Private Equity 2024 Comparisons

2024 has seen a similar number of private equity transactions in the UK compared to 2023. Many of these transactions have been add-on transactions for funds’ existing portfolio companies, rather than new platform investments or exits.

There continues to be a lot of activity in the UK takeover market, with purchasers taking advantage of structural discounts for listed UK shares when compared with similar equities in other jurisdictions, plus a weaker (albeit recovering) pound sterling against the US dollar.

The private equity landscape as a whole in the UK has been affected by continued high interest rates in 2024. Although monetary policy is easing in the second half of 2024, sponsors are still feeling the need to equity underwrite the majority (if not all) of their acquisitions, with attractive debt terms seemingly unavailable for the foreseeable future. There is also a lingering difficulty for sellers and buyers to find agreement on price, with a broad bid-ask spread contributing to a continuing slowdown in larger transactions.

2024 has seen stronger activity from private equity sponsors in the financial services and wealth management industries in the UK, both in terms of new platform and consolidation transactions, notwithstanding inflationary pressures on wages in the sector.

Compliance

The Economic Crime and Corporate Transparency Act 2023 introduces a new “failure to prevent fraud” offence, akin to the “failure to prevent bribery” and “failure to prevent facilitation of tax evasion” offences. This new offence is expected to come into effect by April 2025. The new offence will hold large organisations criminally liable if an associate (such as an employee, agent, or subsidiary) commits fraud for the benefit of the organisation or any person to whom services are provided on behalf of the organisation. Moreover, this offence has a wide jurisdictional reach, applying to both UK and non-UK companies where there is fraud with a UK connection (eg, the fraud is committed under UK law or targets UK victims).

Private equity firms and portfolio companies will be able to avoid enforcement action if they have reasonable procedures in place to prevent fraud (or it was not reasonable in all the circumstances to expect the body to have any prevention procedures in place). Government guidance on reasonable procedures is expected in late 2024 and it is anticipated that it will follow the same principles-based approach taken regarding the guidance in relation to the failure to prevent bribery and facilitation of tax evasion offences. Private equity firms and portfolio companies will require an uplift to existing compliance policies and procedures. Private equity houses will also want to check fraud prevention procedures from a due diligence perspective, as they will wish to check if such policies and procedures are in place at a target, and also regarding a potential compliance uplift at portfolio company level post-acquisition.

Sanctions

The last year has not seen the same level of new Russia-related UK sanctions legislation as 2022-2023. However, an expansion of the goods that are subject to UK (as well as US and EU) trade sanctions, continued uncertainty over the meaning of “ownership and control” in the context of the UK asset freeze, and the increased focus of UK and other sanctions authorities on sanctions circumvention – including the announcement of a new sanctions authority (the Office of Trade Sanctions Implementation) to tackle trade sanctions evasion and strengthen enforcement – mean that sanctions due diligence remains an important part of many private equity transactions and particularly those with a connection to Russia.

ESG

By the end of 2024, the UK Sustainability Disclosure Requirements will be fully in force. Although largely influenced by the EU’s Sustainable Finance Disclosure Regulation, there are some differences in the disclosure and reporting requirements, while the EU’s regulation does not yet include a general anti-greenwashing rule requiring sustainability claims to be “fair, clear and not misleading”. Sponsors that are marketing funds to EU and UK investors will therefore need to be careful to ensure that the relevant rules are being complied with.

Merger Control

The Competition and Markets Authority (CMA) is the UK’s competition regulator, responsible for investigating M&A transactions that may impact competition, enforcing competition laws – such as those against cartels and market dominance abuse – and conducting market studies and investigation to address potential competition and consumer concerns. The UK operates a voluntary merger control system. This means that there is no legal obligation to notify the CMA or seek its approval before implementing a transaction. However, if the transaction meets the relevant thresholds and the parties do not notify, the CMA may launch its own investigation and has extensive powers to impose stringent interim hold-separate orders as well as a range of final remedies, including ultimately to unwind the transaction. Therefore, where material substantive competition concerns arise on an acquisition meeting the relevant jurisdictional thresholds, most private equity buyers will require CMA approval as a condition precedent to closing.

