Private Acquisitions

Private equity backed transactions

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Private equity backed transactions
• Management buy-out (MBO) => purchase by management team of a business or the entire issued
share capital of a company (assisted by significant element of debt finance = leveraged buy-out (LBO))
• Number of MBOs now much lower than historically and many more private equity-run deals
• Private equity investor = private equity fund
• Private equity house (PEH) = party that instructs the firm, as adviser to the general partner of the
private equity fund
Private equity fund
• Traditionally for making investments in unquoted securities, although now may be involved in
takeovers of listed companies
• PEH has a number of funds, each investing, holding and managing those investments and then exiting,
returning capital to investors
• Each fund is generally a limited partnership:
o ≥ 1 limited partner + ≥ 1 general partner
§ Limited partners
• Limited liability for investors (limited partners), provided they do not take
part in management of limited partnership business
• If withdraw part of capital, remain liable for debts of limited partnership up
to amount withdrawn => small proportion capital contribution + remained
as loan to limited partnership
§ General partners
• Unlimited liability, responsible for running partnership business =>
generally a company, whose directors and SHs will be the employees of the
PE firm which established the fund
o No legal personality – legal title to limited partnership’s assets held by general partner, with
shares in T (or acquisition vehicle) often held through a chain of companies under GP
o Tax transparency – avoids double taxation for limited partners + allows investors with special
tax status (charities / low tax jurisdictions) to continue to enjoy tax savings
o Less regulation + greater flexibility than company – CA06 does not apply (Partnership Act
1890 + Limited Partnerships Act 1907) => generally governed by a Limited Partnership
Agreement (as no need for articles)
o Fewer filing requirements + greater privacy – very few filing requirements
• The Walker Guidelines => Private Equity Reporting Group (PERG) responsible for reviewing conformity
with disclosure and transparency guidelines in PE industry
• Alternative Investment Fund Managers Directive (AIFMD) =>
o Managers of PE funds must be authorised and regulated by MS regulating authority (FCA) =>
Investment Funds Sourcebook within FCA Handbook
o Further rules re: disclosure + transparency, capital etc.
• Pensions => highly leveraged against assets of business being bought, meaning unsecured creditors,
including pension funds, potentially do worse in an insolvency than they would have done before the
buy-out => pension funds now have a duty un LBO to demand substantial assets from company up
front to safeguard retirement benefits
© Liam Porritt 2020 2
• Private fund limited partnership (PFLP) => new type of limited partnership (since 2017) =>
o Formation – must:
§ Be constituted by a written agreement (Limited Partnership Agreement)
§ Be a collective investment scheme (s 235 FSMA 2000) => purpose to enable persons
to invest in some form of property
o Differences from other LPs:
§ Limited partners exempt from statutory duties to render accounts, provide
information between partners and not to compete with the partnership business
§ PFLP provides a non-exhaustive list of actions which a limited partner may take
(subject to Limited Partnership Agreement) without being regarded as taking part
in the management of the partnership’s business (white list), including (provided
actions of limited partner do not actually result in taking part in management of
partnership business):
• Taking part in decisions to change limited partnership agreement, nature of
the business of LP or persons responsible for day-to-day running
• Consulting with / advising GP for day-to-day running of LP business
• Approving accounts of LP
• Appointing a person to wind up the LP (avoiding issue where under old LP
general partner had already been removed + limited partners wished to
wind up)
§ No need for PFLP limited partners to make any capital contribution
Private equity activity
1. Venture capital – funding new businesses
2. Development capital – funding existing, more mature businesses
3. Buy-out – funding purchases of established businesses
1. Management buy-out (MBO) – existing management of company / business buy company / business
(T) from existing owners (through newco 1, which owns newco 2, which buys T)
2. Management buy-ins (MBI) – new management team assembled for purposes of running T after its
acquisition from existing owners (through newco 1 + 2)
3. Institutional buy-outs (IBO) – Fund buys T and role of management peripheral
