In CheekyLittleCareers’ latest bluffer’s guide series post, our associate editor and career coach Husnara Begum a former magic circle corporate lawyer, explores the exciting world of private equity M&A (aka leveraged buyouts) and the rise of special purpose acquisition companies (‘SPACs’).
Key features of private equity M&A
Private equity deals have one common feature, namely the source of cash used to fund the purchase of the target business (the ‘target’). Here’s how it works: a sole investor or a consortium collaborate with a management team (this can be either the incumbents or a group of individuals carefully cherry-picked by the private equity investors for their expertise in particular areas) to establish a private equity ‘fund’ for the purpose of investing in a target. This can be a company that’s listed on a stock exchange or privately owned and is going relatively cheap. The idea is to then give the target a facelift and to sell it at a profit in a few years’ time (the onward sale is known as the exit).
There are two important factors that make private equity deals different from other forms of investing and M&A.
The first and most significant is the leverage (hence the name leveraged buyout). What this means is that purchases are typically financed with a mountain of debt that ends up being owed by the target. To achieve this, two new companies are created. At its most basic, this usually comprises a top company, owned by the private equity fund and, if relevant, the management (Newco) and a wholly owned subsidiary of Newco (Newco 2). The former company acts as the investment vehicle for the investors, whilst the latter acts as the purchasing and bank debt vehicle. This structuring cleverly limits the recourse of the debt providers, meaning in essence that the private equity fund does not guarantee the bank debt. Thus limiting its risk. The benefit of using the above structure is that investors can put in a comparatively small amount of cash, amplifying gains if they sell at a profit.
Secondly, investments are hands-on with the private equity investors overhauling how the target is managed on a day-to-day basis. Incidentally, as already touched upon above, the management team lined up by the private equity investors can either comprise the incumbents or a new group of individuals or a combination of both. This hybrid structure is typically referred to as a ‘BIMBO’ or ‘buy in / management buyout.’
The three stages of a buy-out
Equity: This is the deal between the private equity fund and management relating to their subscription for shares in, and management’s employment by, Newco.
Acquisition: This is the deal between Newco 2 and the seller for purchasing the target.
Finance: These are the arrangements between Newco 2 and the lenders for acquiring the target.
We will explore the above stages, including the role of lawyers and key transaction documents in more detail in future posts so watch this space!
If you’ve already started swotting up on private equity M&A then you may have heard lots of mention about SPACs (not smack!). These are incorporated solely for the purpose of making one or more unspecified future acquisitions, typically targeting an identified industry sector or geographic region. The founders of the SPAC often have specific industry expertise or private equity experience. They are commonly referred to as ‘sponsors.’
Once incorporated, the SPAC undertakes an initial public offering (IPO) and listing of its shares on a stock exchange. The funds it raises in the IPO are later used to acquire a private company (or companies), resulting in the acquired target effectively becoming publicly listed through a reverse takeover. But this is where it all gets complicated. Under current UK regulations at the point the SPAC identifies a target trading in the SPAC’s shares are suspended and cannot be resumed until a prospectus is published. Such a requirement has no specified deadline, meaning investors who want to sell their shares find themselves unhelpfully locked in.
But is this all about to change? Possibly, so you’d better watch this space because in April 2021 the Financial Conduct Authority (FCA) outlined plans to relax the rules (you can read the FCA’s press release here).
Separately, for information on the pros and cons of structuring acquisitions using a SPAC check out this very helpful article prepared by Skadden Arps. Note: this piece focuses on the US market so, if you’re an aspiring lawyer targeting law firms with a particular focus on private equity and want to really wow partners, we strongly recommend spending more time doing your own independent research into SPACs, particularly in connection with the FCA’s review into this area.