lbo uk sample-12

The UK LBO Manual

Published byWritten & researched by

Published: September 2004

Introduction

Since the development of highly leveraged transactionsinvolving listed companies in the US in the late 1970s, buy-outs have become an international phenomenon. In Europe,the UK led the way with activity levels growing rapidly in theearly 1980s. The Continental European buy-out market firstsaw growth later in the decade, with France and theNetherlands in particular seeing considerable buy-out activi-ty, whilst Germany has been slower to develop but hasrecently become more important.

Buy-outs have been an important feature of the privatisation ofstate assets during the transition from communism to a marketeconomy in Central and Eastern Europe since the beginning ofthe 1990s.The need for major restructuring in Japan and Koreahas given an impetus to buy-outs in the Far East with buy-outsnow spreading in significant numbers to Asia.

Definitions

Management buy-outs (MBOs) involve the acquisition byincumbent management of the business where they areemployed, with the purchase price being mainly met by aprivate equity/venture capital firm providing significantamounts of equity and/or banks providing debt.Management buy-ins (MBIs) are a similar form of transac-tion but differ in that the entrepreneurs leading the transac-tion come from outside the company. A hybrid buy-in/man-agement buy-out (BIMBO) combines the benefits of exist-ing internal management and the contribution of external

entrepreneurs; these transactions have developed to addressthe shortcomings of pure MBIs where asymmetric informa-tion problems faced by outsiders contributed to significant-ly higher failure rates than for MBOs.

Leveraged buy-outs (LBOs) are typically led by specialistfinanciers whose executives take direct equity holdings inthe acquired corporation but with the vast majority of thefunding for the purchase being in the form of debt.Incumbent management may play a marginal role in put-ting the transaction together and in equity holding and mayeven be replaced. If they are heavily involved, the transac-tion may be termed a leveraged management buy-out(LMBO). Similar to LBOs, investor buy-outs (IBOs) havedeveloped where private equity groups initiate and lead thetransaction, but with the degree of leverage being substan-tially less. Other variants include MEBOs, where manage-ment and employees both provide equity. The initial buy-out transaction may be used as a platform for further acqui-sitions, a so-called buy-and-build or leveraged-build-upstrategy. Such deals are typically aimed at consolidatingfragmented industries.

UK private equity market development

The UK buy-out market began to develop strongly in theearly 1980s and by the end of the decade a first peak inmarket value of £7.5 billion was reached (see Chart One).Following the recession of the early 1990s, market valuebegan to recover from 1994, reaching a new peak of £23.9billion in 2000, before declining to £15.3 billion in 2002. UK

Development of the UK private equity marketAndrew Burrows and Mike Wright, Centre for Management Buy-out Research*

5

LBO6.qxd 3/12/04 1:57 pm Page 5

Acquisition

What is the transaction?

This element of a private equity transaction is familiar to allM&A practitioners. It concerns the acquisition of the com-pany, business, assets or group of companies, businesses andassets in which the private equity funds are to invest. Thesubject matter of the acquisition, whatever its nature or com-position, is referred to as the 'Target'.

Who are the parties?

One party to that acquisition transaction will clearly be thecurrent owner of the Target, in its capacity as a seller.Typically, on a private equity transaction, the buyer is a newcompany ('Newco'), some form of special purpose vehicle -i.e. a company formed specifically for the purpose of makingthe acquisition. Depending on the nature of the acquisitionand related financing transactions, Newco may of course bemore than one legal entity; for these purposes, however, it isassumed that Newco is only one company, incorporated inthe UK (but see also inset box 'One Newco, two Newcos,three Newcos, four').

What are the relationships between the parties?

Seller and buyer will enter into a contractual relationship inthe form of an acquisition agreement.

This structure is shown in Chart One:

Chart One: Structure of an acquisition agreement

15The structure of leveraged buy-out transactions

One Newco, two Newcos, three Newcos, four

Much time and effort is spent, particularly in the larger private equitytransactions, in making sure that the acquisition and financing structureis as tax efficient as possible (see chapter five ‘Structuring an LBO – UKtax aspects’). This may well result in 'Newco' being more than one com-pany - often up to (and sometimes more than) four distinct companies.Where this is the case, the roles and responsibilities of those separateNewcos (and the documentation to which they are a party) are set outbelow.