• Increasingly, buy-outs are being structured as auctions, with PE funds competing against each other +
trade buyers (+ management team)
When buy-outs commonly occur
1. Divestment of non-core activities / subsidiaries
2. Administration / liquidation of company with viable subsidiary / division
3. Death / retirement of owner
4. Management initiative – management feels business needs funding which is not forthcoming from
existing owner
© Liam Porritt 2020 3
How PE funds make money
• Income returns by way of dividends / interest / management/monitoring fees
o NB in an MBO, Newco 2 will have to pay interest on its bank loan used to
fund the purchase of T, and therefore the fund’s income returns may be
relatively low => the fund will be focused on achieving a strong capital return
on exit
• Capital return on exit =>
o Floatation of Newco 1
o Sale of Newco 1 or 2 to trade buyer
o Secondary (or tertiary) buy-out (Fund from Fund)
o Where venture unsuccessful, exit by:
§ Sale of Fund’s equity to management or the company (purchase of
own shares)
§ Insolvent administration / liquidation
• On exit:
o Preference shares / loan notes held by fund redeemed at face value
o Bank debt may be repaid so buyer may refinance T
• RoI must be distributed to investors once made, and therefore funds provide only
very limited warranties => incoming Fund / buyer expected to do thorough DD
o Management team may be expected to provide a separate warranty deed to
incoming purchasing Fund
o Alternatively, Fund may be able to obtain warranties backed by warranty +
indemnity insurance
© Liam Porritt 2020 4
Advantages and disadvantages of MBOs
• For the management, PE house provides capital (in the form of equity, not debt),
which will be used to both buy T and invest in projects
• Obtain an equity interest in the business, such that they have increased control
perhaps to manage the business that they own
• On exit, have the prospect of making a considerable amount of money
• Private equity houses may bring contacts and expertise into the business
• Potential to renegotiate more favourable service contracts
• Loss of control to the PE fund, such that Fund has both majority interest usually, veto
rights and covenants from investors
• Requirement that the managers input considerable investment into the business,
with personal loan liability, and the MBO may fail
• Ratchet could lead to lower returns than anticipated if target IRR not achieved
• Management need to commit for a certain period of time, usually until exit, as if
they leave early they will be penalised through good leaver/bad leaver provisions
© Liam Porritt 2020 5
Standard MBO / MBI Structure
1. Before completion – Lawyers acting for management arrange for transfer of 2 shelf
companies (Newco 1, which is the investment vehicle, and Newco 2, which is the
acquisition vehicle) into ownership of management => Newco 1 subscriber shares to
management + Newco 2 subscriber shares to Newco 1
2. At completion –
a. Funding of Newco 1 (investment vehicle) by:
i. Management team (ordinary shares) +
ii. Fund (ordinary + preference shares)
iii. (Sometimes, Fund in return for convertible loan notes – for exam)
b. Funding of Newco 2 by:
i. Bank loan
ii. Newco 1 (usually by intragroup loan (or investing in further shares))
iii. (Sometimes, Fund in return for convertible loan notes – in practice)
c. Acquisition of shares / assets in T by Newco 2
d. Granting of
i. Security by Newco 2 (and T + T’s subsidiaries, where shares
purchased) to Bank (by way of fixed and floating charges over all
assets) +
§ Must here consider financial assistance if any plcs
ii. Where shares purchased, guarantee by T of Newco 2’s borrowing
PE Fund Management Team
Intra-group loan
Ordinary shares
preference shares
Newco 1
Newco 2
Shares in Target
© Liam Porritt 2020 6
Key players in the MBO/MBI
• PE Fund
• Lawyers for PE fund – prepare equity documentation (e.g. Newco Arts), loan note
instrument if needed, Investment Agreement, Management’s service contracts
• PE Fund lawyers act on behalf of Newcos, due to:
o Fund wishing to have control over loan documents + security documents
o The management team are conflicted re: the negotiation of the purchase
agreement, as they work in T
• Accountants – fund appoints to carry out accounting DD on T
• Bank (holding the Senior Debt), which may then be followed by subordinated debt to
second lender, carrying higher interest (mezzanine debt)
• Lawyers for bank – loan documentation + review of DD on T to assess Bank’s risk
• Management team – manages Newco 1, 2 and T after completion
• Lawyers for management team – structure of management’s equity investment +
negotiate Investment Agreement (including disclosure against IA warranties) +
service contracts with PE fund (+ lawyers)
• Seller
• Seller’s solicitors
© Liam Porritt 2020 7
Principal Documentation
Negotiation points
