2023 has been an active year for private equity. As is to be expected, private equity funds have remained intrepid in the face of dynamic and challenging macroeconomic conditions (discussed further in 1.2 Market Activity and Impact of Macro-Economic Factors).

Private equity has been active in public markets, with the announcement of a number of high-profile take-private transactions (eg, TPG’s proposed acquisition of InvoCare). Competition amongst private equity firms has increased as well, with certain assets attracting attention from multiple private equity suitors (eg, Nitro Software and IntelliHR). Eleven bids in total were made in respect of IntelliHR, culminating in a 280% premium for shareholders. Pre-bid stakes have also featured in a number of deals as private equity bidders seek to cement any first mover advantage.

General partners are also employing innovative deal structures to maximise flexibility and transaction certainty where the bid-ask spread is too wide or the deal is otherwise proving too hard to close. Specifically, the use of concurrent scheme of arrangement and takeover bid structures in public market deals is increasing, having been used twice in 2022 (in the Virtus Health and Nitro Software takeovers). Having recently obtained the blessing of the Australian Takeovers Panel (Australia’s takeovers arbiter), we expect this structure to continue to be explored where the circumstances are right.

In relation to exits, the first half of 2023 continued to be slow for IPOs. From the frothy highs of 2021 (where IPOs raised AUD12 billion), just AUD150 million was raised from only 14 IPOs in the first half of 2023. This has removed a reliable exit strategy, and has led some general partners to look at alternative liquidity solutions.

Macro-economic factors have had a significant impact on M&A activity in 2023. The year has been characterised by rising interest rates and therefore more expensive debt. Geopolitical tensions such as the Russia-Ukraine conflict have disrupted logistics, contributing to inflation and amplifying its impact on the economy and consumer confidence and spending.

To date, this does not appear to have translated into weakness in the fundraising market. Australian private equity funds have remained resilient, with Quadrant’s most recent fundraising effort (the Quadrant Strategic Equity Fund) raising AUD600 million (doubling its initial AUD300 million target).

On the deal-making front, despite the proliferation of AI, which has attracted a lot of media attention and venture capital investment, private equity has been most focused on the healthcare and energy and resources sectors in 2023. Australia’s ageing population is greatly increasing the demand for healthcare services and the country’s abundant natural resources present opportunities to capitalise on the global decarbonisation trend.

On the financing side, given the higher cost of debt financing, general partners have turned towards alternative providers of credit in search of greater flexibility and more competitive terms (aligning with a global surge in the private credit market). Australian superannuation funds are also stepping in to assist, as well as the credit arms of global private equity firms (eg, KKR and Bain). This coincides with Australia’s largest superannuation fund, AustralianSuper, increasing its allocation to private equity, projecting it would grow to AUD50 billion by 2027.

For private equity funds and their portfolio companies, the most significant recent legal developments have been in relation to certain aspects of the Foreign Investment Review Board’s (FIRB) approach to conditions, the introduction of a register of foreign ownership and increased fees, Takeovers Panel guidance in relation to deal protection mechanisms and changes to the ‘thin capitalisation rules’.

Updates to the FIRB regime

Additional approval conditions

There have been discernible trends in FIRB’s approach to approval conditions in recent years. Among other things, FIRB’s attention to tax evasion risks has heightened (in particular, in 2023) – as part of this, private equity applicants must accept ‘standard tax conditions’ (which are generally non-negotiable other than in exceptional circumstances). FIRB is also now more regularly imposing additional requirements on private equity applicants, including notification requirements (eg, regarding disposals above a certain threshold, often 10%, in the relevant company). These conditions are a condition of the approval being granted.

Register of foreign ownership

From 1 July 2023, foreign investors must notify the Australian Commissioner of Taxation of a broad range of their dealings in Australian land, entities, businesses and assets. These notifications do not impact the foreign investment approval process – instead, they introduce new post-transaction notification requirements that private equity buyers need to be aware of and comply with. In certain circumstances, a notification may need to be given even where FIRB approval was not required for the underlying acquisition.

Increased foreign investment fees

In July 2022, FIRB application fees doubled. From 1 July 2023, the current maximum cap on FIRB’s fees is AUD1,119,100. The significance of these fees (and the fact they are non-refundable) is impacting the deal strategy for some private equity buyers. For example, in competitive sale processes, private equity buyers have historically considered applying for FIRB approval early in the process so that their offer was, ideally, less conditional at the time it was made – this is no longer as prevalent, with a number of private equity buyers only applying to FIRB when they have a signed sale agreement (or have at least been granted exclusivity).

Takeovers Panel issues revised guidance note in respect of deal protection mechanisms

The Australian Takeovers Panel (a statutory authority of the Government that is the primary forum for resolving disputes about takeover bids) has introduced new guidance regarding the deal protection mechanisms. The revised guidance:

• rearticulates the policy bases for the guidance, namely that the starting proposition is that deal protection mechanisms may inhibit the acquisition of voting shares taking place in an efficient, competitive and informed market;
• confirms that the effect and appropriateness of deal protection mechanisms is a holistic assessment made in the context of all the relevant circumstances; and
• provides firmer guidance around specific mechanisms, including that ‘hard exclusivity’ (ie, exclusivity that is not subject to a fiduciary carve-out) should not exceed four weeks.

