Private equity (PE) remains a cornerstone of the American financial landscape, driving innovation, growth, and transformation across various industries. As the PE sector in the USA has evolved, so has its legal framework, shaped by regulatory changes, market dynamics, and emerging trends and other issues. This article delves into the latest legal trends and developments in US PE, providing an overview for PE sponsors, investors, issuers, sellers, and legal practitioners.

Regulatory Environment

SEC oversight and enforcement

The Securities and Exchange Commission (SEC) has intensified its scrutiny of PE sponsors. This heightened oversight aims to ensure transparency, fairness, and investor protection. Recent enforcement actions against PE sponsors have focused on issues such as fee disclosures, conflicts of interest, and valuation practices. The SEC's Division of Examinations continues to prioritise examinations of PE sponsors, particularly regarding compliance with the Investment Advisers Act of 1940 and environmental, social and governance (ESG) disclosures. PE sponsors must navigate this evolving regulatory landscape, including balancing ESG objectives with fiduciary duties to investors.

Increased antitrust scrutiny

The regulatory environment for PE is also being shaped by increased antitrust scrutiny. The Federal Trade Commission (FTC) and the Department of Justice (DOJ) as well as foreign antitrust agencies have become more vigilant in examining mergers and acquisitions that could potentially reduce competition. This is particularly relevant for PE sponsors engaged in roll-up strategies where smaller companies are consolidated to create a larger combined entity. These federal and foreign agencies are now more focused on whether these roll-ups could lead to monopolistic behaviour or harm to consumers. As a result, PE sponsors must carefully assess antitrust risks during the due diligence and transaction documentation process and be prepared for potentially longer review periods and more stringent requirements for divestitures and/or other remedies in connection with acquisitions and sales of portfolio companies.

Anti-Money Laundering (AML) and Know Your Customer (KYC) Requirements

PE sponsors are increasingly subject to stringent AML and KYC regulations. The Anti-Money Laundering Act of 2020 expanded the related US regulatory framework, requiring PE sponsors to implement robust compliance programs. This includes comprehensive customer due diligence and ongoing monitoring to detect and prevent illicit activities. The Corporate Transparency Act of 2024 was subsequently enacted to require certain types of entities to file a beneficial ownership information report with the Financial Crimes Enforcement Network, a bureau of the United States Department of Treasury. The emphasis on AML and KYC compliance is part of a broader regulatory effort to combat financial crimes and ensure that PE investments do not facilitate money laundering or terrorism financing. Compliance programs must be continuously updated to reflect evolving threats and regulatory expectations, and PE sponsors should conduct regular training to ensure that all employees are aware of their applicable legal obligations.

Committee on Foreign Investment in the United States (CFIUS)

CFIUS plays a critical and larger role in the regulatory landscape for PE, particularly concerning national security. Recent amendments to the CFIUS regulations have expanded the scope of transactions subject to review, including certain non-controlling investments in critical technology, infrastructure, and data companies. PE sponsors involved in cross-border transactions must be aware of these regulations as well as related foreign direct investment regulations in other jurisdictions and conduct thorough national security assessments where appropriate during the due diligence and transaction documentation process. Compliance with CFIUS and foreign direct investment requirements can be complex and time-consuming, necessitating the involvement of experienced legal counsel to navigate the process effectively with the White House and applicable federal and foreign agencies in PE acquisitions and dispositions.

Non-competition restrictions and legal challenges

Earlier this year, the FTC adopted a rule prohibiting most post-employment non-competition agreements in the USA. While this rule is subject to many lawsuits with respect to its constitutional and statutory authority, it includes an exemption with respect to non-competition agreements entered into in connection with the sale of a business. PE sponsors are co-ordinating with legal advisors to keep up with the status of such legal challenges and structure non-competition and other similar agreements to comply with such rule and related exemption.

