb (see below), a growing number of lenders are having to enforce on their collateral and take the keys to companies. But a faltering M&A market in Germany is making quick exits difficult, requiring lenders to hold on to companies for longer to operationally turn them around and wait out the downturn to maximize their recoveries.
 

That has given rise to a new solution: shareholding as a service, or ShaaS. The service sees a restructuring professional step in as the company’s legal and economic owner via a special purpose vehicle, or SPV, while the lenders who took control of the company don’t need to recognize or consolidate the equity on their balance sheets, which enables them to keep the company legally and financially at arm’s length.

“This is actually an alternative to a classic sale to a turnaround or financial investor, and also an alternative to insolvency,” says Tobias Moser, founder and partner at MR Corporate Solutions, or MRCS, one of the advisory firms offering the service. With few buyers currently willing to pay decent prices for distressed German assets in the slowing M&A market (see below), ShaaS has become an increasingly popular third option, he says.
 

ShaaS, Moser explains, either involves a carve-out of a troubled entity from a group, which the service provider takes ownership of and restructures – an “equity-driven situation” – or a scenario in which the service provider takes on the equity of an entire struggling group to facilitate a restructuring of that group. The latter – what Moser and his MRCS colleagues call “Restructuring as a Service” – is the one this article focuses on.

The thread running through these situations is lenders taking over a company after a shareholder cannot or will not put in any more funds. The focus for the lenders is therefore to “get the current shareholder out of the game and to have someone in control who actually drives these kinds of situations for a living” in order to maximize the company’s value and get the greatest recovery on their debt exposure at exit, Moser says.

While a financial restructuring may only take months to implement, the operational restructuring that accompanies it can often last two or three years, requiring a ShaaS provider to steer the ship after lenders have wrested control from the sponsor, Moser explains. Service providers can help bridge the time between the financial restructuring and the exit sale.

“Germany is currently undergoing a crisis in many industries: it is really hard for many businesses to find buyers, and if they do, prices are often punitive. So, it makes sense to give some time to get more of a recovery through such a structure.”

A Closer Look at the Mechanics

In practice, MRCS and similar providers typically acquire the operating company through a German SPV that acts as the holding company (MRCS SPV in the diagram below).

Depending on the financing situation, the acquisition can be combined with a double LuxCo structure. In that case, a newly established holding company (SPV 1 in the diagram below) and a second special purpose vehicle (SPV 2 in the diagram below) are set up to allow for a possible debt hive-up to SPV 2. Luxembourg is commonly chosen as the jurisdiction for both SPVs because, unlike under German law, overindebtedness alone does not trigger a duty to file for insolvency there. In addition, Luxembourg law is regarded as creditor-friendly with regard to the enforcement of security.

SPV 2 then takes on a percentage of SPV 1’s total debt package, leaving SPV 1 and the operating company no longer overindebted, and generating enough cash flow to service the remaining debt. The ShaaS provider then takes the lead and implements operational measures to improve the performance and increase EBITDA.

After a transitional period, the structure is sold to a third party including the outstanding debt, and any surplus cash proceeds are used to repay debt at the SPV 2 level. Write-down only occurs if the sale is at a lower value than expected, and a portion of the debt cannot be repaid on SPV 2, or on rare occasions at SPV 1 level.

MRCS does not participate in the residual equity value as an investor. Instead, it receives a restructuring fee, alongside a success-based component linked to the value fetched on exit and the resulting debt recovery, to incentivize the ShaaS provider to achieve the best possible outcome for the financing institutions.

Despite taking ownership of the company, the ShaaS provider doesn’t usually put in its own funds unless it is priced in advance as a buffer. However, lenders don’t usually want to pay the service provider to fund a company. “If the banks want that, they can put the money directly into the company, they don’t need the service provider for that,” Moser points out.
 

To date, the service has mostly been used by German banks, according to Moser, due to banking regulations that don’t allow all debt providers to take equity onto their books, unless certain restrictions are in place. Another driver is the German statutory regime for shareholder loans and the banks’ desire to avoid equitable subordination. Where a lender also holds a relevant equity interest, certain shareholder loan claims may become subordinated in the case of insolvency, and security or repayments relating to such claims may be subject to insolvency avoidance rules.

Though banks are the most common users of the service, Moser adds that private credit lenders have also used ShaaS in situations where they do not want to take the company’s equity onto their own books, especially if their fund rules or investment mandate does not cover equity positions. He said he expects that more credit providers will turn to the solution as M&A activity in Germany continues to stall.