Change to Australia’s interest deduction limitation rules

From 1 July 2023, Australia’s revised ‘thin capitalisation rules’ took effect. This aligns the Australian regime with the Organisation for Economic Co-operation and Development’s best practice approach. The changes replace and modify certain tests and ratios used to determine compliance with the rules and shift the focus from the assets of Australian companies to their earnings. Given the importance of debt funding to private equity acquisitions, the changes have led to private equity funds recalibrating their approach to investment structures (particularly in the real estate and infrastructure sectors).

In the private M&A context, parties generally enjoy considerable freedom to negotiate and agree the sale terms and the method by which the transaction is implemented. That said, in certain circumstances, engagement with regulators may be required (as discussed below).

In the public M&A context, private equity buyers and sellers are subject to the rules and requirements of the Australian corporate legislation – the main obligations being those set out in the Corporations Act 2001 (Cth) (Corporations Act), and most particularly in Chapter 6. The Corporations Act regulates the ways in which interests in listed Australian companies and unlisted Australian companies with more than 50 shareholders can be acquired, as well as the circumstances in which a person must disclose their acquisition or disposal of an interest in a listed Australian company. To the extent that the company is listed on the Australian Securities Exchange (ASX) (whether or not it is an Australian company), the company must also comply with the ASX Listing Rules.

ASIC

The Australian Securities & Investments Commission (ASIC) is Australia’s corporate regulator. It has primary responsibility for matters relating to financial services, markets and consumer credit matters, and oversees enforcement of the Corporations Act.

All Australian companies (including those owned by private equity funds) must notify ASIC of changes to their capital structure, officeholders and the passing of certain resolutions (amongst other things). However, ASIC does not ordinarily become involved in private M&A in Australia.

ASIC does have a broader role to play in relation to public M&A in Australia. For schemes of arrangement, ASIC is directly and actively involved, and reviews (and in most cases comments on) the disclosure document that is provided to target shareholders in relation to the scheme. ASIC is not directly involved in takeover offers in Australia. However, by virtue of its role to oversee compliance with the Corporations Act (including Chapter 6), ASIC often becomes involved in relation to potential breaches of the relevant provisions that arise in the course of the takeover. ASIC’s involvement in public M&A transactions is particularly relevant to private equity buyers given their regular involvement in such transactions.

ASIC has had a particular focus on ‘greenwashing’ in recent years. In 2023, ASIC has shown a willingness to take action where it considers this has occurred. For example, in July, ASIC lodged civil penalty proceedings in the Federal Court against Vanguard Investments Australia, alleging misleading conduct in relation to claims about certain environmental, social and governance exclusionary screens applied to investments in a Vanguard fund. 

FIRB

Foreign persons and investors controlled by foreign persons may need FIRB’s approval to acquire an Australian company (amongst other things). The approval comes in the form of a ‘notice of no objection’ from the Australian Treasurer, which sets out certain conditions that the applicant (ie, the foreign person, such as the private equity fund) must comply with in connection with the proposed acquisition (plus certain ongoing reporting and other obligations following completion of the acquisition).

It is possible to apply for an exemption certificate in respect of, amongst other things, proposed acquisitions of Australian companies. If an exemption certificate is granted, the buyer can acquire the relevant companies (FIRB often requires the companies, or at least the category and type of company, be specified) without needing approval in respect of each acquisition. These can be valuable to portfolio companies seeking to undertake a number of acquisitions.

Due to the breadth of what constitutes a foreign person under the relevant legislation, almost all foreign and most medium-to-large Australian private equity funds are characterised as ‘foreign’ and therefore need FIRB approval to acquire Australian companies.

ACCC

The Australian Competition and Consumer Commission (ACCC) regulates competition (as well as consumer) matters in Australia.

Australia has a voluntary notification system for M&A transactions. This means the parties to a transaction are not obligated to notify the ACCC or seek approval before making an acquisition. That said, the ACCC strongly encourages parties who consider that the proposed acquisition may have competition issues (ie, whether it would have the effect, or be likely to have the effect, of substantially lessening competition in a market) to notify the ACCC. This can be done by either:

• requesting an informal review from the ACCC to gauge whether there are any issues; or
• applying for formal authorisation, which provides protection against potential actions by the ACCC.

To the extent FIRB approval is required, FIRB can be expected to consult with the ACCC in relation to the proposed transaction. As a result, where an application is made to FIRB and there is some prospect of the ACCC looking at the transaction, it is customary for a potential buyer to send the ACCC a ‘courtesy letter’ outlining why there are no competition issues.

Australian Takeovers Panel

Unless the transaction is proceeding by way of scheme of arrangement, the Takeovers Panel is the principal forum for resolving takeover disputes in Australia. The only exceptions to this are criminal prosecutions and certain other proceedings commenced or referred by ASIC or the Takeovers Panel itself or by other public authorities.