Changes in Delaware Law

Earlier this year, the Delaware Court of Chancery held that provisions of a stockholder agreement that included a stockholder pre-approval requirement prior to permitting certain company board actions and imposed various other obligations and restrictions on the board were invalid and unenforceable. This ruling caused significant concern among PE sponsors because it called into question the enforceability of stockholder agreements commonly entered into by PE sponsors and their Delaware corporation portfolio companies. In response to these and other concerns, the Delaware legislature passed (and the Delaware governor signed into law) an amendment to the Delaware corporate law that generally overturned such ruling and permits stockholders agreements as long as the agreement does not violate the company’s charter and would not violate Delaware law if included in the charter.

Market Dynamics

Increased cost of debt financing

The cost of debt financing has risen, influenced by changes in monetary policy and economic conditions. Higher interest rates and tighter lending standards have made it more expensive for PE sponsors to leverage buyouts and other investments, which has decreased PE M&A deal volume and resulted in valuation mismatches between PE sponsors and sellers. This has significant implications for PE deal structuring, as PE sponsors must balance the need for leverage with the increased cost of capital. Additionally, higher debt costs affect the overall returns on investments and require PE sponsors to explore alternative financing strategies or seek out opportunities with higher growth potential to justify the increased expenses. These trends and developments have led to many PE sponsors to focus on direct lending strategies to companies (including other PE portfolio companies) in order to take advantage of higher interest rates in circumstances where traditional banks are not able to lend.

Increased competition

The PE market has witnessed a surge in competition, driven by abundant capital and a robust fundraising environment. This competition has led to more aggressive deal-making by PE sponsors that are constantly fundraising, deploying capital and seeking investment exits. PE sponsors must navigate these dynamics, balancing the need for attractive returns with the risks of overpaying for assets. The influx of new market entrants, including family offices and sovereign wealth funds, has intensified the competitive landscape. To differentiate themselves, PE sponsors are increasingly focusing on value creation strategies post-acquisition, such as operational improvements and strategic add-ons, to enhance the performance of their portfolio companies. PE sponsors are also focusing on late stage growth equity as an asset class to broaden their investment scope and seek attractive valuations and returns.

Secondary market growth

The secondary market for PE interests has grown substantially. This trend is driven by the need for liquidity among investors and the desire to rebalance portfolios. The legal landscape surrounding secondary transactions is evolving, with a focus on disclosure, valuation, and transfer restrictions. PE sponsors must navigate these complexities to ensure smooth and compliant transactions. Secondary market transactions offer flexibility for limited partners (LPs) seeking to exit investments before the end of the fund's life cycle. However, these transactions also require careful management of investor relations and adherence to fund agreements and regulatory requirements.

Special Purpose Acquisition Companies (SPACs)

SPACs have declined as a significant force in the PE market. These blank-check companies provide an alternative route to public markets, offering flexibility and speed. However, the SEC has increased scrutiny of SPACs focusing on disclosure practices, conflicts of interest, and the adequacy of due diligence which has substantially decreased the volume of SPACs as well as PE sponsors’ interest in SPAC transactions as a portfolio company exit strategy.

Legal Trends

M&A deal terms

In the current market, M&A deal terms are evolving to address heightened competition and regulatory scrutiny. Some PE sponsors have been "jumping" competitive auctions by submitting bids prior to auction deadlines subject to relatively short confirmatory due diligence to get ahead of other bidders. Certain larger PE sponsors have eliminated the uncertainty surrounding debt financing by offering targets "full equity backstop" commitment letters under which targets can compel such funds to pay the entire purchase price once the applicable closing conditions are satisfied, which has favoured larger PE sponsors in auctions over their smaller counterparts who cannot offer such terms due to fund concentration limits. In private M&A transactions, there has been an increased use of earnouts, where a portion of the purchase price is contingent on the future performance of the acquired business, to help bridge valuation gaps between buyers and sellers and aligns interests. Finally, there is a growing emphasis on representations and warranties insurance (RWI) to mitigate risks associated with breaches of representations and warranties. RWI policies provide buyers and sellers with a mechanism to cover potential liabilities, facilitating smoother negotiations and reducing the need for extensive indemnity provisions. PE sponsors must carefully consider these evolving deal terms to navigate the complexities of M&A transactions effectively.

