Private Equity Comparative Guide

• Published date: 11 January 2021
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Government, Public Sector, Tax, Financial Services, M&A/Private Equity, Corporate and Company Law, Money Laundering, Tax Authorities
• Law Firm: Travers Smith LLP
• Author: Mr Chris Hale and Ian Shawyer

1 Legal framework

1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?

In relation to private equity transactions specifically, the following will generally be of relevance:

• The EU Alternative Investment Fund Managers Directive (AIFMD) requires managers of alternative investment funds (including most private equity funds) to be authorised by the Financial Conduct Authority (FCA) and to comply with a range of prudential, organisational and conduct of business rules. The AIFMD applies restrictions on asset stripping for 24 months from the date of acquisition of control and certain transparency notifications requirements.
• Where a transaction involves communication that could amount to a financial promotion, restrictions under the Financial Services and Markets Act 2000 will need to be considered.
• More generally, the Companies Act 2006 and associated company law apply to any M&A transaction as well as common law principles of contract law. As detailed later in this Q&A, FCA change of control approvals, competition clearances (which for some deals will be further complicated by Brexit) and developing foreign direct investment regimes (in the United Kingdom and other jurisdictions) may also be relevant.
• Where the target is (or has previously been) listed on a UK-regulated market, the Takeover Code may apply (ie, a statutory set of rules administered by the UK Takeover Panel setting out an orderly framework within which the takeover must be conducted).

1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?

Despite the political and economic uncertainty created by Brexit and the disruption caused by the COVID-19 pandemic, the private equity market in the United Kingdom has shown remarkable resilience and continues to attract investment from across the globe. It was the first European market in which private equity and buyouts took root and the features that enabled it to do so are even stronger today:

• deep pools of debt and equity money;
• an ecosystem of advisers who are based mainly in London and are second to none; and
• an open economy receptive to private equity.

The strength of English law and the English legal system is another factor. We often see transactions with no connection to the United Kingdom being run out of London because that is where the financial advisers are often based and due to the familiarity with English law.

2 Regulatory framework

2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?

Private equity firms in the United Kingdom are regulated by the Financial Conduct Authority (FCA) and are subject to specific requirements, including prudential, organisational and conduct of business rules. The FCA has a broad range of enforcement powers - including criminal, civil and regulatory - to protect consumers and take action against firms that do not meet its standards. For example, it can:

• withdraw a firm's authorisation;
• issue fines;
• make a public statement (therefore bringing reputational damage); or
• commence criminal proceedings.

The industry also has its own self-regulatory regime, by way of the Walker Guidelines for Disclosure and Transparency in Private equity and the supporting Private Equity Reporting Group, which essentially provide a set of rules and established oversight and disclosure comparable to those faced by FTSE 350 companies, operated on a comply or explain basis.

2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?

Both the UK merger control and inward investment regimes may apply. While UK merger filings are voluntary and non-suspensory, the UK Competition and Markets Authority will have jurisdiction to investigate a transaction where:

• the target has a UK turnover of more than '70 million; or
• the transaction results in a share of at least 25% of the supply or purchase of goods or services in the United Kingdom (or a substantial part of it) being created or enhanced.

If one of these thresholds is met, the UK government can also intervene on public interest grounds relating to national security, financial stability, media plurality or public health. Where the target is active in computing hardware, quantum technology, military/dual-use goods, artificial intelligence, cryptographic authentication technology and/or advanced materials, such thresholds are reduced to '1 million and a 25% market share (no increment required). A voluntary filing should be considered where the thresholds are met. The UK government can also intervene regardless of thresholds if the transaction involves a current/former defence contractor that holds confidential, defence-related information. The United Kingdom's proposed foreign direct investment regime is likely to result in conditions appearing in deals involving foreign buyers including some private equity buyers.

If the target is a financial services business, or if one or more entities within its group carry on activity regulated by a financial services regulator (eg, arranging consumer credit), regulatory approval may be required if the transaction entails a change of 'control' of the regulated entity. In the United Kingdom, the thresholds for 'control' are usually as low as 10% or 20%, and the term often captures indirect controllers. Failure to obtain change of control approval before completion is a criminal offence.

3 Structuring considerations

3.1 How are private equity transactions typically structured in your jurisdiction?

Rather than investing directly in the target, the private equity investors (whether on a primary, secondary or subsequent buyout) will generally invest, for tax and finance reasons, through a stack of newly incorporated companies (special purpose vehicles) known as the 'newco stack'. Most commonly, a triple or quadruple stack of newcos will be used as follows:

• Bidco: Acquires the shares in the target, and on leveraged transactions will be the primary borrower, so that the lending institutions can have direct rights against the company that owns the business.
• Cleanco: Usually required by the lending institutions so that they can take security over Bidco shares. The lenders will also take security over the target and its subsidiaries (given that Bidco is a shell company), so that the security package covers the operational entities in the group and the assets of the business.
• Midco: Will be the issuer of any shareholder debt held by the private equity investor and managers (if reinvesting into the newco structure).
• Topco: The chain of newly incorporated companies will ultimately be owned by the private equity investors and the management team, which will hold shares at the Topco level.

Typically, the private equity investor will acquire a controlling stake. However, increasingly, minority investment and co-investment strategies are coming to the fore. We also saw an uptick in public-to-private transactions prior to the COVID-19 crisis erupting.

3.2 What are the potential advantages and disadvantages of the available transaction structures?

The newco acquisition structure is largely driven by:

• the structuring objectives of the private equity investor;
• the requirements of the lenders on a leveraged transaction; and
• tax considerations.

Other than the fact that it may appear complex to those unfamiliar with the private equity transaction structure, there are no real disadvantages - albeit that on secondary (and subsequent) buyouts, there may be a need to tidy up structures by winding-up any redundant newcos in a pre-existing stack.

Where a private equity investor acquires a majority stake, it can expect a whole host of provisions in the equity documentation with management, aimed at protecting the private equity investment and allowing control over exit. There are fewer 'rules of thumb' in relation to minority investments and co-investment structures, and a carefully considered approach to the legal terms will be essential. The structural and economic terms of the transaction (eg, the amount of investment; the level of rollover; the size of any sweet equity pot; the amount of debt to be raised; and the ranking of securities as between shareholders) will influence the legal terms. Provided that the private equity investor can strike the correct balance under the deal documents, minority investments and co-investments can open opportunities to invest with less risk.

Public-to-private transactions provide an opportunity to acquire listed companies at attractive multiples. However, executing a buyout within the constraints of the Takeover Code presents a unique set of challenges.

3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?

Funding for the transaction will typically be by way of equity and shareholder debt (from the private equity investor and management) and third-party debt. Private debt providers (eg, private equity firms with their own credit arms) have come to the fore recently, to some extent replacing traditional bank lenders.

The private equity investor's funds will usually be invested in a combination of ordinary shares in Topco and shareholder debt in Midco (and/or preference shares in Topco). These funds are then pushed down to Bidco via share subscriptions and/or inter-company loans. The managers' equity investment will be structured as 'sweet equity' (ordinary shares without a proportionate holding of shareholder debt/preference shares) and, for those reinvesting more than is required to acquire sweet equity, an element of additional equity and shareholder debt/preference shares in the same proportion as the investor holds those instruments (the 'institutional strip'). The managers will often fund their reinvestment using a proportion of manager...