Q1 2021 has been busy for those in the private equity industry, with a number of legal developments potentially impacting on investors and the underlying portfolio businesses they invest into. Short summaries are provided below, together with links to the full articles for those requiring a more in-depth review.
Mid-market M&A barometer
Our colleagues have produced the inaugural edition of our bi-annual Mid-Market M&A Barometer reflecting on the movement of deals annually and by quarter. In our Barometer we share insights and projections for the market utilising data from S&P Global Intelligence and insights from our M&A and Corporate Finance team, coupled with case studies of movements we are seeing in the market.
Our inaugural Mid-Market M&A Barometer finds that:
- U.S. Mid-Market M&A made a recovery in the second half of 2020, with a positive outlook for 2021.
- Mid-Market M&A participants used the first part of 2020 to evaluate strategic approaches and reposition themselves given the uncertainty in the business and financial markets, but showed a willingness to engage in the second half of the year.
- Private Equity continues to play a dominant role in Mid-Market M&A deal activity.
- We expect that increasing confidence and stability in the markets will result in increased Mid-Market M&A activity in 2021.
The report was co-authored by our US colleagues Stephanie M. Hosler and Michael A. Schwartz. Stephanie is also our Global Department Leader – Corporate and Finance Transactions. The full report can be downloaded here: https://www.bclplaw.com/en-GB/insights/mid-market-manda-barometer.html
The evolution of warranty and indemnity (W&I) insurance on PE deals
In the last few years, new features of the W&I product have emerged. This includes contingent risk insurance, which tends to cover “low risk, big number” items for things like tax, title, litigation and environmental. Another new facet has been W&I coverage enhancements, for example:
- “scrapes” whereby the policy disregards awareness or materiality qualifications in the Share Purchase Agreement or extends time limits;
- synthetic policies whereby the Share Purchase Agreement contains no warranties but the insurer nevertheless agrees to cover a set of warranties on the sale;
- zero excess/retention in some sectors (such as real estate) and a small “de minimis”; and
- “new breach cover” where the insurer covers issues discovered between exchange of contracts and completion.
It is likely that COVID-19 will increase the demand for all these features and drive the creation of new ones as buyers, sellers and insurers seek to allocate risk in a highly uncertain climate. The features are clearly advantageous to policyholders and mark a sea change from the old complaints that the product had so many exclusions that it was not worth taking out.
This is an abbreviated summary of a recent article by our UK colleague Adam Bogdanor. The full article is linked here: https://emergingthemes.bclplaw.com/bclp-emerging-themes-2021/take-cover
Private Equity public deals/take-privates
Private equity funds are now arguably the dominant force in global M&A. Over the last decade, fund sizes have continued to balloon, PE sponsors’ appetite for leverage has remained strong and debt markets, stoked by a decade of ultra-low interest rates, have made available a wall of cheap credit. Buoyed by the amount of capital ready to be deployed, incentivised to do deals and frequently involved in unwelcome auctions for privately held assets which have also often already had a lot of the fat rendered from them during prior rounds of PE ownership, PE investors have increasingly become key players in public takeovers.
Although bidders in the UK cannot under the Takeover Code benefit from many of the advantages that they enjoy when doing private deals such as confidentiality, exclusivity and break fee arrangements, bids for public companies allow PE sponsors to deploy large amounts of capital and often to pick up assets that are poorly understood or relatively undervalued by traditional institutional investors. In addition, PE sponsors are able to re-engineer the balance sheets and business models of ex-public companies once delisted in ways that are often almost impossible while listed and are therefore subject to pressures of achieving consistent performance and meeting consensus forecasts. PE sponsors can also tempt management teams with incentive packages linked to out-performance that are many times greater than are now acceptable in public companies – and all out of the public gaze.
With many traditional corporates now saddled with debt from the pandemic, it is expected that deep-pocketed PE sponsors (who are themselves largely unaffected by additional debt in their portfolio companies) will both continue to enjoy massive financial firepower and be able to exploit relatively depressed valuations in many parts of the public markets in at least the short term (the UK market’s FTSE 100 having essentially moved sideways for 20 years).
