A Practical Guide to Private Equity Transactions
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The acquisition agreement
The basic structure of a retention account is that a sum of money is placed
(usually by the buyer) into the blocked account held by the solicitors or escrow
agent as the case may be. The terms of appointment of the solicitors or escrow
agent in respect of such sum are then designed to ensure that the relevant sum
(and any interest earned on it, less charges) are paid over to the entitled party or
parties as appropriate. The terms of the agreement, and of the appointment of
the solicitors or escrow agent, are drafted in a way that ensures that the monies
must be released on the happening of the relevant events on the basis that has
been agreed, and cannot be released in any other circumstances without the
consent of both parties.
A retention account is often used to secure liability under the warranties or
tax covenant given on the acquisition for a period, or at least certain obligations
under them. There can sometimes be more than one retention in a deal; for
example one for a price adjustment mechanism such as completion accounts,
one for a specic liability such as a pension shortfall that the seller is covering
against the price, one for general warranty claims, and so on. The issue can
then arise of whether monies not used to meet one type of claim can be used to
meet another. For example, if there is a retention for the completion accounts
that is not actually needed (or not fully needed) to satisfy a shortfall in the
tested gures, what should happen if, by the time the completion accounts are
agreed, a claim is made under the general warranties? These areas can lead to
tricky negotiations, or can become complicated if multiple seller(s) are only
subject to some, but not all, of the relevant liabilities.
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2.5 Conditionality
The acquisition agreement will specify any pre-conditions applicable to the
purchase of Target. Inclusion of such a condition will usually result in a delay
between exchange of the acquisition agreement and its completion. Typical
conditions encountered in practice include:
(a) competition clearances;
(b) shareholder approval;
(c) tax clearances; and
(d) other regulatory consents.
(a) Competition clearances
Generally speaking, the granting of approval from a competition authority
allowing a transaction to proceed is less likely to be a condition in private-
equity-backed acquisitions than in an acquisition by a trade buyer. A trade
buyer is more likely than a private-equity-backed buyer to be increasing its
7 For example, a private equity investor as seller may agree to contribute to a completion
accounts price adjustment mechanism, but would not expect to have any liabilities under the
general warranties; see further chapter 13.
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Acquisition issues
market presence, reducing customer choice, or otherwise having an adverse
impact on the competitiveness of a market by virtue of the merger of two com-
peting businesses.
Special issues can, however, arise in certain overseas jurisdictions depend-
ing upon the nature and extent of the trade and market presence of Target. A
more detailed review of the competition issues that can arise on an acquisition
by a private-equity-backed buyer is set out in section 4 of this chapter.
A competition review must be conducted at an early stage; not least as,
in some jurisdictions, approval may need to be obtained before a contract is
even exchanged. In cases where a contract may be exchanged conditionally on
clearance being granted, the delays and complexities caused will still be of sig-
nicant concern to both parties, and for that reason seller(s) will often require
competing buyers to conrm the likelihood of such a clearance application
being necessary at an early stage in the process.
The outcome of that review may well lead to the need for one or more com-
petition conditions in the agreement. There is often a commercial sensitivity
which prevents a clearance application being made before agreement has been
reached in writing between the parties that the acquisition should proceed, and
sellers in particular are usually keen to see as much commitment as possible
from the buyer(s) by way of a conditional agreement as quickly as possible,
whilst the clearance application may take weeks or even months before it is
concluded.
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(b) Shareholder approval
In certain transactions, it will be necessary for the shareholders of the seller, or
a parent company of the seller, to approve the sale.
This typically arises where the sale is of a subsidiary company or business
in a group where the ultimate parent company is traded on a stock exchange.
Where the seller is listed on the Ofcial List, the following provisions of the
Listing Rules of the Financial Services Authority may be relevant.
(a) Related party transactions. Chapter 11 of the Listing Rules requires that
any related party transaction (disregarding a very small de minimis) be
subject to shareholder approval. This would require the relevant listed
company to issue a circular to shareholders, and to convene a general
meeting at which the necessary ordinary resolution will be proposed to
approve the transaction. Under the relevant rules, the related party and
its associates are not allowed to vote on the resolution. On the acquisition
by a private-equity-backed Newco, the related party transaction require-
ments will be triggered if Newco is an associate of a director of the seller
(or of any of its subsidiaries), or of any person who holds at least a 10
per cent equity stake in the seller (or of any person who satised any of
8 For more details, see section 4 below.
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The acquisition agreement
those conditions at any time in the preceding twelve months). In order
for Newco to be such an associate, it is necessary that the directors and
their associates together have at least 30 per cent of the voting rights in
Newco. In a larger buyout, this would be unusual, but it is not impossible
in a smaller transaction and, accordingly, whenever the seller group is
listed, this must be considered.
