Private Equity Divestment Policies

Background

The following is a list of divestment policies commonly adopted by private equity firms. Some of these are documented at the point of original investment in the subscription and shareholders agreements. Others are simply custom and practice and need to be borne in mind if you are considering buying a company currently owned by a private equity firm.

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Vendor Warranties

No vendor warranties will be given by the private equity firm, except a warranty as to capacity to enter into the sale transaction and title to the shares being sold. Fundamentally the private equity firm wish to return the proceeds of sale to its underlying investors as soon as possible and this could not occur if there was a warranty claims risk.

Indemnities

No commitments in the form or nature of indemnities will be given.

Exit bonuses

In certain circumstances, where management shareholders require incentivisation (over and above the sale proceeds they are due to receive) in order to drive forward and deliver an exit, the management may be paid an exit bonus. The private equity firm will require an exit bonus to be paid by the investee company, not by the reallocation of the sale proceeds. The tax treatment of any such exit bonus needs to be considered carefully.

Warranty Insurance

Usually the management team's shareholding or proceeds on an exit are only a minor share of the overall proceeds, with the consequence that the vendor warranty exposure is small, the private equity firm may agree to assist the management team in purchasing warranty insurance (and thereby agree to give additional warranty cover and support the sale price) by agreeing an exit bonus to management payable by the company to meet the insurance cost.

Set-off arrangements

The private equity firm will be concerned to ensure that any set-off arrangements in respect of the purchase consideration do not apply to them and the proceeds they receive as this might otherwise expose them to warranties by the back door.

Post-completion adjustment of consideration

As above, the private equity firm will be concerned to ensure that no arrangements for post-completion adjustment of the purchase consideration (whether by reference to an amount held in a retention account or not) exposes them to warranties by the back door. Any adjustment will need to be by reference to defined events, not exceed the consideration received by the private equity firm and be closed off during a relatively short period following completion.

Earn-outs

If the purchaser is willing to pay an increased amount of consideration based on performance of the company following completion, the private equity firm will wish to participate in any such additional receipt or may forego it for a larger up-front cash consideration on completion.

Restrictive covenants

Vendors of shares are often required to observe restrictive covenants following sale (typically covenants not to directly or indirectly compete with the business sold) - a private equity firm will refuse to give any such covenants in view of its portfolio of other investments, some of which may be competitive.

Sale consideration

Private equity firms have a preference for:

cash consideration; or
if cash is not available, listed shares to which no dealing restrictions apply;

Irrevocable undertakings

In the context of a bid, a private equity firm will often be approached to give an irrevocable undertaking to accept a prospective purchaser's offer. The private equity firm will seek to ensure that any such irrevocable undertaking given is 'soft' (ie it does not prevent it from accepting a higher offer if made).

Prospectus responsibility/liability

A private equity firm will normally have appointed a director of the company to monitor its investment and that director will normally be expected to resign from office before the issue by the company of a prospectus in order to avoid responsibility and liability for that document and its contents.

Listed shares received as consideration

Where a private equity firm wishes to dispose of listed shares it will often arrange for the issuer's broker to place those shares in the market, requiring the broker to do so as principal (not as agent for the private equity firm), thereby shielding the private equity firm from any claim made by the placee/purchaser.

Lock-in/dealing restrictions

Where a private equity firm holds listed shares either as a result of a portfolio company achieving an IPO or receiving shares by way of sale consideration, it will resist any request for it to agree a lock-in or dealing restrictions. The private equity firm will seek the greatest possible freedom to dispose of its listed shares as and when it wishes.

'Greenshoe' options

This describes an arrangement whereby the company's IPO sponsor is entitled to acquire an amount of shares for it to use for the purposes of stabilising the market. The 'greenshoe' can dilute the premium that may otherwise be enjoyed on the exit and so is generally resisted by private equity firms.

Investor entitlements

A private equity firm will inevitably wish to collect all its monitoring fees, directors fees and dividends due up to the date of exit.

Redeemable shares

Although these shares may carry a pre-determined redemption date or profile, redemption should be accelerated on an exit.

Repayment of loans

As above, repayment of private equity loans will normally be accelerated on an exit.

Agreement to END the shareholders agreement

This will normally be required on an exit. The private equity firm's agreement to terminate will be conditional on the exit transaction proceeding as planned.

Abort costs

Traditionally, private equity firms resist any responsibility for abort costs on an exit transaction, except in relation to their own fees.

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