BCLP’s London public markets and PE teams, which sit within the wider M&A team, have acted on numerous “P2P”/”Take-private”/”public to private” deals and together with colleagues in Banking and Employee Benefits are experts in planning, financing and executing these deals. For further details please feel free to contact Nick Myatt (London Corporate) https://www.bclplaw.com/en-GB/people/nicholas-myatt.html
Investor trends – direct acquisition of fund and asset management platforms
A recent trend in the commercial real estate sector has been the acquisition of fund and asset management platforms by investors. Whilst not a new concept, traditionally real estate investors have typically favoured a more classic deal structure by which they acquire a portfolio outright (either alone or via a joint venture or consortium), or alternatively by investing into a fund as one of several passive limited partner investors.
There are now a couple of recent high profile examples in the market of direct acquisitions of management platforms. Oxford Properties Group, the real estate arm of Canadian pension fund OMERS, recently acquired European investment and asset manager M7 Real Estate. The €51bn real estate investor said it was making the acquisition as part of plans to deploy £3bn into multi-let industrial and urban logistics across Europe. M7 Real Estate, which manages about €4bn of assets on behalf of third-party investors, will continue to operate as a standalone business. This isn’t the first fund management business acquired by Oxford Properties. In 2018 it acquired the Investa Office Fund in Australia and in November 2020 bought a stake in Investment Office Management Holdings.
Meanwhile Stockholm-based EQT AB has signed a deal to acquire Exeter Property Group, a global real estate investment manager with more than USD10bn of assets under management, for a total consideration of USD1.87bn, comprising new EQT AB shares worth USD800m and USD1.070bn in cash, including refinancing of USD300m of existing Exeter debt. The consideration is reported to equate to a mid-teens EBITDA multiple. EQT AB will acquire 100 percent of the Exeter management company and 25 percent of the right to carried interest in selected existing Exeter funds. In addition, EQT AB will be entitled to 35 percent of the carried interest of future funds.
Looking slightly further back, a team at our firm was involved as legal advisers on the formation of joint venture company Resolution Property Investment Management between Fosun Property and Resolution Property, creating Fosun’s exclusive investment manager to invest in value-add real estate opportunities in 14 countries across Europe. Fosun Property is the global real estate investment & management platform of Fosun Group, a leading investment group from China.
For the manager, such transactions potentially gives them an aligned cornerstone investor for each fund they raise plus scale and access to a greater pool of capital, which can be significant as the sector continues to evolve with new real estate technologies, e-commerce, evolving supply chains and smart buildings. For the investor, these transactions provide diversification into new asset classes and geographies, exposure to another part of the value-chain via fee income and a share of the carried interest as well as the addition of new management team expertise and a more guaranteed pipeline of assets. The manager will also bring with it relationships with its existing fund investors, which can be particularly significant in new territories where it is desirable to team up with local partners.
Typically these transactions will be structured using a mixture of cash and non-cash consideration and any share consideration will be subject to a lock-in period to keep and incentivise management going forward. Depending on the deal size they will also be subject to usual completion conditions, including regulatory and competition/anti-trust filings and clearances.
In the real estate sector the fund manager role itself involves managing the portfolio assets on behalf of others, making investment decisions, maximising value and dealing with downside risks. In a real estate context this can be complex and specialised work given the physical nature of the assets, the risks of damage and deterioration over time and the intricacies around construction, development, financing, insurance, letting and selling and so on, plus the complex taxation treatments that usually overlay all of this. The asset manager role is distinct from that of a real estate property manager, who handles the day-to-day activities relating to a property's operations and physical structure.
