Phil Sanderson, Ropes & Gray private equity transactions partner, discusses the M&A auction process in the UK.
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Businesses in the UK are invariably bought and sold using an auction process, and so I am going to talk about the evolution in the auction process in the UK and draw out certain themes that we have seen over the last several years.
Vendor diligence is common across both sides of the Atlantic and other places in the world. Legal diligence is provided to help the process be smooth, to help the bidders get to a deliverable point and instead of requiring each of the five or six bidders to, in silos, do their diligence on the data room, feed questions through to management teams in a disorganized way, the vendor process, essentially, requires the seller's counsel to put together, in a sensible, thoughtful way, a diligence package before the process has even started. So I would favor legal due diligence on the vendor side.
Warranty cover is, obviously, provided in an ordinary way in the “SPA” (in the Share Purchase Agreement) – nothing unusual there. But in the UK, on private equity sales, it has become completely accepted that the private equity seller will not give or stand behind any of the business warranties. That naturally reduces the pot available to cover the business warranties in times of a liability to the management cash consideration, and over time, even that has diminished. In addition to this, another phenomenon that has happened, in more recent years on auction processes, is that all of the warranties are qualified by awareness of the management team, which makes a warranty claim harder to prove and, therefore, harder to bring. So there are likely to be fewer successful warranty claims.
So, how does a buyer/how do our clients meet this challenge? Partly through diligence, partly through the commercial comfort that a private equity bidder can get from a management team rolling into the new structure, and thirdly, by use of W&I insurance (warranty and indemnity insurance). The insurance product can do two things – it can take the cover from, let's say, a cap liability of £1 million to, let's say, £10 million, so the insurer will provide the cover over and above the cap provided by the management warrantors. But also, the insurance product can do what is called a “knowledge scrape,” so it can take what I've just talked about in terms of the general qualifier of management awareness, and give cover, as if that qualification was not there.
“Certain funds” is a concept that in the public market scenario, is a legal obligation, so the obligation to actually provide certainty that the funding is there, available, committed to pay the cash purchase price which is being offered. Essentially, we are talking about the point where the bidder, the winning bidder, signs the “SPA” – they have to be able to convince the seller that the cash consideration is all committed. How does a buyer do that? How do clients look at that? Well, firstly, they may win the bid – so get to the second round bid date, win the bid, and then use a period of exclusivity to arrange that certainty of funding. And where that is particularly relevant is in terms of agreeing funding, certain funding, with banks. If that time is not available, they may simply equity underwrite the whole purchase price and that's particularly common for large-cap clients, that they will, effectively, underwrite the whole consideration price from their own equity funds. However, there are circumstances where there is not the luxury of time to put in place full financing and there is not the ability to equity underwrite the whole purchase price. And in those cases, there is a work stream that needs to be done, usually prior to the bid date, to put in place some kind of interim or bridge financing to convince the sellers that this bidder is as good as the other bidders who have certain funding through an equity underwrite.