The CMA has the power to investigate and intervene in M&A transactions that meet at least one of the following jurisdictional thresholds: (i) the target’s UK turnover exceeds GBP70 million (set to increase to GBP100 million under the new Digital Markets, Competition and Consumers Act (DMCCA); or (ii) the merger results in a 25% or greater share of supply in the UK (or a substantial part of the UK), provided there is an increment in that share. The DMCCA will introduce additional thresholds, granting the CMA jurisdiction if (i) at least one party has an existing 33% share of supply in the UK and a UK turnover of GBP350 million; and (ii) another party has a “UK nexus” (broadly defined to be satisfied where the party has any activity, legal entity or supply of goods or services in the UK). This change removes the current requirement for overlapping UK activities (ie, an increment in the share of supply) and is likely to bring a larger proportion of private equity transactions into scope of the UK merger control rules. Additionally, the DMCCA will introduce a mandatory notification obligation on companies designated by the CMA as having “strategic market status” if (i) the transaction increases their stake above 15%, 25%, or 50%; (ii) the target company is or will be active in the UK; and (iii) the transaction consideration is at least GBP25 million.

Private equity investors should also note the CMA’s increased scrutiny of roll-up acquisitions, with the CMA’s CEO Sarah Cardell noting in 2023 that these would “come in for very close scrutiny”. This has been evidenced by recent CMA investigations relating to roll-up acquisitions in the dentistry and veterinary industries, which involved acquiring portfolio companies controlled by private equity firms. In many cases, the CMA has reviewed the transaction after completion and only approved the deal subject to remedies (such as divestments) offered by the parties.

Foreign Direct Investment (FDI)

The Investment Security Unit (ISU) oversees and implements foreign direct investment screening in the UK, aiming to protect national security while maintaining the country’s appeal to foreign investors. The ISU assesses transactions for national security risks and may block or impose conditions on those deemed too risky. Under the National Security and Investment Act 2021 (NSIA), mandatory filing and ISU approval are required for certain acquisitions if the target’s activities fall within one of the 17 sensitive sectors identified by the NSIA, including defence, energy, critical suppliers to government, and data infrastructure. The scope of the NSIA rules goes much further than many other global FDI regimes, which generally require a local subsidiary, assets or at least branch office to be triggered. The UK regime can be triggered by sales to UK customers alone – ie, potential filings under the NSI Act may be required in the context of global private equity transactions even where the target has only a remote UK nexus.

In addition to evaluating the sectors involved, the ISU also considers the identity of the proposed acquirer. For private equity firms, the presence of sovereign wealth funds as a significant LP investor in the acquiring fund may lead to increased scrutiny of an M&A deal, particularly if those investors originate from countries considered to pose a higher national security risk to the UK. Chinese investors have come under greater scrutiny, with 53% of final orders (remedies or prohibition) between 2022 and 2023 relating to transactions involving Chinese entities. Where an acquisition is being made by a consortium of private equity investors careful assessment will need to be made as to whether any of the co-investors poses a greater risk from a national security perspective. In such circumstances, consortium members will need to consider how to appropriately allocate (as between themselves) the risk of mitigations being required to obtain approval (eg, providing for certain investors, if considered individually problematic, to reduce their governance rights, lower their stake or take specific measures to allay potential concerns).

Legal due diligence is conducted thoroughly in the UK. Legal due diligence reports are important not only for the private equity sponsor in finding out about any legal risks associated with a target, but also for the purpose of insuring a set of warranties relating to the transaction where the liability for the warranting party/ies is limited to GBP1, or securing third-party financing for a transaction.

Scoping of a due diligence exercise is crucial in ensuring that the key legal (and geographical) areas relevant to a particular target are covered, but in a focused and efficient way. Legal due diligence exercises will almost always cover verification of the ownership of a target and its subsidiaries, details of any third-party shareholdings within the group and details of the contractual arrangements with those parties, key customer and supplier agreements, and employment law issues. The extent to which other areas – such as intellectual property, data protection, or real estate – are focused on will depend on their relevance to a particular transaction. In addition, for regulated businesses, legal due diligence will cover compliance by the target with applicable regimes, and the details of any consents which may be needed from the authorities in connection with the transaction.