The position can become more complicated on a secondary buy-out (or,even worse, a tertiary buy-out). The same financing structures may be repli-cated resulting in eight, or 12, or sometimes more (!) Newcos in a chain,as each private equity fund buyer puts in place its own tax structuring ontop of the previous structure.

1 If there is mezzanine debt finance, and that mezzanine has a warrant enti-tlement - see ‘Debt’ below.2 If new service agreements for management are to be put in place –see ‘Equity’ below.3 In addition, other Newcos may, and each Target will, be party to thesecurity documents – see ‘Debt - What is the required documentation?’ below4 There may be multiple 'bottom' Newcos, for example, there may beNewcos in each jurisdiction, on a cross-border transaction, to make theacquisition in the relevant jurisdiction and/or to borrow the senior bank debt.

Involvement inTransaction

(Pure) equity finance from(a) private equity fund and(b) management

Loan stock/DDB fromprivate equity fund(and, if relevant,management)

Mezzanine finance frommezzanine bank(s)High yield/securitisationfinance, if relevant

Senior debt finance fromsenior bank(s)Buyer under acquisitionagreement4

Party to

Subscription agreementArticlesWarrant instrument1

Service agreements2

Loan stock/DDB instrument

Mezzanine loan documentsHigh yield/securitisationdocuments

Senior loan agreementSecurity documents3

Acquisition agreementAcquisition documents

Newco

'TOP' NEWCO

NEWCO 2

NEWCO 3

'BOTTOM' NEWCO

TARGET

LBO6.qxd 3/12/04 1:57 pm Page 15

44 The UK LBO Manual

guarantee and security


equity/intercompany loan

purchase price

Intercreditordeed

The classic capital structure for a UK leveraged buy-out senior and mezzanine debt

equity (ordinary/preference shares+ subordinated loan stock)

Senior debtmezzanine debt

Parent

NewcoVendor

Opcos

TargetTarget



Chart One: Buy-out structure - overview

Each company in the target group will then grant guaran-tees and give security over all of its assets in favour ofthe lenders as security for the loans which the lenders haveprovided.

The giving of the guarantees and the security by target andits subsidiaries will constitute financial assistance within sec-

tion 151 of the Companies Act 1985.This means that beforethe guarantees and security can be given, the target groupwill need to go through the financial assistance whitewashprocedure set out in sections 155 to 158 of the CompaniesAct 1985. Essentially this involves each director of eachmember of the target group swearing a statutory declarationof solvency which is reported upon by the auditors.

LBO6.qxd 3/12/04 1:59 pm 4

The terms of typical high yield debt and the associated doc-umentation are different from those of a traditional mezza-nine loan agreement. There will be a trustee for the note-holders and an 'indenture' constituting the notes (ratherthan a loan agreement).There will also be an offering mem-orandum which is prepared with a detailed businessdescription and description of the notes being offeredtogether with financial information on the group. There is aminimum feasible deal size for high yield of around £100million (although deals have been seen in sterling (relative-ly rare) as low as £50 million). High yield therefore tends tobe used only on the larger transactions.

If high yield is being utilised on a transaction then, becauseof the lead time involved in preparing the necessary offer-ing memorandum and soliciting interest from noteholders,there is an eight-week period (at least) involved in gettingthe note issue away. This means that the high yield elementof the transaction needs to be bridged by mezzanine bridge

finance - usually provided by the underwriter of the highyield issue. The terms of the bridge to a high yield canbecome complex, because the bridge provider needs to leg-islate for the contingency of the high yield not happening.

