A Practical Guide to Private Equity Transactions

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that shareholders’ interests may have been affected by a conict of interest

could prejudice the success of a public-to-private offer and have adverse repu-

tational consequences for all concerned.

This issue gives rise to several specic considerations which are explained

in more detail in the following sections. Advisers must also remain aware

when advising any director of the provisions in the P2P Target’s articles, and

the Companies Act 2006,

on directors’ interests, as well as the requirements

of the Takeover Code.

2.3 Board approval to pursue offer

Any directors of P2P Target who are contemplating becoming involved in

an offer for the company should take independent legal advice at the outset,

before notifying the chairman of the board of such proposed involvement. In

particular, there are strict obligations on a director not to be in a situation

where he has any interests which may possibly lead to a conict with his duty

to P2P Target unless he rst obtains authorisation at a meeting of the board of

P2P Target. Generally, the board acting by its unconicted directors can give

this authorisation (rather than needing to refer the matter to shareholders for a

decision), although the articles of association of P2P Target should be checked

on this point. The board may, of course, impose conditions on any such author-

isation, and in any event is likely to keep the position under review.

A director will not be able to pursue the possibility of an offer for P2P

Target without the full approval of the board of P2P Target given by the other,

unconicted directors. Without this approval, he would inevitably breach his

duties to P2P Target at some stage. For example, his involvement is likely to

involve a signicant time commitment during business hours, which is incon-

sistent with his obligations under his service contract. Participation would

also inevitably involve the disclosure by him to potential funders of conden-

tial, unpublished information about P2P Target, which would also need P2P

Target’s authority.

If the independent directors do decide that it is in the best interests of P2P

Target and its shareholders to allow the relevant directors to explore the pos-

sibility of a buyout, that consent should be formally minuted and recorded,

ideally in a letter between P2P Target and the relevant directors. The letter

should set out the terms of the consent and the ground rules to be followed

by the directors and their advisers to ensure that the conict of interest and

Takeover Code issues described below are properly handled.

A director of P2P Target who is involved in the offer need not, with these

safeguards, resign his directorship. However, he will continue to be bound by

his duciary duty to act in the best interests of P2P Target; an approval to pur-

sue the opportunity does not override that fundamental duty.

2 See further chapter 11, section 6.

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2.4 Appointment of independent committee of directors

As soon as it becomes apparent that any of the P2P Target directors may be

involved in a proposed offer, P2P Target should form an independent commit-

tee of directors. This will be important to those directors forming part of the

offer, as it helps demonstrate that P2P Target shareholders’ interests have not

been affected by the conict of interest. The function of the committee will be

to consider the proposals to be made by the private equity investors and Bidco,

and to advise P2P Target’s shareholders on whether or not to accept any offer

from Bidco. The non-independent directors should not participate in the deci-

sion of their board colleagues to set up an independent committee (and will typ-

ically be precluded from doing so under P2P Target’s articles of association).

The independent committee should be comprised of P2P Tar get directors

who are independent of, and unconnected with, the private equity investors

and Bidco. This means that any director who could have an ongoing role after

the buyout may be regarded as not independent. Note 4 to rule 25.1 of the

Takeover Code provides that, for this purpose:

a director will normally be regarded as having a conict of interest where

it is intended that he should have any continuing role (whether in an

executive or non-executive capacity) in either Bidco or the offeree com-

pany in the event of the offer being successful.

Typically, the independent committee would consist of non-executive direct-

ors satisfying the independence criteria, as they are likely to be least affected

by an offer being successful or otherwise. The identication of those directors

who are independent, and those who are not, will need care. The choice of the

independent committee will also need to recognise that the position of indi-

vidual directors, and particularly the nature of their proposed involvement in a

buyout, may change as the transaction progresses.

It is possible that there might be no independent directors. In such cases,

P2P Target’s nancial advisers would often take the role of the independent

committee and advise P2P Target’s shareholders on the merits of the offer.

The directors who are involved in the proposed offer should not be entitled

to attend meetings of the independent committee or any part of board meet-

ings at which the proposed offer is discussed. They should not have access

to documents generated by or for the benet of the independent committee

or otherwise relating to the company’s consideration of the proposed offer.

Consideration should be given to the scope of the matters to which access

should be restricted, balancing the need for a director to continue to receive

certain information to allow him to perform his functions as a director against

the interests of P2P Target in restricting his access to information which it

would not be appropriate for such a director to receive.

