Management Buyouts And Private Equity Funds Notes

• 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

• 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)

Return of investment/Exit

1. flotation of Newco1 on a recognised exchange

2. sale of N1 to trade B

3. secondary b/o

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

IRR

What is purpose of ratchet and how goes it work?

• 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

BVCA MOU conditions

BVCA Memorandum of Understanding conditions:

- BVCA is optional but if you sign up for BVCA Memo it’s a safe haven 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

Wheres shares are subject to a ratchet arrangement

Conditions (1), (2), (4) and (6) from above apply, plus:

1. the ratchet agreements must vary according to performance of the co and not of individual s’ers (in the other words they can’t act as a quasi bonus scheme)

2. ratchet arrangement must exist @ same time PEF acquires its ord shares; and

3. M must pay a price for share that reflects maximum economic entitlement they could achieve under ratchet (basically ensuring ratchet works to decrease M’s entitlement if IRR isn’t met, ensuring ratcheting up doesn’t happen)