Financial, tax, and insurance matters are among those commonly excluded from legal due diligence.

Vendor due diligence is common in structured processes for the sale of UK assets to private equity purchasers, as a good vendor due diligence report can reduce the time needed for purchasers and their advisers to understand the legal issues associated with a target, and to factor them into a transaction. Sell-side law firms will typically provide reliance on their reports to the buy-side, although their contents are commonly more factual in nature, and less likely to give a “view” on legal risk or potential solutions to issues (with some sellers being of the opinion that this is something for the purchaser to form a view on with the aid of its advisers).

Sale and purchase agreements govern the transfer of shares and assets in UK transactions where there is no public element to the transaction. For UK take privates by private equity sponsors, the majority of transactions are implemented by a court-approved scheme of arrangement.

Private equity sponsors will typically incorporate an “investment stack” of holding companies to, among other reasons, ensure tax structuring efficiency, obtain financing, limit fund-level liability, and set the structure up for an eventual exit. The final entity in the stack will be the “BidCo”, the SPV incorporated for the sole purpose of acquiring the relevant shares or assets. The funds themselves will only be party to an equity commitment letter.

Private equity transactions have typically been funded with a mix of third-party debt and equity from the fund and any co-investors. At the time of signing a transaction, an acquiring fund provides an equity commitment letter to its BidCo (enforceable by or also directly addressed to the seller) in which it commits to fund the BidCo with equity up to a capped amount on or before completion. Also at signing, the buyer will deliver evidence of its acquisition finance package (if any) to the seller. This may constitute debt commitment letters appending a financing term sheet (or something in longer form), but crucially will be provided on a “certain funds” basis. This means that any conditions to the provision of financing will be satisfied at signing, and there will be only very limited opportunities for a lender to refuse to fund on completion. Given the continuing difficulty of obtaining attractive debt terms in 2024, it is becoming more common for funds to fully equity underwrite a transaction, and then try and arrange a financing package before or shortly after completion.

Transactions involving a consortium of private equity sponsors are common in the UK. They permit sponsors to de-risk an investment by reducing their equity funding requirement. More common is a structure where limited partners in the fund making the acquisition are given the opportunity to invest alongside the sponsor. Typically, this is a passive investment by limited partners in a pooled vehicle which invests alongside the sponsor, but in some cases (particularly where an LP is providing a material portion of the overall equity commitment) a limited partner will invest directly alongside the sponsor. This is becoming increasingly common for sovereign wealth funds. It is uncommon in the UK for a private equity sponsor to invest in an asset alongside a corporate or strategic investor, given that these investors will likely have a differing view of the horizon for the timing of an exit (if they consider that an outcome at all). 

Private equity transactions in the UK will typically include either a locked-box or completion accounts consideration mechanism, depending on the nature of the transaction and the competitiveness of the process. Although corporate purchasers (particularly from the US) may be reluctant to use a locked-box mechanism even in the most straightforward acquisition, their identity alone would not typically be sufficient to flip the transaction to completion accounts, particularly in a competitive process. Given the present difficulty in finding alignment between buyers and sellers on pricing expectations, EBITDA or milestone-linked earn-outs are commonly being used to provide greater comfort to purchasers, who may wish to see the results of predicted future growth before paying for it.

A fixed daily ticker is commonly added to the locked-box equity price from the date of the locked-box accounts until completion, to reflect cash profits generated by the target during this period, the benefit of which the buyer would otherwise take (but which would in theory be calculated as part of the target’s cash at completion in a completion accounts mechanism). Sometimes, interest is also charged on leakage of value from the locked box to (or for the benefit of) the sellers from the locked-box date to completion, but more usually this is just deducted from the completion purchase price (if identified before completion), or repaid, on a pound-for-pound basis.

