A European fund has issued a term sheet, and somewhere in the conditions precedent sits a sentence that reads as administrative but is not: the investment will be made into a company incorporated in the European Union. Founders and CFOs frequently treat this as a formality to be cleared between signing and closing. It is not. It is a request to rebuild the ownership, governance and reporting layer of the group before anyone has agreed what that layer should look like, and it arrives when leverage is thinnest. The question is not whether to comply. It is what you decide before due diligence begins, because almost every decision taken after that point is taken under someone else’s timetable.
Why the fund is asking
Four motives usually sit behind the same clause, and they carry different degrees of negotiability.
The first is investment policy. Many European funds are constrained by their own limited partnership agreements as to where portfolio companies may be domiciled. Regional mandates, state-backed co-investment programmes and institutional allocators impose geographic tests that are hard-coded and not waivable by the general partner, however sympathetic that partner may be. Where the constraint is of this kind there is no negotiation, only execution.
The second is legal familiarity. A fund’s counsel prices risk according to what it can read. A Dutch BV with a shareholders’ agreement drafted to continental conventions is a known quantity: directors’ duties, minority protections, the enforcement route and the insolvency ranking are understood without a foreign law opinion. The same investment into a jurisdiction the fund has never litigated in carries a legal-uncertainty premium, usually reflected in the price or the warranty package.
The third is governance. Funds do not simply want shares; they want a board seat, information rights, veto rights over defined matters and a mechanism to enforce them, and those mechanisms must attach to a corporate form that recognises them. A structure built for founder control and administrative simplicity rarely accommodates a professional investor without substantial amendment.
The fourth, less often stated, is reputational and regulatory. Funds subject to sustainability disclosure obligations and anti-money-laundering diligence have limited appetite for a chain of ownership that is hard to explain to their own investors. Transparency of beneficial ownership matters here: the Dutch UBO register held at the KVK exists to record it, though public access was restricted following a judgment of the Court of Justice of the European Union in November 2022.
A fund is not asking you to move a company. It is asking you to produce, before closing, the governance and reporting apparatus that most groups only build after their first serious dispute.
What a European entity actually means
The phrase is imprecise, and imprecision at term-sheet stage becomes expensive at completion. It may mean incorporation in an EU member state; tax residence there; the top holding company of the group being European; or the operating business itself being European. These are not the same requirement and do not carry the same consequences.
The most common formulation is that the fund subscribes for shares in a European holding company sitting above the existing operating entities. That leaves the trading business where it is, preserving customer contracts, licences and employment relationships, while placing the investment where governance and exit can be organised. It also raises questions most groups have not yet answered: whether the holding company will hold anything else, whether it will charge for services, and whether it has the substance to be treated as resident where it is incorporated rather than where its directors actually sit.
The Netherlands is a frequent answer because the toolkit is conventional rather than exotic. Corporate income tax runs at 25.8% in the upper bracket with a reduced rate in the first; the participation exemption removes qualifying dividends and capital gains from the base, which is what makes a holding layer neutral rather than an additional point of taxation. That exemption is not elective. It is mandatory and symmetric, so losses on qualifying holdings are equally outside the base, and it depends on a minimum shareholding together with the motive, subject-to-reasonable-tax and asset tests. The mechanics are set out in our note on how the participation exemption operates in practice.
The corporate form question
The Dutch toolkit offers the BV, the NV, the cooperatie, the stichting, the STAK, the CV and the VOF. For a funded holding company the candidates narrow quickly. The BV is the default: private, flexible as to share classes, familiar to European fund counsel, incorporated by Dutch notarial deed and registered with the KVK. The NV becomes relevant where a listing is genuinely contemplated. The cooperatie has its own profile and its own consequences on distribution, and is not a substitute chosen for convenience. The STAK is a separate instrument, separating economic entitlement from voting control; it is a layer sitting alongside a holding company rather than an alternative to one.
What matters is that the form supports the share class architecture the fund will require. Preference shares with a liquidation preference, anti-dilution mechanics, conversion provisions and separate voting thresholds by class are ordinary requests, and a vehicle that cannot accommodate them without repeated notarial amendment will generate cost and delay at every subsequent round.
