A more recent version of these Management Buyouts And Private Equity Funds notes – written by Cambridge And Oxilp And College Of Law students – is available here.
The following is a more accessble plain text extract of the PDF sample above, taken from our Private Acquisitions Notes. Due to the challenges of extracting text from PDFs, it will have odd formatting:
Management Buy-Outs and Private Equity
Ads and disads for M of participating in an MBO Ads
- potential for really big capital growth
- less restrictive/more flexibility than floating (basically private co. flexibility)
- incentivisation - personal efforts go towards their rewards
- not restricted by listing co procedure
- fund likely to leave in 3-7 yrs - could be a pro - on secondary b/o M often given chance to buy more equity
- PEF offers skill/expertise
- PEF often revise e'ee contracts and cull pointless staff - leaving more of the profits for M
Types of PEF activity
Return of investment/Exit
- usually have to use personal wealth (as M) to buy in - take out loan/debt fin against their personal assets
- dilution of equity thr/ratchet provision if IRR [Internal Rate of Return - ideal profit calculated by PEF] not made
- PEF might restrain M in the form of covs and in the form of good leaver/bad leaver cl's
- maximum potential equity for M is set out
beginning -> no potential to exceed as ratchets only ever work downwards
- Ws - although mainly for flushing out info re T - d'ors are still made personally liable (usually capped 3 yr's salary)
- fees involved (eg. lawyers) will need money to cover this as well
- PEF takes control - can appoint/remove d'or, reserve right to appoint chairman and execs and negative covs (saying what T can't do)
Venture capital - funding of new business Development capital - funding of existing, more mature businesses (3) B/o -funding of purchases of established businesses (1) flotation of Newco1 on a recognised exchange (2) sale of N1 to trade B (3) secondary b/o (1) (2)
Position of M and their Duties and Obligations to be borne in mind during the Negotiations
Position of M, Duties and Obligations to be borne in mind during negotiation
- Directors' Duties: M have d'ors' duty to act in a way that will promote success of co for existing s'ers (s.172 CA) as well as duty to declare interest (s.177)
- M must therefore make sure they obtain highest price for T and to obtain lowest Ws (but they themselves are the B!)
- Duty to exercise r'able care and skill and diligence (s.174 as well as fiduciary duty in e'ent contract).
- E'ent contract: as e'ers they owe T good faith = unlikely that interest of both co's will be the same: eg. time, confidentiality (M will get a confidentiality letter from T giving permission to avoid breach of their duty)
- Action? in practice, d'ors who are part of MBO will not participate, any retiring/independent d'ors will act as S or if none existing, T will appoint independent d'ors to do the job. M who participating in MBO must retire [cf. board mins] to avoid this conflict of interest
- What to do before approach to PEF?
- DD to reduce risk/liability
- PEF will ask M For Ws (not as contractual redress but) to flush out info
Ratchet IRR What is exit?
What is purpose of ratchet and how goes it work?
Internal Rate of Return - level of return PEF want to achieve via capital and income time when PEF want to achieve their capital gain thr/selling their shares
- used to incentivise M, usually set something attainable
- To work out - take the current number of shares [X] as 20% so divide by 20 then multiply by 100 to work out what new number of shares post ratchet would be
- Then minus X as number of shares M already hold will never chance so new M s'ing = Y
- Minus however many shares M already own (X) and the remaining number will need to be converted to ord shares on a successful ratchet
Tax issues on a PEF MBO BVCA Memorandum of Understanding conditions:
- BVCA is optional but if you sign up for BVCA Memo it's a safe haven conditions for ensuring shares for M are taxed under CGT not income by HMRC when the shares are sold by M to achieve their capital gain so in practice everyone does it
Buy the full version of these notes or essay plans and more in our Private Acquisitions Notes.