1. How equity investment (i.e. OSC) in Newco 1 will be structured as between the Fund
+ Management
2. Rights associated with different classes of Newco 1 shares
3. How Newco 1 will be managed after completion
4. Terms of employment of Management – incentivisation package
5. Contractual protection/information given by Management to Fund
6. Terms of AA between S and Newco 2
7. Terms of bank debt finance to Newco 2
1. Acquisition documentation – AA (SPA on SS), disclosure letter, completion
documents (e.g. share transfer form, share certificates delivered, T to deliver new
share certificates + Newco share certificates)
2. Articles of Newco 1 – standard articles +
a. Dividend entitlements
b. Rights of SHs on return of capital
c. Restrictions on transfer of shares (pre-emption rights)
d. Good/bad leaver provisions (may alternatively be in investment agreement)
i. Purpose:
1. Incentivise management team to stay involved with the running of
Newco and Target for a minimum period of time by contractually
obliging managers to sell their shares if they leave employment of
Newco 1, the price of such shares depending on the nature of their
2. As the manager leaving employment will affect the manager’s position
as employee, but not as shareholder, these provisions prevent a
manager benefiting on exit, as a SH, from the positive impact of work
done within the business, to which they did not contribute, following
their leaving
ii. Sought by Fund to ensure motivation to remain in post (with narrow ‘good
leaver’ definition) + by managers, who must balance desire to be treated
fairly if they leave with making sure other managers sufficiently penalised if
they leave
© Liam Porritt 2020 8
iii. Negotiation:
1. Definition of ‘good leaver’, ‘bad leaver’ being anyone who is not a good
leaver =>
a. Death, long-term illness = good leaver
b. Time limit on the employee being a bad leaver (e.g. 3 years),
usually to end after period in which desired exit sought
c. Unfair / wrongful dismissal argued by Fund as bad leaver, as: 1)
employment law remedies may be enforced; 2) unfair dismissal
may arise due to procedural irregularity, and Fund does not
want to be caught by this; and 3) where the manager is
dismissed, this will not be without any reason, and there will
have been prior warnings
2. Price paid for shares:
a. Bad leaver – lower of nominal value or market value; for
management, seek that they receive at least what they paid for
the shares (as will likely have taken on debt to buy the shares,
which must be paid off)
b. Good leaver – higher of nominal value or market value
e. Drag along/tag along provisions (may alternatively be in investment agreement
where jurisdiction does not permit provisions in Articles)
i. DRAG along –
1. Purpose: operates at the time of an exit to allow the majority SHs to
force minority SHs (managers) to sell their shares should there be an
offer for the company that the majority SHs wish to accept (as
purchasers will generally want to purchase the entire company), thus
preventing minority SHs from preventing a sale
2. Sought by both Fund + managers, to prevent a manager blocking the
3. S 979 CA06: statutory ‘squeeze-out’ providing right for offeror to buy
out minority SHs only where the offeror has managed to secure the
acceptance of his offer by holders of 90% in value of shares to which
the offer relates => unlikely to apply, unless management hold ≤ 10%
share capital + is time-consuming and costly, as involves litigation
4. Negotiation:
a. Percentage at which drag activated: Fund to seek their preratchet percentage as the threshold, such that they alone can
invoke the provisions
b. Management to ensure that drafting provides that terms on
which they have to sell their shares under the drag along are no
less favourable than the terms on which the fund proposes to
© Liam Porritt 2020 9
ii. TAG along –
1. Purpose: operates at the time of exit to allow the minority SHs to
require that they be able to sell their shares to a purchaser if an offer is
received for the majority shareholding
2. Sought by managers to prevent fund negotiating themselves a good
deal and leaving the minority SHs behind on exit
3. S 983 CA06: statutory sell-out permitting minority to have his shares
purchased by an offeror only applies where offeror has secured
acceptance of offer by 90% in value of shares
4. Negotiation:
a. Management to seek that drafting provides that terms on
which their shares are bought are the same as those according
to which the fund’s shares are bought; may be negotiation as to
whether have the right to receive an offer at the highest price
offered to majority SHs
b. Fund may resist inclusion of the tag along, arguing that it is
unlikely anyone will want to buy less than 100% of company
and thus unnecessary (but the inverse argument may be made
by the managers, i.e. therefore no issue in including it!)