What the fund will require beyond the entity
The entity is the container. The requirements attach to what goes inside it, and cluster into five areas.
- A recognisable corporate form with articles readable to the fund’s counsel and consistent with the shareholders’ agreement rather than in tension with it.
- Share classes that reflect the economic deal: ordinary shares, one or more preference classes, and a clear treatment of any option pool, with the dilution consequences modelled before signature rather than discovered afterwards.
- A shareholders’ agreement covering transfer restrictions, pre-emption, tag and drag, deadlock, founder commitments and the consequences of departure. Continental drafting conventions differ from Anglo-American ones on several of these points, and blending the two produces ambiguity.
- Reliable financial information: a defined reporting pack, an agreed accounting framework, statutory filing discipline, and consolidation where the group structure requires it. Funds demand consistency and timeliness, and notice when historic numbers cannot be reconciled.
- Governance with reserved matters: a board with defined composition, a list of decisions requiring investor consent, and a workable process for taking them. These design questions are treated at length in our note on governance design for Dutch holding companies.
Decisions to take before due diligence opens
Diligence is not the moment to form views. By then every open question becomes a disclosure item, a warranty qualification or a price adjustment. The following should be settled first.
Where the top of the group will sit, and why. The reason must be commercial and capable of being stated plainly. Dutch ruling policy since July 2019 requires genuine economic nexus and rules out advance certainty where tax saving is the decisive motive or where listed jurisdictions are involved. A structure whose only rationale is fiscal will not survive scrutiny, and increasingly will not survive the fund’s own diligence either.
How the holding company will be funded. Debt and equity are not interchangeable. Interest deductibility is constrained by the earnings-stripping rule implemented under ATAD, expressed as a percentage of fiscal EBITDA subject to a minimum threshold, and the parameters have been revised over time. Intercompany funding must also satisfy article 8b, which imposes arm’s length pricing and documentation with no de minimis threshold. Master and local file obligations attach from consolidated turnover of 50 million, country-by-country reporting from 750 million, and the Pillar Two minimum rate of 15% applies from that same threshold.
How value will move up and out. Dividend withholding tax applies at 15% in general, with treaty reductions and EU exemptions available, all subject to anti-abuse conditions. Since 2021 a conditional withholding tax applies to interest and royalties paid to low-tax or listed jurisdictions. These are not considerations for later; they determine whether the structure functions.
Whether the holding company will have substance. Directors, decision-making, premises and the capacity to exercise the functions attributed to it. A holding company administered from elsewhere invites a challenge to its residence, and the fund’s counsel will ask about it. Our note on substance expectations covers the current position.
Whether any of this is reportable. DAC6 requires disclosure of cross-border arrangements bearing specified hallmarks, the obligation falling on the intermediary or, failing that, on the taxpayer. Reorganisations undertaken alongside a financing are the category where this is assessed rather than assumed.
The reorganisation itself
Interposing a holding company above an existing group is a transaction. Shares change hands, sometimes at a value that has to be defended. Existing shareholders may realise gains, and contracts may contain change-of-control provisions. Where the group holds Dutch real estate, transfer tax deserves attention: a general rate applies to immovable property, a different rate applies to a dwelling acquired as a principal residence, and acquiring shares in a property-rich company can itself fall within the charge.
VAT treatment of the new entity should also be settled early. A pure holding company is generally outside the scope and does not recover input VAT; one that supplies management services for consideration is within it. Since the reorganisation itself generates advisory costs carrying VAT, the answer has an immediate cash consequence.
What to concede and what to hold
The domicile requirement is usually immovable. The architecture underneath it rarely is. Founders who accept the first draft of the share terms because the entity question felt non-negotiable tend to discover that the two were separable. Resisting domicile on grounds of inconvenience consumes goodwill better spent on reserved matters, information rights and the definition of a qualifying exit.
The structure being built now is the one a buyer will diligence later, and through which the fund will eventually seek liquidity. Designing it solely to satisfy a condition precedent is how groups end up with a holding layer they cannot explain and cannot unwind cheaply.
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This article is informational and does not constitute tax, legal or investment advice. Each engagement is subject to scope and applicable regulation.