Use the Lexology Getting The Deal Through tool to compare the answers in this article with those from other jurisdictions.
Transaction formalities, rules and practical considerations
Types of private equity transactions
What different types of private equity transactions occur in your jurisdiction? What structures are commonly used in private equity investments and acquisitions?
A buyout typically involves acquiring a controlling stake in a business, although there are a significant number of transactions in which a minority interest is obtained. In order to enter into a buyout of a private company the private equity sponsor will incorporate one or more ‘newcos’ or special purpose vehicles. Funding will be provided in the form of equity (provided by the private equity sponsor and often by existing management) and, in most cases, debt. The inclusion of debt will provide the sponsor with the benefit of ‘leveraging’ its equity investment.
If the target of a buyout is, or has recently been, a public UK-listed or publicly traded company, the City Code on Takeovers and Mergers (the Takeover Code) will usually apply (see question 4). Where there are many sellers, such as in the case of a listed target, the purchase will take place by way of an offer or, alternatively where the target agrees, by way of a scheme of arrangement under the Companies Act 2006. A scheme of arrangement is, essentially, a court-sanctioned agreement between the company and its shareholders (in this context) pursuant to which all of the shares of the company are transferred to the bidder. Most private equity transactions are purchases of shares in a private company by way of a private sale and purchase agreement. Where the target is a UK company, ‘mergers’ (ie, where one of the bidders and the target ceases to exist as a result) are generally not available as a transaction structure.
Corporate governance rules
What are the implications of corporate governance rules for private equity transactions? Are there any advantages to going private in leveraged buyout or similar transactions? What are the effects of corporate governance rules on companies that, following a private equity transaction, remain or later become public companies?
Private companies are required to comply with the provisions of the Companies Act 2006 and associated companies legislation. Public companies are subject to more stringent regulation as are listed public companies. Listed public companies must comply not only with companies legislation but also with the relevant listing, transparency, disclosure and stock exchange rules. For those companies listed on the London Stock Exchange, these regulations will be the Listing, Prospectus, Disclosure and Transparency Rules as well as the Admission and Disclosure Standards. Owing to this increased regulatory burden, private equity sponsors who acquire listed public companies will often seek to delist the target company. Another advantage for sponsors of going private is that they avoid the UK’s prohibition on a public company giving financial assistance to purchasers who are acquiring shares in that public company.
Issues facing public company boards
What are some of the issues facing boards of directors of public companies considering entering into a going-private or private equity transaction? What procedural safeguards, if any, may boards of directors of public companies use when considering such a transaction? What is the role of a special committee in such a transaction where senior management, members of the board or significant shareholders are participating or have an interest in the transaction?
Directors of all UK companies must consider their statutory and fiduciary duties when entering into any transaction. The statutory duties, which to a large extent codify existing common law duties, require directors to act in a way that promotes the long-term success of the company for the benefit of its shareholders as a whole. This duty also requires the directors to consider the interests of the company’s employees. Directors also have a duty to use reasonable care and skill, avoid conflicts of interest and declare any direct or indirect interest in the proposed transaction.
For going-private transactions there are additional considerations, in particular those contained within the Takeover Code (where applicable - see question 4 for further information). For example, when exercising their fiduciary duty to promote the success of the company, the Takeover Code provides that price may not be the sole determining factor when directors decide whether or not to recommend a transaction. The Takeover Code provides for six general principles that all parties to a going-private transaction (including the company and its board) must adhere to, as follows:
- that all shareholders in the target are treated equally;
- that all shareholders have sufficient time and information to assess an offer and that the board of the company gives its view on the offer;
- that the board of the company must act in the interests of the company as a whole and not deny the shareholders the opportunity to decide on the merits of an offer (eg, by taking unlawful frustrating action such as ‘poison pills’);
- that there is no false trading market created in the company’s shares;
- that the bidder makes an offer only once he or she can satisfy the offer in full and in cash; and
- that the company must not be hindered for longer than is necessary as a result of any offer.
It is not uncommon for a target company’s board to form a special committee of directors to be responsible for the conduct of any bid and such committees will usually be formed of independent directors. This is particularly important where, for example, executive directors or members of senior management are participating in the transaction either by taking a stake in the bid vehicle, rolling over their current interests or being appointed by the private equity sponsor (which may be an existing shareholder). Every director will usually be required to disclose to such a special committee all relevant facts relating to him or herself (and close relatives and related trusts) that may be relevant to the proposed transaction. The Takeover Code does, however, provide that where any such special committee is constituted, appropriate arrangements must be in place to enable the board as a whole to monitor any transaction.