Initially, the independent committee will need to consider whether or

not it is in the interests of P2P Target’s shareholders for it to co-operate with

the formulation of an offer by a bidder vehicle in which some or all of P2P

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Target’s directors are involved. It will also ultimately fall to the independent

committee formally to recommend the offer to its shareholders, or to decide

not to do so. In practice, the public-to-private transaction is unlikely to proceed

unless it is recommended to the P2P Target’s shareholders by the independent

committee.

2.5 Appointing independent advisers

Rule 3.1 of the Takeover Code provides:

The board of the offeree company must obtain competent independ-

ent advice on any offer and the substance of such advice must be made

known to its shareholders.

Note 1 to that rule goes on to provide:

The requirement for competent independent advice is of particular import-

ance in cases where the offer is a management buyout or similar transac-

tion … In such cases, it is particularly important that the independence of

the adviser is beyond question. Furthermore the responsibility borne by

the adviser is considerable and, for this reason, the board of the offeree

company should appoint an independent adviser as soon as possible after

it becomes aware of the possibility that an offer may be made.

The board of P2P Target will often appoint the company’s existing broker (or

nominated adviser, if admitted to trading on AIM) as its rule 3 adviser. It is

usual for Bidco to appoint its own independent nancial adviser for the pur-

poses of the transaction. Bidco’s adviser will negotiate the commercial terms

of the bid, ensure compliance by Bidco and its shareholders with the Takeover

Code, make the necessary cash conrmation required by the Code, effect any

purchases of P2P Target shares in the market before or during the course of the

bid, and advise generally on bid tactics.

2.6 Due diligence

As the acquisition of P2P Target will be made by public offer, rather than

by private sale, Bidco will not obtain the benet of any warranties from the

shareholders of P2P Target about the company and its business. In the absence

of such warranty protection, any equity or debt provider to Bidco is likely to

require extensive due diligence on P2P Target.

There is no general restriction on the dissemination of publicly available

information about P2P Target. However, as outlined above, disclosure by any

director of information, except in accordance with the terms of the consent

from the independent committee, could constitute a breach both of his con-

tractual obligations to P2P Target and of his duciary duties as a director. The

receipt of such information by funders could also expose them to liability to

P2P Target, particularly if they are aware that the disclosure is unauthorised.

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The independent directors will be particularly concerned to control the

release of information concerning P2P Target to potential bidders, as those

directors have specic obligations under the Takeover Code in this area. Rule

20.2 of the Takeover Code provides:

Any information … given to one offeror or potential offeror, whether

named or unnamed, must, on request, be given equally and promptly to

another offeror or bona de potential offeror even if that other offeror is

less welcome. This requirement will usually only apply when there has

been a public announcement of the existence of the offeror or potential

offeror to which information has been given or, if there has been no pub-

lic announcement, when the offeror or bona de potential offeror request-

ing information … has been informed authoritatively of the existence of

another potential offeror.

P2P Target directors who are involved in an offer will already have a great deal

of detailed information about P2P Target, which may have been amassed over

many years. It would not be practicable to make all such information avail-

able to other offerors. This situation is dealt with in note 3 to rule 20.2 which

provides:

If the offer or potential offer is a management buyout or similar transac-

tion, the information which this rule requires to be given to competing

offerors or potential offerors is that information generated by the offeree

company (including the management of the offeree company acting in

their capacity as such) which is passed to external providers or potential

providers of nance (whether equity or debt) to the offeror or potential

offeror. The Panel expects the directors who are involved in making the

offer to co-operate with the independent directors of the offeree company

and its advisers in the assembly of this information.

In order to ensure compliance with this requirement an independent commit-

tee would usually seek undertakings, both from Bidco’s independent advisers

and from potential equity and debt providers to Bidco, that information will

only be disclosed to them with the consent of the independent committee, or at

least only if it is provided to them at the same time. This requirement obviously

gives rise to practical difculties when it comes to monitoring compliance, and

when dealing with meetings and other situations where oral information is

passed to funders.

Note 3 to rule 20.2 covers information generated by P2P Target directors

only where it is generated by them in their capacity as directors of P2P Target.