If a European high yield bond is to be sold not only intoEurope but also to investors in the United States, to tapinto the huge investor base there, then careful considerationwill need to be given to US regulatory requirements. A cru-cial consideration is whether or not the high yield notes areto be registered with the US Securities and ExchangeCommission (SEC) or whether reliance is going to be madeon exemptions in Regulation S (offerings outside the USnot requiring SEC registration) and Rule 144A (offeringsto 'qualified institutional buyers'). An issuer offering highyield bonds in the United States also needs to consider themandatory provisions of the US Trust Indenture Act 1939.Some senior lenders are more comfortable with traditionalmezzanine funding rather than high yield, because there is a


High yieldbond holders

Senior lenders

Topco/HYBissuer

Holdco

Opcosguarantees and

(for senior only) security

security and downsteam guarantees

pledge of Holdco shares

subordinated guaranteeintragroup loan ofbond proceeds

Key features:F Vertical structural subordination of high yield bond butsubordination is 'unlocked' against Holdco by upstreamguarantee.F Subordination of intragroup loan i.e. no repayment ofintragroup loan until senior debt has been repaid; interestequal to high yield interest provided no senior default(179 payment block if senior default + 120 to 180 daystandstill before bondholders can pursue claims afterdefault under high yield bond indenture/trust deed).F Holdco guarantee the 120-180 days after high yieldpayment default.F Bondholder recourse to Opcos via guarantee (i.e. paripassu with secured creditors of Opcos) but subordinatedof course to senior.F Enhanced guarantee release mechanics, based on fairvalue protection: HY required to give up guarantee onsale provided at fair value.

Chart Three: European high yield bond structure

LBO6.qxd 3/12/04 1:59 pm Page 48

interest in them) to a special purpose vehicle, which then issuesbonds to investors. Typically, the proceeds of the bonds areapplied to repay either bridging finance put in place to bridgethe procedural process of issuing the bonds,or to refinance exist-ing forms of traditional senior and/or mezzanine debt.The prin-cipal and interest payments due on the bonds are funded out ofthe cashflows generated by the underlying assets. In recent years,a wide range of assets have been securitised - mortgages, creditcard receivables, royalties from record sales, Formula One mediarevenues, etc. However, the concept has been extended to thecashflows generated by the business of an operating company -the concept of 'whole business securitisation'. The technique ofwhole business securitisation has been used on London CityAirport (airport revenues), Wightlink and Red Funnel (ferries),Welcome Break and Roadchef (motorway service stations),Madame Tussauds (waxworks), Rank Hovis McDougall (food-stuffs) and the Really Useful Theatre Group (theatres).

Asset-based financeAsset-based financing techniques enable borrowers to raisefunds against debtors via factoring or invoice discountingarrangements and often incorporate an element of fundingagainst stock, property, existing plant and machinery and otherbusiness assets. Typically, the amount of asset-based financethat a lender will make available will be a proportion of thevalue of 'eligible assets' e.g. 80 per cent of eligible stock andreceivables. The eligibility criteria will be set by the lenderto exclude damaged or obsolete stock, bad or doubtfuldebts and other impediments on value.

Asset-based finance can be an attractive alternative to sen-ior debt on smaller leveraged buy-outs particularly if theunderlying business is growing quickly. In conventionalcashflow-based leveraged lending, the senior lenders needto monitor the performance of the business regularly to


Swapcounterparty

Noteholders

Liquidity facilityprovider

notes

note issue grossproceeds

security over all rights of Issuer underIssuer/Borrower Facility Agreement,

and all other documents and guarantees andsecurity for them and any Issuer cash accounts

term advances

Issuer/Borrowerloan facility

guarantees andsecurity

Securitytrustee

Borrowers/Opcos(and guarantors

and securityproviders)

Issuer

Chart Six: Basic 'whole business' securitisation structure

LBO6.qxd 3/12/04 1:59 pm Page 54

to potentially significant civil liability for them. For a debtprovider, the consequences of a breach of the financialassistance prohibition may include the invalidity of guar-antees and security received by the lenders and further-more any recovery of any money received by the lenderspursuant to the guarantee or security may be invalid. For acompany, the consequences of breach may include a cross-default/acceleration of loans triggered by the invalidity ofthe guarantees or security.

There is a relaxation of the prohibition for private compa-nies, provided that certain formalities are complied with;

this process is generally known as the 'whitewash proce-dure' (see 'The financial assistance whitewash procedure').