Any proposed incentivisation arrangement between a bidder and management of a target company is regulated by the Takeover Code. See question 8 for further information.
Are there heightened disclosure issues in connection with going-private transactions or other private equity transactions?
The Takeover Code will apply to a going-private transaction involving the following:
(i) a company that has its registered office in the UK, Channel Islands or Isle of Man if any of their securities are admitted to trading on a regulated market or a multilateral trading facility in the UK, Channel Islands or Isle of Man;
(ii) any publicly traded company (not covered by (i) or (iii)) or societas Europaea, which has its registered office in the UK and that has its ‘place of central management and control’ in the UK, Channel Islands or Isle of Man; or
(iii) any company that has its registered office at either of the following:
- in the UK and whose securities are admitting to trading on a regulated market in one or member states of the European Economic Area (EEA) but whose shares do not trade on a UK regulated market;
- in any other member state of the EEA and whose shares trade on a UK but not any other EEA-regulated market; or
- in any other member state of the EEA and whose shares trade on more than one EEA-regulated market but not on a regulated market in the jurisdiction of its registered office. This type of company will also be subject to the Takeover Code.
The disclosure requirements of the Takeover Code apply to a takeover offer and to takeovers effected by English law schemes of arrangement.
The Takeover Code’s disclosure regime is intended to provide the market with a greater degree of transparency during the course of a takeover when compared to the disclosure rules applicable at other times. Disclosure can be divided into two sub-sets: offer disclosure and disclosure during the offer period itself. Rule 1(a) of the Takeover Code provides that when the bidder is ready to announce its bid, it must put forward its offer to the target board. This applies to both bids recommended by the target board and hostile bids contested by the target board. Prior to the bidder approaching the target board, rule 2.2 of the Takeover Code provides that where there is rumour, speculation or an untoward movement in the target’s share price that can reasonably be attributed to the actions of a potential bidder (whether through inadequate security or otherwise), the Takeover Panel may require the potential bidder to make an immediate announcement stating its intentions. If the bidder accordingly announces that it may make an offer for the target it will be subject to a 28-day ‘put-up or shut-up’ period by the end of which it must announce that it has a firm intention to make an offer or announce that it will not be making an offer (and, in the event it announces that it will not be making an offer but subject to certain exceptions, it will be prevented from making another offer for a period of six months).
In the event that the bidder announces that it has a firm intention to make an offer it must send a formal offer document to the target’s shareholders, or, if a scheme of arrangement is to be used to implement the offer, the target must send the scheme document to its shareholders. The offer document must detail the principal terms of the offer including the bidder’s intentions for the target; details of the financing used to fund the acquisition; any irrevocable undertakings (commitments from existing shareholders) and special arrangements or interests that exist between the bidder and the target. Rule 24 of the Takeover Code provides that the offer document (or scheme document) must be sent within 28 days from the date of an announcement of the offer. This document must be sent to the Takeover Panel in electronic form, as well as to target company shareholders and all other individuals who have the right to receive information from the target.
At the commencement of the offer period, the Takeover Code requires all market participants to disclose long and short positions in respect of the shares (and any instruments linked to the shares) of the target if it holds more than 1 per cent of those shares to the Takeover Panel and to a Regulatory Information Service (RIS). Each of the bidder (with respect to the target) and the target (with respect to the bidder) are required to disclose all interests irrespective of size, in the same manner. During the offer period any dealings in the securities of the target must be reported on a daily basis to an RIS and the Takeover Panel.
Notwithstanding the provisions of the Takeover Code, significant shareholdings are required to be disclosed whether or not an offer is being made if the target company is listed on the London Stock Exchange by virtue of the Disclosure and Transparency Rules. If a private equity sponsor wishes to enter into a stake-building exercise for such a target, either before making an offer or post making an offer, then it will be required to comply with such rules and make an announcement of its interest in the target company’s securities if, and when, it holds 3 per cent or more and every time it then passes through a percentage threshold, in the case of UK-incorporated issuers, or at 5, 10, 15, 20, 25, 30, 50 and 75 per cent, in the case of non-UK incorporated issuers.
