Setting Up a Search Fund in Germany: Legal and Tax Structuring

A Traditional Search Fund has its own legal and tax structure before a target has been identified.

Investors finance the search phase. The searcher manages the search. Participation rights and governance arrangements need to reflect this phase and provide a workable transition into a subsequent acquisition.

The search vehicle therefore has its own structural function. Its role needs to be distinguished from the subsequent acquisition structure. Whether these functions are implemented through separate entities or within an existing structure depends on the specific setup.

The search vehicle provides the framework for the search phase

The search vehicle establishes the legal framework between the searcher and the investors during the search.

Its design depends on how search capital is provided, which rights investors hold during the search phase and how the searcher's participation is structured. The documentation also needs to address the rights arising from the financing of the search when a specific acquisition becomes available.

A German GmbH or UG can be used for this purpose. The choice of legal form does not, by itself, fully define the economic relationship between the parties. The articles of association and the relevant investor arrangements need to reflect that relationship.

No specific target exists during the search phase. The subsequent acquisition structure can therefore be prepared conceptually, with its final design being based on the business that is eventually acquired.

Investor rights and governance form part of the same structure

Financing the search phase creates an ongoing relationship between the searcher and the investors.

The corporate framework needs to define the searcher's decision-making authority and the matters that require investor involvement. These arrangements cover the search phase and the transition into a specific acquisition.

Governance directly affects the searcher's ability to act. Extensive consent rights affect decision-making processes. Unclear investor rights can create uncertainty when acquisition capital is required.

Decision rights, information rights and equity participation arrangements therefore need to operate as a coherent framework throughout the search phase and the transition into the subsequent acquisition.

The searcher's participation is part of the structuring

The searcher's economic participation is a central element of the Search Fund model.

Its legal design needs to reflect the searcher's role during the search, the acquisition and the subsequent management of the acquired company. Vesting arrangements, changes in participation and provisions dealing with the searcher's departure can form part of this structure.

These arrangements can also have tax consequences. Their treatment depends on the legal design of the participation and the individual circumstances.

The searcher's participation therefore forms part of the overall structure of the search vehicle, investor rights and the subsequent acquisition structure.

Tax structuring starts before the acquisition

The tax structure of a Search Fund begins with the search vehicle.

The search phase already involves expenditure and capital flows. The legal form, financing and participation structure affect how these items are treated for tax purposes across the relevant entities and investors.

A further level is added when a target is acquired. In a share acquisition, an acquisition vehicle may hold the interest in the target and form part of the financing and distribution structure.

Where a German corporation acts as a holding entity, dividends and gains from the disposal of shares in corporations are subject to different provisions of Section 8b of the German Corporate Income Tax Act. Dividends are subject to separate participation requirements. German trade tax rules also need to be considered, including Section 9 no. 2a of the German Trade Tax Act for qualifying interests in German corporations. The tax treatment depends on the specific ownership structure and the applicable statutory requirements.

The tax structure of the Search Fund and the subsequent transaction structure are therefore connected. The search vehicle, the searcher's participation, the investor level and the acquisition structure need to operate within a coherent tax framework.

The search vehicle and acquisition structure perform different functions

The search vehicle organises the search phase and the relationship between the searcher and investors. The subsequent acquisition structure reflects the specific acquisition and its financing.

This functional distinction does not require separate legal entities. The corporate implementation depends on the specific structure and transaction.

Once a target has been identified, the acquisition structure can be designed around the ownership arrangements, purchase price and financing.

The requirements of a share acquisition can differ from those of an asset acquisition. Seller financing, rollover participation, bank debt and additional equity can also affect the acquisition structure.

Investor rights agreed during the search phase need to work within this later structure, including participation in the acquisition and governance following closing.

Regulatory treatment depends on the actual structure

The term Search Fund does not determine its regulatory classification.

The starting point under the German Capital Investment Code is the specific structure and the requirements of Section 1(1) KAGB. An investment undertaking is an undertaking for collective investment that raises capital from a number of investors with a view to investing it in accordance with a defined investment strategy for the benefit of those investors and is not an operating company outside the financial sector.

The statutory exclusions under the KAGB also need to be considered. Section 2(1) no. 1 KAGB excludes certain holding companies from the scope of the KAGB where the statutory requirements are met. Whether that exclusion applies to a particular Search Fund structure depends on its actual design and purpose.

The chosen corporate form does not determine the regulatory treatment. Establishing the search vehicle as a GmbH or UG does not, by itself, bring the structure within the KAGB or take it outside its scope.

The transition into the acquisition needs to work within the structure

Once a target has been identified, the purchase price, acquisition perimeter, financing and ownership arrangements become sufficiently concrete for the legal and tax acquisition structure to be developed around the transaction.

The arrangements established during the search phase need to support this transition.

Investor rights, the searcher's participation and governance arrangements need to translate into the specific acquisition structure.

A workable structure therefore creates a clear route from the search phase into the subsequent acquisition structure without predetermining the detailed M&A structure.

The acquisition can change the original tax structure

The specific target introduces its own tax characteristics.

Its legal form, existing group structure, financing, distribution capacity and purchase price structure affect the tax design of the acquisition.

Tax Due Diligence adds further information. Identified tax exposures can affect the acquisition structure, transaction documentation and purchase price.

The tax structure of the Search Fund therefore needs to accommodate the later transaction.

Corporate and tax structuring need to reflect the same economics

The legal and tax structure of a Traditional Search Fund arises from the same economic relationship between the searcher and investors.

The search phase is organised through defined participation and decision-making rights. The acquisition adds the specific acquisition and financing structure and the ownership arrangements following closing.

This creates a practical requirement for the structure: the participation and decision-making rights established during the search phase need to translate into an acquisition structure that works from both a corporate and tax perspective.

CLIQ advises Search Funds on the corporate and tax structuring of the search vehicle and its transition into the subsequent acquisition structure. The specific acquisition can then be addressed through M&A legal advice and transaction tax advisory.