Acquisition and exit

Acquisitions of controlling stakes

Are there any legal requirements that may impact the ability of a private equity firm to acquire control of a public or private company?

For most private equity transactions involving unlisted companies, there is no mandatory consultation with any bodies unless the business is regulated, in which case the regulator of such business may need to approve a change of control, or at least be notified of it.

UK merger control is governed by the Enterprise Act 2002, as amended by the Enterprise and Regulatory Reform Act 2013. The Competition and Markets Authority (CMA) is the principal regulatory body tasked with ensuring that the markets are competitive, and examines mergers and acquisitions. The UK has a voluntary regime, which means there is no obligation to refer deals to the CMA. However, if the transaction meets the relevant thresholds and the parties do not notify, the CMA may launch its own investigation and has extensive powers to impose remedies, including ultimately to unwind the transaction. Therefore, where material substantive competition issues arise on an acquisition meeting the relevant jurisdictional thresholds, most private equity buyers will require CMA approval as a condition precedent to closing.

There is a mandatory offer regime under the City Code on Takeovers and Mergers. Where a person is interested in shares carrying 30 per cent or more of the voting rights, that person must make a mandatory offer in cash (or including a cash alternative) at no less than the highest price paid by that person during the 12 months prior to the announcement of the offer.

Exit strategies

What are the key limitations on the ability of a private equity firm to sell its stake in a portfolio company or conduct an IPO of a portfolio company? In connection with a sale of a portfolio company, how do private equity firms typically address any post-closing recourse for the benefit of a strategic or private equity acquirer?

Normally, the private equity fund has full flexibility to achieve its exit. Private equity funds are typically closed end funds and therefore the usual investment horizon is between two and seven years, to fit with the life of the fund as well as completion of business plan milestones for the portfolio company’s business and exit market conditions.

The most common form of exit is by way of an auction sale to strategic trade buyers or other institutional investors (including private equity funds). IPOs are common where the IPO market conditions are good for the relevant sector. Often a private equity fund will run a dual-track exit process, where the company undergoes both an auction sale process and an IPO exit process and ultimately the sellers proceed with whichever option achieves the best valuation (balanced with execution risk).

Private equity sellers will always seek to minimise their liability following the sale of a portfolio business, because they aim to return all proceeds to investors as soon as possible, in order to maximise their investors' return. Holding back funds to satisfy contingent liabilities following the sale of a portfolio company would be a drag on the returns and therefore affect the fund's performance.

The obligations assumed by a private equity seller under the terms of a sale and purchase agreement are normally restricted to matters that the private equity seller can be sure will not give rise to any liability. These typically include the obligation to transfer its shares (or other securities) free from encumbrance, warranties as to its ownership of the shares (or other securities) and capacity to enter into the agreement, a leakage covenant, an undertaking to exercise its rights to operate the target business in the ordinary course and not to undertake certain material matters without the buyer’s consent, and confidentiality obligations. It is unusual for a private equity seller to provide specific indemnities or tax covenants. A private equity seller will seek to limit its total liability to the amount of consideration received in respect of the shares and to a maximum period of 18 or 24 months.

Private equity sellers will not normally give restrictive covenants, such as a non-compete undertaking and an undertaking not to solicit senior employees, because it is problematic to limit the business of a private equity fund which is to buy and sell other companies, frequently in sectors in which it has experience. They will occasionally agree not to solicit key employees for a restricted period, provided that such an obligation extends only to the actual fund that owns the selling entities, and not to related funds.

It is increasingly common for warranty and indemnity insurance to be procured on transactions involving private equity sellers, to increase the protection provided by business warranties to 10 or 20 per cent of the total consideration. It is unusual to insure known problems (such as the outcome of a particular investigation or piece of litigation), as the cost is prohibitive.

Portfolio company IPOs

What governance rights and other shareholders’ rights and restrictions typically survive an IPO? What types of lock-up restrictions typically apply in connection with an IPO? What are common methods for private equity sponsors to dispose of their stock in a portfolio company following its IPO?

Relationship agreements are required to be put in place between the private equity shareholder and the listed company where the shareholder will retain 30 per cent or more of the company following an IPO. The private equity shareholder will typically retain the right to appoint representatives to the board for so long as its shareholding remains above a specified level (for example, two representatives at or above 20 per cent, falling to one below 20 per cent and none below 10 per cent). Owing to UK Listing Rules requirements that listed companies operate independently of their controlling shareholders, the appointment of such directors is subject to the approval of independent shareholders as well as of the shareholders as a whole. Listing Rules requirements also mean that private equity shareholders do not retain contractual veto rights over the operation of the target business.

Private equity shareholders are typically restricted from selling their shares for six months following an IPO, with management sellers locked up for a longer period, usually 12 months. Following expiry of the lock-up, private equity shareholders typically sell down their stakes through block trades arranged by one or more banks, usually in the form of an accelerated book build conducted over the course of a few hours after the markets close. Because all shares are listed as part of the IPO, the required documentation is limited and there is no need for a prospectus or other registration document.

Target companies and industries

What types of companies or industries have typically been the targets of going-private transactions? Has there been any change in industry focus in recent years? Do industry-specific regulatory schemes limit the potential targets of private equity firms?

Technology, media and telecoms and manufacturing remained a sharp focus in 2020 across Europe, with increased deal volume in these sectors. Online businesses have been attractive, as has healthcare. The hospitality sector is in decline, deal activity being focused on restructurings.