What are the timing considerations for a going-private or other private equity transaction?
There are a number of timing considerations to think about for a going-private transaction to which the Takeover Code applies (as detailed in question 4). If the transaction is not subject to the Takeover Code, then there is no formal timetable. There are, however, several points that are common whether or not the Takeover Code applies. The bidder will need to evaluate the likely length of any due diligence process and whether any regulatory approvals will need to be sought.
Transactions to which the Takeover Code applies will have to conform to the strict timetable and procedures set out in its rules. The rules mandate when acceptance levels must be announced, minimum and maximum periods for which the offer must be held open and the earliest date at which the offer may close.
If the transaction is subject to the Takeover Code and is being effected by an English scheme of arrangement the target will have to comply with the requirements of the Companies Act 2006 and book a court directions hearing so that the court can convene a meeting of the target’s members to approve the scheme and subsequently book a court sanction hearing so that the court may (at its discretion) sanction the scheme. The Takeover Code applies a modified timetable to a transaction being implemented by way of a scheme of arrangement.
Dissenting shareholders’ rights
What rights do shareholders have to dissent or object to a going-private transaction? How do acquirers address the risks associated with shareholder dissent?
Under English company law there is a ‘hierarchy of benefits’ contingent on the proportionate amount of shares held in a company. Few of these provide a dissenting shareholder with means to obstruct a going-private transaction other than where their interest is sufficient to block the transaction. The relevant percentages and an explanation of the rights associated with them are set out briefly below:
Total percentage held
Rights that can be exercised
Call a shareholders’ meeting
Require a bidder with 90 per cent of the shares to acquire the remaining 10 per cent
25 plus one vote (or more)
Block a special resolution
50 plus one vote (or more)
Effective control as holder can block or pass ordinary resolutions
Pass special resolutions and vary rights attached to the class of share it holds
Require minority shareholders with holdings of up to 10 per cent to sell their shares on an offer (known as squeeze-out)
Pass special resolutions on short notice (less than 14 days)
Shareholders have the option of not accepting the bidder’s offer or voting against a scheme of arrangement. In any offer, once the bidder has acquired 90 per cent of acceptances (which for these purposes generally excludes the acceptances of any ‘associate’ of the bidder) it can squeeze out the remaining dissenting shareholders. Such squeeze-out action can be challenged by the dissenting shareholders before the courts. Minority shareholders have further statutory protection, in the form of derivative actions or unfair prejudice petitions. Exercise of these protections is at the discretion of the court and in any ordinary course transaction would be unlikely to be successful.
A scheme of arrangement must be approved by a majority in number of the company’s shareholders voting on the scheme representing at least 75 per cent of the value of the shares voted. A shareholder holding more than 25 per cent of a company’s shares can, therefore, block a scheme at the court-ordered shareholder meeting stage. In addition, shareholders who disagree with the proposals also have the statutory right to attend the sanction hearing. They are able to challenge the validity of the scheme, on a variety of procedural grounds, or attempt to delay or ‘stay’ its implementation.
Activist shareholders have become an increasingly frequent feature in Takeover Code transactions, especially where a scheme is being used, as a blocking stake can be amassed with significantly less than 25 per cent of the target’s shares if there are many dormant shareholders who do not vote at the scheme meeting. Further, such shareholders have also considered divesting shares to affiliates in order to try and ‘swamp’ the initial shareholder meeting and ensure that the ‘majority in number’ test fails, even though the 75 per cent threshold may be met by the minority in number. The likely success of such a tactic is yet to be tried before the courts.
What notable purchase agreement provisions are specific to private equity transactions?
In secondary buyouts, sponsors will typically ask existing management for a wide-ranging list of warranties as to the target business as the exiting sponsor is unlikely to give any business warranties. Management will typically try to qualify these warranties by introducing a cap, time limits and a number of other general limitations.
Conditions to closing will typically be very limited, even in private sales (where the conditionality requirements of the Takeover Code do not apply (see question 20)). The purchase agreement needs to be negotiated to work with any financing commitments made by lenders to the sponsor bidder. These may include undertakings to assist with the financing by preparing an offering document for bonds issued to finance the transaction.