As with most fund structures, the manager receives a fee from the fund vehicle (traditionally a limited partnership). This is usually formed of annual fees based on the size of investor commitments, assets or net assets of the fund, fees for specific transactions, and fees (carried interest) based on the performance of the fund. The manager is often referred to in business jargon as the general partner of the fund, but in reality the roles are different and the general partner is often a wholly-owned subsidiary of the fund manager and ring-fenced as a special purpose vehicle company with few or no assets of its own. This is due to the fact that the general partner has unlimited liability for the debts of the partnership fund. For this reason each separate fund will have its own general partner, so as not to run the risk of cross-default across different funds, whereas the fund manager may be engaged to advise multiple funds at any one time.
With intense competition amongst investors, easy access to funding and a widespread appetite for new ways to invest, it is likely that the trend to acquire management platforms will continue to grow in the sector as we emerge from lock-downs and the market adjusts to life in a post-pandemic environment.
This is part of an article by Ian Ivory and our UK colleague Sam Narula. https://www.bclplaw.com/en-GB/people/samant-narula.html
Funds First Spring Update
Our funds team have put together a snapshot of some of the main developments and upcoming changes that we think will be of interest to fund managers, fund investors and to the funds sector as a whole. Despite the ongoing focus on COVID-19, regulators and legislators have still been busy and there is much that managers and investors should be keeping watch on over the next few months. In particular, there is news of HM Treasury’s review of the UK funds regime and of the European Commission’s review of AIFMD. We take stock of the outlook for funds post-Brexit, including an update on ESG developments and DAC 6, as well as what to expect from the revised UK financial promotion approval regime.
The full article by our UK colleagues Matthew Baker and Chris Ormond is linked here: https://www.bclplaw.com/en-GB/insights/funds-first-spring-update.html
Private Equity UK tax developments
As part of an initiative to promote funds the UK government is proposing a beneficial new tax regime for asset holding companies (AHC) in investment fund structures. This is intended to make the UK a more competitive location for holding companies, recognising that increasingly there are reasons to locate these entities in the same jurisdictions as the funds themselves. One of the fund sectors that may be interested in the new regime is private equity.
But there are challenges. One is creating a regime which is sufficiently simple and certain to compete with established regimes, such as in Luxembourg. The consultation on AHCs is wide-ranging at this stage. Many ideas are being considered, with scope for fine-tuning down the line. In terms of timing, we are expecting the regime to be introduced in the Finance Act 2022 with draft legislation being provided this year.
What structures will be eligible? The base case is that an AHC should be wholly owned by a widely held qualifying fund or funds. These could be a collective investment scheme (CIS) or an alternative investment fund (AIF), or maybe even a REIT. Helpfully, the government is also considering allowing more diverse investors to invest directly in the AHC without setting up a fund vehicle, provided in either alternative the AHC is essentially widely held by investors.
The UK government proposes that the AHC’s assets are managed by an independent asset manager, rather than the owners, and for a fee. This asset manager would in turn need to prove its credentials by being authorised or registered for the purposes of asset management and be regulated. The condition that the manager be independent from the investors may prove a stumbling block for some, e.g. an AHC wholly owned by one or more institutional investors. But there may be a special exception to allow asset managers to hold a carried interest in the AHC, subject to a cap.
There will be a limit to the activities the AHC can undertake. Its role is what it says on the tin – it’s there to hold assets and also facilitate flows of capital, income and gains between investors and investment assets. The government is thinking of prohibiting any form of trading, which may be relevant to a private equity fund.
What will the benefits of the AHC regime be? The aim is for any UK tax leakage in the AHC to be limited. The ultimate goal is to ensure no significantly worse outcome than if the investors had invested directly in the underlying assets. Income profits in the AHC will be taxable, but only taxable proportionate to the AHC’s limited role of facilitating income and capital flows between investors and the assets.
In relation to capital gains, relief would be given so that the AHC does not generally pay tax on capital gains provided they are either returned to investors (where tax may be paid instead, depending upon the nature of the investors) or reinvested. Significantly, an absolute exemption is not being considered, so there could be an exit charge on leaving the AHC regime. This could be in the form of an immediate tax charge on capital gains that have not been returned to investors or reinvested and a subsequent tax charge on cumulative gains when the AHC’s assets are sold after leaving the regime. The risk of an exit charge is an unattractive aspect of the proposals in contrast to other jurisdictions. This is particularly the case given limits on the investor eligibility criteria conferring AHC status; it may narrow the category of buyer an investor could sell an AHC on to.