The Takeover Panel’s primary responsibility is to determine whether the circumstances in respect of a takeover are ‘unacceptable’. The Takeovers Panel makes this assessment not only based on the black letter law of Chapter 6 of the Corporations Act, but applies a pragmatic and commercial lens to the relevant circumstances. The Takeovers Panel has the ability to make broad orders if it does consider that unacceptable circumstances have arisen. 

Private equity buyers, along with their advisers, usually undertake extensive due diligence investigations before irrevocably committing to acquire a target. This due diligence often covers commercial, financial, accounting, legal and tax matters (and in some cases technical matters). The focus areas generally reflect the buyer’s existing knowledge of the business and broader sector, the risk profile of the company/sector, any specific requirements from debt and/or equity providers, and the time available (which can be driven by whether it is a bilateral or competitive sale process).

From a legal perspective, due diligence generally covers the following:

• corporate – capital structure, constituent documents, shareholders’ agreement (or similar), incentive arrangements, and board papers and minutes (usually from the last three years);
• material contracts – key customer/supplier contracts and joint venture arrangements;
• real property – freehold and leasehold interests;
• related party arrangements – material arrangements with shareholders and/or directors;
• banking and finance – existing debt facilities and financing and security arrangements and any other arrangements necessary to understand the target’s debt position, obligations to financiers, historical compliance with debt covenants, and any guarantees or similar security provided by or on behalf of the target;
• employment – key employment agreements, template employee and contractor agreements, and material policies;
• IP – material intellectual property owned or used;
• IT, privacy and data protection – material IT agreements and policies relating to privacy and data protection;
• litigation, disputes and investigations – litigation searches, and review of any threatened, anticipated, pending or current litigation and investigations into the target;
• regulatory and compliance – any applicable regulatory frameworks that apply to the business, and material licences and authorisations required to operate it; and
• anti-bribery and corruption – systems and policies related to applicable laws combating bribery and corruption, money laundering, terrorist financing, economic sanctions and fraud.

When a private equity seller runs a competitive sale (or auction) process, it is customary for potential bidders to be provided with certain vendor due diligence reports. In most cases, these reports cover accounting and legal issues, and in some cases tax issues. The reports are initially provided to potential bidders on a non-reliance basis, with the successful bidder being given reliance.

From a legal perspective, the legal vendor due diligence report generally looks relatively similar to a buy-side due diligence report. Just like a buy-side report, it generally covers the usual areas for legal diligence (see 4.1 General Information). A key difference is how the information is presented – in a buy-side report it is usual to make recommendations as to how to deal with any issues that are identified (eg, completion should be conditional on any material third party consents that are required), whilst in a vendor report that information is more usually objectively presented, with the potential bidders then left to form a view as to how they wish to deal with the relevant issues.

The benefits of undertaking legal vendor due diligence is that the private equity seller can:

• identify and address potential issues that may impact the proposed transaction or reduce the purchase price before the bidders discover them;
• have greater control of the narrative in relation to any likely issues;
• help drive the optimal legal and tax structure for the sale;
• more easily answer the bidders’ questions regarding the business; and
• make the sale process more efficient.

The majority (at least by number) of acquisitions by private equity buyers are undertaken by way of private treaty acquisition. However, the acquisition of Australian companies with more than 50 shareholders must, for the most part, be undertaken by way of takeover bid or scheme of arrangement.

Companies With Less Than 50 shareholders – Private M&A

In most cases, private M&A is undertaken by way of a negotiated share sale agreement (ie, a private treaty transaction). Private equity buyers ordinarily acquire a 100%, or otherwise a controlling interest, in the relevant company by acquiring the relevant shares. Control of the company or its business can also be obtained by the private equity entity subscribing for shares in the company (by way of a subscription agreement), or by acquiring the business from the company (by way of a business sale agreement). The advantage of acquiring the business is that, unless otherwise specifically agreed, the buyer does not acquire the company’s residual liabilities (eg, under material contracts with third parties) and can cherry-pick the assets that it wants. However, this can result in additional complexity and, largely for this reason, share acquisitions are more common.

In theory, the acquisition terms should be materially the same regardless of whether the buyer and sellers are negotiating on a bilateral basis or the sale is part of a competitive process. However, in practice, the buyer may need to accept less favourable terms if there is competition for the asset.

Companies With More Than 50 Shareholders – Public M&A

In most cases, public M&A is undertaken by way of takeover (off-market or on-market) or scheme of arrangement. Schemes are more common than takeovers (with off-market takeovers the far more common of the two takeover structures), especially in the case of +AUD1 billion transactions (at least 80% of such transactions per year were undertaken by scheme since 2018). Private equity buyers, often driven by a desire to obtain 100% of the target (with schemes having a 75% threshold for this versus 90% under a takeover) and a need to do due diligence (customarily to facilitate debt funding and/or equity co-investment), have an even stronger bias towards schemes.

Pure auction processes are not really a feature of public M&A. However, it is not uncommon for a rival bidder to emerge, which does create a competitive process. Where there is a rival bidder, the original bidder often has to improve its terms (eg, by increasing the purchase price or waiving conditions) to secure the asset.