A sale and purchase agreement with a locked-box consideration mechanism will not include a specific dispute resolution mechanism regarding the purchase price. The buyer and seller agree the locked-box accounts before signing the transaction, and the buyer should be comfortable that it can recover any leakage from the locked box under the seller’s leakage covenant (demonstrating the importance of ensuring that definitions of “Leakage” and “Permitted Leakage” in the acquisition documents are carefully reviewed and negotiated).

On the other hand, completion accounts will be drawn up post-completion, based on a hierarchy of accounting policies set out in the sale and purchase agreement underpinned by definitions of “Cash”, “Debt”, and “Working Capital”, to land at final number, following payment of an estimated consideration amount at completion. Following receipt of the draft completion accounts, the recipient (it could be either the seller or the buyer) will have the opportunity to point out any items of disagreement, along with its supporting argument. If this cannot be agreed between the parties, the sale and purchase agreement will contain a mechanism for resolution of the dispute by an independent expert accountant.

Mandatory (but given the context of the antitrust regime in the UK provided above, also including voluntary CMA referrals) and suspensory conditions are typically the only acceptable conditions to completion of the sale of any asset owned by a private equity sponsor in the UK. Material adverse change clauses, or third-party consent conditions, are not prevalent in UK private equity transactions.

Private equity buyers will often accept “hell or high water” undertakings (requiring the buyer to do everything it can to secure satisfaction of the condition, including agreeing to remedies required by the relevant authorities) in relation to antitrust conditions, but only after doing a significant amount of preliminary work to establish the likelihood of any substantive issues regarding overlapping assets within their portfolios, and where they have a good understanding of the antitrust authority. Any such remedial action will typically be limited to the sponsor’s fund making the acquisition, and not its wider universe of funds (which it may not have authority to bind). 

For foreign direct investment approval conditions, buyers are much less likely to accept a “hell or high water” obligation, owing not only to the increasing interventionism of FDI regulators but also to the uncertainty surrounding what behaviourial remedies may be required before consent to the transaction is provided. Although not as new (and uncertain) as the EU’s FSR regime, intervention under the NSIA is still nascent, and buyers are cautious of agreeing to comply with any, unknown, remedies to get the transaction approved.

Break fees in favour of the seller, although common in the USA, are not a customary feature of UK private equity transactions.

Conditional sale and purchase agreements in the UK contain a “long-stop date” by which the conditions must be met, failing which the seller typically has the ability to terminate the agreement. After a further period of time (usually between one and three months following the long-stop date) the buyer is usually also permitted to terminate the agreement (provided it is not at fault in failing to satisfy the condition).

It is generally understood in UK transactions where the seller is a private equity fund that, given the nature of those funds, and their need to return capital to investors, they require a “clean break” as far as possible. For that reason, extending liability beyond the customary limitations is generally not negotiable.         

Regardless of the identity of the purchaser, private equity sellers in the UK will typically provide only title and capacity warranties concerning their ownership of the shares and ability to enter into the sale and purchase agreement. Given the fundamental nature of the warranties, liability for breach warranties will typically be capped in time at six years, and in value at the amount of consideration received by the seller, without any de minimis or thresholds. Beyond the leakage covenant described above, private equity sellers will seek to resist providing any other contractual protection to the buyer. On occasion, however, a risk may be so apparent regarding the target’s business that the seller will covenant to indemnify the buyer in respect of any loss arising out of that issue. Commonly, these issues are tax related. Any such covenants may be subject to bespoke financial limitations, but will typically be available to a buyer for six or seven years from completion (where tax related).

In addition to title and capacity warranties, a core group of managers will usually be expected to provide a set of business warranties concerning the affairs of the target. Liability for management is typically capped at GBP1, with recourse for the buyer being limited to the W&I policy. Liability under management warranties is typically limited in time to two years, and is subject to exclusions for matters which are disclosed against the warranty, which will usually include a set of specific disclosures in a disclosure letter, but also the contents of a data room prepared in connection with a transaction. The buyer will also not be able to claim in respect of any matters of which it was aware at the time of signing.