Such directors would not be required to make available to another offeror any

information generated specically for the purpose of the bid. For example,

another bidder would not be entitled to see the Business Plan. There may be

circumstances where the distinction between information generated for the

purpose of the company and that generated for the purpose of the offer may be

less clear. This is sometimes an area of debate.

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These rules are designed to ensure that all potential bidders are treated

equally. They might require that information which has been disclosed to an

outside nancier is also provided to a less welcome bidder, such as a trade

competitor. As a result, the rules need to be considered with care by both the

bidding directors and the independent directors.

2.7 Copy of information to the independent committee

Rule 20.3 of the Takeover Code deals with a related issue – the rights of the

independent directors to be supplied with all information provided by the buy-

out team to their funders. This requirement reects the concern that a man-

agement buyout team might be in possession of information about P2P Target

which gives them an unfair advantage over the independent directors. The rule

provides:

If the offer or potential offer is a management buyout or similar transac-

tion, the offeror or potential offeror must, on request, promptly furnish

the independent directors of the offeree company or its advisers with all

information which has been furnished by the offeror or potential offeror

to external providers or potential providers of nance (either equity or

debt) for the buyout.

It should be noted that, unlike rule 20.2, the provision of information under

rule 20.3 is not restricted to information generated by P2P Target or by the

management of P2P Target acting in that capacity. The independent committee

can request all information provided to funders of Bidco, including any infor-

mation generated by management solely for the purpose of the proposed offer.

Unlike information generated by P2P Target, information supplied back to the

independent directors under rule 20.3 which has been generated by the buyout

team in that capacity does not need to be supplied to competing bidders under

rule 20.2.

2.8 Management equity participation and terms

The directors of P2P Target who are involved in the offer would normally

expect to subscribe for shares in Bidco (or the ultimate holding company of

Bidco), as in any other buyout. If they hold shares in P2P Target, the sub-

scription price for their shares in Bidco will usually be satised, in whole or

in part, by the transfer to the Bidco of their shares in P2P Target. Bidco will

not generally be in a position to offer the other shareholders of P2P Target the

opportunity to subscribe for shares in Bidco as consideration for the transfer of

their shares on acceptance of the offer.

Rule 16 of the Takeover Code provides that:

Except with the consent of the Panel, an offeror or persons acting in

concert with it may not make any arrangements with shareholders and

may not deal or enter into arrangements to deal in shares of the offeree

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company, or enter into arrangements which involve acceptance of an

offer, either during an offer or when one is reasonably in contemplation,

if there are favourable conditions attached which are not being extended

to all shareholders.

Therefore, an arrangement to acquire shares held by the management buyout

team in consideration for the allotment of shares in Bidco is one falling within

rule 16, and requiring the consent of the Takeover Panel.

This situation is anticipated by note 4 to rule 16 which provides, by refer-

ence to note 2 to that rule:

Sometimes, an offeror may wish to arrange for the management of the

offeree company to remain nancially involved in the business. The

methods by which this may be achieved vary but the principle which the

Panel is concerned to safeguard is that the risks as well as the rewards

associated with an equity shareholding should apply to the management’s

retained interest. For example, the Panel would not normally nd accept-

able an option arrangement which guaranteed the original offer price as

a minimum.

There are two further requirements imposed by the Takeover Code in relation

to such arrangements:

(a) rst, the Panel will require a public statement from P2P Target’s inde-

pendent nancial adviser that, in their opinion, the arrangements with the

management of P2P Target are fair and reasonable; and

(b) secondly, the Panel will also require that the management arrangements

are approved at a general meeting by the P2P Target shareholders (where

the bidder and relevant management would be disenfranchised and the

vote would be taken on a poll).

The parties will need to consider carefully the structure of Bidco to ensure

that management comply with the Takeover Panel requirement that they par-

ticipate in the risks as well as the rewards associated with an equity sharehold-

ing. Provisions requiring management’s shares in Bidco to be offered round

for sale at specied prices in given circumstances (most obviously, Good/Bad

Leaver provisions

) need particular care. Compulsory transfer provisions pro-

viding for the transfer of management’s shares if they cease to be employed

by Bidco cannot provide that such a transfer will be at a guaranteed minimum

price, for example.