Subordination

A typical UK leveraged financing structure will incorporatesenior secured debt, secured hedging exposure, secured mezza-nine debt and/or other junior debt (for example (i) high yieldbonds, (ii) PIK (payment-in-kind) notes or (iii) vendor loans)and unsecured investor debt. Although the loan and securitydocuments are obviously important because they stipulate thefacility terms (including the borrower's obligations and the


'Financial assistance' will not be unlawful if the fol-lowing requirements are satisfied:

F The company giving the financial assistance is aprivate company (as opposed to a public company)provided it is not a subsidiary of a public companyat the level of the company being acquired or below.

F The company giving the assistance has positivenet assets which are not reduced by the giving of thefinancial assistance (or if they are reduced, thereduction is only to the extent of the company's dis-tributable profits).

F Where the company giving the financial assis-tance is not a wholly-owned subsidiary of anothercompany, the giving of the financial assistance isapproved by the shareholders of the company byspecial resolution (75%) at a general meeting ofthe company. (Where the financial assistance isbeing given by a company in respect of an acquisi-tion of shares in a holding company of that compa-ny, a special resolution must also be passed by themembers of that holding company and any interme-diate holding company between it and the compa-ny giving the financial assistance, except, in eachcase, where it is a wholly-owned subsidiary). Anyspecial resolution must be filed with the Registrar ofCompanies within 15 days after having beenpassed.

F All the directors of the company proposing to givethe financial assistance must swear a statutory dec-laration in the prescribed form confirming that, in theiropinion, immediately following the date on which thefinancial assistance is proposed to be given there willbe no ground on which the company could then befound to be unable to pay its debts and the companywill be able to pay its debts as they fall due in the 12months immediately following such date.

F Where the shares acquired or to be acquired areshares in a holding company of the company givingthe financial assistance, all the directors of that hold-ing company and of any intermediate holding com-pany must also swear a statutory declaration.

F The directors' declaration must have annexed to ita report from the company's auditors confirmingthat, having enquired into the company's affairs, theyare not aware of anything to indicate that the opinionof the directors in the statutory declaration is unrea-sonable in all of the circumstances. It must be filedwith the Registrar of Companies within 15 days afterbeing sworn.

F The time limits relating to the giving of the financialassistance must be observed. These are:

l Where a special resolution of a company isrequired, the resolution must be passed on the same

date as the date of the directors' statutory declarationor within the week immediately following that date(i.e. it cannot pre-date the date of the directors' dec-laration).

l Where a special resolution approving the giving ofthe financial assistance has been passed, share-holders holding in aggregate not less than 10% innominal value of the company's issued share capi-tal can apply to the court to have the resolution setaside (shareholders who voted in favour of the reso-lution do not have the right to object).

l Where a special resolution is required to approvethe giving of the assistance, the assistance cannotbe given until the expiry of four weeks after the dateon which the special resolution was passed unlessall of the members voted in favour of the resolution.This is to allow shareholders holding not less than10% in nominal value of the company's issuedshare capital (or any class of it) (other than thosewho voted in favour of it) to apply to the court to can-cel the resolution.

l The financial assistance must be given before theexpiry of eight weeks after the date on which thedirectors of the company giving the assistance sweartheir statutory declaration or, if earlier, the date onwhich the directors of any relevant holding companyhave sworn their declaration.

The financial assistance whitewash procedure - sections 155 to 158 of the Companies Act 1985

LBO6.qxd 3/12/04 1:59 pm Page 58

Tax treatment of transaction costs

On a leveraged acquisition there will be a significant numberof transaction costs involved, ranging from advisers' fees tobank arrangement fees, often totalling up to 5 per cent of thetotal price of the deal. It is worth noting that the Revenue arebecoming increasingly hostile in disputing the tax deductibil-ity of costs claimed as revenue deductions for corporation taxpurposes when such costs are, in reality, capital costs incurredon acquisition. Costs which relate to the acquisition of sharesin the target (e.g. legal due diligence, negotiating the sharepurchase agreement) will not be deductible and capital costsgenerally are now precluded from relief by new rules inFinance Act 2004.

