Private equity today: legal issues and developments in private equity dealmaking

Wednesday 5 June 2024, 1130-1245

Chairs
Akshay Chudasama Shardul Amarchand Mangaldas & Co, Mumbai
Jennifer S Perkins Kirkland & Ellis, New York

Speakers
Ezra Davids Bowmans, Durban
Youssef Djehane BDGS Associés, Paris
Elisabeth Kreuzer Hengeler Mueller, Munich
Miguel Tornovsky Pinheiro Neto Advogados, São Paulo
Lieke van der Velden NautaDutilh, Amsterdam

Reporter
Charles D Z Martin CDZM Associates, London

Current market trends

Lieke van der Velden started by saying that while deal values are down significantly in Europe, volumes are up, driven by platform deals (which represent more than 50 per cent of all deals done) and minority investments. Other features of the market include the prevalence of public-to-private transactions, broken deals (including for regulatory reasons), aborted auctions, restructuring deals, continuation vehicles, fund-to-fund deals and structured transactions, including earn-outs. The private equity deal outlook is good, driven in no small part by the existence of $2.6tn of dry powder, globally.

Elections are a key theme around the world this year. Akshay Chudasama talked about the shock of the previous day’s announcement that Prime Minister Narendra Modi will need a coalition government in India. Ezra Davids reported that there would two weeks of intense activity ahead in South Africa to pull together a coalition as a result of the recent election there, with both good and bad outcomes possible. Youssef Djehane pointed to the danger of a resurgence of right wing political parties in the forthcoming EU elections. Miguel Tornovsky talked about the fact that a number of global private equity funds have exited the Brazilian market, leaving the management of their portfolio to their local team.

Elisabeth Kreuzer focused on the topic of structured deals. Structuring deals is a necessary part of bridging the price gap between buyers and sellers. Vendor loans and earn-outs are clearly part of the picture, but Kreutzer chose to focus on roll-overs and partial exit deals and, in particular, the problem posed by sovereign wealth funds acting as shareholders in those deals. In Germany, regulators want to look at the make-up of sovereign wealth funds in a general partner’s (GP) investor base if, in addition to incoming sovereign wealth money, the existing fund retains a stake. She also pointed out that structurally, deals often get done at the bottom end of the corporate structure, because of the way in which ownership stakes are aggregated for regulatory purposes the higher you go up the ownership structure. Deals also run into difficulties as a result of conflicting regulatory regimes.

Another feature of the current market is private initial public offerings (IPOs), particularly in the Nordic countries, where sponsors bring in third-party investors or limited partners of their own. This creates challenges in terms of liquidity going forward, as well as governance and the triggering of management incentive programmes. These deals have also been seen in India, but generally as a precursor to an IPO in the short term, rather than as a long-term ownership structure in its own right.

Djehane discussed control deals in relation to public companies and, in particular, the Believe transaction in France, where the initial structuring of the deal, giving the target board a fiduciary out in terms of a recommendation concerning a follow-on tender offer, allowed Warner Brothers to intervene as a potential interloper in the deal. Delisting is a vital component of a private equity sponsor in a take-private transaction in France and that right is triggered by the exercise of a squeeze-out at 90 per cent.

Platform deals were considered next. Davids talked about the prevalence of these deals in Africa, as they have advantages in terms of scale and synergies. Particular success has been noted in wind energy, where a Cape to Cairo strategy has been deployed. The same is true in the fast-moving consumer goods (FMCG) sector, where the African Continental Free Trade Agreement created a single market, giving rise to consolidation opportunities. Platform deals are also common in Brazil and across Latin America. In the US, such deals are facing regulatory scrutiny because, although not triggering regulatory thresholds as individual deals, they allow for the creation of significant market share over a certain period of time.

Locked box deals are prevalent in some parts of the world, while being unusual in others. Davids reported that they were common in Africa, giving the vendor certainty in regards to the price and an ability to distribute the proceeds to investors. On the other hand, they leave any profit generated on the upside, between signing and closing, for the benefit of the purchaser. With increasing regulatory delays, this is proving to be a problem. In Europe, 90 per cent of deals are locked box, but that could change because of increasing regulatory timeframes. An exception is regulated financial services businesses, where closing accounts are the norm. Closing accounts are also prevalent in Brazil and the US.

Regulatory approvals are causing problems for deals around the world. Tornovsky talked about the fact that in Brazil, outside specific regulated sectors, a major problem is agricultural land. He described the El Dorado deal, in which a small parcel of agricultural land was used as a reason to potentially void a transaction. Getting the necessary consent could take a number of years. Also, the lack of restrictions to those imposed by the Committee on Foreign Investment in the United States (CFIUS)/foreign direct investment (FDI) restrictions in Brazil means that they are seeing a great deal of investment from China, Russia and the Middle East, because consent is difficult to achieve in other parts of the world. South Africa has no FDI restrictions as such, but a component of the general merger control requirements is the public interest and that creates the potential for issues analogous to FDI concerns.

In Europe, van der Velden pointed to the fact that in Holland, FDI rules were introduced a year ago and apply to domestic transactions, as well as cross-border transactions. Europe’s Foreign Subsidies Regulation 2022/2560 is creating uncertainty in the market, as it has significantly increased the level of scrutiny by regulatory authorities. Djehane noted that in the EU generally, thresholds for clearance differ depending on whether the counterparty is EU-based or not. In India, the regime differs depending on whether the counterparty has a border with India or not. This is creating problems for China-related deals, where private equity sponsors are creating vehicles that exclude Chinese investors to avoid the need for clearance. In the US, much of the attention of CIFIUS is focused on China.

Representation and warranty insurance is prevalent in Europe and indeed, in many cases, synthetic policies mean there is no need to negotiate representations and warranties. Exclusions can be a sector-specific problem. Djehane pointed to the existence of the availability of cover for specific risks, such as tax-related risks. Insurance cover is not prevalent in Brazil, partly because non-private equity sellers often provide full indemnification. Insurance is becoming more common with private equity sellers. It is ubiquitous in the US and widely used in South Africa and India.

Finally, the panel looked at management equity. Djehane commented that in France many schemes that had required management to take out loans got into trouble during the Covid-19 pandemic and had to be restructured, such that the norm now is for incentive schemes to offer free shares.