f. Ratchet provisions (normally in Articles of Newco 1, but may be investment
i. Purpose: further incentivisation mechanism whereby Management’s
proportion of equity on Exit is adjusted according to success of bought-out
business + value at the Exit
ii. Sought by Fund
iii. E.g.1 ‘negative’ ratchet – parties agree proportion of equity to which
management entitled if Fund’s required IRR is achieved at Exit => if venture
less successful, Management’s proportion of equity reduced accordingly (by
Fund obtaining more shares)
§ Share structure such that management subscribe for proportion of
equity it is agreed they should receive if Fund achieves IRR; Fund
subscribes for remaining OSC + convertible preference shares / loan
notes, which may be converted into ordinary shares in accordance
with ratchet
iv. E.g.2 ‘positive’ ratchet – Management rewarded by conversion of proportion
of Fund’s B Ordinary Shares into (worthless) deferred shares
o Ratchet calc:
§ Work out new percentage represented by Management’s shares
post-completion (remember: management’s number of shares stays
the same)
§ Gross up to find out what entire issued share capital should be
§ Calculate number of shares to be held by Fund + number that need
3. Articles of Newco 2
© Liam Porritt 2020 10
4. Investment Agreement (or Subscription Agreement) – similar to SH agreement:
a. Parties – Fund, Management, Newco 1
b. Key provisions –
i. Veto rights for Fund (provided it retains a certain percentage level of
company’s ISC) at board level (through appointed director = right to appoint
in Investment Agreement) + SH level:
1. Fund consent (in Newco 1 & 2) to – issue of shares; change in Arts of
Newco 1 or subsidiaries; acquisition/ disposal of undertaking; merger;
insolvency etc.
2. Appointed director consent (in Newco 1 & 2) to – issuing securities;
dividends; change in nature of business; entry into / termination of
material contracts
ii. Warranties by Management to fund (and disclosure letter) – DD based on
information provided by Management (on MBO), and therefore give Fund an
action in contract, rather than negligent misstatement / misrep
1. Reasonableness of business plan prepared by Management
2. Accuracy of financial information in business plan
3. Accuracy of information given to Fund’s lawyers + accountants for DD
4. General warranties re: T, e.g. no key contracts subject to change of
5. Accuracy of information contained in the disclosure letter =>
effectively turns information in DL into quasi-warranties (subject
possibly to entire agreement clause) = Fund seeks some reassurance
that the disclosures are true + given bargaining power likely to be
given, perhaps qualified by materiality or knowledge
6. All info which might reasonably affect an investment decision disclosed
=> wide + managers may argue that should have specific warranties to
disclose against, rather than a sweep-up warranty (especially one that
involves our interpreting what may be important to the Fund); but,
bargaining power + given purpose of warranties to flush out
information (rather than give redress, which is unlikely), may be
iii. Key man insurance – to protect the company in the event that a key manager
is unable to work as a result of his/her death/illness/injury, which could lead
to lost revenue, inability to service key customers or inability to afford a
replacement => covers lost revenue + cost of search for replacement
§ NB especially important in MBO, as investors are investing on
the basis of the strength of the managers + all forecasts and
business plan on which decision based included all managers
iv. Deed of Adherence – will be required of any new SHs, such that they are
bound by the terms of not only the Articles of the relevant company in the
Newco 1 group, but also the Investment Agreement
© Liam Porritt 2020 11
5. Service agreements – in MBO, directors currently employed by T, and become
employees of Newco 1 =>
a. Restrictive covenants
i. Purpose: Protect the legitimate interests (trade interests, trade secrets and
workforce) of Newco 1 and T by preventing managers who leave Newco 1
from joining or starting a competing business (non-compete + non-dealing
with clients) and from using know-how and confidential information
ii. Sought by Fund + managers (as both are SHs of Newco) to protect T
iii. Enforceable if:
1. Reasonable in scope (geographic, business and duration); and
2. Go no further than necessary to protect legitimate business interest
iv. Included in investment agreement, as:
1. More likely to be enforceable than in a service contract due to greater
equality of bargaining power between co-investors than employeeemployer => longer time periods for RCs possible in Investment
Agreement (3-6 months in emp cont.; here 9-12 months), and possibly
more extensive scope
2. RCs will also be unenforceable if Newco 1 (employer) breaches the
employment agreement with management (e.g. by failing to give
notice) (General Billposting v Atkinson), even if the contract states RCs
remain enforceable regardless of how the contract is terminated