Private equity buyers customarily incorporate an Australian special purpose vehicle to acquire the target company. This ‘BidCo’ is typically a wholly-owned subsidiary of an Australian incorporated holding company (ie, a HoldCo). It is not unusual for a number of other Australian companies to also be incorporated as part of the group – this often includes a MidCo or a MezzCo. The companies do not have any trading history, assets (other than shares in the other entities) or liabilities (other than under the transaction agreements in relation to the acquisition).

Private equity buyers rarely agree to, and strongly resist, the fund itself entering into the sale agreement. Sellers can sometimes request this (including to guarantee BidCo’s obligations under the sale agreement); however, they can often be satisfied with the provision of equity and debt commitment letters to demonstrate BidCo’s ability to fund the acquisition.

Private equity deals are normally financed with a combination of equity and debt. It is customary for sellers to be given copies of equity commitment letters to provide the certainty of the equity funding. Certainty also needs to be provided regarding the debt funding – in most cases, this is done with a debt commitment letter that attaches the associated term sheet (with the key commercial terms, other than the aggregate amount of debt to be provided, redacted). Sale agreements customarily impose restrictions on what can be done in relation to the commitment letters (eg, the buyer cannot reduce the amount of equity covered by the equity commitment letter), and the buyer provides certain representations and warranties regarding the commitments – a material breach of these can entitle the sellers to terminate the sale agreement.

In the context of public M&A, the Australian takeover rules require bidders to have certainty of funding before a bid is announced.

True consortium arrangements between private equity funds are rare in Australian private treaty transactions. A key factor in this is the relatively limited pool of appropriate targets and the number of private equity funds looking to deploy capital. Consortium arrangements are slightly more common in large public M&A – for example, the Brookfield-led consortium involving Morrison & Co (amongst others) that acquired Uniti Group for AUD3.4 billion in 2022 – due to the amount of capital required to complete mega-deals.

In the context of private treaty transactions, what is more common is for there to be passive investment alongside the primary private equity buyer. Offshore institutional investors and superannuation trustees (including those attracted by competitive performance and favourable fee arrangements) sometimes invest alongside the general partner of the main fund in a specific portfolio company. In most cases, this is done through a separately structured co-investment vehicle governed by a standalone set of agreements.

Private equity buyers tend to determine the most appropriate consideration mechanism for acquisitions on a case-by-case basis. Some businesses (and indeed some entire sectors) lend themselves to a ‘locked box’ (no adjustment to the agreed purchase price absent unauthorised leakage by the seller), whilst others are better suited to completion accounts (purchase price is adjusted, in favour of either the buyer or the seller, following completion if the agreed metrics (eg, working capital or net debt) are not at the levels agreed). Earn-outs and deferred consideration structures are also relatively common, in particular where there is some uncertainty about the future performance of the business or an actual or perceived risk to it (eg, a potential third party claim). When the seller is also a private equity fund, there is generally a reluctance for the consideration to be deferred in this way.

It is common for private equity buyers to incorporate a special purpose vehicle as the ‘BidCo’ (see 5.2 Structure of the Buyer). Assuming that is the case, it is customary for the sellers (in particular, sophisticated corporates or private equity funds) to insist on the buyer providing equity and debt commitment letters to demonstrate its ability to fund the acquisition. It is usual for the buyer to give the sellers representations and warranties in relation to these arrangements (see 5.3 Funding Structure of Private Equity Transactions). 

Given the recent rise in interest rates, some sellers are seeking to be paid interest on the purchase price between the locked-box date and completion. The rationale is that, as the deal was priced at a historic point in time, the seller should be treated as having sold at that point and should benefit from interest on the purchase price from then until completion (ie, when the money would actually be paid).

In the same way, some private equity buyers are seeking interest on any leakage that occurs during the locked-box period. The approach to interest is often reciprocal. 

Where the parties agree to use completion accounts, it is customary for a specific dispute resolution procedure to apply to the determination of any adjustments under the completion accounts regime. In most cases, one party will prepare the completion accounts and the other party will have the opportunity to challenge them to the extent it does not agree with them. If the parties cannot agree the completion accounts within a specified time period, an independent expert (usually, an appropriately qualified accountant) is engaged to make a determination.

Where the parties agree to use a locked box, any disputes tend to be dealt with under the dispute resolution framework (eg, arbitration, court proceedings, etc) that applies to the sale agreement more generally.

Private equity buyers tend to insist on, and in most cases get, a relatively high level of conditionality in private treaty acquisitions. In addition to conditions regarding any necessary approvals from regulators (eg, FIRB, ACCC and APRA, etc), it is common to have conditions regarding third party consents (although the list of required consents is almost always heavily negotiated), key executives entering into new employment contracts and the satisfactory resolution of any business specific issues (eg, any proposed pre-completion restructure). Material adverse change provisions are also becoming more common, although these are generally resisted by sellers and heavily negotiated (in particular, the relevant triggers and exceptions). It is less common to have finance or shareholder approval conditions in private treaty transactions.

In Australia, it is very rare for private equity buyers to agree to “hell or high water” undertakings. Sellers do, on occasion, ask for them where they consider there to be a real prospect of the ACCC (or an equivalent foreign regulator) taking a particular interest in the transaction. Even where a seller does ask for such an undertaking, and the private equity buyer is prepared to make some concessions, the negotiated outcome usually falls well short of “hell or high water”.

