Private Equity 2020 features 32 jurisdictions. The guide provides expert legal commentary on M&A transactions, due diligence, funding structures, dispute resolution in consolidation structures, takeovers, management incentives, shareholder control and liability, exits and IPOs.
Last Updated: September 17, 2020
Private equity is a significant part of the global M&A market, and the popularity of private equity as an investment is clear. Global fund-raising slowed again in 2020, with fewer funds reaching final close in the first half of 2020 compared with 2019, and similar amounts raised has also declined. This is at least in-part due to the COVID-19 pandemic, mass lockdowns and impaired travel which consequently impacted fundraising. That being said, some of the major flagship funds such as CVC, EQT and Silver Lake have all closed their funds in 2020.
The recession, political uncertainty, escalating trade tensions and volatile stock markets have created adverse conditions for deal activity in 2020, but again the pandemic caused a rapid decline in deals, no doubt impacted by the inability of PE investors to meet face-to-face with sellers, management teams and other stakeholders. Most fund managers have focused their attention on their existing portfolio and obtaining liquidity for those businesses that needed it. Many contributors have noted the negative impact on new deals, although some large PE deals have nonetheless been transacted.
The sectors dominating private equity transactions vary from jurisdiction to jurisdiction, but technology (particularly online platforms), healthcare, infrastructure and natural resources all appear to be active sectors across the globe. One of the legal changes affecting private equity transactions that has taken hold globally is the increase in protectionism, which has translated into greater regulation of foreign investment or investment in critical sectors (such as infrastructure and technology).
Further regulation of the healthcare sector has been adopted in some jurisdictions in response to the COVID-19 pandemic and, in addition, many governments in Europe, Australia and elsewhere have adopted measures to provide funding and liquidity to businesses and minimise employment losses, which have also benefited some private equity backed businesses.
Commonalities in private equity
There are many common features of private equity transactions across the globe. Market terms vary depending on the maturity and sophistication of the relevant market, for example, less developed markets have greater variability in terms. Most deals are concluded by a negotiated sale and purchase agreement, with the buyer and seller allocating risk through warranty and indemnity protection.
The absence of customary or “market standard” provisions is notable in public to private deals, where the lack of precedent usually perpetuates the rarity of this form of deal activity, as it is a riskier venture for private equity firms. Public to privates represent a small portion of private equity deals, although they are increasing in popularity in the UK, the USA and Germany. There are legal barriers to doing take privates in certain countries, such as the PRC. There are some common features across the different legal systems, however. Generally speaking, hostile takeovers are rare, and most takeover regimes have mandatory offer thresholds and a disclosure regime for significant shareholdings.
One of the striking differences in practice from one market to the next in private equity transactions is the approach to consideration mechanisms. While Western European jurisdictions such as the UK, Germany, France and Spain favour locked-box consideration mechanisms, which fix the price based on the locked-box balance sheet, therefore giving the seller almost complete protection on price, jurisdictions such as the USA, Brazil and the PRC generally use completion accounts mechanisms (with the associated adjustments). In some European and many Asian jurisdictions, the practice is more mixed, with consideration mechanisms varying from one deal to the next.
In the emerging markets, such as India and Angola, fixed price mechanisms are also common and, where the bargaining position favours the seller, locked-box mechanisms are increasingly used. Of course, there are situations where completion accounts mechanisms are more appropriate regardless of the market standard, ie, in complex carve-outs or other circumstances where there are no standalone accounts for the target.
The appetite of sellers to accept conditionality varies from one jurisdiction to the next. Private equity sellers usually seek to limit the conditionality of transactions so that they enjoy deal certainty, but market practice generally dictates what conditions are acceptable. All jurisdictions permit regulatory/antitrust conditions.
Financing conditions are rare across most jurisdictions, although not wholly unusual in the USA. Indeed, the US market permits a much higher level of conditionality than is usual in Europe or Asia. US private equity deals will often include the repetition of representations and warranties and the absence of litigation as conditions, third-party consents will be conditions, and “no material adverse effect” conditions are often included as well.
Whatever the approach to conditionality, break fees are rare in almost all jurisdictions. The notable exception to this is the USA, where a buyer is typically required to pay a reverse break fee if it exercises a termination right. This reverse break fee is often linked to a failure to secure debt financing. They are also common in some Asian jurisdictions, such as Vietnam.