Participation of target company management
How can management of the target company participate in a going-private transaction? What are the principal executive compensation issues? Are there timing considerations for when a private equity buyer should discuss management participation following the completion of a going-private transaction?
The retention and incentivisation of management is frequently a key part of any private equity buyout or going-private transaction, and management will often be invited to acquire shares in the target or acquisition vehicle that will enable them to participate in a proportion of future equity growth (known as ‘sweet’ equity). Usually this is under a formal management equity plan set out in the shareholders’ or investment agreement and the constitutional documents of the target, and management will typically be separately advised.
The portion of total equity allocated for management as sweet equity will depend on the specific transaction, but is usually around 10-20 per cent. Sweet equity is typically subject to transfer restrictions, a three to five-year vesting schedule, and leaver provisions that determine the price at which management’s shares may be bought on or in a period following their departure (known as ‘good’ or ‘bad’ leaver provisions). If a ‘ratchet’ mechanism is included, the economic entitlement of the sweet equity holders increases if certain performance targets are reached. There are a number of different ways that ratchets can be structured. Participation of management in different forms of future exits, including the impact of those exits on unvested sweet equity and the operation of ‘tag-along’ and ‘drag-along’ provisions, are always heavily negotiated issues.
As the sponsor will typically make the majority of its investment in the form of shareholder loans (or similar debt or quasi debt instruments in other jurisdictions), the sweet equity will always rank behind those instruments and may also rank behind any shares held by the sponsor. Managers who hold equity in the target prior to the buyout may be able to ‘roll over’ that investment into the new structure, or may, in addition to their sweet equity allocation, be invited or required to re-invest a portion of their sale proceeds alongside the sponsor in debt or quasi-debt instruments and shares that rank pari passu with, and are on the same terms as, the sponsor (known as the ‘institutional strip’).
UK tax-paying managers will be keen to ensure that any future equity growth is taxed as a capital gain instead of employment income. Depending on the circumstances, the sponsor may consider a structure that accommodates entrepreneur’s relief planning or employee shareholder status.
There are additional considerations if management already holds shares or outstanding share-incentive awards in the target and the Takeover Code applies to the transaction (see question 4). The bidder is required to treat all shareholders of the target in the same way (ie, no special treatment can be given to existing management shareholders) and the principle of equal treatment also applies to holders of options or other share-incentive awards, to whom a bidder must, under rule 15 of the Takeover Code, make an ‘appropriate’ offer or proposal. Furthermore, if the sponsor has entered into or reached an advanced stage of discussions on incentivisation arrangements with pre-existing management shareholders, rule 16.2 of the Takeover Code requires details of such arrangements to be disclosed and an independent adviser must opine on whether the arrangements are ‘fair and reasonable’. In certain circumstances, prior consent of the Takeover Panel and the independent target shareholders is required. While it is rare for the Takeover Panel to withhold its consent for these arrangements it may, in certain circumstances, require that such incentivisation arrangements (if significant or unusual) be approved by the target company’s independent shareholders. Where no incentivisation arrangements are proposed, this must also be stated publicly.
What are some of the basic tax issues involved in private equity transactions? Give details regarding the tax status of a target, deductibility of interest based on the form of financing and tax issues related to executive compensation. Can share acquisitions be classified as asset acquisitions for tax purposes?
The principal tax issues fall into four broad categories, as follows:
- transaction tax costs of the acquisition;
- the tax profile of the target group (including its historic tax risks) and the extent to which it is possible to obtain and use tax deductions for the costs of acquisition finance;
- tax-efficient incentivisation of management; and
- preparing for a tax-efficient exit.
We cover below a high-level summary of some aspects of these issues as they relate to an acquisition of a UK target company by a UK newco. Many other tax issues are likely to be relevant and full due diligence and tax structuring should be undertaken in light of the particular circumstances. In many private equity transactions it will also be necessary to consider tax rules in other jurisdictions, including in all countries where the target operates and where the sponsor or fund investors are based.
The main transaction tax cost of the acquisition of shares in a UK company will be a UK stamp duty charge, payable by newco, of 0.5 per cent of the consideration. An acquisition of shares in a UK company does not attract VAT. Although most costs incurred by a UK newco that relate to the acquisition (such as adviser fees relating to the share acquisition) will not be immediately deductible for UK tax purposes, they may form part of the capital gains tax base cost and therefore reduce the newco’s chargeable gain upon exit. It may be possible to recover some VAT incurred on transaction costs, although the position is complex and detailed advice would need to be taken.