(Briggs v Oates) BUT in IA are likely to remain enforceable
3. Where employee on garden leave, the courts will deem that the period
to which the RCs apply under the service contract begin when garden
leave begins; under Investment Agreement, RC period will only begin
once garden leave is over
b. Notice provisions (PILON)
c. Garden leave – usually lasts for the same period as the notice period
i. Purposes: designed to overcome problem during an employee’s notice
period and subsequent to their leaving that leaving employees may
(inadvertently or intentionally) harm the business by preventing them from
coming into the office / doing business following notice
ii. Benefits:
1. Overcome possible lack of enforceability of, or difficulties in enforcing,
RCs => during garden leave, the manager remains employee bound by
duties to their employer + RCs in contract during employment
2. Period of garden leave may generally be longer than RCs, as paid
3. Enables the company to restrict the contact of an outgoing employee
with other employees and customers during their notice period,
generally by requiring that they do not come into work, during their
notice period, for a total period of 3-6 months
4. Ensures the manager is unable to obtain another job during this
period, such that much of the employee’s company-specific knowledge
will become out of date by the time they join a new employer
iii. Negotiation – Fund will be concerned re: expense of paying contract of
leaving manager, but equally seeks protection (3-12 month notice period)
d. Remuneration (+ bonus schemes)
© Liam Porritt 2020 12
6. Banking documentation => FA (bank + Newco 2), guarantees (from T, subject to
financial assistance), security documentation (from Newco 2, T and T’s subsidiaries),
Intercreditor deed (where mezzanine debt)
7. Loan notes issued by Newco 1 (Newco 2 in practice) to the Fund
8. Intra-group loan from Newco 1 to Newco 2
Negotiating documentation – key concerns
PE Fund
• Information – DD to ensure proper price paid by Newco 2 for T + build in contractual protection
(warranties + indemnities) => DD reports addressed to Newco 2 + Fund + Bank
• Control –
o Fund has majority stake in Newco 1 ≠ necessary for Fund to have extensive provisions
restricting activities of Newco 1; Investment agreement to have covenants re:
communication + reporting obligations of directors
o Fund has minority stake in Newco 1 = extensive provisions restricting activities of Newco 1 by
requiring permission of Fund prior to major decisions
o Fund will insist that Investment Agreement gives it the right to appoint a director to the
board of Newco 1 / an ‘observer’ who attends and speaks but does not vote
• Risk (on MBO) –
o Historically, Sellers have given limited warranties due to high level of constructive knowledge
of T of Fund (through management) = insurance
o Now, increasingly strong bargaining position + extensive warranties given on more common
IBOs = more extensive warranties on MBOs
o Secondary buy-out => outgoing fund gives very limited warranties due to desire for clean
break, to return exit proceeds to investors, + not involved in day-to-day running of T
§ Management may give warranties up to certain financial limit; or
§ Warranty + indemnity insurance
o Management warranties => required re: accuracy of information in business plan +
projections (to encourage full disclosure, rather than to provide a Fund with a claim vs
management, which it would not wish to pursue, as the managers are running the business
in which it has invested)
• Share transfer provisions – pre-emption rights on transfer attached to all classes of Newco 1 shares,
with exception of transfers:
o For fund: within Fund’s group, other funds on an agreed syndication + entities that will stand
in the shoes of the fund
o For management: family trusts + leaver provisions
• Good leaver / bad leaver – compulsory transfer provisions in Arts of Newco 1 in event one of
Management leaves
• Tag along / drag along – s 979-984 CA only apply following a takeover offer – provisions rarely apply in
private transactions (see above) => provisions in Newco 1’s articles (or investment agreement where
jurisdiction so requires)
© Liam Porritt 2020 13
• Share structure – in MBO, Management subscribe for equity in Newco 1
o For Fund’s ordinary shares to carry rights, e.g. to preferred dividend / ranking on a winding
up, separate classes of ordinary shares created =>
§ Managers – A Ordinary Shares
§ Fund – B Ordinary Shares
o Fund also receives (in order to ensure Management retains a sufficient proportion of the
overall value of the business)
§ Further shares (e.g. non-voting, convertible, preference shares);
§ Loan notes
o Apportioning equity – in appraising potential investment in Newco 1, Fund will work out rate
of return sought = Target Internal Rate of Return (IRR – growth rate of investment (dividend,
interest + capital on exit) accounting for period for which money invested) is metric used; it
then incentivises management through sufficient equity + new service contract granting
favourable salary
