Introduction

The UK referendum on membership of the EU took place just over one year ago (on June 23, 2016). Since then, much has been written by various commentators about the potential consequences for every conceivable industry or business sector, and private equity is no exception. However, the focus of that discussion for PE has been almost exclusively on the funds/investment management side of the PE equation (perhaps because there is a greater perceived risk for, and undoubtedly greater uncertainty about, that aspect). For recent Dechert briefings and advice on this topic, see here and here.

Relatively little has been written about the other side of PE activity: the potential impact on the investment of those funds in portfolio companies and, equally importantly, on the exit from those portfolio investments. This article looks at the exit: in particular, whether and, if so, how the UK's decision to leave the EU might affect the process, timing or choice of exit route. Typically, a PE exit involves a decision to proceed with either a sale (whether secondary or trade) or an IPO, and each of these is considered below.

The unhelpful, but painfully true, position (as with many discussions on Brexit topics) is one of uncertainty. Nobody knows what the position will be on March 30, 2019 – at least for now. However, there should be and remains a meaningful degree of confidence and optimism when considering private and public M&A. It is difficult to envisage material changes in law or practice as a result of Brexit, although business confidence and sentiment will be key factors. But there are undoubtedly important steps which PE funds, and their portfolio companies, can and should be taking now to ensure that the exit is not affected by Brexit (whether the exit is before or after the UK leaves the EU).

The Sale Route

In summary, no need for immediate concern, but watch this space.

  • Seller (and Buyer) DiligenceThe Boy Scout motto is “be prepared”. That motto applies equally to an exit or divestment. More often than not, a sale will be successful (or more successful) if the sale process (diligence, etc.) has been carefully prepared ahead of time. Most PE managers would have made good Boy Scouts: one of PE’s many strengths (and one of the many benefits for portfolio companies) is being prepared. PE managers bring an appetite to address any issues in, or that arise in, their portfolio investments’ businesses. By the time of a potential exit, issues have typically been considered and, wherever practicable, addressed; the business is prepared for an exit. That same approach applies to Brexit-related issues.Look critically at the portfolio company and identify (and address) any particular issues which might lead a buyer to look less favourably on the business. In other words, how “Brexit-ready” is the portfolio company? This will remain something of a moving target until the negotiations between the UK and the EU progress and particular contentious areas are identified. For now, obvious matters to consider include:
    • geographic structure of the business: where does the business have its operations/facilities, customers and/or suppliers and what is its target market (i.e. from the UK into the EU, or vice versa);

    • the potential for business interruption: whether in the form of potential customs controls or related issues (concerns over trading relationships and the potential for tariffs in/out of the EU are likely to remain until late in the negotiations);

    • third country considerations: the EU has, and the UK currently benefits from, over 50 free trade agreements with third countries (with Canada a recent notable addition, and Japan also recently announced). The UK may lose the benefit of these on Brexit, which means that having suppliers and/or customers outside the UK may expose a business to a further category of uncertainty;

    • labour, employment and staffing issues. This remains another high-profile issue (although scheduled for the early stages of the negotiations). Is the business reliant upon EU nationals who are in the UK (or vice versa), whose right to remain post-Brexit is not yet certain; will it need to recruit EU nationals in the future, and how badly will it be impacted if access to EU staff dries up or becomes more burdensome?;

    • business-specific internal-market related issues: for example, a regulated business or which otherwise depends on EU-wide licensing, pass-porting or similar rights; a particularly IP-heavy business (with EU-wide IP protection – which may not cover the UK post-Brexit); or a business which has received, is receiving or is to receive EU funding);

    • contract review: are there EU-wide contractual arrangements? Are there any EU-sensitive terms (for example, MAC – though see further below); and is there any concern over the governing law and jurisdiction provisions?

  • Diligence overcome? What about the sale documents?

    • ConditionsThe UK’s stance on the need for merger clearance will be one area to watch. It is possible that the UK Competition and Markets Authority seeks to take a more “protectionist” and UK-national stance than currently. Irrespective of that, competition filings and clearances will need careful consideration (particularly as the benefit, under the EU Merger Regulation, of one approval for all member states, including the UK, may be replaced by the need for a separate UK national filing in addition to Brussels).Similarly, material adverse change (or MAC) provisions may fall back into the spotlight. The reaction of most UK-qualified lawyers is that a MAC provision is rare in a UK private M&A transaction (at least compared with other jurisdictions such as the USA). However, anecdotal evidence, and our experience, is that there is almost always a discussion on MAC and, more often than not, some sort of provisions (possibly more restrictive than, again, commonly seen in the USA). As a general comment, Brexit is now a “known”, which means that it may be difficult for a party to seek to use Brexit as a MAC trigger event going forward. However, care should be taken when considering giving a MAC right to a buyer because of Brexit: although the fact of Brexit is a known, if there is a “no deal” Brexit (with no transitional period) a buyer may consider this a MAC. In addition, might the buyer look to re-negotiate the deal terms (or walk away) if there are currency fluctuations or continuing general economic uncertainty in the intervening period (or other unforeseen, Brexit-related circumstances for particular industries or deals that could leave the door open to a Brexit-related MAC)?