W&I insurance is a common feature of private equity transactions in the UK. It is most commonly used to insure against breaches of warranties given by the seller or, on a secondary buyout, management, whose liability in respect of the warranties is capped at GBP1.

Given their need to distribute returns back to investors as quickly as possible to preserve IRR metrics, private equity sellers will almost always seek to avoid any sales proceeds being held in escrow. They will always try and push the risk on to an insurer, or otherwise require the buyer to take comfort that the reputational damage to a private equity firm from it not standing behind its liability would be such that in practice, it should never be allowed to happen. This is a position which has survived the recent slowdown in exit transactions in the UK.

Litigation under sale and purchase agreements in the UK typically relates to leakage claims (ie, whether or not something was leakage) under locked-box pricing mechanisms, warranty claims (the litigation often focusing on the limitations of the seller’s liability in relation to those claims), and earn-out calculations. 

Completion accounts mechanisms, although commonly contentious, are arguably less commonly litigated given that the dispute mechanism which they contain usually results in a binding decision of an independent expert absent manifest error, a term which is interpreted narrowly by the English courts.

Public-to-privates involving private equity-backed bidders are very common in the UK. The roles of the target company and its board are broadly the same as in other public company takeover transactions, but there are unique features particularly where members of the management team are to have a continuing role in the business.

The Takeover Code requires the target board to obtain independent advice as to whether the financial terms of any offer are fair and reasonable and must ensure that the substance of the advice is made known to its shareholders. This is particularly important in a management buyout (MBO) or similar transaction where the independence of the adviser must be beyond question.

The Takeover Code also contains special provisions regarding information that must be provided to the target’s independent directors and a competing bidder in an MBO or similar transaction. In such transactions, the bidder must provide to the target’s independent directors all information which it has provided to external providers of finance. In addition, information generated by the target (including its management acting in that capacity) which is passed to external providers or potential providers of finance to the bidder must be provided to a competing bidder.

Special rules also apply to management incentivisation arrangements that the bidder intends to provide. These need to be disclosed in the offer documentation and the target’s financial adviser will need to state in the documentation that the arrangements are “fair and reasonable”. Where shares are being provided to management on a basis which is not being extended to other shareholders, the arrangements will need to be approved by the target’s shareholders.

As with any other public company takeover, it is common for the target and bidder to enter into a co-operation agreement, particularly where the transaction is structured as a scheme of arrangement. These agreements cannot contain offer-related arrangements that are prohibited under the Takeover Code, such as exclusivity undertakings, undertakings relating to the conduct of the target’s business and warranties relating to the target business.

Under the Listing Rules, a shareholder is required to notify a listed company (which in turn must issue an announcement) when certain thresholds are crossed.  For UK issuers, the threshold is 3% and each 1% threshold thereafter. For non-UK issuers, the threshold is 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75%.

The Takeover Code also requires the bidder, target and certain other parties to make an opening position disclosure relating to interests held in the bidder’s or target’s securities at the start of an offer period or, if later, after the announcement identifying a bidder. The parties are also required to make dealing disclosures of any subsequent deals in such securities.

Where an offer is structured as a contractual offer (as opposed to a scheme), the bidder is also required to announce the level of acceptances reached at various stages during the course of the offer.

The Takeover Code requires an offer to be made when a person acquires an interest in shares in a Takeover Code company which, when aggregated with any shares held by that person and by persons acting in concert with it, carry 30% or more of the voting rights of a company. A mandatory offer is also required if a person, or any person acting in concert with it, increases its share interests, where the person and its concert parties held between 30-50% of the company’s voting rights before the acquisition.

The Takeover Code presumes that certain categories of persons will be presumed to be acting in concert with each other unless the contrary is shown. These include portfolio companies with a private equity bidder where the bidder has a controlling interest in the portfolio companies and limited partners in a private equity fund where the limited partner’s interest in the fund is 30% or more. The Panel may agree that the presumption of acting in concert will only apply from the earlier of when the bidder is first identified and the portfolio company or limited partner is made aware of a possible offer.