• Ratchet (normally in Articles of Newco 1, but may be investment agreement) – further incentivisation
mechanism whereby Management’s proportion of equity on Exit is adjusted according to success of
bought-out business + value at the Exit
• Exposure in relation to warranties in Investment Agreement –
o Information used in business plan accurate (throughout deal process and pre-completion) +
objectively verifiable
o Limitations on exposure, related to salary
o Several or joint and several liability – negotiation as to whether knowledge of one manager
imputed to others
o Contribution agreement between managers, for event Fund sue jointly
• Risks where management = directors of seller => conflicts of interest, statutory +
contractual duties
o S 172 CA 2006 duty to promote the success of the company for the benefit of
the members as a whole => issue, as conflict when agreeing price and
warranty cover between buyer side and seller side
o S 177 – duty to declare interests + under Arts likely to be prevented from
voting at BM
o S 174 duty to exercise reasonable care, skill and diligence – while the MBO is
being negotiated, they should be continuing to manage the business =>
resolved by side letter from employer / SHs consenting to the managers
pursuing MBO
o Contract of employment – duty of confidentiality (management to initially
disclose to fund public information, and then NDA, then SH consent)
© Liam Porritt 2020 14
• Priority – best possible priority over assets of Newco 2 + T + subsidiaries
o Senior debt – term loan to Newco 2
o Mezzanine debt to newco 2
o Loan notes / preference shares in Newco 1
o Equity in newco 1
• Value of assets over which security to be taken
© Liam Porritt 2020 15
Tax issues on buy-out
• Fund, as LP, is tax transparent
• Limited partners (investors) generally non-taxpaying by virtue of location / special
• Management => given attempts to incentivise, should also ensure tax efficiency
• Newco 1, 2 + T => CT liability
Interest relief on borrowings made by management
Conditions to be satisfied to set off interest on borrowing against income for income tax
1. Loan to individual applied in acquiring ordinary shares
2. At time of acquisition of shares, company in which shares bought (Newco 1) must be
a close company controlled (> 50% OSC)
a. By ≤ 5 participators (SHs); or
b. By any number of SHs all of whom must be directors of the company
NB when Newco 1 taken off shelf, Management invest nominal sums in proportion
to their intended equity before Fund holds any shares; managers then draw down
the necessary amounts and subscribe for the rest of their shares + Fund immediately
afterwards subscribes for its shares, at which point Newco 1 ceased to be a close
company => if it ceases to be a close company soon after the initial investment by
the managers, this does not affect the availability of interest relief
3. Throughout accounting period in which investment made + all periods in which
interest paid on the loan, company must exist for the purpose of:
a. Carrying on commercial trade; or
b. Holding shares in or securities of or making loans to subsidiaries that existing
wholly or mainly for the purpose of carrying on commercial trade (i.e. Newco
2 exists for commercial trade)
4. Throughout the period between loan being made and interest paid, individual either:
a. Owned shares in company + worked for the greater part of his time in the
actual management or conduct of the company (or an associated company);
b. Held a material interest (≥ 5%)
© Liam Porritt 2020 16
Income tax and NI liability in connection with shares acquired by management
• Management must pay full market value for Newco 1 shares – otherwise, as
acquiring by reason of employment, management subject to income tax on
difference between market value and amount paid + Newco 1 liable for employer’s
national insurance contributions
• To avoid liability, BVCA memorandum of understanding (MOU) => sets out safe
harbour which exists if a number of tests are satisfied (i.e. HMRC will accept market
value paid + no income tax charges will arise on acquisition or later, and all of gain
on exit will be subject to CGT, rather than any income tax)
Test where shares not subject to ratchet arrangements
1. Management’s shares must be OSC
2. Where leverage provided (preference shares / loan notes) by any other holder of
OSC, must be on commercial terms => fixed-rate dividend realistic, e.g. reflecting
interest rate on third=party loan
3. Price paid by management ≥ price paid by fund for ordinary shares
4. Management acquires shares at same time as Fund (all shares, except for managers’
nominal subscription shares for purpose of making Newco 1 a close company for
interest relief, are acquired at completion)
5. Management’s shares do not have features that given them rights not available to
other holders of OSC; and
6. Management must be fully remunerated for work they do by salary and bonuses
through a separate employment contract
Test where shares subject to ratchet arrangements
Conditions 1, 2, 4 and 6 above must be satisfied, in addition to 5,6 and 7 below.