In giving its consent to any favourable conditions, the independent com-

mittee will be concerned to ensure that the directors receiving shares in Bidco

are not receiving a greater value of consideration than that being offered to

other shareholders under the terms of the offer. In recent transactions, a state-

ment has appeared in the offer document to the effect that the price paid by

3 See chapter 5, section 4.16.

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management for its shares in Bidco was the same as that paid by the private

equity providers, on the basis that the value of management’s shares in P2P

Target is the bid price under the offer.

Under rule 24.5 of the Takeover Code, full details must be set out in the

offer document of any special arrangements between Bidco, or any person act-

ing in concert with it, and any of the directors, recent directors, shareholders

or recent shareholders of P2P Target connected with the offer. This disclos-

ure requirement would cover any favourable conditions falling within rule 16.

It would also cover any proposed service agreements to be entered into, and

any termination arrangements agreed with any of the directors of P2P Target,

whether or not the relevant directors are involved in the offer.

Any payment for termination of the appointment of any P2P Target dir-

ectors would also need to be approved by P2P Target’s shareholders under the

terms of section 219 of the Companies Act 2006 if it exceeds the amount prop-

erly payable for breach of contract.

3 Overview of other key issues and provisions relating to public takeovers

3.1 Financial support and exclusivity (inducement and break fees)

It is unlikely that a management team would be able, and/or that the debt and

equity providers to Bidco would be willing, to underwrite the costs of profes-

sional advisers in preparing a public-to-private offer should the offer not be

successful. For that reason, it is not uncommon to agree with the independ-

ent directors a basis upon which some fee compensation (characterised as an

inducement or break fee) would be payable by P2P Target in certain circum-

stances where management’s offer is not successful. This is a complex area,

given the duties of the independent directors and legal restrictions on public

companies providing nancial assistance for the purchase of their own shares.

The Takeover Code permits this kind of fee arrangement in limited circum-

stances (set out in rule 21.2), principally that:

(a) the inducement fee must be de minimis (no more than 1 per cent of the

offer value);

(b) both the board of P2P Target and its nancial adviser must conrm the

following in writing to the Takeover Panel:

(i) that the inducement fee was agreed as a result of arm’s length commer-

cial negotiations;

4 For tax reasons, this would usually be the case on any buyout. See further chapter 9, section

4.4.

5 Note that, under section 678 of the Companies Act 2006, the giving of nancial assistance

remains unlawful for public companies. However, in this context, market practice is to rely

on the argument that an inducement fee of no more than 1 per cent of the offer value does

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(ii) the circumstances in which the inducement fee will become payable

and the basis on which such circumstances were considered to be

appropriate;

(iii) any relevant information concerning possible competing offers;

(iv) that there are no side agreements or understandings that have not

been fully disclosed; and

(v) that they believe the fee to be in the best interests of P2P Target’s

shareholders;

ment of a rm intention to make a bid and in the offer documents; and

(d) the Takeover Panel should be consulted at the earliest opportunity where

an inducement fee or similar arrangement is being proposed.

The independent committee will be under a duty to negotiate the lowest fee

possible.

The size of fee, and the circumstances in which it becomes payable, will

often be a contentious area. A break fee arrangement will often include an

agreement by P2P Target not to solicit competing offers from other bidders

for a certain period of time. This kind of exclusivity agreement will not pre-

vent other bidders tabling offers or gaining access to P2P Target’s information

under rule 20.2, but will give the bidder some comfort as it incurs costs in

preparing its offer.

3.2 Insider dealing

The existence of the prospective transaction will almost certainly constitute

price-sensitive information. Great care therefore needs to be taken in making

others ‘insiders’. This could arise either by making other parties or persons

aware of the transaction itself, or by disclosing to them condential informa-

tion about P2P Target which is sufciently material to be price-sensitive. The

insider dealing provisions of the Criminal Justice Act 1993 could apply crim-

inal sanctions in the event of dealings (or encouraging others to deal) in P2P

Target’s shares or the disclosure of information about the proposed offer in

breach of the provisions of that Act.

The acquisition of shares in P2P Target by Bidco in order to facilitate the

bid in circumstances where the only inside information known to Bidco and

its advisers is the fact that a bid is in contemplation ought to be permissible,

although detailed analysis and advice should always be sought. Similarly,

such behaviour ought not to amount to market abuse under section 118 of the

Financial Services and Markets Act 2000, although again detailed advice will

be necessary.

not constitute a material reduction of net assets and therefore is not ‘nancial assistance’ as

dened by section 677 of the Companies Act 2006.