(b) Class 1 transactions. Even if there is no related party in the transaction
or if the stake of the related parties in Newco is not sufcient to make it
an associate, it is possible that a shareholder vote may be required if the
transaction is sufciently large to satisfy the criteria for a Class 1 trans-
action.
9
If the deal does constitute a Class 1 transaction, then the relevant
public limited company is required to issue a circular to its shareholders
and to convene a general meeting at which the necessary ordinary reso-
lution will be proposed to approve the transaction. Assuming that it is
not also a related party transaction, there is no reason why any existing
interested related parties and their associates cannot vote on the Class 1
resolution.
If the seller is listed on AIM, the similar related party rule only requires noti-
cation and not shareholder approval. However, if the Target constitutes more
than 75 per cent of the listed company (applying the various class tests speci-
ed for AIM), this constitutes a fundamental change of business and the same
requirement for a shareholder approval arises. In that event, the related parties
and their associates are not prohibited from voting.
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Even if the seller (or ultimate parent company) is not listed on the Ofcial
List or traded on AIM, or if it is only a private company, the fact that the
managers will be shareholders in the buyer can, in certain cases, trigger the
requirement for shareholder approval of the transaction under section 190 of
the Companies Act 2006. For this section to be relevant, it is necessary that
the buyer is a connected person of a director of the seller (or of a director of
the seller’s holding company). Under section 252 of the Companies Act 2006,
this will arise where the director (and certain related parties) has a stake of at
least 20 per cent of the voting equity in the buyer. In larger transactions where
the private equity investors have a majority equity stake in the buyer, it is less
likely that any one director will have such a signicant minority stake, but
this point should be checked. If section 190 does apply, the transaction must
be approved by an ordinary resolution of the members of the seller (or, as the
context may require, of its ultimate holding company). There is no prohibition
under the Companies Act 2006 on the director or other related party voting on
the resolution.
9 For more details of these tests, see chapter 10 of the Listing Rules and the Annex to that
chapter.
10 See Rule 15 of, and Schedule Three to, the AIM Rules.
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Acquisition issues
It is possible in this context to make the transaction conditional upon such
approvals being obtained (so that the sale agreement can at least be signed);
however, the necessary shareholder consent must be obtained before comple-
tion occurs. The risk that completion may not occur due to approval not being
granted can be mitigated to some degree before signing by seeking irrevocable
commitments from signicant shareholders of the seller (or the seller’s holding
company, as applic able) to vote in favour of the proposal. Where the shares are
publicly traded, there can be issues of condentiality in seeking such irrevo-
cables, and the specic market conduct rules which regulate this practice will
need to be complied with.
(c) Tax clearances
In certain transactions, one or more sellers may seek a tax clearance from
HMRC to ensure that the desired tax treatment will arise on disposal. Usually,
these clearances will be sought in good time to ensure they are in place before
the contract is signed; however, where that is not possible, the sellers may seek
to make the disposal conditional upon the clearances being granted.
Generally, HMRC will be able to provide tax clearances in a relatively
short period; however, they do have up to thirty days to provide necessary
clearances, and the timescale to secure a clearance may be longer if further
queries are raised in response to the application. In some circumstances, there-
fore, the sellers may be left without formal clearance at a time when signing
could otherwise occur. In that situation the question of whether a deal should
proceed on a conditional basis, be delayed until clearance has been obtained,
or be completed immediately (leaving the seller(s) exposed to a risk that the
relevant tax treatment will not be obtained) will be determined on a case-by-
case basis, depending on the extent of the risk, bargaining power of the parties
and overall deal momentum.
(d) Other regulatory approvals
There may be sector-specic regulatory approvals required for the transaction
to proceed. In certain situations, the buyer or its directors require regulatory
approvals to own the Target or to carry on the business, or the change of con-
trol arising from completion of the transaction means that existing approvals
held by Target are revoked or at risk of review. In many cases, the continuity
of management that ows from a management buyout may well mean that
these regulatory consents are already in place, or that the regulator will be
more readily persuaded to re-grant them. A legal adviser should ensure that the
extent of any regulatory approvals are veried as part of legal due diligence,
and identify any approvals which require either the consent of a regulator, or
notication of the transaction, as the case may be. A typical example would be
a change of controller for the purposes of the Financial Services and Markets
Act 2000 (and related rules) if the business being acquired is, for example, an
insurance company.