Break fees are rare in the context of private treaty acquisitions in Australia. Reverse break fees are even rarer still.

However, break fees are effectively standard in recommended public M&A transactions in Australia. Typically, a break fee is an agreed amount that becomes payable if certain specified events occur that prevent the takeover or scheme of arrangement from proceeding (such as a change of recommendation by one or more of the target directors or a rival bid emerging). Generally, a break fee not exceeding 1% of the target’s equity value is considered acceptable by the Takeovers Panel.

Reverse break fees are also becoming increasingly common in recommended public M&A transactions. This year, consistent with the last few, approximately 50% of bidders agreed to pay a reverse break fee to the target in certain circumstances. This is usually agreed in exchange for the target agreeing not to sue the bidder for damages under the implementation agreement. This is usually advantageous to the target as it may find it difficult to quantify its loss. However, it can also be detrimental because the reverse break fee usually acts as a cap on the bidder’s liability, potentially limiting the target’s recoverable loss to less than its actual loss.

The 1% cap on break fees does not apply to reverse break fees (although the prohibition on penalties under Australian law still applies). However, it is usually the case that the break fee and reverse break fee are the same amount.

Private equity buyers usually require a right to terminate private treaty sale agreements if one of the following occurs:

• a condition precedent for their benefit is not satisfied or waived (if applicable) by the agreed date;
• a material breach of a seller representation and warranty;
• a material breach of the sale agreement (eg, of the conduct of business restrictions); or
• an insolvency event in relation to a seller or a member of the target group.

A seller can usually terminate sale agreements in similar circumstances. However, in practice sellers’ termination rights are narrower – this is because it is customary for fewer of the conditions precedent to be for the benefit of a seller, the scope of the buyer’s representations and warranties are narrower and the buyer has fewer obligations under the agreement to breach.

A long stop date of six months from the sale agreement is typical.

Historically, private equity buyers and sellers have adopted different starting positions to risk allocation than corporates. This could be seen most acutely in the context of post-completion claims in respect of breaches of representations and warranties and under indemnities – private equity generally sought such protections as the buyer, but heavily resisted such exposure as the seller (which led to interesting negotiations when private equity was on both sides of the transaction). For the most part, corporates’ position was more variable.

Private equity sellers’ reluctance to have any post-completion exposure has, in part, contributed to the increase in usage of warranty and indemnity insurance in Australian private treaty transactions (it can also be used in public M&A; however, this is much less common). Warranty and indemnity insurance protects either a seller (in the case of a sell-side policy) or a buyer (in the case of a buy-side policy) from financial loss that may arise in the event that there is a breach of warranties and/or indemnities given by the seller in the sale agreement.

Private equity funds (whether on the buy side or the sell side) tend to insist on warranty and indemnity insurance being used in private treaty transactions. As such, whilst risk allocation still remains a function of the specific circumstances of the transaction (eg, the parties’ relative bargaining power (including whether the acquisition is part of a competitive sale process), the parties’ comfort with the headline purchase price and consideration structure, the identified and inherent risks that apply to the business, etc), warranty and indemnity insurance has in effect narrowed the gap between what private equity and corporates are willing to accept.

As set out in 6.8 Allocation of Risk, private equity funds (whether on the buy side or the sell side) tend to insist on warranty and indemnity insurance being used in Australian private treaty transactions. On the basis that the majority of the warranties and indemnities are covered by the insurance policy (see below for some of the customary exclusions and limitations), it is customary for a seller to provide standard representations and warranties covering:

• its title to the sale shares;
• its authority and capacity to enter into the sale agreement and perform its obligations under it;
• certain aspects of the business (eg, accounts, assets, material contracts, compliance with laws, employees, intellectual property, information technology, property and tax, etc); and
• the sufficiency and accuracy of the information provided to the buyer during due diligence.

The warranties are supported by an indemnity in favour of the buyer. It is also customary for the buyer to be given an indemnity for any tax issues the target has. Additional indemnities for known or likely issues are negotiated on a case-by-case basis.

In most cases, the buyer will have two to three years from completion to bring a claim for breach of a representation and warranty (except regarding tax), and seven years for breaches of the tax warranties or under the tax indemnity. Assuming there is warranty and indemnity insurance in place, the seller will generally not have any personal liability for breach of warranties or under the tax indemnity (except for in the case of fraud). If there is no insurance in place, the seller’s liability will be capped at the purchase price.

De minimis thresholds also apply. That is, the buyer cannot bring a claim (either against the insurer, if there is insurance, or against a seller, if there is no insurance) unless the amount recoverable meets a specified threshold. Generally, each individual claim must exceed 0.1% of the purchase price and the aggregate amount recoverable must exceed 1% of the purchase price.