The majority of public-to-privates involving private equity houses are cash only bids, but there has been an increased use of stub equity in recent years. The driver for this is sometimes a key target shareholder wishing to retain an ongoing economic exposure in the target, which necessitates extending this to other shareholders under the Takeover Code rules that require target shareholders to be treated equally.

Acquisitions of target shares during the offer period and in the three months before the start of the offer period will normally result in the offer price having to be at least equal to the highest price paid for the shares. Acquisitions of target shares during the offer period and in the twelve months before the start of the offer period (for cash acquisitions) or the three months before the start of the offer period (for acquisitions made in exchange for securities) may also result in a requirement to offer a particular form of consideration as well as setting a minimum offer price, depending on the percentage of target shares acquired and whether the dealing took place before or during the offer period.

Takeover offers are usually subject to a wide range of conditions, including an acceptance condition (for contractual offers), conditions relating to the scheme process (for schemes), anti-trust and other regulatory conditions, conditions relating to the target’s business, shareholder approval and listing conditions.  However, the ability of the bidder to invoke a condition is restricted by the Code. Any conditions should not be subjective in nature or be ones where the fulfilment is in the bidder’s hands.

Where the offer is for cash, or includes an element of cash, and the bidder proposes to finance the cash consideration by an issue of new securities, the offer must be made subject to any condition required, as a matter of law or regulatory requirement, in order validly to issue such securities or to have them listed or admitted to trading. Subject to this, a bidder is not permitted to make its offer conditional on financing. In addition, where the offer includes cash consideration, the bidder’s financial adviser is required to confirm in the offer documentation that the bidder has sufficient resources to satisfy full acceptance of the offer. The effect of this is that any finance documentation can only be subject to very limited conditions.

The Takeover Code prohibits a target company from agreeing a break fee except where it has announced a formal sale process or where another bidder has announced an unrecommended offer and the target company wishes to agree a break fee with a competing bidder. Where these exceptions apply, any break fee must be de minimis (usually no more than 1% of the offer price). The Takeover Code also prohibits other deal protection measures (“offer-related arrangements”) such as matching rights, force-the-vote provisions, non-solicitation provisions and requirements to notify the original bidder about any approach received. A target company can, however, enter into non-disclosure agreements, agreements not to solicit employees, customers and suppliers, and agreements that only impose obligations on the bidder.

Where a takeover is structured as a contractual offer, the bidder will usually make its offer conditional upon it acquiring not less than 90% of the shares to which the offer relates. This is because this is the threshold at which a bidder can exercise squeeze-out rights to buy out minority shareholders. A bidder will often waive a 90% acceptance condition when acceptances have been received in respect of 75% of shares carrying voting rights, since at this level the bidder will be able to pass special resolutions and apply to have the target delisted. Where the financing arrangements require the target group to give financial assistance (for example by charging their assets), the target company will need to re-register as a private company, which will require a special resolution. Where debt finance is used to fund the bid, the lender’s permission will usually be required for the bidder to waive down the acceptance condition to below 90%.

However, most UK takeovers are implemented as a scheme of arrangement and, under this structure, the bidder will acquire 100% of the target company’s shares upon the scheme becoming effective.

Given the Takeover Code restrictions on break fees and other offer-related arrangements, a bidder will often seek irrevocable commitments from the target board and from key shareholders. These are usually procured before a firm offer is announced, although the requirement to keep the potential offer secret and the so-called rule of six will limit the number of shareholders that can be approached before a possible offer or firm offer is announced. Where the takeover is structured as a contractual offer, the UK Market Abuse Regulation prohibition on persons discharging managerial responsibilities dealing in shares will restrict the directors’ ability to enter into irrevocable commitments during a closed period.