Where costs can fall under FA 1996, section 84, being“charges and expenses incurred by the company under or forthe purposes of its loan relationships and related transac-tions”, such costs can be deducted in accordance with theaccounting treatment as and when the costs are amortisedunder FRS4. These costs will include arrangement fees,advisers' fees relating to the ‘financing’ side of the transactionand issue costs incurred directly in connection with the issueof a capital instrument as per FRS4. Typically, the amortisa-tion period will be the full term of the bank debt, this beingthe funding to which most of the acquisition costs will beattributed. Some of the fees relating to the financing (e.g.negotiation with finance providers) can be written off to theprofit and loss account and generate immediate tax relief.

Many of the transaction fees (particularly those of profes-sional advisers) will carry VAT. This VAT can only be recov-ered to the extent that it can be attributed to taxable suppliesmade by the recipient. By and large the various Newcos willnot be making taxable supplies. The preferred method tomaximise VAT recoverability is to VAT group the UKNewcos with the UK target companies (which in most caseswill make taxable supplies) effective from closing. Thisenables the input VAT to be recovered by reference to theoutput VAT of the target companies.

Tax objectives for management

Summary

Management will commonly participate in the equity of anLBO and hold shares in Newco. They will generally want toensure that:

(a) there is no income tax charge on their initial acquisitionof shares and any subsequent growth in value; and

(b) any return on their investment is treated as capital (asopposed to income) and, so far as possible, qualifies for busi-ness asset taper relief for capital gains tax purposes.

This section considers the circumstances in which anincome tax charge might arise (and how such a charge canbe avoided) and the conditions which need to be satisfiedso as to qualify for business asset taper relief.

Initial investment

If an individual acquires shares at less than market value inconnection with his employment, he will generally be subjectto income tax on the difference between the amount paid forthe shares and their market value (taking account of anyrestrictions which might be attached to the shares, such as badleaver provisions or restrictions on transfer). It will usually bedifficult to argue in the context of an LBO that managementhave not acquired their shares in connection with theiremployment. It is therefore essential to ensure that manage-ment pay market value for their shares.

While, in the classic management buy-out model, manage-ment might establish and acquire shares in Newco beforethe institutional investors have committed their capital tothe project and the acquisition of the relevant target hasbeen agreed (and it is therefore possible to argue that Newcois then a mere valueless shell), this may be more difficult toachieve in the context of an institution led LBO.


LBO6.qxd 3/12/04 2:00 pm Page 74

of market share and the generation of synergies are preciselythe rationale for further investment in the same sector.

How will the OFT calculate turnover?

Even in the absence of a substantive overlap with existinginvestee businesses, the turnover test can bring LBO activ-ity within the EA 2002. Under the EA 2002, turnover iscalculated in a broadly similar fashion to under theECMR although it is only necessary to consider theturnover of the target. The figures in the latest publishedaccounts of the target company will normally be sufficientto measure whether the turnover test is met (unless therehave been significant changes since the accounts were pre-pared).

What does the notif ication process entail?

There is no obligation to notify the OFT of transactionscaught by the EA 2002 thresholds (although a referencecan be made to the Competition Commission (‘CC’) atany time up to four months from completion of a transac-tion (or, if later, publication of the fact of the merger) andthe OFT will frequently write to parties upon hearing ofan acquisition to establish if it has jurisdiction). In addi-tion, although satisfaction of the turnover test may resultin a transaction qualifying for investigation, this is, ofitself, unlikely to give rise to regulatory concerns in the

absence of material market share overlaps. Accordingly,whether to notify for clearance essentially turns on anassessment of the likelihood that the transaction would bereferred to the CC and, accordingly, notification is usuallynecessary only where there is a risk that a transaction maygive rise to substantive competition concerns.

How will the OFT assess the transaction?

The OFT is under a duty to refer a relevant merger situ-ation to the CC for further investigation where the OFTbelieves that it is, or may be, the case that:

(a) a relevant merger situation has been created, or arrange-ments are in progress which if carried into effect will resultin the creation of a relevant merger situation; and

(b) the creation of that situation has resulted, or might beexpected to result, in a substantial lessening of competi-tion within any market in the UK for goods and services.

However, the OFT may decide not to refer a merger to theCC if it believes that:

(a) the market(s) concerned is/are not of sufficient impor-tance to justify a reference (which will rarely be the case); or

(b) any relevant customer benefits arising out of the merg-er outweigh the substantial lessening of competition; or

(c) in the case of an anticipated merger, the arrangementsare not sufficiently advanced, or not sufficiently likely toproceed, to justify a reference.