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The acquisition agreement
Ideally, the parties will seek to resolve all such regulatory matters before
signature, so that there does not need to be a condition in this respect, even
where consent and not merely notication is required. However, whether this
is practicable will depend on the regulatory body concerned; in many cases,
the authority may not be familiar with the nuances of corporate transactions,
which can lead to a delay in approval being given, and the parties may be nerv-
ous about disclosing any details concerning the proposed transaction before
signing to maintain condentiality.
2.6 Consequences of conditionality
Whenever there is a condition precedent to completion of the transaction, the
following points (of general application) must be borne in mind when drafting
the relevant provisions.
What are the precise terms of the condition? It is important that the con-•
dition is drafted so as to be sufciently clear and certain as to whether,
and when, it is met.
Whether any party is under any obligation to procure or assist in sat-•
isfying the condition. Often, there is a requirement on both parties to
use their respective reasonable endeavours to ensure its satisfaction,
although the onus may be placed on one of the parties more extensively,
depending on the nature of the condition and the party likely to be most
instrumental in ensuring its satisfaction.
Whether either party is entitled to waive the condition, although, by de-•
nition, the implications are usually sufciently serious for neither party
to be able to do so unilaterally.
A longstop date for satisfaction of the condition, which may be driven •
by the timescale prescribed for the relevant external approval process
(where applicable), and the length of time for which the buyer’s funding
remains available.
Consequences if the condition is not met (for example, does either •
party have any form of cost exposure to the other). This will very
much depend on the bargaining power of the parties, and the circum-
stances in which the need for a conditional contract has arisen. A
condition which is inserted for the benet of the seller or required by
the seller (for example, shareholder approval) may well lead to a cost
underwrite in favour of the buyer, or at least a partial abortive pay-
ment if the transaction does not proceed due to lack of shareholder
approval. If the approval is related more to factors associated with
the buyer, there may be a suggestion that the buyer should pay abor-
tive costs, although, in general, a private-equity-backed buyer will
be reluctant to do this, not least because the transactional funding to
meet such a cost underwrite will not be available if the transaction has
not proceeded.
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The fact that the deal is conditional, and that there may well be a delay
before the conditions are satised, also results in other practical issues for
the process.
(a) Conduct of Target during the delay
The Target remains in the ownership of the seller(s) following exchange of the
acquisition agreement. If the condition is never actually met or waived, it will
remain with the seller(s), whereas the buyer will take over the Target if the con-
ditions are met or waived. Both parties therefore have a legitimate interest in
how Target is run and in maintaining it as a going concern. This issue is even
more acute if the circumstances of the delay also makes the transaction public
(for example, the need for a circular and shareholder approval). This aspect is
normally regulated by agreeing a set of rules for the conduct of the business,
including certain matters requiring the consent of the buyer during this interim
period. Where the management team is in day-to-day operational control of
the Target (as is often the case in a buyout), this also gives some practical
comfort to the buyer and its funders, although the specic rules would still be
prescribed in any event. The scope of such rules is a matter for detailed nego-
tiation, but in general terms they will seek to ensure that the business is carried
on in the ordinary course following exchange, and that no signicant actions
are taken that could have an adverse impact on the value of Target’s business
or the sale shares without the consent of the buyer. The restrictions will include
both constitutional matters, such as making alterations to the share capital,
and operational issues, such as entering into material contracts or signicant
capital expenditure commitments.
(b) Risk in the business during the delay
Even if the sellers comply with the rules for the running of the business, there
is a risk that something may change adversely in the business or the wider sec-
tor. It may be that there is an adverse reaction from key customers, suppliers or
employees to the news of the imminent sale. A major issue from the past may
come to light or material litigation may be threatened. Something may occur
or become known which suggests the possibility of a claim under the warran-
ties given on exchange. A key employee may leave the business, or become ill
in a way that prevents him from carrying on working. There may well be some
incident that causes major disruption to the business of the Target, or to that of
a key customer or supplier. All these matters may well have resulted in a mate-
rial change in the terms of the deal if they had become known before exchange,
or may even have resulted in the sale not being exchanged at all.
A seller would normally wish to hold the buyer to the terms already agreed,
and to put the parties into the same position as if the deal had actually com-
pleted when signed. For example, a seller might argue that any such events
should be at the buyer’s risk assuming the agreed conditions, and those condi-
tions only, are satised. If such an event is so serious as to give rise to a claim
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The acquisition agreement
under the warranties or other price adjustment mechanism in the agreement,
then the buyer should still be expected to complete the transaction, and then to
pursue any warranty claim or price reduction afterwards.
