Private WS7: Equity
1. 2. 3. 4. 5.
Explain some common private equity terminology Basic structure of a private equity investment by way of a leveraged buyout. Principal documentation involved in a leveraged buyout. The interaction between various principal documents Common terms of a Subscription and Shareholders Agreement. And the Articles of Association of the investment vehicle which regulates the Target Co. Objectives & drivers behind a private equity investment
___________________________________________________________________________________________________________ _______________________________________Ch 8.2: TRANSFER OF ASSETS _ ____________________________________ _
1. OVERVIEW
Private equity is an investment in the share capital of a private company (ie acquisition) Aims of private equity investors: high rate of return a) to receive income from profits generated by the company (dividends) b) to make a capital gain from the eventual sale of the shares. Quick exit route needed. The risk with private equity is that they are investing in a private co. This is risky as the shares can not be easily sold if the private equity venture fails. But if the venture succeeds then high returns. Traditional private equity : private equity began with the provision of finance to new business. This was by managers seeking to finance the purchase of the business in which they worked (`buyout'). They put in `venture capital' for a minority stake. Private equity today: Investors will want to take a majority stake in an underperforming co. They hope that investors involvement will turn the co's fortunes around so it can be sold for a profit when it has returned to its optimum level. a) Management buyout b) Institutional leveraged buyout The private equity provider The private equity fund is the money to be invested in the acquisition The fund may come from a variety of sources (eg individuals/companies/institutional investors) The private equity provider invests the money. The provider makes money by successful investments as he will get fees based on % of profits. The decision to invest The private equity provider will usually have an internal procedure to follow when deciding what to invest in. The decision of what to invest the money in will be based on anticipated rate of return and risks. Types of investments made by private equity provider a) Start-up capital (providing finance at the outset of a business) b) Development capital (providing finance for expansion) c) Buyouts (finance provided for the acquisition of a business) management buyout institutional leveraged buyout
2. MANAGEMENT BUYOUT
Transaction by which the target is acquired by some or all of its management Management team unlikely to have enough money themselves. Therefore they will come to a private equity provider for money. Management team will in turn give the private equity provider shares in the co. The investment Investment by the private equity provider will often be through a NewCo. Both the private equity provider and the management team will subscribe for shares in NewCo NewCo will then be used to purchase shares in the target co (the co of the managers) Private equity provider will want redeemable preference shares as they carry preferential rights to dividend and an exit strategy. The investment agreement will determine the terms on which the private equity provider is investing. warranties will have to be given by the management team about the state of the target business.
Conflict of interest Managers of the co which they are buying should be careful there is no conflict of interest. For example, they will want the lowest price whereas co will want the highest price. Manager who is also a director of the co also has statutory duties: a) Declaration of interests in transactions (the purchase of shares in the co). OR needed before director can continue
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WS7: Private Equity
b)
Company selling a substantial asset to a shareholder (SPT). OR needed to approve it
3. INSTITUTIONAL LEVERAGED BUYOUT
Warranties Seller (target co) is to likely resist extensive warranties because it will argue the managers know more Private equity provider will be using funds provided by institutional investors (eg pension funds, banks) This fund will be increased by taking a loan from a bank. The money will then be used to buy a majority shareholding in private co. Debt/equity ratio The private equity provider will have money from (a) institutional investors [equity]; and (b) loan [debt]. He will find the best mix of these to get the highest rate of return. the lower the amount of equity used, the greater the gains per share (ie more loan money used)
The loans from the bank are secured by the target co (financial assistance is allowed as it is a private co)
The management team The management team will not be the driving force. But they will be given a financial incentive (such as sweet equity shares) to achieve a successful exit from the target co. Seller will provide full warranties. Private equity provider will pursue seller rather than management team (who will also make warranties) Common structures on leveraged buyout Private equity director will not invest directly. Common structure is:
4. KEY DOCUMENTATION
There are 3 key parties: (1) the private equity provider; (2) the debt financiers; (3) the management team
1. The investment agreement
The agreement will cover 3 main areas: a) The terms of the investment Specify how the money for the proposed purchase will be raised. How much money is invested by the private equity provider / management team and how much from a loan? Relatively small proportion of the funds will be used to buy ordinary shares. The rest will be used to buy redeemable preference shares (due to dividends & exit route) Details of the proposed investment b) Governance of the investment Structures for the ongoing management of the target business a) If private equity provider has taken a minority stake in target then the provider will want very strict restrictions on the activities of the target co usual for management buyout b) If private equity provider has taken a majority stake in target then provider will be more relaxed (as it will be able to take control of co if necessary) usual for intuitional leveraged buyout The private equity provider will usually require the right to appoint/remove directors and to veto decisions c) Realisation of the investment How the investment will be realised (usually within 5 years). This could be done by: a) A listing of the shares for sale on a Stock Exchange b) If not possible then sale through a trade sale
Private equity investor will refuse to give warranties when he sells the shares. Articles of association will usually prevent a member of the management team from selling its shares (except that a director will be forced to sell its shares on dismissal/retirement) Transfer articles will also include a provision on `drag along' and `tag along' a) Drag along: minority management shareholders can be forced to sell their shares [makes it easier for private equity provider to sell all shares]
b)
Tag along: minority shareholder can join in on any sale of shares where an offer has been made for the shares of the private equity provider.
2. Associated documentation
a) The investment Parties to the transaction must agree the terms of the articles of association of the top company (see diag on p2) rights attaching to shares (eg rights to income and return on capital) rules on the transfer of shares (drag along / tag along?) rules that managers can not sell shares (but if removed/retire then they must sell shares) b) The debt finance
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WS7: Private Equity
Banking documentation to govern the provision of debt finance. Document detailing the security given by target co. Inter-creditor agreement if more than 1 bank making a lona.
c) The acquisition The acquisition process is exactly the same as in WS6. The private equity provider will enter into a contract to buy the shares of the target (the SPA). The target will be required to make warranties and will provide a disclosure letter.
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