Significantly for private equity, the government is thinking of allowing returns to investors to be streamed so that a capital receipt in the AHC is treated as capital when returned to investors, however that return is structured. So a capital profit paid up to the investor by way of a share buy-back would be capital, not income. Whilst welcome, this streaming is likely to create complexity.
Other benefits being considered to save administrative costs and tax for investors are:
- an exemption from withholding tax on interest paid by AHCs – this would avoid the need to claim tax treaty benefits or alternatively list a quoted Eurobond; and
- an exemption from stamp duties on selling equity and debt interests in the AHC.
Some reporting is envisaged. The degree of compliance is likely to depend upon the degree of the regime’s complexity. It is proposed the AHC will elect into the regime rather than enter it unintentionally.
Now that the second round of consultation on this new regime has closed we await with interest whether the UK government has listened to the calls from industry to devise a regime that can compete with Luxembourg.
This is a summary by our UK colleagues Anne Powell and Matthew Poole.
Data protection representatives
The concept of the Article 27 representative (Representative) is common to both the UK GDPR and the EU GDPR (the EU General Data Protection Regulation (2016/679)). It is the key part of the mechanism by which the territorial reach of the legislation and its enforcement is extended beyond the borders of the UK (in the case of the UK GDPR) or beyond the EU (in the case of the EU GDPR).
Under the UK GDPR, a Representative is an individual, company or organisation located in the UK which is “designated in writing” by an entity which lacks a UK presence but which is nevertheless subject to the UK GDPR under Article 3(2). This can happen for example where, as explained below, the appointing entity is targeting the offer of goods or services to individuals who are located in the UK. The obligation to appoint a Representative applies to processor entities as well as controller entities.
An Representative is mandated (usually under a written service contract) to act on behalf of the appointing entity with regard to certain of its obligations under the UK GDPR or EU GDPR as the case may be. In the UK this would primarily involve facilitating communications between a non-UK established entity and the UK’s supervisory authority, the Information Commissioner’s Office (ICO) or with any affected data subjects in the UK. Once appointed, an organisation is required to provide data subjects with the identity and contact details of its Representative.
Organisations that are based outside of the UK and which do not have a branch, office or other establishment in the UK are required to comply with UK GDPR in accordance with Article 3(2) where they process personal data in relation to:
- the offering of goods or services to individuals who are located in the UK (in a targeted way), or
- the monitoring of the behaviour of individuals who are located in the UK.
Complying with the UK GDPR means that such an organisation is required to appoint a Representative in the UK unless the organisation’s processing:
- is occasional, i.e. outside the regular course of business or activity of the organisation;
- does not include, on a large scale, processing of special categories of personal data or processing of personal data relating to criminal convictions and offences; and
- is unlikely to result in a risk to the rights and freedoms of natural persons, taking into account the nature, context, scope and purpose of the processing.
The EU GDPR applies a substantially identical set of rules.
Under the UK GDPR, the Representative should of course be in the UK. Under the EU GDPR, this is more nuanced. A Representative should be located in one of the EU Member State where individuals whose personal data are being processed, are also located. When selecting the location (and qualities), an organisation will want to ensure that the Representative is in a position to communicate efficiently with supervisory authorities and data subjects.
The end of the Brexit transition period on 31 December 2020 triggered the following potential changes in terms of the obligation to appoint a Representative for affected organisations:
- Companies outside the UK which are subject to the UK GDPR need to appoint a UK Representative; and
- Companies in the UK (with no EU branch, office or other establishment) which are subject to the EU GDPR need to appoint an EU Representative.