A buyer (and, most signicantly in a private equity deal, its funders) may
well take a different view, especially in a market that favours a buyer. Such
funders will usually insist that:
(a) the seller(s) should repeat the warranties set out in the acquisition agree-
ment as at completion; such repetition of warranties may result in the
seller(s) being required to prepare and deliver a supplemental disclosure
letter on completion, setting out details of any matters that have arisen
between exchange and completion which have resulted in a breach of
warranty;
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(b) a contractual right for the buyer to rescind the acquisition agreement if
any breach of warranty arises during the period between exchange and
completion (perhaps with a materiality threshold);
(c) similarly, a right to rescind in the event that there is any other material
breach of the acquisition agreement by the seller(s), for example as a
result of a breach by the seller(s) of the obligations for the conduct of the
business between exchange and completion as referred to in (a) above;
and/or
(d) possibly, a right to rescind in the event that there is any other material
adverse change (often abbreviated to MAC) which has an adverse impact
on Target and its business between exchange and completion.
This debate can result in real tension between the parties. Where there is insuf-
cient protection for the buyer in the event of an adverse change in the busi-
ness, this will cause particular concern to the funders of the buyer, particularly
the senior lender(s). Whilst in a seller-friendly market there may be sufcient
bargaining power to resist any right to walk away from the transaction, there
will generally be strong pressure from the bank funders in particular, who
would often seek indirectly to enforce any agreed MAC provisions by having
a right to withdraw its debt commitment in those circumstances. Accordingly,
the precise negotiation of any right to rescind or walk away, the circumstances
in which that right can be exercised, and the contractual consequences if it is
exercised or not exercised, can be the most difcult aspects of a conditional
private equity deal.
12
11 On warranties in the acquisition agreement, see further sections 2.7 to 2.9 below. On disclo-
sure, see section 3 below.
12 The interaction of the banking documents, equity documents and acquisition agreement when
including any MAC clause or other walk away rights must also be considered carefully: see
further chapter 5, section 3.2.
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2.7 Warranties, indemnities and risk allocation
As highlighted in sections 2.2 and 2.3 above, where a specic and quantiable
risk is identied as part of the acquisition process (typically, as part of due dili-
gence), it is likely to lead to an adjustment to the price, or some form of mech-
anism to determine which party will bear the risk or the basis upon which the
risk is to be shared. It is a known problem; the only question is whether and
how it affects the deal (or whether the deal can be agreed at all, if the issue is
sufciently serious).
However, it is inherent in many businesses that problems caused in the past
will only become known or relevant in the future. Often, issues cannot be iden-
tied fully (or even at all) during due diligence. For example, there may well be
claims not yet notied to or anticipated by the seller(s) as a result of contracts
already entered into by Target, or liabilities to employees for occupational ill-
nesses of which people are not yet aware.
The allocation of the risk arising as a result of these unknowns (and, indi-
rectly therefore, the means for adjusting the price after the event to reect the
effect of such unknowns on the value of the sale shares) is effected by the
warranties set out in the acquisition agreement. It is important to bear in mind
that, in the absence of formal contractual warranties, there are no implied
terms to protect a buyer of shares. In particular, in the absence of fraud or
negligent misstatement, the buyer will have no claim against the sellers if the
business is not as the buyer expected and there is no appropriate warranty or
other protection in the acquisition agreement. An acquisition agreement will
almost invariably include an express provision that no warranty is given save
as is set out in the agreement.
For this reason, the buyer of a private company will seek to negotiate exten-
sive warranties from the sellers. The warranties in the acquisitions agreement
are commonly referred to as fullling two functions:
(a) to allocate risk; and
(b) to elicit disclosure.
The warranties are given subject to matters disclosed to the buyer pursuant to
a disclosure letter provided by the seller(s). The process of disclosure is con-
sidered further in section 3 of this chapter, and requires the warranting seller(s)
to disclose details of any matter of which they are aware which would breach
the warranties given. For a seller to give a warranty which he knows to be
breached at the time the warranty is given may constitute a criminal offence.
Further, the acquisition agreement will provide that no seller will be liable
under the warranties to the extent a matter is disclosed, motivating any seller
to enter into a comprehensive disclosure exercise. To this extent, therefore,
the warranty schedule will elicit information about the Target and identify
potential difculties and actual problems. This will support the buyer’s own
due diligence in identifying any areas which require the acquisition price to be
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The acquisition agreement
revisited, or which may need a specic indemnity or some other contractual
risk-allocation mechanism to be agreed.
