The new Private Equity 2021 guide features 35 jurisdictions. The guide provides the latest legal information on mergers and acquisitions; due diligence; the structure of transactions; terms of acquisition documentation; public-to-private takeovers; mandatory offer thresholds; hostile takeover offers; management incentives; shareholder oversight and liability; and exits, including by an initial public offering (IPO).
Last Updated: September 14, 2021
Private equity is a significant part of the global M&A market, and the popularity of private equity as an investment class is clear. This year – 2021 – is becoming a landmark year for PE fundraising, with 500 funds having closed on commitments valued at USD366 billion in the first half of the year. Global fundraising has been particularly strong for the mega-funds with Carlyle, Hellman & Friedman, KKR North America, KKR Asia and Bain Capital all having closed funds in excess of USD10 billion so far this year.
Private equity M&A activity is strong: there is evidence of pent-up demand after COVID-depressed 2020, culminating in USD939.49 billion in value of deals globally up to mid-June 2021, compared with USD247.65 billion in the same period last year. This has also been a very active year for take-privates, by private equity – with takeover battles over Morrisons, G4S and Signature Aviation.
The IPO markets have also been very healthy, with private funds having successfully listed a number of their investments, particularly in the technology sector, with the listing of Blackstone’s Bumble and KKR’s AppLovin being good examples. Following the surge of special-purpose acquisition company (SPAC) transactions in 2020, this strategy has cooled a little, although these transactions still represent a substantial proportion of IPOs in the US.
The sectors dominating private equity transactions vary from jurisdiction to jurisdiction, but technology (particularly online platforms), healthcare, and infrastructure are the dominant 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 (eg, infrastructure and technology). Despite these modifications and some high profile deals being blocked, overall this does not appear to have impacted activity levels.
Commonalities in Private Equity
There are many common features of private equity transactions across the globe, although market terms vary depending on the maturity and sophistication of the relevant market (eg, 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.
In many jurisdictions, club deals have been increasingly popular in 2021. In several deals, private equity sellers have retained a stake on exit to take advantage of preferential sellers' market terms while maintaining some future upside to their investment. 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 common 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, Switzerland, 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, 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.
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 that has strengthened yet again in 2021, becoming the norm for private equity deals in many jurisdictions, is the increasing use of warranty and indemnity (W&I) insurance. Private equity buyers use 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. This insurance is, however, still very unusual in certain markets such as the PRC, India and Brazil.
Generally speaking, litigation is rare in private equity transactions across all markets due to concerns about the reputational impact. 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 buy-side due diligence exercise covering the usual areas of risk, such as corporate structure, employment, impediments to the transaction, regulatory, compliance and litigation. The precise scope varies from one deal to the next and depends on the nature of the target. Across all jurisdictions a much greater focus on environmental, social and governance aspects of private equity investments has developed.
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 sell-side 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 their 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 manager 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 for 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 IPO varies from one market to the next, depending on the position of the capital markets more generally. IPOs have been a popular exit route this year. 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.