Even if there is insurance in place, the buyer will generally not be able to recover under the policy for losses that arise from:

• known or disclosed risks, including matters that are the subject of a specific indemnity in the sale agreement;
• forward-looking warranties;
• warranties in areas where the insurer considers that there has been insufficient due diligence;
• certain environmental or contamination issues;
• bribery and corruption;
• fines and penalties not insurable under law;
• underfunding of pension plans;
• misclassification of employees/independent contractors; or
• transfer pricing, post-completion tax or stamp duty liabilities.

Where the parties do not put warranty and indemnity insurance in place, there will nonetheless be limits on the buyer’s ability to claim from the seller for breach of warranty or under the indemnities. In most cases, the warranties and indemnities are qualified by (and the buyer cannot claim in relation to):

• materials uploaded to the data room, including any Q&A;
• information accessible on an agreed list of public registers (eg, such as company and land registries); and
• information contained in a disclosure letter, which contains specific disclosures against the warranties in the sale agreement.

Members of the management team will not usually provide warranties in their personal capacity (as distinct from the warranties they may provide in their capacity as shareholders in the target). On that basis, this regime only applies to management in their capacity as shareholders.

As outlined in 6.8 Allocation of Risk, private equity funds (whether on the buy side or the sell side) tends to insist on warranty and indemnity insurance being used in private treaty transactions. Subject to the limitations in 6.9 Warranty and Indemnity Protection, the policy ordinarily covers the fundamental warranties, business warranties and most tax matters.

The use of warranty and indemnity insurance means it is not necessary for a private equity seller’s obligations to be backed by escrow or retention arrangements.

It is not uncommon to have disputes in relation to private treaty sale agreements in Australia. In most cases, these relate to purchase price adjustments (whether in connection with completion accounts or alleged leakage in the context of a locked box), earn-outs and non-competes. However, in most cases the parties resolve the relevant dispute commercially before formal litigation commences.

Private equity-backed bidders are common in Australian public-to-private transactions. There was significant public M&A activity in the first six months of 2023 (more than AUD50 billion of deals announced), surpassing the total deal value for 2022 (approx. AUD45 billion). A substantial proportion of the 2023 activity was private equity driven.

Bidders can acquire control of publicly held companies in Australia in various ways. The most common ways are by takeover bid or scheme of arrangement. In general terms, a takeover bid involves an acquisition undertaken by making offers to the shareholders of the target company. Once sufficient shares have been acquired (normally 50%), control of the target will pass to the bidder, who will then be able to appoint new directors and control the company’s operations. A takeover can be done on-market or off-market (which is more common). It is possible to have a friendly (recommended by the target board) or hostile (not recommended by the target board) takeover. On the other hand, a scheme of arrangement becomes binding on all shareholders once it is approved by a majority of shareholders (including 75% of votes cast) and also by the court. Schemes are driven by the target and so, unlike a takeover, can only be done on a friendly basis.

The bidder and target enter into an implementation agreement (which sets out things such as the offer price, conditions, steps the parties must undertake to effect the transactions, and break fees and deal protection mechanics) in respect of a friendly takeover and a scheme of arrangement. The target board plays a significant role in public-to-privates – including, to recommend that shareholders accept the offer or support the transaction (in accordance with the terms of the implementation agreement) in the context of a friendly takeover or scheme (as applicable), and to recommend that shareholders not accept the offer in respect of a hostile takeover.

Under Australian law, a person that has, either alone or together with their associates, control over 5% or more of voting shares in an ASX-listed company has a “substantial holding” in that company and must fulfil certain notification requirements. A person must, within two business days, give a notice that sets out certain details of their holding (including their name, address and the basis on which they have the interest in the shares) to the company and to ASX once they:

• begin to have, or cease to have, a substantial holding; or
• increase or decrease a substantial holding by 1% or more.

A person making a takeover bid for a listed company is also deemed to have a substantial holding in the target during the takeover period. Therefore, whenever there is a movement of at least 1% in the bidder’s holding, the bidder must notify the company and ASX by 9.30am on the next trading day.

The Australian takeovers rules are underpinned by a number of prohibitions. The key prohibition applies where there is:

• an acquisition of control over issued voting shares in an ASX-listed company, or in an unlisted company that has more than 50 shareholders; and
• that acquisition results in the number of shares controlled by one person or their associates (being entities in the same corporate group, entities with whom the bidder has entered into an agreement for the purpose of controlling or influencing the company of the board of the target or the conduct of its affairs) or with whom the bidder is proposing to act in concert in relation to the company affairs) increasing:

1. from 20% or less, to more than 20%; or
2. from a starting point that is above 20% and below 90%,

unless an exception applies. The main exceptions allow acquisitions under a formal takeover bid or under a formal scheme of arrangement, acquisitions approved by target shareholders or creeping acquisitions of no more than 3% in a six-month period.

This means a private equity bidder (or indeed any other person) cannot purchase a stake greater than 20%, unless it does so under an exception (such as under a formal takeover bid or scheme of arrangement). In other words, unlike in the UK, there is no ‘mandatory offer threshold’ that permits a bidder to buy a stake over 20% (for example) provided they then make a bid to other shareholders.