Accordingly, the warranties are not the principal mechanism for allocating
the known risks. They are, however, very important in allocating the unknown
risks – or at least the risks which have not been disclosed. The warranties
serve a useful function to enable a buyer to bring a claim against the seller(s)
for any matters to which the warranties relate, if such warranties subsequently
prove to have been ina ccur ate and diminish the value of the ac quired shares.
This risk allocation function is the principal purpose of the warranties once
the agreement has actually been signed. For this reason, the precise form of
the warranties and, in particular, whether they are given in absolute form or to
the knowledge of the seller (or subject to some other qualication) forms a key
part of the negotiation of the acquisition agreement, as does the extent of any
limitations on the buyer’s ability to claim under those warranties.
The precise areas covered by warranties will vary deal by deal, but they
typically include (in the buyer’s rst draft at least):
the title of the seller(s) to the sale shares and capacity to contract;•
the legal status of the company;•
the proper preparation of accounting records and the statutory accounts •
of the Target;
Target’s title to its assets (including property) and their state and •
condition;
Target’s contracts, including both material and long-term arrangements, •
and standard terms of trading;
Target’s employees;•
Target’s tax affairs;•
Target’s compliance with laws, and any relevant regulatory require-•
ments, whether of general application to all businesses (e.g. environmen-
tal, health and safety) or sector specic (e.g. requirements of industry
regulators such as the Financial Services Authority);
Target’s pension schemes and any related exposures;•
Target’s litigation and litigation risk;•
Target’s intellectual property rights and IT systems;•
Target’s solvency; and•
interests of the seller(s) in Target and its affairs, any dealings between •
them and any ongoing reliance by Target on any seller, or vice versa.
2.8 Warranties and knowledge/awareness
One very signicant area of negotiation in relation to warranties (and the limi-
tations which apply to any warranty claims) is that of the knowledge or aware-
ness of the parties. This will be the case on any arm’s length UK off-market
transaction, but there is a particular focus on these aspects in a management
buyout.
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Acquisition issues
(a) Awareness of the seller
Many sellers will seek to limit the warranties (or at least certain of them) so
that they are only given ‘so far as the seller is aware’, or are otherwise quali-
ed by reference to the knowledge, awareness or belief of the seller. Particular
warranties are often referred to in negotiations as being acceptable if given
‘to knowledge’, or using similar shorthand. Clearly, this can be an important
protection for a seller, particularly in respect of matters outside the knowledge
of the day-to-day internal management of the company. For example, a seller
may be unaware that a regulatory body is considering an investigation into
the affairs of Target, or that a customer or supplier is contemplating a claim
against it.
Where the warranties are qualied by reference to seller awareness, this
creates an additional hurdle for the buyer in bringing a successful claim.
The buyer must rst prove that the substantive issue has arisen resulting in
a loss (for example, that there is a potential investigation into the affairs of
the Target, which has diminished the value of the sale shares), and must then
prove that the seller was aware of this at the relevant time. In the absence of a
clear ‘smoking gun’, it can be difcult, therefore, for the buyer to show that the
seller ha d actual knowledge of circumstances giving rise to the breach of the
awareness-based warranty.
Where the seller is a company or other body corporate, it is usual to spec-
ify that the knowledge of the seller for this purpose means the knowledge of
certain named individuals (and it follows that, in a buyout context, this may
include any or all of the managers: see further below). Buyers may seek to
extend seller awareness to include matters of which any employee is aware, or
other agents of Target (particularly advisers) are aware, or even of which such
persons ought to have been aware. Clearly, a seller is likely to try to limit this
list such that it is as short as possible, and to resist any language which implies
knowledge on the part of any such person in any event.
It is also important, in this context, to differentiate between imputing to
the seller the knowledge of any such party, and requiring the seller to make
enquiry of the third party. For example, if the knowledge of particular employ-
ees is imputed to the seller, then it is sufcient to prove that one of the employ-
ees knew of the matter, even if the seller did not know (or c annot be proved
to have known). In contrast, if warranties are stated to be given by a seller
based on that seller’s knowledge ‘after making due and careful enquiry of the
employees’ or similar, then the risk that an employee did not mention some-
thing (perhaps because he forgot the matter, did not realise its relevance, or
had his own reasons for not mentioning it) is effectively borne by the buyer
and not by the seller. Sellers are inevitably reluctant to see knowledge extended
beyond the actual knowledge of the sellers themselves (or, in the case of a
corporate seller, of designated individuals), and will certainly seek to resist
imputed knowledge, whereas buyers will normally seek to extend the concept