The OFT considers that a merger may be expected to leadto a substantial lessening of competition when it is expect-ed to weaken rivalry to such an extent that customerswould be harmed. This may come about, for example,through reduced product choice, or because prices could

DID YOU KNOW? The way the test for referral to theCC is now interpreted

Recent case law has indicated that the OFT has a wide margin of discre-tion whether to refer, where the risk of a merger leading to a substantiallessening of competition is believed to be more than fanciful but less than50 per cent. Above a 50 per cent risk (i.e. the OFT believes that a sub-stantial lessening of competition is more likely than not to result from themerger), a reference must be made.

Under the EA 2002, the OFT may accept binding undertakings as analternative to making a reference to the CC.

89EC and UK merger control aspects of leveraged buy-outs

LBO6.qxd 3/12/04 2:01 pm Page 89

give a cash confirmation statement (see ‘Financing the offer andcertain funds’below), effectively means that the bidder's work ondue diligence, the equity financing documents and the debtfinancing documents must be completed, and all such docu-ments signed and reports issued, immediately before the offer isannounced. The costs of the deal are therefore largely incurredwhilst there is considerable deal risk remaining.

Documents

Offer documentation

The bid is effected not by way of a privately negotiated acquisi-tion contract, but is announced by press release and formallymade to shareholders by way of an offer document. The offerdocument constitutes a conditional contract between eachshareholder and the bidding vehicle, as well as being the docu-ment where the bidder (and on a recommended deal, the target)satisfies its obligations of disclosure under the Code.There are anumber of specific issues on a take private that arise on thesedocuments.

Responsibility statementsRule 19.2 requires the directors of a bidder to take responsi-bility for information contained in any document sent to tar-get shareholders. On a recommended deal, some informationwill fall to the target directors. This taking of responsibilityplaces potential personal liability on the persons named inthe statement.

Responsibility statement - bidderIn respect of the bidder, one issue that arises on take privates iswho on the MBO team, including the private equity house, isnamed in the responsibility statement and how far up the chainof ownership in the bidding structure the Panel will require thistaking of responsibility to extend. Recently, the Panel hasrequired the directors and partners of the private equity fundmanager to take responsibility for all information in the offerdocuments (other than that relating to the target and its direc-tors). It has also required the directors of the general partner of

the managed funds to take responsibility for the informationrelating to it and those funds. It has not yet required the direc-tors of the fund manager's parent, or the equity investors them-selves, to take responsibility.

Responsibility statement - targetOn a recommended take private offer document, there willgenerally be two target responsibility statements. All targetdirectors will take responsibility for information in the docu-ment concerning the target. In addition, the independent direc-tors alone will take responsibility for any statement of advice toshareholders on the merits of the offer (see note 3 to Rule 25.1).

Information disclosure - Rule 24Rule 24 details the financial and other information required onthe bidder (as well as the target and the offer). More informa-tion is required on the bidder if equity securities are offered asconsideration instead of cash; this will generally not be relevanton a take private.

Take private offer documents, therefore, generally contain lit-tle financial information on the bidder. The bidding vehicle isgenerally newly set up and, so far, financial backers, funds andthe like have not had to disclose very much information. Oftenonly a brief narrative description of the structure of the fundsand the financing arrangements has sufficed.

Further information (in the form of contract summaries) as tothe equity and debt financing documentation will be requiredto be included in the material contracts disclosures which formpart of the offer document.

Equity documentation

The equity documents on a take private differ in certainrespects from those on a private MBO.

ConditionalityThe documents, due to the requirement for a cash confirma-tion, should only be conditional on the offer becoming whol-

101Public to privates

LBO6.qxd 3/12/04 2:01 pm 1


Chart One: Pros and Cons - Scheme versus Offer

The following chart is intended as a short-form summary of the advantages and disadvantages of two potential structures proposed asways to effect a bid. These comprise a scheme of arrangement (‘scheme’) of the target under section 425 of the Companies Act 1985(as amended) and an offer for the target by the bidder (‘offer’) pursuant to the City Code on Takeovers and Mergers. This chart assumesthe scheme will involve a reduction of the share capital and re-issue to the acquiring company (not a transfer of shares to the acquiringcompany).