The UK’s data protection regime looks set for a period of change in 2021, notwithstanding the significant impact already brought about by Brexit. Businesses with UK operations or customers will need to be alert to these regulatory changes and monitor developments carefully.
This is an abbreviated summary of a recent article by our UK colleagues Kate Brimsted, Geraldine Scali, Tom Evans and Jack Dunn. The full article is linked here: https://www.bclplaw.com/en-GB/insights/the-data-and-brexit-digest-data-protection-representatives.html
Key vaccination issues for UK employers
Our UK employment team has considered some of the most pertinent issues arising from the Covid-19 mass vaccination programmes.
Can an employer require an employee to be vaccinated?
No. The Public Health (Control of Disease) Act 1984 provides that individuals must not be compelled to undergo any mandatory medical treatment or vaccination. In addition, employees may have the protection of Article 8 of the European Convention on Human Rights which provides that individuals have the right to not be physically or psychologically interfered with. Furthermore, any forced vaccination is likely to amount to a criminal offence.
What are the discrimination risks associated with vaccination?
Discrimination issues may arise either as a result of compelling employees to take the vaccine or putting in place measures which are detrimental to those employees who have not taken the vaccine. The two key risks are likely to be disability discrimination (where an employee is unable to get the vaccine because of a health condition) and religious or philosophical belief discrimination (where, for example, there may be concerns for vegan employees due to animal testing on the vaccines).
What impact will vaccination have on the COVID-secure workplace?
As well as the fact that no vaccine will be 100% effective, there will be populations in the workforce who cannot or will not be vaccinated. Accordingly, employers should be cautious (irrespective of government guidance on the point) about removing any COVID-secure measures in the medium to long term.
Can employers contractually oblige employees to be vaccinated?
It seems likely that those employees who are reluctant to be vaccinated will also object to a contractual requirement to be vaccinated. Without employee consent, employers would either have to unilaterally impose the change or terminate and re-employ on the new terms. Both options carry significant risks, particularly when the change is so controversial and may have an impact on the health of the employee. On that basis, it is unlikely that many employers will want to take this route.
What other options are open to employers when employees refuse to be vaccinated?
Employers will need to consider how best to achieve voluntary vaccination within their workforces. Winning hearts and minds will be crucial. Educating the workforce and consulting with employees and, where relevant, their representatives, may contribute towards voluntary take-up of the vaccine.
Can an employer refuse to let an unvaccinated employee enter the workplace?
Careful consideration will need to be given as to whether it is appropriate to stop those who have not been vaccinated from entering the workplace. Such an approach could potentially give rise to discrimination claims. Employers should consider other alternatives, such as working from home or COVID testing of employees who are not vaccinated.
Is it possible to discipline or dismiss an employee who refuses to be vaccinated?
ACAS guidance suggests that a refusal to be vaccinated could, in some situations, result in a disciplinary procedure. However, this would depend on whether vaccination was necessary for an employee to carry out their duties. A classic example may be a care home worker. Such action should, however, be carefully considered. This is particularly the case given that there is currently very little evidence to suggest that vaccines actually stop transmission and, therefore, employees will be able to argue that there are other ways to reduce the risk of workplace transmission.
Can an offer of employment be conditional on proof of vaccination?
This is, potentially, possible. However, such an approach will run the risk of numerous potential discrimination claims. In addition to disability and religious/philosophical belief discrimination, age discrimination claims are also feasible given that younger applicants will be at the back of the vaccination queue.
What are the data protection issues for employer?
From a GDPR and privacy perspective, vaccination data is special category data. Employers will therefore need to ensure that any records are kept in accordance with GDPR and privacy laws. For example, the data must be held securely and must not be held for any longer than is reasonably necessary. In the first instance, data protection policies and Privacy Notices should be reviewed and updated accordingly.
This is an abbreviated summary of a recent article by our UK colleagues Mark Kaye and Rebecca Harding-Hill. The full article is linked here: https://www.bclplaw.com/en-GB/insights/coronavirus-uk-10-key-vaccination-issues-for-employers.html