Irrevocable commitments provided by the target board will usually continue to be binding even if a higher competing offer is announced (“hard”), but commitments provided by institutional investors will often cease to be binding if a higher competing offer is made (“soft”) or if a competing offer is made a certain percentage above the original bidder’s offer price (“semi-hard”). Where the commitment is soft or semi-hard, it is common for the bidder to reserve the right to improve its offer so that it is at least as favourable (“matching right”) or exceeds (“topping right”) the value of the competing offer, in which case the irrevocable commitment will not lapse.

Private equity sponsors need to ensure that their interests are aligned with those of their portfolio companies’ management teams. Accordingly, management is usually granted ownership of a portion of the business – in the UK, it is typical for management to hold between 10 and 20% of the ordinary shares of the company, via a so-called sweet equity pot.

Management sweet equity takes the form of ordinary shares. Typically, subject to investor tax advice, the value of these shares is structured such that the fair market value is as low as possible at the point of acquisition, giving management the greatest possible chance of upside in a successful exit scenario. A minority of management incentive schemes in the UK also include a performance-based ratchet element, further incentivising management by entitling them to a greater share of exit proceeds in the event that the private equity investor reaches certain returns thresholds. Some more senior managers may be encouraged to invest alongside the private equity investor in the institutional strip, a mix of fixed-return instruments and ordinary shares typically in the ratio of 99:1 or 98:2.

When managers leave the business, their shares are typically subject to a call option in favour of the private equity sponsor controlling the company (or the company itself). Vesting is relevant for those management incentive plan participants who leave the business before an exit is completed by a private equity sponsor. In particular, it is important for those managers who leave but are neither “Good Leavers” (eg, people who die or retire at mandatory retirement age and who receive fair market value for all of their sweet equity), “Bad Leavers” (eg, where managers are terminated for cause (or, in some cases, resign), and receive the lower of cost and fair market value for all of their shares), nor “Very Bad Leavers” (a more punitive category dealing with “bad acts” of managers, and who may receive a discount to cost or (if lower) market value). This category of “Intermediate Leaver”, namely managers who are terminated other than for cause, or who resign, will receive fair market value for those of their incentive shares which have vested, and the lower of cost and fair market value for the remainder.

In the UK, vesting typically occurs on a “cliff” vesting on an annual basis over four or five years, although the final 20 or 25% of incentive shares typically only ever vests on exit. On an exit, 100% of incentive shares will vest. Shareholder agreements with management contain detailed provisions around the determination of fair market value, the timing of payment for leaver shares, and what happens to the incentive shares repurchased from managers (usually, these are held for the benefit of future managers who will also need to be incentivised).

Restrictive covenants are a key tool for private equity sponsors in protecting their portfolio companies from managers who leave and who may seek to divert business away. Market practice in the UK is that carefully drafted non-compete undertakings will have a duration of 18-24 months from cessation of employment for senior managers, and around 12 months for more junior managers. As has also recently happened in the US, non-compete undertakings are firmly in the crosshairs of the CMA, whose CEO has said the rules “may need updating” given the prevalence of non-competes in employment agreements in the UK. This accords with the stated objective of the previous UK government to limit the maximum term of a non-solicit to three months – although only in employment contracts. It is typical for private equity sponsors to ensure that restrictive covenants are also included in the shareholders’ agreement, which the courts in England have typically been more likely to enforce on the grounds that they are more likely to have been negotiated and the power imbalance is less pronounced.

For non-solicitation undertakings, a period of 18-24 months is customary, beginning either on termination of employment or (less commonly) the date of repurchase of securities. Covenant durations being reduced by garden leave is increasingly common in the UK market, though by no means universal.

Customary confidentiality and non-disparagement clauses will also be included in shareholders’ agreements.

Managers will not typically have a suite of operational vetoes which limit what the private equity sponsor, as the controlling shareholder, can do with the business, or in what circumstances an eventual exit may take place (an exception to this might be made for a founder or senior manager who holds a material portion of the institutional strip and may wish to be treated more like a co-investor for these purposes).