It is likely that the tool has been used in the latest restructuring of German commodities, construction and energy producer BayWa, according to Moser, who added he expects to see usage of the service rise.

“We are seeing an increasing number of these types of situations due to the fact that M&A markets are, at least in Germany, quite disturbed with a large number of broken deals, so a straight sale of assets is often not an option; you don’t find the right buyer or you don’t get sufficient prices for the asset,” Moser says.

Toeing the Line: Control vs. Deconsolidation

The ShaaS providers take on the legal and economic responsibility for the company. They are intentionally untethered from the lenders, but are seeking to maximize the value of the company, so that the lenders can get a better return. That involves a leap of faith from the lenders, having to give up direct control.

MRCS and similar providers are usually not initially mandated by a bank. Instead, the lenders, after enforcing on the equity, tell the borrower that they need to install a new management and have a new shareholder, but there is no direct agreement between the lenders and ShaaS provider.

“Technically speaking, they are not the clients, but obviously, given they initiated the process, you’re very willing to take their interests into consideration.”

Nonetheless, Moser admits it can be difficult to align with lender interests while being “careful not to cross the line into the lender being seen as the commercial owner of the business,” adding that it comes down to a trade-off between control and trust.

If lenders want full control, they must install a trustee, but then they will be viewed as the owner from a legal and balance-sheet accounting perspective, no matter who’s actually holding the shares. Conversely, if they do not want to consolidate the asset onto their balance sheet, then they need to put in place someone they can trust.

“What we always say to the lenders is, you can’t have everything – control and full deconsolidation,” Moser stresses, “So, decide what’s more important for you and structure it in that way.”

Aligning the ShaaS provider’s interests “with those who actually put him in the chair” without a contractual obligation requires both trust in the provider and creating a payment incentive, the latter of which is paid out of the company structure, rather than by lenders, Moser points out.

These incentives depend on the market standard, but can include change-of-control clauses triggering a default if the service provider sells prematurely, other financial covenants or an additional success fee paid following the ShaaS provider’s exit from the company. However, neither the company nor the lenders can withhold payment if the service provider does something different to the lenders’ wishes, and the lenders cannot give them formal instructions, Moser cautions.

He also recommends commissioning a memo or expert opinion, stating that the structure of the ShaaS is acceptable from an accounting perspective, and explaining why the equity does not have to be consolidated by the lenders. The memo differs from a German restructuring opinion, or IDW S6, or a certificate proving a company is not insolvent, the IDW S11. The memo is also important as it can come to a different conclusion if the respective lender is applying German GAAP (HGB) or IFRS accounting methods.

Despite these safeguards, Moser admits that it “can’t be ruled out completely” that a lender crosses the line into economic control, and someone complains that the banks or other financial institutions are the economic owner of the company.

But if lenders avoid including clauses in the documentation that only shareholders would have – for example, back-to-back agreements with the shareholding providers and any sort of proceeds turnover agreements – then Moser says there is very little reason to argue that ShaaS is merely a trusteeship for the banks.

Regardless, the difficulty with identifying where the line between lender alignment and economic independence lies also underlines that ShaaS is quite new, and to Moser’s knowledge, has not yet been challenged by accountants or authorities.

“These kinds of structures are currently being worked on, but we are not yet seeing a lot of exits and even less litigation on them,” Moser says. “If it comes to that, then it will be very interesting to see the concrete documentation basis on which it has been challenged, because it’s been done very differently by players in the market with varied approaches.”

An ‘Entrepreneurial Spirit’

Though ShaaS is a relatively new development, Moser admits “we have seen similar concepts before,” pointing to more than a decade of experience executing trusteeships for companies in similar situations. However, ShaaS differs from trusteeship because there are no contractual bindings and no back-to-back agreements between the shareholding provider and the lender who initiates it.

Moser also thinks there is more to ShaaS than just a “tick-the-box trustee,” given the ShaaS provider has more of an “entrepreneurial spirit,” taking an active role as a shareholder and driving the restructuring. The shareholder is “responsible for it, he is the economic and legal owner and if it fails, it fails – he has no one else to blame on,” Moser states.

Nonetheless, ShaaS does not make mandatory filing and directors’ duties obsolete. If, despite the ShaaS provider’s best efforts, the company becomes insolvent, the management or in their absence the shareholder, has to file for insolvency, Moser adds.

In that situation, the company’s lenders usually retain the benefit of their security package, so they would be able to enforce the security or possibly request it from an insolvency administrator.