Fund structuring and terms

Innovations in fund structuring continue to shape the PE landscape. There is a growing trend towards bespoke fund structures tailored to the specific needs of investors. This includes the increased use of continuation funds, which allow PE sponsors to extend their investment horizons and provide liquidity to existing investors, and related restrictions on use of continuation funds by co-investors of PE sponsors in portfolio companies. Additionally, terms related to management fees, carried interest, and hurdle rates are evolving to align interests between fund managers and investors. PE sponsors are increasingly adopting flexible fee structures, such as tiered management fees that decrease as the fund size increases or increase as certain performance milestones are achieved. These innovations aim to enhance alignment and attract a broader range of investors.

Co-investments and syndications

Co-investment opportunities have become increasingly popular among LPs. These arrangements allow LPs to invest alongside the main fund, often with reduced fees and improved terms. Legal considerations include the structuring of co-investment vehicles, disclosure of conflicts of interest, and alignment of incentives. PE sponsors must carefully navigate these issues to maintain strong LP relationships and meet regulatory requirements. Co-investments offer LPs the opportunity to increase their exposure to attractive deals while maintaining a close relationship with the PE sponsor. However, managing co-investment opportunities requires clear communication, transparency, and a thorough understanding of the legal and regulatory implications.

Digital transformation and cybersecurity

The digital transformation of PE operations is a significant trend. PE sponsors are leveraging technology to enhance deal sourcing, due diligence, and portfolio management. However, this digital shift brings cybersecurity risks. Legal considerations include data protection, incident response planning, and compliance with cybersecurity regulations that are constantly changing around the world including in each state in the USA. PE sponsors must implement and continually update robust cybersecurity measures to protect sensitive information and maintain investor confidence. The increasing reliance on technology also necessitates the adoption of best practices for data governance and cybersecurity hygiene. PE sponsors should regularly assess their cybersecurity posture, conduct vulnerability assessments, and invest in employee training to mitigate risks and comply with new regulations effectively.

Emerging Issues

Artificial intelligence

Artificial intelligence (AI) is increasingly being integrated into PE operations, offering new opportunities for efficiency and value creation. AI is being used by PE sponsors to enhance deal sourcing by analysing vast amounts of data to identify potential investment targets and trends. Additionally, AI-powered analytics are improving due diligence for PE sponsors by providing deeper insights into a target company's financial health, operations, and market positioning. However, the use of AI also raises many legal considerations, including data privacy, algorithmic bias, and compliance with evolving regulations in numerous areas. PE sponsors must navigate these challenges to harness the full potential of AI while ensuring legal compliance.

Presidential election and wars in Israel and Ukraine

Political and geopolitical events, such as the upcoming US presidential election and conflicts like the ongoing wars in Israel and Ukraine, significantly impact the PE landscape. Changes in government policies, regulatory priorities, and economic stability influence market dynamics and PE investment strategies. For instance, shifts in tax policies, trade agreements, and foreign investment regulations significantly affect PE deal structuring and cross-border transactions. Additionally, geopolitical conflicts introduce uncertainties and risks that require careful consideration in the PE due diligence process and strategic planning. PE sponsors are closely monitoring these developments and assessing their potential impact on their current and potential investments.

Focus on diversity and inclusion

Diversity and inclusion (D&I) have become critical considerations for PE sponsors. There is increasing pressure from investors, regulators, and stakeholders to improve D&I practices within PE sponsors and their portfolio companies. Legal considerations include the implementation of D&I policies, compliance with anti-discrimination laws, and the incorporation of D&I metrics in performance evaluations. PE sponsors are prioritising D&I to enhance their reputation and attract top talent. Efforts by PE sponsors to improve diversity include setting measurable goals for diverse representation, implementing bias training programs, and fostering an inclusive culture that supports the career advancement of under-represented groups.