1. Management’s shares must be OSC
2. Where leverage provided (preference shares / loan notes) by any other holder of
OSC, must be on commercial terms => fixed-rate dividend realistic, e.g. reflecting
interest rate on third=party loan
3. Management acquires shares at same time as Fund (all shares, except for managers’
nominal subscription shares for purpose of making Newco 1 a close company for
interest relief, are acquired at completion)
4. Management must be fully remunerated for work they do by salary and bonuses
through a separate employment contract
5. Ratchet arrangements must vary according to performance of the company and not
the individual SH (i.e. not quasi-bonus scheme for individuals);
6. Ratchet arrangements must exist at the time the Fund acquires its ordinary shares;
7. Management must pay a price for their shares that reflects the maximum economic
entitlement they could achieve under the ratchet (i.e. ratchet must be downwards
© Liam Porritt 2020 17
Loan relationship rules – Loan to Newco 2 from Bank
• Loan relationship rules – where corporate buyer (Newco 2) borrows to fund
acquisition, borrower may set off cost of borrowing (interest + commitment fees)
against income profits and chargeable gains of borrower and/or any other group
company where in a loan relationship
• Company in a loan relationship where either a creditor or debtor in a transaction for
lending money
Transfer pricing rules – convertible preference shares in Newco 1 + convertible loan notes
in Newco 2 held by Fund
• Loan notes are generally more tax efficient, as interest is tax deductible against the
profits of the Target group for CT purposes, where dividends are not => Newco 2 / T
may set off interest payable to Fund on loan notes against taxable profits
• However, under transfer pricing rules (thin cap rules), to the extent company issuing
loan notes (Newco 2) agrees to pay more interest to Fund than it would have paid on
arms’ length terms to an unconnected party (bank), Newco may not deduct ‘excess’
interest against taxable profits for CT purposes
• If fund has agreed to lend amount in circumstances where a bank would not be
willing to lend, all of interest payable by Newco on loan may be disallowed
• Therefore, where loan notes to be used, should obtain evidence that similar debt
finance was available from an unconnected third party at a similar rate of interest
(e.g. an offer letter from a bank)
© Liam Porritt 2020 18
Investment Agreement completion provisions
• Completion of subscription by Investor (fund) + Managers at offices of I’s Solicitors
• Events to occur on Completion Date in such order as Investor may require:
o Fund + Managers each pay Company (Newco 1) by transfer to Newco’s
solicitors bank account
o BM:
a) Adopt Articles
b) Issue, allot and enter into register of members Investor + managers
c) Execute and deliver share certificates
d) Appoint Investor Directors
e) Approve and authorise execution of Service Agreements
o Enter into Service Agreements
o Company Secretary instructed to file appropriate resolutions + forms
o Company, within 5 business days, to take out key man insurance for each of
Completion documents
1. Equity documents –
a. Investment agreement – Fund, Newco 1 & management team
b. Disclosure letter (to investment agreement) from management to fund
c. Articles of association of Newco 1 (& Newco 2, which will likely be simpler)
d. Service agreements – Management & Newco 1
2. Debt documents –
a. Inter-group loan – Newco 1 (Lender) + Newco 2 (Borrower)
b. Loan agreement – Bank + Newco 2
c. Security documents – security from Newco 2 + guarantee and debenture
from T
d. Loan note issued by Newco 1 to Fund
3. Acquisition documents –
a. Acquisition agreement – Seller + Newco 2
b. Disclosure letter from Seller to Newco 2
c. Ancillary documents where asset sale – see below
© Liam Porritt 2020 19
Newco 1 Completion steps
1. BR to approve entering into of documents –
a. IA
b. Disclosure Letter (although Newco 1 not party, this amends IA, so must be
available at meeting)
c. Intra-group loan
d. Service contracts
2. Written resolution to adopt the Articles (MBO provisions + authority to allot +
disapplication of pre-emption rights) => signed by management who are current SHs
3. Subscription for shares + register of members updated with immediate effect =>
a. By Fund (Ordinary + Preference)
b. Management => NB management already hold 1 share, so subscribe for
number of shares they need to hold minus 1
