PRIVATE EQUITY OVERVIEWP.181

Private equity is aninvestment in the share capital of a private Co.
Investor (private equity provider) hopes to receive via dividends (Co distributable profits)& a capital gain (sale of Co).
Shares in a privateCo.not readily sold, so need expert advice, & risk minimising strategies.

The private equity providerP.182

The private equity fund is themoney that is to be invested.
Fund may come from individuals, Cos, institutional investors (pension funds), banks &insurance Cos.
Specialist funds created whereby investors agree, usually(primarily for tax reasons) through form of a limited partnership, to provide funds to beinvested in particular types of private Cos.
Fund usually has astatement as to type of investments for which fund may be used.
Investment of within fund made by a private equity provider (AKA private equity house).
Provider makes profit often through imposition of fees based on % profits of successful investment returns.
Vital forinvest successfully, as if it doesn’t, investors unlikely to put into funds run by that provider again.

The decision to investP.182

Before investment, provider usually follows an agreedinternal procedure for approval of investment.
Requirements for such internal approvals can have a significant impact on timetable of a proposed acquisition.
Internal procedure usually involves production of an investment paper which is presented to an investment committeeof the private equity provider.
Paper sets out proposed structure for transaction & anticipated rate of return on investment.
Where funds to beprovided are for buyout (see below), offer for acquisition made on basis of thisinitial approval, & final approval of investment committee may also be required whendetail of proposed acquisition has been agreed.
Investment of funds oftenprovided through particular corporate investment structures.
Large transactions may involve use of a number of corporate entities in order to layer input of requiredfinances (‘structural subordination’) & may also involve use ofoverseas holding Cos (for tax & investment planning purposes).

3 Types of investmentsP.183

	START-UP CAPITAL	DEVELOPMENT CAPITAL	BUYOUTS
WHAT IS IT?	Providing financing at outset of a business	Providing finance for expansion	Finance is provided for acquisition of a business
WHAT FORM DOES INVESTMENT TAKE?	Subscription of shares in target	Subscription of shares in target	Depends on if management (p2) or institutional buyout (p3) (see below)

3 Types of Buyout

	SMALL MANAGEMENT BUYOUT	LARGE MANAGEMENT BUYOUT	LARGE INSTITUTIONAL BUYOUT
METHOD OF INVESTMENT	Likely direct subscription for shares made in Co undertaking target.	Likely subscription of shares & debt finance. Corporate structure (see above) may be created to undertake the acquisition	Likely a fairly complex corporate structure used to cope with numerous layers of investment & debt finance.

MANAGEMENT BUYOUT ‘MBO’P.182

Transaction by which target’s shares or assets is acquired by some or all of its management, usually a ‘Newco’.
Prospectivemanagement team unlikely to be able to generate sufficient capital itself to finance acquisition & will .^.. usually seek funding elsewhere.
Management team drawsup a business plan designed to attract investment by a private equity provider.
Often, severalprivate equity providers will be invited to bid for the opportunity to be involved in the deal.
Financing usually = equity finance (from management team &provider), & debt finance (secured on target’s assets).
If existingmanagement team instigate MBO, provider expects management team to provide asubstantial investment
- Ensures that team is heavily committed financially aswell as commercially to the success of the venture.
Provider prefers to take a majority shareholding in venture. May take minorityshareholding if it can negotiate measures to allow it morecontrol if it’s concerned that venture is failing.

The investment

Investment by provider often made through anew corporate vehicle established for the purpose (‘Newco’).
Both provider& management team subscribe for ordinary shares in Newco.
- Each partywill have carefully negotiated the rights attaching to those shares.
Providerwill also make a large % of its investment in return for redeemable preference sharesthat carry preferential rights to receive dividends & to return of capitalon a winding up of Newco (Minimises risk of unsuccessful venture).
Parties toventure will expect to enter into an ‘investment agreement’ (see p4-5).
Thisagreement sets out basis on which investment has been made, any requiredrestrictions on running of acquired Co& relevant provisions governing realisation of investment through an onward sale or listing.
On a traditional MBO, investment agreement will also include extensive warranties given by management teamabout target business & also business plan drawn up by team to attract investment.
If Co is being sold to its own management, seller will often beable to resist giving extensive warranties (see below).
Providerwon’t be satisfied with seller’s limited warranties & will require management teamto provide comfort by warranting all key info about target business

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Conflict of interest

Management team contemplating buyout must not breach obligations of good faith/confidentiality owed to target.
Management team willtry to achieve best possible. May conflict with their duties to Co, its SHs& employees.
If managementteam member = D, consideration should be given to his statutory duties (s170-177 CA).
As soonas a D has decided to initiate a MBO, should declare his interest to the board & to seek consent to proceed.
Even if management teammember not a D, an approach to board is still advisable as MBO process isotherwise likely to involve breaches in terms of his employment contract, in particular anyterms as to confidentiality.
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