Certain costs relating to acquisition finance (including interest expense) may be deductible under the UK rules on the taxation of loan relationships. To the extent such deductions are available, they may give rise to losses that can be surrendered to the target company (under the UK’s ‘group relief’ rules) to shelter its operating profits. A private equity sponsor will often also consider whether, in addition to third-party acquisition finance, it will be possible to generate further deductible interest expense by introducing shareholder loans. Under current UK tax law there are various rules limiting the availability of tax deductions for interest and other finance expenses. In the case of shareholder loans, these include transfer pricing rules that limit deductible interest to an arm’s-length amount. It should be noted that in response to the Organisation for Economic Coooperation and Development’s Base Erosion and Profit Shifting initiative, the UK government is now considering further restrictions on interest deductibility under which permissible net interest deductions would be limited to a fixed ratio of profits of the borrower entity or its group.
Interest on acquisition debt or shareholder loans is subject to 20 per cent UK withholding tax, unless an exemption or reduced rate applies. An exemption may apply if the lender is within the charge to UK corporation tax. An exemption or reduced rate may apply if a non-UK lender qualifies for relief under a double tax treaty with the UK. Alternative exemptions under domestic UK law that may be considered include the ‘quoted eurobond’ exemption for debt listed on a recognised stock exchange or the recently introduced ‘private placement’ exemption. Dividends paid by UK companies are not subject to UK withholding tax.
As discussed in question 8, the management team may participate in the equity of the target group. As a general rule, the acquisition of shares by management should not be taxable provided the shares are acquired for full value for UK tax purposes. The UK tax authorities and the British Private Equity & Venture Capital Association published a ‘memorandum of understanding’ in 2003 in relation to management participation and, where the conditions in that memorandum are complied with, the UK tax authorities generally accept that the price paid by management for their shares is equal to the full value for UK tax purposes. It is common practice, therefore, for management to request that the incentive package is structured in accordance with this memorandum. Upon exit, where the relevant conditions are satisfied, management may be able to benefit from a reduced rate of capital gains tax under the UK’s entrepreneur’s relief rules. In recent years management employees receiving at least £2,000 worth of shares in their employer (or a parent company of their employer) have, in return for giving up some statutory employment rights, also sought to benefit from relief from capital gains tax on the disposal of the shares under rules relating to ‘employee shareholders’.
It is important that the tax implications of potential exit scenarios are considered when establishing the acquisition structure. Where an exit is at the level of a UK newco, relief from UK tax on capital gains may be available under the UK’s participation exemption (the ‘substantial shareholding exemption’) provided that certain conditions are satisfied. Unlike participation exemption regimes in other jurisdictions, the relevant conditions look to the activities of the target and the seller, not merely minimum shareholding requirements. If the UK newcos are owned by a non-UK resident parent company, it may be preferential for the parent company to be the seller since the UK does not have a non-resident capital gains tax on share sales. Other relevant matters to be considered from the outset include the tax treatment of management on exit, and of holders of carried interest in the private equity fund. There are also likely to be tax implications of any pre-sale restructuring, including, for example, the insertion of a new parent company in anticipation of an IPO.
Transactions structured as share acquisitions by newco cannot be classified as asset acquisitions for UK tax purposes.
Debt financing structures
What types of debt are typically used to finance going-private or private equity transactions? What issues are raised by existing indebtedness of a potential target of a private equity transaction? Are there any financial assistance, margin loan or other restrictions in your jurisdiction on the use of debt financing or granting of security interests?
Private equity sponsors use a variety of methods to finance their acquisitions. The nature of the financing used will, to a large extent, depend on the sort of transaction that the private equity sponsor is entering into (for example, the acquisition of a whole or just minority interest), as well as its ability to draw on its own reserves to finance the deal. In the first instance there may be existing indebtedness at the target company level. The sponsor will have to look at the terms of the existing indebtedness and specifically at the repayment schedule, any mandatory prepayment events (such as those triggered by a change of control) and whether additional leverage can be incurred under existing leverage baskets. Typically, leveraged buyouts will require refinancing of the existing debt of the target group, which will be acquired ‘cash free and debt free’.