Cross-border transactions

Cross-border PE transactions are becoming more prevalent and present unique legal challenges that continue to shift. These include compliance with changing international regulations, navigating complex tax structures with new laws, and managing shifting geopolitical risks. The evolving global landscape, including trade tensions and regional conflicts, adds complexity to cross-border deals. PE sponsors must stay informed about international developments and work with experienced legal counsel to navigate these transactions successfully. In addition to regulatory compliance, cross-border deals require careful consideration of cultural differences, local market dynamics, and potential legal disputes. Effective cross-border transaction management involves thorough due diligence, strategic risk mitigation, and collaboration with local advisors to ensure successful outcomes.

Best Practices for Legal Compliance

Robust compliance programmes

To navigate the complex and changing legal landscape, PE sponsors must implement robust compliance programmes. This includes regular training for employees, comprehensive internal policies, and ongoing monitoring and auditing. A strong compliance culture can mitigate risks and enhance operational efficiency. Effective compliance programmes should be tailored to the PE sponsor’s specific risks and regulatory environment, incorporating best practices and lessons learned from previous regulatory actions. Regularly updating and reviewing compliance policies, conducting internal audits, and fostering a culture of compliance are essential components of a robust compliance framework.

Proactive regulatory engagement

Proactive engagement with regulators is essential for PE sponsors. This includes participating in industry consultations, staying informed about regulatory changes, and maintaining open lines of communication with regulatory bodies. By engaging proactively, PE sponsors can influence policy development and ensure compliance with evolving regulations. Building constructive relationships with regulators can also facilitate a better understanding of regulatory expectations and reduce the risk of enforcement actions. PE sponsors should consider appointing dedicated regulatory affairs professionals or external advisors to manage regulatory interactions and stay ahead of emerging regulatory trends.

Emphasis on transparency

Transparency is a key component of legal compliance in the PE sector. PE sponsors must prioritise clear and accurate disclosures to investors, regulators, and other stakeholders. This includes transparent fee structures, conflict of interest disclosures, and comprehensive ESG reporting. Enhanced transparency builds trust and strengthens relationships with stakeholders. Transparency initiatives should extend beyond regulatory requirements to encompass all aspects of the PE sponsor’s operations, from investment strategies to portfolio company performance. By fostering a culture of transparency, PE sponsors can enhance their reputation, attract capital, and mitigate the risk of regulatory scrutiny.

Frequent communication with legal counsel on changing regulatory landscape

Frequent communication with legal counsel is vital for PE sponsors to navigate the changing regulatory landscape. Legal counsel can provide valuable insights into new regulations, enforcement trends, and emerging legal risks. Regular consultations with legal advisors can help PE sponsors stay informed and proactively address potential compliance issues. This communication should be integrated into the PE sponsor’s overall compliance strategy, ensuring that legal counsel is involved in decision-making processes and has a comprehensive understanding of the PE sponsor’s operations and risk profile. By maintaining close collaboration with legal advisors, PE sponsors can better anticipate and respond to regulatory changes, reducing the risk of non-compliance and enhancing overall legal resilience.

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The PE landscape in the USA is dynamic and evolving, shaped by regulatory changes, market dynamics, and emerging trends. PE sponsors, investors, issuers, sellers and legal practitioners must stay informed about the latest developments and proactively address legal challenges. By implementing robust compliance programmes, engaging with regulators, prioritising transparency and communicating with legal counsel on regulatory changes, PE sponsors can successfully navigate the complex and constantly changing legal landscape and drive sustainable growth. As the PE sector continues to evolve in the USA, staying ahead of legal trends and developments will be crucial for success.