    • Certain funds?If the buyer is a financial or PE buyer, the seller may rightly be concerned about the potential impact of Brexit on the drawdown of funds: both from the banking/debt finance syndicate (whether a traditional bank or an alternative debt provider/debt fund) and from limited partners for the PE fund sponsoring the deal. It may be important to ensure that, and have visibility that, there will be certain funds at signing (i.e. funding is unconditional except as to closing of the sale and purchase agreement/transaction documents, and that there are no other conditions (open or hidden in the financing documents) which may be used use to try to avoid funding).

    • SterlingIn a similar vein, where various financial limits and other amounts in the sale transaction documents are expressed in Sterling, caution may be required. In part, this is because of the anticipated fluctuations in the Sterling exchange rate as the Brexit negotiations take shape; but in part also where the portfolio company has revenue (and/or expenses) in currencies other than Sterling. This may include warranty limitations (such as de minimis, basket and cap warranty limitations), price adjustments (such as completion accounts and earn-outs) and vetoes/consent thresholds in an investment agreement).

    • Restrictive covenantsExisting (and proposed) restrictive covenants (non-competition and non-solicitation of customers, suppliers and employees) may need review and revision (for example, if the restricted geographic area refers, for example, to the member states of the EU or the EEA.

    • Enforceability?Enforceability of an English law judgment throughout the EU may be important, particularly where transactions involve EU 27-based parties or assets. Although it is expected that English law judgments will remain generally enforceable in the EU, issues may arise over choice of law and jurisdiction provisions in M&A documents if there are any concerns arising (during the course of the UK-EU negotiations) over the effectiveness of a UK jurisdiction clause.

    • Futureproof documents?Much of the above amounts to crystal-ball gazing, and the chances are that there will be some changes in practice (even if not in law) as the post-Brexit landscape becomes clearer – some of which may not be anticipated. It may be sensible, where possible, to build in some flexibility, to allow the parties to agree to amend the terms in line with the post-Brexit landscape.

Many of the points above are already being seen in practice. The Dechert team has standard language which seeks to address the different issues raised above (whether for DD questions or for the transaction documents), as well as experience of multiple recent negotiations on the points.

The IPO Route

The PE exit plan will often start with a dual track process, assessing the relative merits of the sale versus the IPO; weighing up price, certainty of execution, and access to liquidity. As the Brexit negotiations start in earnest, might Brexit-related market uncertainty mean that the certainty offered by the sale route becomes all the more compelling for the PE seller?

The impact of the referendum decision?

There is no doubt that appetite in London for IPOs slowed down in the run-up to the Brexit referendum; uncertainty and volatility are the enemies of IPOs. Uncertainty over Brexit cast a shadow in 2016 — according to Dealogic, just under US$7 billion was raised in IPOs in London compared with US$17.2 billion in 2015.

What about now though?

Whilst it may be true that compared with some of London's rivals there has been a sluggish start to 2017 (although there have been recent signs of activity building), it is generally accepted that the UK's invocation of Article 50 of the Treaty on European Union on March 29, 2017 (which was the action which formally began the United Kingdom's withdrawal from the EU) of itself has not had any direct impact on companies’ decision making when looking at whether to proceed with an IPO, but how the process unfolds will be closely watched.

There is no question that the impact of the political overhang can make investors cautious (particularly if the company in question may be affected by any of the "EU Specific" issues raised above); however, most commentators are comfortable investors will still invest for the right equity story. The London Stock Exchange insists that London’s “natural strengths” will outweigh any uncertainty generated by the Brexit negotiations.

In fact, at the moment, the weakening of sterling (in large part Brexit-driven) may have more of an effect on dampening the IPO market, with increased appetite for UK assets being shown from overseas buyers; and with more private capital available to support these companies, they can continue their growth without any additional scrutiny and costs of being a public company.

Whilst some may fear that Brexit will make a post-EU London less attractive to PE-backed IPO candidates and investors, others perceive a possibility of achieving the best of both worlds, with London retaining its gold plated status as a premier global finance venue with the added flexibility around the edges once it’s no longer subject to EU rules. We shall see.