#10206 - Private Equity Acquisitions - Mergers and Acquisitions (Private Acquisitions)

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

3 Types of Buyout

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

.

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.

• MBOs may be an SPT (s190CA) ifCo buys asset from or sells an asset to a D&.^.. need an OR from SHs’.

• If D will hold shares in Newco, could = an associated Co&so be deemed to be ‘connected’ with D(s254CA).

• Although asingle D unlikely to hold relevant 20% holding required for Newco to be hisassociated Cos254(2)legislation refers to a 20% holding by a D&/or his connected persons.

• .^..need to know whether any ofother SHs of Newco are ‘connected’ with D= a holding of +=20% of Newco’s shares.

• Where management team will have a shareholding of +=20% or more in Newco, a detailed review should be undertaken to ascertain whether or not SHs’ approval under s190CA will be required for sale.

Warranties(seldom used to sue the D’s they act as way to incentivise D’s honesty and performance)

INSTITUTIONAL LEVERAGED BUYOUTP.184

• Provider will hope to acquire amajority shareholding in a private Co (or even an underperforming public Co thatcould be converted into a private Co) that has potential to generate substantialprofits.

• Provider will be managing funds created by institutional investorssuch as pension funds, banks & insurance Cos.

• These institutional fund holders willbe seeking to achieve good returns whilst trying to minimise potential risks.

• Once target is identified, Providerwill follow its internal procedures for approval of the proposed investment.

• Recently, Cos have been sold through auction process = lots of Providers bidding for rightto acquire the Co.

Debt/equity ratio

• Provider will try to achieve bestdebt to equity mix in order to maximise its profit (i.e. balance the amount of debt and equity).

• Provider willconsider its internal rate of return (gain on sale based onprojections for increase in of target Co).

• This depends on how muchequity needs to be provided: lower the amount of equity, greater the gains per share

• A high level of debt funding is often a feature of private equity-led acquisitions.

• Key advantage of private Co investments = they aren’t subject to prohibitions on theprovision of financial assistance.

  • Means that any borrowing for acquisition of target Co’s shares can be secured on assets of the target Co.

• Problem – in a public Co acquisition through a private-equity led investment, you can’t secure assets in this way,

• Solution - publictarget will immediately be converted into a private Co.

The management team

• On a leveraged buyout, management team not driving force behind acquisition but still instrumental as it will usually have expertise necessary tomaximise the investment potential of target Co.

• Management team selectedmay be existing managers, external managers brought in by provider or a combination.

• Managers usually be provided with financialincentive in order to achieve a successful exit from target Co.

  • Usually = class of equity shares (‘sweet equity’) that management team can sell when target Co is sold.

• Managementteam expected to give warranties in relation to its business plan &info provided by it about target.

• Warrantiesneeded to help ensure management team’s full commitment to...