In general, the allocation of risk favours private equity funds, which are very unwilling to accept liabilities on exit. Typically, therefore, they do not provide commercial warranties or indemnities. In all markets, warranty protection is subject to a raft of limitations, such as caps, thresholds, and de minimis provisions. Indemnity protection has more bespoke limitations.
Another recent trend is the increasing use of W&I insurance in private equity transactions, with many private equity buyers using it to bridge the gap between the low limitation on liability for warranties often offered by sellers and the coverage provided by insurance, for modest additional cost. Where private equity funds are sellers, W&I insurance can be used effectively to limit their exposure, achieving their aim of a “clean break” post exit.
Generally speaking, litigation is rare in private equity transactions across all markets due to concerns about the reputational impact of litigation. Where disputes arise, private arbitration is usually favoured. Common areas for dispute are earn-outs and certain warranties or indemnities. Many consideration mechanisms have dispute determination mechanisms involving experts, rather than having disputes decided by the courts. In addition, where closing accounts mechanisms are used, an escrow is often used to secure payment of the top-up payment or refund.
Private equity buyers across all markets generally conduct a thorough buyside due diligence exercise covering the usual areas of risk, such as corporate structure, employment, impediments to the transaction, regulatory, compliance risk and litigation. The precise scope varies from one deal to the next and depends on the nature of the target.
Vendor due diligence is not common in all markets. Even in jurisdictions where vendor due diligence reports are typically prepared, some markets providers do not afford reliance to bidders, with some offering merely a legal fact book that a buyer cannot rely on. For obvious reasons, where it is not market practice for vendor advisers to offer reliance to bidders, it is less widespread. Generally speaking, private equity buyers will do top-up due diligence rather than relying solely on sellside due diligence, even where reliance is granted.
Liabilities of Private Equity Funds as Shareholders
The general principle under most legal regimes is that private equity fund shareholders are not liable for the liabilities of their portfolio companies. Circumstances in which the corporate veil can be pierced are generally very limited, and structures used by private equity funds aim to ensure these risks are managed, both by good governance and by the adoption of compliance policies by their portfolio companies. There are some exceptions whereby the corporate veil can be pierced, which should be analysed carefully, usually when the shareholder is the de facto manager of the company.
The alignment of management and the private equity fund shareholder (whether majority or minority) is an important part of the private equity strategy globally. However, the approach to management equity incentivisation varies from jurisdiction to jurisdiction. How such equity incentivisation is ultimately structured is often tax driven. In many countries, options and profit participation schemes are also common.
Generally, any management incentive schemes have “leaver” arrangements, so that the incentive is linked to the manager continuing his employment. Equity or other incentives are usually forfeited by a leaver, with the economic consequences varying according to the nature of the leaver: a “good” leaver will receive more than a “bad” leaver.
In almost all markets, managers are subject to restrictive covenants, such as non-compete provisions and non-solicitation. These can often be set out separately in employment arrangements rather than forming part of the equity package. The terms, duration and enforceability of such covenants vary from one country to the next.
Limited minority protections are offered to managers who hold equity in the business. These protections include pre-emption rights as anti-dilution protection. Most management equity holders enjoy tag rights as one of the few minority protections afforded.
A common feature in all private equity deals is that the private equity fund has liquidity and freedom to achieve an exit on its own terms, without restrictions from management shareholders or co-investors. That being the case, drag rights – whereby the majority shareholder can force minority shareholders to sell on the same terms – are common in private equity transactions globally. Very often, these include a minimum floor protection to the minority shareholders.
The enforceability of drag mechanisms is not guaranteed; certain jurisdictions have specific conditions that must be satisfied in order for a drag to be enforceable. Management usually assists on an exit. It is unusual for members of management to provide warranties in most jurisdictions, unless they are themselves shareholders.
Auction processes are common for attractive assets. The popularity of exits by initial public offering varies from one market to the next, depending on the position of the capital markets more generally. IPOs on global markets have declined, due to market volatility generally as well as the effects of the COVID-19 pandemic. Dual track exits (ie, where a sale and an IPO are pursued in tandem) are not that common, with most commentators noting that the high costs outweigh the perceived benefits of that exit strategy.