The nature of consideration that a bidder is allowed to offer under a takeover differs depending on whether it is an off-market or on-market bid. Only cash may be offered for an on-market bid, whereas cash, scrip, or a combination of cash and scrip may be offered for an off-market takeover. The most common form of consideration offered by bidders is straight cash, with approximately 70% of bidders in takeover transactions that were announced and became unconditional in the first half of 2023 (up to 31 July 2023) offering cash only. 

In the context of a takeover, the consideration offered for target shares must equal or exceed the maximum consideration that the bidder or an associate provided, or agreed to provide, for a target share during the four months before the bid. There are particular rules for determining the value of pre-bid non-cash consideration, and for applying this rule where the consideration under the bid is or includes scrip.

On-market takeover bids must be unconditional. This is one of the primary reasons that they are relatively uncommon (compared to off-market takeover bids).

Off-market takeover bids may be subject to conditions, and common conditions include:

• minimum acceptance conditions (50% or 90%);
• conditions relating to material adverse changes in the financial or trading position or condition of the target;
• conditions requiring government approvals (such as FIRB approval or ACCC clearance); and
• conditions relating to adverse movements in market indices or in key commodity prices.

The bid can be subject to finance (provided it is framed in a way that means its satisfaction turns on the bidder’s opinion or events within the bidder’s control – see below). In practice, few takeovers contain such a condition due to the uncertainty it provides.

Certain conditions are also prohibited. These include:

• maximum acceptance conditions;
• conditions allowing the bidder to acquire securities from some but not all of the accepting shareholders;
• conditions requiring approval of payments to officers of the target ceasing to hold office; and
• conditions that turn on the bidder’s opinion or events within the bidder’s control.

The position is largely similar for a scheme of arrangement, except that minimum acceptance conditions are not applicable in the context of schemes (which are all-or-nothing transactions).

In the case of a friendly off-market takeover bid or a scheme of arrangement, it is customary for the parties to agree exclusivity arrangements in the implementation agreements. These generally include:

• ‘no shop’ or ‘no talk’ agreements, under which the target agrees not to solicit rival proposals from third parties and, subject to a fiduciary exception, not to negotiate with potential rival bidders; and
• notification and matching rights, under which the target agrees to notify the bidder if it receives an unsolicited proposal from a rival bidder, and not to recommend that proposal unless and until it has given the initial bidder a short period (usually three business days) to match or better that proposal.

A scheme of arrangement is an ‘all-or-nothing transaction’. If the requisite conditions (including target shareholder approval) are satisfied or waived (to the extent that they are capable of waiver), the bidder will acquire all of the shares of the target that it does not already hold. If the conditions are not satisfied or waived, the bidder will not acquire any shares.

Under a takeover, a bidder is able to compulsorily acquire all of the shares it does not hold if it holds at least 90% of the shares in the relevant class and acquired at least 75% of the shares that it offered to acquire under the bid. If the bidder ends up with more than 50% but less than 100% of the shares in the target, a private equity buyer will be entitled to reconstitute the board and will be largely able to control the strategic direction of the company (eg, M&A, dividend policy, etc). Bidders must set out their intentions regarding the target if their shareholding ends up at this level in the disclosure document in relation to the takeover bid, and ASIC will require the bidder to act in accordance with its disclosed intentions. Further, whilst the target remains listed on ASX, it will remain subject to the ASX Listing Rules as well as the Corporations Act even if it ceases to be listed, which will, amongst other things, require the bidder to obtain shareholder approval for certain transactions (including related party transactions).

In Australian public M&A transactions, it is not uncommon for private equity bidders to secure pre-bid commitments from existing shareholders to increase the likelihood of them obtaining control over the target (including by acting as a disincentive to any potential rival bidders).

These commitments can take the form of, amongst other things, call options (under which the bidder can acquire the relevant shares in certain circumstances), pre-bid acceptance agreements (under which a shareholder agrees to accept the takeover offer) or voting agreements (under which a shareholder agrees to vote in favour of the scheme of arrangement). Such arrangements are generally entered into prior to the initial approach to the target and are subject to certain conditions (eg, no superior proposal emerging for the target).

It is customary for private equity buyers to seek to align management’s interests with theirs by putting in place a management equity plan (in some cases, to sit alongside a cash incentive plan) following their investment in, or acquisition of, the company. Management’s equity participation will generally be limited to 5%–10%.

Management participation can be structured as either sweet equity or an institutional strip. Where employees roll their existing securities (whether they vested as a result of the private equity shareholders’ acquisition of, or investment in, the company or otherwise), they generally participate in the institutional strip. In respect of a management equity plan, or the rolling of unvested incentives, employees generally receive sweet equity.

In most cases, this takes the form of options or loan-funded shares issued in accordance with the terms of the management equity plan. Management is not usually issued preferred securities. The preferred treatment given to these types of securities (eg, redeemable preference shares) is usually reserved for the private equity shareholder.

As set out in 8.2 Management Participation, management equity plans generally contain time-based and/or performance-based vesting conditions. For the time-based conditions, these are often linked to the private equity shareholder’s proposed timeline to exit its investment in the company (eg, three to five years). For the performance-based conditions, these are often linked to the financial of the company or the relevant business divisions (ie, those in which the employee is involved).