Senior bank debt will be provided in the form of a syndicated facilities agreement that would usually include a term loan A, term loan B and a revolving credit facility which will be repayable and amortise differently. Term loans A, which are typically amortising, have been less common in recent times with private equity sponsors preferring the bullet repayment profile of term loans B. Banks will be required to undertake credit assessments on the target and its prospects so bidders should factor this into their consideration of transaction timing. Facilities of this type will be secured against the target’s assets. The facility documentation will also include a fairly restrictive negative pledge and positive and negative covenants. Financial covenants will mainly be on a maintenance basis unless the deal is a true ‘cov-lite’ deal in which case the financial covenants will be tested only when debt is incurred rather than every quarter. Senior secured debt is now often provided in the form of senior secured notes or bonds either alongside or instead of senior secured loans.
Additional leverage may come from more junior forms of financing: mezzanine debt, second lien debt and subordinated or unsecured high yield debt or payment in kind (PIK) notes. Mezzanine debt will rank behind the senior debt and will consequently bear a higher interest rate to reflect this risk. Second-lien debt or second-lien notes will rank between the senior bank debt and more junior debt. PIK notes are instruments that can be issued whereby interest payments are paid in kind (ie, by way of additional loans or notes) rather than in cash.
Unitranche loans have also been used for recent mid-market transactions. A unitranche loan replaces both the senior secured debt and junior debt with a single layer of debt, provided at a ‘blended’ interest rate that a private equity sponsor might otherwise pay in a senior secured debt and junior debt structure. These are provided by direct lenders, typically the lending arm of a fund rather than a traditional bank. A unitranche deal may involve a single lender or multiple lenders. Where there are multiple lenders, the lenders may agree to apportion the loan and interest allocation between themselves with an ‘agreement among lenders’.
As mentioned in question 2, there are special rules relating to financial assistance under the Companies Act 2006. Under this regime it is unlawful for a public company to provide financial assistance for the purchase of its own shares or the shares of the private holding company of a public company. Financial assistance has been broadly interpreted to include guarantees, indemnities and other quasi-security arrangements. Where the target is a public company it will be reregistered as a private company to be able to give guarantees and security.
Debt and equity financing provisions
What provisions relating to debt and equity financing are typically found in going-private transaction purchase agreements? What other documents typically set out the financing arrangements?
Where the Takeover Code applies to a transaction a bidder will have to announce that it can fulfil any cash consideration (or a cash alternative if this is offered) in full. This principle, known as ‘certain funds’ is common to private equity transactions in many European jurisdictions. In going-private deals in the UK the conditions to bid financing are prescribed by the Takeover Code. Where an offer is for cash or includes an element of cash consideration the sponsor bidder’s financial adviser must confirm (and make a statement to that effect) in the offer document that resources are available to the bidder to satisfy full acceptance of the offer. This statement by the financial adviser will rarely be provided until the financial adviser has received the sponsor’s equity commitment letter, lenders’ commitment letters, has completed its own due diligence and the conditions precedent to the lender’s commitment papers have been satisfied.
There will, of course, be a gap between a lender (or indeed the underwriters who plan to syndicate the debt if the transaction progresses) initial commitment to fund and the transaction closing.
At the time an offer is announced or a binding bid is made in a private company auction process, the documentation will likely be very advanced, including an equity commitment letter and certain funds financing commitments in the form of full facility documentation or an ‘interim facility agreement’, which is capable of being drawn to fund the transaction along with an executed commitment letter that includes a term sheet for the full facility documentation.
Fraudulent conveyance and other bankruptcy issues
Do private equity transactions involving leverage raise ‘fraudulent conveyance’ or other bankruptcy issues? How are these issues typically handled in a going-private transaction?
Transactions that are entered into by the directors of the target company in breach of their statutory and fiduciary duties may be voided or subject to challenge under English common law principles and statutory provisions.
English insolvency law (primarily the Insolvency Act 1986) will seek to unwind certain transactions entered into by the insolvent company in the period leading up to the commencement of insolvency. Transactions at an undervalue, unlawful preferences and transactions to defraud creditors can be unwound for a period of up to two years if the transaction was entered into with a ‘connected’ person (which has a specific statutory definition) or six months if with others. Transactions involving the avoidance of floating changes can be unwound for a period of up to two years if the transaction was entered into with a connected person or 12 months if with others.