4. Completion
5. Written resolution to change name of Newco 1, signed by all SHs (management +
Fund, as after entry of fund into register of members)
6. Member of management authorised to act as Newco 1’s representative of Newco 2
at GMs for purposes of s 323 CA 2006 + signing written resolutions for purposes of s
296 CA 2006
© Liam Porritt 2020 20
Newco 2 Completion steps
1. BR to approve entering into of documents –
a. AA (business sale agreement / SPA)
b. Disclosure letter (not entered into by Newco 2, as from Seller to Newco 2)
c. Agreed Form documents for transfer of shares (+ assets) (Shares = stock
transfer form; Premises = TR1; IPR + software + Goodwill = Deed of
Assignment; Contracts + debtors = Deed of Assignment)
d. Intra-group loan agreement
e. Loan agreement with Bank
f. Debenture over assets of Newco 2
2. Written resolution(s) to change name, on asset sale generally to name of seller, (and
adopt new articles) => signed by member of management as representative of
Newco 1
Seller Completion steps
1. Asset sale – BR that letters of resignation of members of management moving to
Newco 1 accepted with immediate effect
2. BR to approve entering into of documents –
a. AA
b. DL
c. Agreed Form documents
3. Asset sale – Written resolution to change name of seller (required as the buyer will
generally wish Newco 2 to be renamed to the name of the seller)
Power of attorney
• Executed by member of management when cannot be present => important for
other signing parties to ensure that the power of attorney will bind the party on
behalf of whom documents are being executed
• Check:
o Capacity
o Scope – authorised to execute any documents which attorney thinks in his
absolute discretion desirable in relation to the acquisition of []
o Duration
o Identity of attorney
o Powers
© Liam Porritt 2020 21
• Stamp Duty – this needs to be paid by seller in respect of the shares transferred
within the 30-day deadline at a rate of 0.5% of the consideration (apportioned to the
• SDLT – complete Form SDLT 1 and pay SDLT for the properties being transferred
within 14 days.
Real property
• Submit TR1 to the Land Registry
• Notify any tenants of the change of Landlord.
Companies House filings & Company books
• Forms AP01 and AP03 notifying the appointment of directors and secretary for
Newcos 1 & 2 (if not already done) and two Form AP01s notifying the appointment
of the Investor Directors of Newco 1
• Form AD01 notifying the change of registered office (Newcos 1 and 2)
• Form AA01 notifying the change of accounting reference date (Newcos 1 and 2)
• Form SH01 Return of Allotment of Shares (Newco 1)
• Written Resolutions on change of name x 2 (Newco1 and Newco 2), Form NM01 and
• Written Resolution adopting new Articles plus a print of the new articles (Newco 1)
• Update Newco 1’s Register of Directors and register of directors’ residential
addresses to show details of the Investor Directors
• Update T’s Register of Members and Register of Transfers to show transfer of shares
from Seller to Newco 2
• Update Register of Charges of Newco 2 + T to show security given to bank
PSC Registers and filings
• Newco 1: Complete PSC Register and file Form PSC02 (Notice of relevant legal entity
with significant control) at Companies House in respect of Advance Capital’s
• Target: Update PSC Register and file Form PSC02 (Notice of relevant legal entity with
significant control) at Companies House
© Liam Porritt 2020 22
Customers & Suppliers
• Inform them of the new ownership of the business and also of the new registered
• Arrange for assignment of any contracts still outstanding
• Hold meetings with the employees to reassure them and to deal with any employee
related concerns or issues. The informing (and if necessary consulting) process must
have taken place before the transfer in order for it to comply with TUPE. It is
however a sensible suggestion to meet with employees or their representatives
post-completion to deal with any outstanding employee related issues
• Send out formal notices with details of new employer
• Register assignments of trademarks and any other registrable IP rights.
Data protection
• As there will be a transfer of data on the business sale, the parties will be under an
obligation to inform all data subjects (e.g. employees) that a new controller is now
holding personal data and in practice it is normally the buyer who will do this


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