The leaver provisions are often among the most heavily negotiated aspects of management equity plans (given employees will likely lose some or all of their benefits if they are a bad leaver). A relatively customary construct is for someone to be a bad leaver if their employment is terminated for cause or they resign, and for them to be a good leaver if their employment ceases for any other reason.

It is customary for manager shareholders’ employment contracts, as well as often the management equity plan for the company, to include provisions preventing management shareholders from competing (including by way of solicitation) with or disparaging the company. The private equity shareholder and the company are also often given rights under the shareholders’ agreement in respect of breaches.

Such provisions – in particular, non-competes – must operate in a certain way to be enforceable under Australian law. Although the exact requirements vary depending on the relevant Australian State or Territory, throughout Australia only reasonable non-compete clauses are legally enforceable. That is, they should be no more restrictive than is necessary to protect the employer’s legitimate business. The provisions must be carefully drafted to ensure that they are enforceable.

Manager shareholders’ minority protections depend on the nature (ie, the class of securities that they hold) and size of their shareholding. It is not unusual for manager shareholders to have veto rights over a limited a set of actions (eg, amendments to the company’s constitution or shareholders’ agreement), where that action would prejudice them in a manner that is materially and adversely disproportionate as compared to the rest of the company’s shareholders. Manager shareholders will also have the benefit of certain Corporations Act (eg, in relation to directors’ duties and oppression against minority shareholders) and common law protections. Where manager shareholders have a larger holding in the target – whether because they rolled as part of the acquisition of the company or as a result of the company’s incentive plan – they may have broader protections, although seldom do managers have any specific anti-dilution protection or the ability to control or influence the private equity shareholder’s exit from the company.

It is typical for private equity shareholders to have very high degrees of control over their portfolio companies.

Where there is a material minority shareholder in the portfolio company, that minority shareholder will usually have the benefit of certain limited minority protections. These protections will be set out in the shareholders’ agreement, and require the minority shareholder’s consent to be obtained to actions such as material acquisitions or disposals, related party transactions, departures from the agreed dividend policy and payment of directors’ fees (with the list to be negotiated at the time the shareholders’ agreement is entered into).

Where the portfolio company is wholly owned (including where members of management hold securities pursuant to an incentive plan), the private equity shareholder’s control will be subject only to the company’s constituent documents and general Australian law (eg, as set out in 8.5 Minority Protection for Manager Shareholders, the shareholder oppression provisions).

In Australia, shareholders are generally not liable for the actions of the company in which they own shares. Their liability is limited to the capital they have contributed to the company – for example, a private equity firm cannot be liable for the actions of its portfolio company. This is referred to as the ‘corporate veil’.

There are, however, circumstances in which the corporate veil can be pierced and a shareholder may be liable for more than its contributed capital. These include where a shareholder uses the company to commit fraud or its nominee director is deemed to be a shadow director and therefore subject to directors’ duties.

In addition to trade sales (to other private equity investors or corporates) and IPOs, there has been an increase in the use of continuation funds (being vehicles established by the sponsor to acquire an asset from an existing vehicle operated by the same sponsor, effectively a general-partner-led secondary) in the last 12 months.

Trade sales remain the most common private equity exit route. The use of ‘dual track’ processes (ie, the concurrent pursuit of a trade sale and IPO) is still rare, largely as a result of the challenges in relation to public markets exits (see 1.1 Private Equity Transactions and M&A Deals in General).

It is not common for private equity sellers to reinvest upon exit.

In Australia, drag rights and tag rights are, effectively, standard in shareholders’ agreements for companies with private equity shareholders. However, in practice, these provisions are used relatively rarely. 

Drag Rights

These provisions allow majority shareholders to, when they are selling at least the agreed percentage of their shares in the company, force the minority shareholders to also sell their shares (usually on materially the same terms). The drag threshold is generally somewhere between 60% and 80% of all shares on issue. However, whilst management shareholders will almost always have to sell their shares if the drag rights are validly effected, it is not uncommon for the consent of institutional co-investors to have to be obtained before they can be dragged.

Tag Rights

These provisions allow minority shareholders to, when the majority shareholders are selling at least the agreed percentage of their shares in the company, to force the majority shareholders to also procure the sale of their shares (usually on materially the same terms). The tag threshold is generally somewhere between 10% and 20% of all shares on issue.

As set out in 1.1 Private Equity Transactions and M&A Deals in General, the first half of 2023 has been one of the most challenging periods in recent history for IPOs.

The approach to lock-up (or escrow) arrangements has, however, remained unaffected. These arrangements comprise either mandatory (ie, ASX-imposed lockup) or voluntary (ie, determined by the issuer, usually in conjunction with the lead manager(s) of the IPO) escrow arrangements that, in most cases, run for a period of 12–24 months from the IPO. In some cases, certain shares may be released from escrow once the issuer’s financial results are announced to ASX.

It is common practice for private equity sellers to enter into relationship agreements with issuers to govern their ongoing relationship following the IPO. These agreements generally deal with the private equity seller’s rights to appoint a nominee to the board and its information rights, and can also sometimes set out the basis on which the issuer will assist with a sell-down of the seller’s shareholding.