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Rule 4.1 of the Takeover Code provides that:

(a) No dealings of any kind in securities of the offeree company (includ-

ing options and derivatives in respect of or referenced to such secur-

ities) by any person, not being [Bidco], who is privy to condential,

price-sensitive information concerning an offer or contemplated offer

may take place between the time when there is reason to suppose that

an approach or an offer is contemplated and the announcement of the

approach or offer or of the termination of the discussions.

(b) No person who is privy to such information may make any recommenda-

tion to any other person as to dealing in the relevant securities …

3.3 Dealings of Bidco and concert parties

A number of provisions of the Takeover Code affect concert parties, both of

Bidco and of P2P Target. In particular, restrictions on dealings in shares in

P2P Target are imposed on concert parties, and some previous dealings by a

bidder vehicle’s concert parties can require a change in the terms proposed for

the offer itself.

Under the Takeover Code, persons acting in concert broadly are those

who, pursuant to an agreement or understanding (whether formal or infor-

mal), co-operate to obtain or consolidate control of a company or to frustrate

a successful bid by a third party. The Takeover Panel will make certain pre-

sumptions as to persons acting in concert for the purposes of the Takeover

Code unless the contrary is established. In a public-to-private transaction,

Bidco’s concert parties will be deemed to include the private equity investors

and the management team. More complex is the question as to whether, and,

if so, which, companies in the investors’ investee group are deemed to be act-

ing in concert with Bidco. Debt providers, where no warrants or other equity

element in the Bidco are involved, would not normally be treated as acting in

concert; however, the Takeover Panel should always be consulted if there is

any doubt.

Examples of issues which can arise for Bidco and concert parties of Bidco

include the following matters.

(a) Prohibition on sale

Rule 4.2 of the Takeover Code prohibits Bidco or its concert parties from sell-

ing any shares in P2P Target without the Takeover Panel’s consent during an

offer period.

(b) Rules concerning offer terms

Under rule 6 of the Takeover Code, where Bidco or its concert parties have

purchased shares in P2P Target in the three-month period before the offer, the

offer to shareholders of the same class must not be on less favourable terms.

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Similarly, under rule 11 of the Takeover Code, where 10 per cent or more of the

shares of P2P Target have been acquired by Bidco or its concert parties within

the twelve months preceding the of fer, the offer must include a cash of fer at not

less than the highest price paid to ac quire those shares.

In addition, an acquisition of shares by Bidco or its concert parties during

an of fer period for cash at a higher price than the of fer price will require the

terms of the offer to be revised to include a c ash of fer at that price.

Under rule 9 of the Takeover Code, if persons acting in concert acquire shares

carrying 30 per cent or more of the voting rights in a company to which the

Takeover Code applies, or increase a holding of between 30 per cent and 50 per

cent, they will be required to make a mandatory offer for the remaining shares

in that company.

There are onerous restrictions on the terms of a mandatory offer. In

particular:

(a) a mandatory offer will be conditional only on 50 per cent acceptances;

(b) the offer must include a cash offer at the highest price paid by Bidco and its

concert parties for shares in P2P Target in the preceding twelve months.

A bank lending to a bidder vehicle is likely to seek assurance that Bidco and

its concert parties have not acquired and will not acquire interests which could

trigger a mandatory offer.

3.4 Announcements

Rule 2.2 of the Takeover Code sets out the circumstances in which an

announcement of a proposed offer is required. Rule 2.2(e) provides that such

an announcement is required when negotiations or discussions are about to be

extended to include more than a very restricted number of people.

The Takeover Panel places very great emphasis on this provision, and wishes

to be made aware of any prospective public-to-private transaction before any

Bidco begins approaching prospective funders. In general, the Takeover Panel

will seek to restrict discussions with prospective funders and shareholders

before an announcement, but this will depend on the specic circumstances.

Rule 2.2 of the Takeover Code also sets out other circumstances when an

announcement is required, including the following:

(a) when a rm intention to make an offer is notied to the board of P2P

Target; and

(b) when P2P Target is subject to rumour or speculation or there is an unto-

ward movement in its share price.

P2P Target will need to be mindful of its obligations to avoid the selective dis-

closure of price-sensitive information. While P2P Target and Bidco may have