M&Aactivity among LLPs is expected to be a growing trend in the future. Barry Stimpson and Paul Flood explore some of the main issues which arise on LLP M&A
Limited Liability Partnerships (LLPs) were introduced into the UK in 2001 and have now become a feature of every day business life. As of Summer 2007 there were 22,000 LLPs registered at Companies House for England and Wales and the vast majority of large accountancy firms as well as a significant number of legal and other professional firms had converted to LLP status.
Now that LLPs have become so widespread, mergers and acquisitions of LLPs and/or their businesses are becoming more and more common. Reynolds Porter Chamberlain LLP has been involved in a number of these transactions including, most recently, the merger of Grant Thornton UK LLP and RSM Robson Rhodes LLP.
What is the best group structure post deal?
There must be an assumption that most professional services businesses would now prefer to operate as an LLP as opposed to a partnership, all things being equal. The post deal structure should reflect this.
If an LLP were acquiring the business of a partnership, this would clearly involve a sale of a business by the partnership to the LLP.
If the business of an LLP were being sold to a firm that is currently a partnership, one option would be for the members of the partnership to undertake a “reverse takeover” by selling their business to the target LLP and then becoming the dominant members in the target LLP. They would achieve this by being allocated capital in consideration for the sale of their business to the target LLP. Another alternative in this situation would be for the LLP and the partnership to both sell their businesses to a new LLP established for the purpose.
This route would have advantages if there was any concern on the part of the partners in the acquiring partnership as to the level of risk associated with becoming a member of the target LLP itself.
If both the acquirer and the target are LLPs at the time of the transaction, either the acquiring entity can simply acquire the target LLP or it could acquire the business out of the target LLP and leave the then empty shell of the target LLP to be wound up in due course. Another possibility would be to create a new LLP
and simply put that on top of the corporate structure with the two existing LLPs remaining as subsidiary entities. This would not normally be an efficient way of running the combined group but it could be desireable in specific circumstances, perhaps where the two LLPs carry on slightly different businesses.
What are the mechanics of the acquisition?
An LLP is a body corporate with its own assets and liabilities separate from those of its members. The consequence of this is that buying an LLP is similar to buying a company although, as we will see, there are important differences.
From a transactional point of view, the members of the target LLP would give warranties and indemnities to the purchaser as part of the transaction. Given that all of the assets and liabilities of the LLP would be transferred with it, a comprehensive set of warranties and indemnities would be required as would be the case with a purchase of a company.
The main area in which the transaction would be simpler, however, is tax in that an LLP is tax transparent and so does not itself pay corporation tax. This would negate the need for many of the tax warranties and the tax deed of indemnity that normally form part of the purchase of a company.
The purchase of a business from an LLP would be similar to the purchase of a business from a company. Where the LLP will be an empty shell after the sale of the business is completed, the purchaser will wish to receive warranties and indemnities from the members themselves rather than from the LLP itself.
How would the deal be financed?
For the majority of LLPs involved in M&A transactions there will be no need for external finance. In many cases, even where there is a finance element, the documentation will be relatively simple: typically an unsecured working capital overdraft facility. However, there will be significant legal issues if a more complex acquisition finance structure is required.
One of the key areas in any finance arrangement in an LLP M&Atransaction is the correct categorisation and treatment of members’ capital. In a conventional corporate acquisition a lender can be certain that it will have priority over equity capital. In an LLP M&Atransaction the distinction between working capital and permanent capital may not be as clear-cut and lenders may need to carry out significant due diligence on the capital structure. They may also attempt to negotiate formal subordination agreements whereby the repayment of members’ capital is formally subordinated to the repayment of bank debt. In order to be effective these will need to involve the members individually which may create issues, even if only logistical ones. Alternatively, lenders may seek to impose operational restrictions on the return of capital to LLP members through covenants or undertakings by the LLP; these need to be reviewed carefully to ensure that they are not inconsistent with the firm’s constitution and the members’ existing rights.
Even if there is no borrowing by the LLP, a further series of issues may arise where finance has been provided to individual members to fund capital contributions to the LLP. Although the LLP is not a party to that loan arrangement, conventionally in such cases the lender will require an undertaking from the LLP that, as and when the member is entitled to a return of capital, the LLP will pay that amount to the lender rather than the member. In an M&A transaction such undertakings can create difficulties, particularly if a member will not be joining the merged entity but will not be entitled to an immediate return of capital after the merger (perhaps because of long-term notice periods).
Although it is not solely relevant to LLPs a further issue which can create difficulties relates to pensions. In particular, where there is a defined benefit pension scheme, clearance from the Pensions Regulator will be required for any Type A event: broadly a change in priority to creditors (which would include the giving of security), a return of capital or a change in control. The giving of a charge to a funding bank by an LLP can therefore require clearance from the Pensions Regulator and the timing of an issue like this can have a very significant impact on an M&A deal.
It is important to remember that most LLPs have “people businesses”, being accountancy, legal, private equity, architects or surveyors firms. Issues such as capital calls, repayment of capital, the requirements of banks for subordination arrangements and pension funding must therefore be handled sensitively and speedily if the deal and resulting firm are not to suffer significantly from the diversion of staff time and energy away from the business itself. The attitudes of and communication with clients and their perception of the deal are also crucial and a consistent and positive message must be portrayed at all times.
The future of LLP M&A
M&Aactivity among LLPs will be a growing trend in the future. Although the fundamental structure of LLP M&Adoes parallel the world of M&A for companies, there are a number of very important differences that require specific expertise in this area.