Issue

Stamp duty

Required approvals

Competitor intervention

Structural flexibility

Control of transaction

Timing

Offer

0.5 per cent of value of consideration ispayable in stamp duty.

Could go unconditional as to acceptancesat 50 per cent of target shareholders BUTneed 90 per cent of target shareholders toaccept to squeeze out minorities (and seebelow).

Historically seen as more flexible if com-petitor intervenes (subject to time limits).Break/inducement fees can be used.

Offer limited in scope to the acquisition ofthe target shares.

Controlled by bidder. Conditions nor-mally at the discretion of bidder(although in practice bidder not likely tobe allowed to invoke subjective businessconditions to withdraw).

Panel timetable; 60 days from posting(maximum) to go wholly unconditional,21 days (minimum) possible.

Scheme

No stamp duty on a (reduction) scheme.

A majority in number representing 75 per cent of target shareholdersactually voting to approve scheme (with the resultant minority thensqueezed out by virtue of the court order).

Historically seen as less flexible but there are recent examples(Debenhams, Canary Wharf) of schemes used in competitive situa-tions. Timing of intervention key; once shareholders approve, risk ofintervention reduced, although court unlikely to sanction until share-holders have voted on a higher offer subsequent to EGM.Break/inducement fees can be used.

In complex deals, court can sanction variety of matters (e.g.s.151financial assistance) simultaneously with the scheme (therefore notrequiring any additional process).

Can usually only be used in recommended situation; needs signifi-cant target input. Practical control matter for negotiation. Mutualconditions can be used.

Timing subject to court dates; will be gap between announcing andposting, EGM notice periods, then between EGMs and main courthearing. Court vacations can be significant.Once scheme sanctioned, effective for 100 per cent of shareholders.

à

LBO6.qxd 3/12/04 2:01 pm Page 106

valuation is sometimes applied to the transferred shares,such as the lower of the original issue price and the marketvalue at the transfer date. Where the cessation is for anyother reason (for example, death or redundancy), a valuationbased on market value at the transfer date is more common.

However, care needs to be taken with provisions whichforce employees to transfer their shares at less than marketvalue. Depending partly on the price paid for the shares atacquisition, this may result in the employees receiving anincome tax charge (and possibly corresponding PAYE andNICs obligations on the company) on the disposal of theshares on a proportion of their then market value, althoughthere are measures which can be taken to mitigate theincome tax liability.

How can a gain on share options or awards berealised?

The employee will wish at some point to dispose of sharesacquired under equity incentive arrangements in order to realisea gain. In the case of a private company, this may be achieved asfollows:

F the shares may be sold when the company becomes listed oris bought;

F the shares may be acquired on a secondary buy-out;

F an internal market may be created (see ‘Can shares be held ina trust?’ below);

F where appropriate, there may be a put option on to the par-ent company.

Can shares be held in a trust?

An unlisted company which wishes to use existing shares tosatisfy share options and awards rather than issuing newshares may establish an employee benefit trust (‘EBT’) the

trustees of which are put in funds by the company or by out-side borrowing to acquire shares in the company. These arethen held in trust until such time as they are distributed toparticipants in one of the company's employee share plans.

Shares may be acquired by the trustees from share plan par-ticipants on disposal and ‘recycled’ through the EBT.This canbe useful for unquoted companies where there is no readymarket in the shares.

The establishing company should be able to obtain a corpo-ration tax deduction for contributions to an EBT but thededuction will be deferred until a payment is made out ofthe EBT which gives rise to a liability to income tax andNICs.

What other considerations need to be taken intoaccount?

The following matters also need to be taken into account whenestablishing an equity incentive plan.

Prospectus and f inancial promotion requirements

Under the Public Offers of Securities Regulations 1995(‘POS Regulations’), when an offer of unlisted securities isbeing made to the public in the UK for the first time, theofferor must produce a prospectus which is made publiclyavailable for inspection for the duration of the offer period.Although the POS Regulations do not contain a definitionof ‘public offer’, it is deemed to include an offer to any sec-tion of the public in the UK.