In a private equity context, the above could relate to guarantees, indemnities and other types of quasi-security that are provided by the target or subsidiaries to the bidder or persons providing financing for the transaction.
Shareholders’ agreements and shareholder rights
What are the key provisions in shareholders’ agreements entered into in connection with minority investments or investments made by two or more private equity firms? Are there any statutory or other legal protections for minority shareholders?
The shareholders’ agreement, also called the investment agreement, will set out the terms on which the sponsor will make its investment. Understandably the sponsor will want to exert a significant amount of control over the target. Typically, the shareholders’ agreement and the target’s articles of association (which will be revised or drafted afresh by sponsor’s counsel) will provide the sponsor with ‘veto’ rights over certain ‘reserved matters’. These rights will delineate the decisions that can be made by the management on a day-to-day basis and those that have to be referred to the sponsor. The nature of this agreement will depend on how much discretion the sponsor is willing to give the management, but such veto rights will extend to acquisitions and disposals by the target; transactions outside the ordinary course of business and the right to conduct any litigation or arbitration on behalf of the target. The reserved matters will enable the sponsor to prevent certain actions from being taken by the board without the sponsor’s prior approval.
Where a minority interest is acquired by the sponsor or several sponsors invest together it will be important to build in ‘deadlock’ provisions in the shareholders’ agreement. Deadlock refers to situations where shareholders cannot agree on a major issue. These clauses can be drafted in a number of ways but it is common for the matter on which there is deadlock to be escalated by referral to the senior management of the parties or an independent third party, such as an arbitrator or expert before shareholders are allowed to terminate the shareholders’ agreement or for one party to sell their stake to another. It is also important to draft mandatory transfer (‘drag’ and ‘tag’) provisions and ‘call rights’ (where one party can sell) or ‘put rights’ (where one party can buy) the stake of another. A metric to determine the valuation of such rights will also need to be included in the documentation.
Legal protections for minority shareholders (also outlined in question 6) are incorporated into the Companies Act 2006. A shareholders’ agreement may not, as a matter of company law, modify certain statutory provisions, for example, the requisite percentage required to pass a special or ordinary resolution though a shareholder may be able to enforce any agreement made in a shareholders’ agreement contractually. In addition, shareholders may bring derivative actions in the name of company if they feel that the company has been wronged but the directors refuse to bring such an action. The requirements to prove a derivative action are fairly onerous, which explains the paucity of applications that have been considered by the courts since the new regime was introduced in 2006. Shareholders may bring a statutory unfair prejudice claim if they believe that the business of the company is being conducted in a way that is unfairly prejudicial to its members. In practice, however, a successful unfair prejudice claim will be remedied by a purchase order forcing the wrongdoer to purchase the minority shares.
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?
Stakebuilding is the strategic purchase of shares in the target by the bidder. If the Takeover Code applies, the bidder and parties acting in concert with it will be required to make a mandatory offer to each shareholder of the target upon it acquiring shares that carry 30 per cent of the voting rights in that company (other than via a formal takeover offer). A mandatory offer is required to be made in cash (or a cash alternative) and at a price that is equal to the highest price paid by the bidder for any shares in the 12 months before the announcement of the mandatory offer.
A bidder must also be alert to the market abuse rules prescribed under the Financial Services and Markets Act 2000. Currently, however, purchases of a target company’s shares by a bidder with knowledge that it is considering making an offer for that target should not fall foul of such rules provided that such purchases are made for the purpose of gaining control of that company.
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 buyer?
The commercial limitations on the choice and timing of an exit strategy in the UK are common to most jurisdictions. Legal aspects to be considered are the restrictions on the transfer of shares in the company’s memorandum or articles of association; any pre-existing shareholders’ agreements and whether ‘drag-along’ and ‘tag-along’ provisions will apply.
If an IPO is chosen (as discussed in question 16) a prospectus will probably be prepared in accordance with the rules of the relevant stock exchange and listing authority. If a prospectus is prepared then liability may arise for the existing private equity sponsor based on the information disclosed in that document. Additionally, the underwriters will require the private equity sponsor to enter into a ‘lock-up’ agreement in relation to any retained stake. The underwriting agreement will also require warranties as to title, authority and capacity of the private equity sponsor.
