With so much macroeconomic uncertainty, one could be forgiven for thinking that legal issues are taking a backseat to economic concerns in the private equity industry. In fact, the lawyers advising sponsors see another busy year ahead. Here are the five legal issues at the top of the private equity agenda.
1 Brexit’s legal implications
It is impossible to deny that Brexit is front and centre of UK-related investment decisions as we move into the second quarter of 2019, and there are plenty of associated legal issues that are already keeping funds and their advisors busy. For a start, a slowdown in deal activity means a window in which to focus on compliance across the portfolio.
Stephen Drewitt, head of private equity at Macfarlanes, says: “Given the current macroeconomic and political situation, legal issues are not getting much airtime and there is an obvious slowdown in the rate of investment. For the time being, a number of PE houses are very much focused on their portfolios and driving good behaviours within those businesses, rather than embarking on new investments or exits.”
Where deals are proceeding, there is an extra layer of due diligence to be completed, according to Kem Ihenacho, global co-chair of the private equity practice at Latham & Watkins.
He says: “Overall we have not seen a drop in activity, though investors are approaching businesses with predominantly UK revenues in certain sectors with caution.What we do see is another line of diligence in deals, to look at what the impact of Brexit might be on the business, and what that business is doing to plan for different types of Brexit. That may lead to some investments being delayed, but overall activity is still pretty strong.”
On fundraising, the Brexit impact is already significant: “All UK managers are having to grapple with fund structures for their next funds,” says Nigel van Zyl, a partner in the funds practice at Proskauer. “They are thinking about where they are going to be located, whether they will have access to EU markets with or without pass- porting and whether a particular jurisdiction will impact on their investor base and make fundraising easier or harder,” he says.
Such decisions come down to where managers believe their future investment will come from and, for larger GPs, whether to commit resources to establishing their own Luxembourg entities. “For small GPs, that’s not really an option, so they have to assess the structure in light of that,” he says.
2 More opportunities in the public markets
Many private equity firms are increasingly focused on the opportunity to invest in companies listed on stock markets around the world, as evidenced by this year’s consortium acquisition of Inmarsat, the UK satellite group that was once a FTSE 100 business. Inmarsat accepted a $3.4 billion cash bid from a consortium comprising Apax Partners, Warburg Pincus, Canada Pension Plan Investment Board and OntarioTeachers’ Pension Plan Board, just weeks after Hellman & Friedman and Blackstone had made a $6.4 billion offer for online classified group Scout24, which will be the biggest takeover of a listed German company by private equity.
Ihenacho says: “One thing our clients continue to focus on is the opportunities to acquire public companies, where valuations are seen as attractive. Being able to navigate the rules around public company transactions and being ready to be flexible and innovative around those approaches, focused on a path to control, is something we are working with clients on.”
A related trend sees buyout firms circling divisions of major corporates for carve-out deals, with German industrial gases group Linde agreeing in March to sell its South Korean assets to private equity firm IMM for $1.15 billion. Michael Francies, managing partner of Weil’s London office, says: “We are currently seeing a lot of carve-out sales, with corporates selling off non-core assets, and those deals are proving attractive to private equity. Carve-outs are not necessarily easy transactions to do, but buyout firms have a good track record of finding value in those transactions and it looks like we will see more of them this year than maybe we have in the recent past.”
3 GP-led restructurings move up the agenda
With a glut of funds raised between 2006 and 2008 now reaching the end of their 10-year life span, many of those GPs find themselves holding assets that their limited partners would like to liquidate and they would prefer to keep working. With the global financial crisis having impacted many of those funds, managers are increasingly exploring ways to move on without having to exit assets that may yet have plenty of value left to be extracted.
One of largest such deals took place last year, when Coller Capital and a unit of Goldman Sachs backed a €2.5 billion restructuring of Nordic Capital’s 2008 seventh fund.That deal, which involved nine companies worth €4.4 billion, allowed the firm to hold the assets for another five years, with about 60 percent of the original LPs selling their stakes to secondaries investors, and the remainder rolling over into the new structure.
Drewitt says: “What we see now is that, instead of GPs being almost passengers in secondary transactions, they are now actively pursuing and participating in those arrangements as a means of assisting their investors with liquidity solutions; previously for investments leftover at the end of the life of a fund but also now creatively as a means of actively managing the portfolio.”
4 The return of the club deal
With the prospect of large public-to-private transactions coming back onto the table, we are seeing a renewed trend towards consortia of private equity investor s clubbing together on larger transactions, as well as a growing number of LPs seeking more active co-investment opportunities.
David Walker, global vice-chair of the corporate department at Latham & Watkins, says: “Private equity lawyers are thinking carefully about the terms of the equity arrangements between consortium members on these deals, which is probably something we have been less focused on in recent years.That gives rise to a whole host of issues around board rights, governance and exit and also links into another hot topic around anti-trust, where there is an increasing regulatory focus on non-controlling stakes.”
Ihenacho adds: “The pool of capital available for these deals continues to expand – we are increasingly seeing family offices buying into large companies and sovereign wealth funds and pension funds doing direct investments.”
5 Directors’ liabilities continue to increase
A raft of new legislation in Europe and around the world in recent years has often made directors criminally liable for the activities of employees and agents, most notably in areas such as bribery and corruption, terrorist financing, tax evasion, money laundering and sanctions. Regulators and authorities are showing a greater willingness to flex their muscles, and new legislation has often changed the criminal standard to put directors on the hook. Such advances have driven a renewed focus on compliance policies and procedures within private equity firms, with culture and ethics becoming buzzwords.
Drewitt says: “There’s a fair amount of concern around criminalisation of the board and where that is going, covering issues such as the Bribery Act, modern slavery and the new tax evasion rules. People are looking very closely at all of these new items of legislation that the government has introduced as a means of holding directors responsible on a criminal basis for acts where they might previously have used the corporate veil to protect themselves.
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