“If the possibility of insolvency is approaching, the bank has to decide what they want, because they are sitting on the debt, so they either can extend the maturities further and give it another try and inject fresh money, or they can simply say enough is enough and enforce, or they state that the maturity is due and the company files for insolvency,” Moser says.

Filing for insolvency is “obviously not a good scenario” for service providers, who are often incentivized by success fees. Given insolvency is not counted as success, the provider is not getting fully paid in that outcome: what Moser terms an “entrepreneurial risk.”

All Quiet: Helpful to the Business or Harmful to Stakeholders?

The service is particularly appealing for private companies, because they do not have to publicize that they have turned to ShaaS. This means that the operational transformation and later sale can be done without disrupting operations and stakeholder relationships.

However, the lack of transparency and market testing could raise some concerns over fairness and the true value of these companies, similar to those triggered in the private credit space following the collapse of subprime auto lender Tricolor and autoparts maker First Brands late last year.

Moser, however, notes that in many ShaaS situations, an M&A process had previously been launched and failed. “There has been a market testing in many cases, but the market was not good enough.”

He also underlines that ShaaS and debt recovery is a bridge to an exit, not the exit itself, as the stakeholders try to give the company time until the market improves, or the company can operationally restructure, before testing the market again, either via a sale or an IPO.

Additionally, the ShaaS provider often has to deal with other stakeholders, including customers or landlords, to ensure a change-of-control clause is not triggered in any other contracts – outside of the financing documents, which are addressed at the start of the process.

Moser says that in practice the other stakeholders are “quite happy” with the use of ShaaS because it means that a financial restructuring is getting done, and is often accompanied by lenders putting in fresh money, predicated on the removal of the prior sponsor.

Landlords, customers and any other parties that are contracted to the company are “usually happy to waive or amend in these kinds of situations, because the company is on a more stable basis than it was before, given it is no longer on the brink of insolvency,” Moser adds.

Luxembourg: Avoiding Insolvency or Forum Shopping?

Germany’s insolvency rules explain the choice of a Luxembourg SPV 2, despite ShaaS being deployed almost exclusively in German situations. Moser notes its structure is designed specifically to avoid triggering an insolvency filing, something a German SPV 2 could not do.

Germany is one of very few European countries in which overindebtedness – where liabilities exceed assets on a liquidation basis – may itself constitute a trigger for mandatory insolvency filing. Since that condition typically applies to a distressed situation, a new shareholder stepping in without fresh money would be forced to file for insolvency on day one, which goes against the purpose of ShaaS.

“It doesn’t make sense to set up a structure that has to go to insolvency in Germany, because you’re doing all of this in order to avoid insolvency,” Moser says.

Luxembourg also offers a “more lender-friendly environment,” given enforcement through a double LuxCo is far quicker than a comparable share-pledge enforcement in Germany, he adds, cautioning that using such a structure only makes economic sense for larger situations, given the increased cost involved in retaining local lawyers and tax advisors in any new jurisdiction.

Asked whether German or EU regulators could start treating this as forum shopping, in the way some liability management transactions have drawn scrutiny, Moser states he doesn’t see any risk, since the issue raised by judges and regulators regarding forum shopping in restructuring, often centers on switching the seat of the operational company to another country, which is not the case under the usual ShaaS structure.

“The holding structure set up by lenders or the ShaaS provider was never present in Germany so nothing has changed there, and the operating company was always in Germany, where it stays,” Moser says. “You have nothing that has been historically in one place and has been switched to another place, you are just setting up a new structure on the level above the operating business.”

He adds that Luxembourg has been used for these types of business structures across Europe for “quite some time and is well established,” reducing concerns for the usage under ShaaS.

For now, Moser says, ShaaS remains largely a German phenomenon, driven in part by the country’s shareholder-loan subordination regime, regulatory and accounting considerations affecting certain lenders, and a domestic M&A market that has left few other exit options available. Awareness of the service outside of the country is thin, though he argues that’s a gap larger U.S. and London-based funds should close, calling ShaaS a “more sophisticated” option worth having on hand for German distressed situations specifically.

The volume of deals landing on his desk is itself new, Moser adds – the market environment has increased “the sheer amount and complexity of shareholding situations we are seeing currently” to a degree practitioners haven’t dealt with before. And with Germany’s M&A market showing few signs of a near-term thaw, he said he expects that volume to keep growing. ShaaS’ real test still lies ahead, as providers strive to deliver recoveries for lenders through eventual exits of the companies they took over.