In a sale to a corporate or upon a secondary buyout the private equity sponsor will resist giving warranties (save as those to title, authority and capacity). Existing management will have given warranties to the private equity sponsor on acquisition so it is likely that they will, if they are remaining in post, be persuaded to give similar warranties again. Alternatively escrow arrangements, warranty and indemnity insurance and further financial incentives may be used.
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?
The private equity sponsor will want certain rights over the company after its IPO. Where the offering is listed on the premium segment of the London Stock Exchange and the sponsor and its associates retain a significant shareholding (usually more than 30 per cent) a relationship agreement will be need to be executed. It is common practice to produce such a document when listing on AIM as well. Any agreement will be required to contain undertakings as to the independence of the company and to ensure that it trades on an arm’s-length basis with significant shareholders to comply with the Listing Rules. Additionally, the Listing Rules require that if a company has such a significant shareholder the appointment of any director who is to be considered an independent director must be approved by the shareholders of the company as a whole and the shareholders of the company excluding the significant shareholder. That being said, there are no legal restrictions on rights (such as board appointment rights or veto rights for board representatives) that may subsist after an IPO and the ability for the private equity sponsor to retain such rights will largely depend on their retained equity stake, the requirements of the Listing Rules, UK Corporate Governance Code (in each case if applicable) and any negative marketing implications foreseen by the underwriter.
A lock-up agreement may be contained in the body of the underwriting agreement but more likely will be a separate standalone document. It will prohibit the sponsor from disposing of its retained interest in the business without the underwriters’ consent. Some agreements will be more restrictive in preventing the sponsor from engaging in any similar dealings (ie, derivatives transactions). The length of the lock-up period will also be heavily negotiated. There is no market standard, but typically these lock-ups last for between six and 12 months. The purpose of the lock-up is to give investors comfort that the shares sold in the IPO will not fall in value owing to large sales of shares not sold in the IPO.
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 focus in recent years? Do industry-specific regulatory schemes limit the potential targets of private equity firms?
The UK market has continued to remain popular among sponsors within the European context. There continues to be great sector diversity in the deals that are coming to the market. However financial services, information technology as well as consumer and retail businesses remain strong areas.
There may be additional due diligence, regulatory and timing considerations for private equity sponsors looking to invest in the financial services, consumer credit and energy sectors of the market.
What are the issues unique to structuring and financing a cross-border going-private or private equity transaction?
The takeover regime does not have a specific set of rules that apply to cross-border investments by private equity sponsors. However, the Enterprise Act 2002 does provide the power for the Secretary of State for Business, Innovation and Skills to intervene in certain takeovers or transactions. This ‘public interest test’ applies to companies that operate in national security, media and broadcasting and financial stability sectors.
Club and group deals
What are some of the key considerations when more than one private equity firm, or one or more private equity firms and a strategic partner or other equity co-investor is participating in a deal?
There is no specific legislation or regulation relating to the participation of multiple private equity firms in a club deal. However, the impact of bidders clubbing together and sharing information and due diligence will need to be considered in particular in the context of antitrust or competition laws. Additionally, club deals may trigger the concert party rules of the Takeover Code that attribute the actions of one member of a concert party to other members. If, for example, the bidder, together with parties acting in concert with it, acquires shares that together represent more than 30 per cent of the target then it will be required to make a mandatory offer for the target.
Issues related to certainty of closing
What are the key issues that arise between a seller and a private equity buyer related to certainty of closing? How are these issues typically resolved?
Where a transaction is subject to the Takeover Code, the conditions to closing on which a bidder can rely on are in practice very few, such as competition or other regulatory approvals or, in the case of an offer, a minimum number of acceptances (ideally 90 per cent to enable squeeze-out and facilitate financing, but sometimes lower percentages such as 75 or 50 per cent). The limited conditionality required for offers subject to the Takeover Code are often seen in private purchase agreements and ‘financing outs’ (ie, where the purchaser’s commitment to close is subject to obtaining the required financing) are very rare. This means that the conditions to the financing have to be tailored to the conditions to the completion of the sale of the target’s shares. The ability of a public company to pay termination fees is restricted by financial assistance rules. If the transaction is subject to the Takeover Code then break fees payable by the target are generally prohibited.