Management protections are limited to fundamental protections of their economic position. Managers will usually be entitled to pre-emptively subscribe for new securities alongside the sponsor, but only if they subscribe for the same proportion of securities as the sponsor subscribes for. Managers, who may not have the liquidity to follow their money and subscribe for additional institutional strip, will often seek additional protection around the price at which further securities in the company are issued (referring to an independent fair market valuation, or the most recent fund valuation conducted by the sponsor). However, private equity sponsors will push back hard on this as they seek to maintain the flexibility to inject further capital on terms which they deem fit.

Controlling private equity sponsors will control the boards of their portfolio companies (including, if needed, any subsidiaries of the Topco where the investor directors usually sit). To preserve the value of their portfolio companies, they will also insist on a detailed list of consent matters – operational actions which the managers of the business (who run it day-to-day) cannot take without the consent of the sponsor. Controlling sponsors will also have access to as much information as they require from the portfolio company, in addition to the usual management accounts and other financial information.

A core tenet of private equity investing is the importance of preventing the liabilities of a portfolio company from affecting the fund itself. English company law generally supports this position – case law has confirmed that in all but the most extraordinary circumstances (for example, where a company is interposed to evade the liabilities of a shareholder) a limited company’s liability does not extend to its owners. The Supreme Court has, however, recognised that in some cases, a parent company (having greater scope to intervene in the affairs of its subsidiary) may assume a duty of care in relation to the activities of a subsidiary where it establishes “group-wide” policies or standards regarding certain matters and takes responsibility for compliance with them (or holds itself out as having implemented such policies, even if it does not in fact do so). Although the case in question concerned a multinational mining company, private equity sponsors will need to give due thought to the control they are assuming over portfolio companies, and any statements they make about ensuring their portfolio companies do things in an “environmentally friendly” way, for example. 

Sponsors also need to be conscious of the circumstances in which a shareholder may be deemed by UK regulatory authorities to assume responsibility for matters affecting its subsidiaries. The CMA has already issued fines directly to private equity funds for the anti-competitive practices of their portfolio companies, and guidance issued by the UK’s Information Commissioner’s Office also confirms that it may hold parent companies (which could include private equity funds) jointly and severally liable for the data protection law breaches of their subsidiaries.

Sales by private equity sponsors of portfolio companies to other financial investors or strategic players have been the most common form of exit in the UK in 2024. The UK IPO market – while showing signs of recovery and with a simplification of FCA Listing Rules on the horizon – has not been a common private equity exit strategy for some time. There have only been seven IPOs of portfolio companies in the UK since 2022, according to Prequin.

As an alternative to an “exit”, in the current climate, many sponsors are choosing to hold on to portfolio companies by transferring them to new funds or continuation vehicles, sometimes combining this by bringing in new co-investors to provide additional capital. 

A controlling private equity shareholder will typically have the right to drag all other shareholders pro-rata in a transaction where it sells a majority of the shares in the target to a third party. Management will usually be dragged 100% in such a transaction. Tag-along rights, where the selling sponsor elects not to drag, will also be available to the minority shareholders, typically on terms mirroring the drag.

Where sponsors sell an asset to another of their funds, they will also seek to include an obligation for managers to roll a portion of their sale proceeds into the new structure, to prevent them cashing out completely. However, most sponsors in the UK market accept that a transfer between funds will constitute an exit and management’s tag right will apply if the original investing fund loses control. Often this is drafted to provide that exit provisions for management are only not triggered if the transfer between funds does not trigger carry rights in the original fund.

Private equity sellers will typically agree to a lock-up period (during which it cannot dispose of its shares in the listing vehicle) of 180 days for a premium listing. Senior management will be subject to a longer lock-up period of one year. The revised Listing Rules have removed the need for a private equity sponsor with a stake of 30% or more post-IPO to enter into a relationship agreement with the company, but the listed company must still be independent from the controlling shareholder. More flexible capital structures are also encouraged under the new Listing Rules, including the ability for the listed company to have a dual-class share structure where pre-IPO shareholders (including the private equity sponsor, subject to a ten-year sunset clause) can enjoy greater influence post-IPO, subject to compliance with the requirement for independence from the controlling shareholder. 

*Ben Tansey (associate) contributed to this chapter.