The Financial Services and Markets Act 2000 (‘FSMA’)restricts the promotion of investments and related activities.

However,both the POS Regulations and the FSMA restrictionsare subject to certain exemptions. For example, in the case of thePOS Regulations, in relation to an offer made to all employeesgenerally, an exemption applies where a private company offers

119Equity incentives

LBO6.qxd 3/12/04 2:02 pm Page 119

role for unsecured creditors and that it is generally perceived asa poor mechanism for corporate rescue.

LPA receivership/f ixed charge receivership

These are less commonly encountered than administrativereceiverships. This involves a receiver being appointed over aparticular fixed charge asset or assets of a company, often realproperty or shares in a subsidiary, and typically where there isno floating charge over the company's assets or where theappointor has security over limited assets and wishes to enforcesecurity over those assets only. The receiver's powers derivefrom the charge and to a limited extent from the Law ofProperty Act 1925. Such receivers are appointed in a similarway to administrative receivers and act to realise the relevantassets for the benefit of the chargeholder.

Liquidation

In a liquidation, a liquidator is appointed for the purposesof collecting in and realising the assets of a company anddistributing the realisations to satisfy, in so far as possible,its liabilities, and to distribute any surplus to its sharehold-ers (see Part IV IA 1986). A company may be wound upcompulsorily by the court or voluntarily.

The court may order that a company is put into compulso-ry liquidation on the presentation of a petition by the com-

pany, its directors, a creditor or shareholder on severalgrounds (set out in section 122 IA 1986), most commonlyon the ground that the company is unable to pay its debts.The Official Receiver will act as liquidator unless a liq-uidator is appointed by creditors and shareholders.

A voluntary liquidation is commenced by a resolution ofthe shareholders of a company and may be of two types:

F a members' voluntary liquidation (‘MVL’), whichrequires the directors to swear a statutory declaration ofsolvency within five weeks prior to the shareholders' reso-lution; or

F a creditors' voluntary liquidation (‘CVL’), where nostatutory declaration of solvency has been signed. In aCVL, a meeting of creditors must be held within 14 daysof the members' resolution.

In a compulsory liquidation or a CVL, the creditors' choiceof liquidator prevails if different to the one chosen by themembers.

A liquidator has no power to carry on the company's busi-ness except in so far as may be necessary for the beneficialwinding up of the company, but he has the power to dis-claim onerous property (giving the contractual counterpar-ty a right to prove for damages) and also has wide powers

129Insolvency

Chart One: Spectrum of restructuring processes

ADDITIONALDEBT

FINANCING?

HIGHYIELDISSUE?

ADDITIONALEQUITY

INJECTION?

COVENANTWAIVERS?

STANDSTILL

IBR MANAGEMENTCHANGE /

INCENTIVISA-TION

SALESPROCESS

BONDTENDEROFFER / SCHEME

SENIORDEBT

REFINANCING

DEBTFOR

EQUITYSWAP

PRE-PACKRECEIVERSHIP

RECEIVERSHIPADMINISTRA-

TION

LIQUIDATION

LBO6.qxd 3/12/04 2:02 pm Page 129

The United Kingdom (1.26)

The United Kingdom has a favourable environment in terms of:

1. Fund structure: (Limited Partnership, LP)

F The UK limited partnership is tax transparent fordomestic investors' tax purposes.F The UK limited partnership provides internationalinvestors with the ability to avoid having a permanentestablishment.F A tax efficient capital investment or incentive for fundmanagers can be incorporated. It should be noted that newlegislation introduced last year means that certain condi-tions must be met to achieve capital gains tax treatmentfor carried interest.F Management charges and carried interest are not liableto VAT, subject to structuring so that the general partnerand manager are in the same VAT group.F There are no undue restrictions on the types of invest-ments undertaken.

2. Merger regulation: The notification of a merger (fallingunder the national merger regulation thresholds) is voluntary,although in practice the voluntary system of notification isfrequently used for reasons of legal certainty. The mergerauthorities can investigate a merger on their own initiative.

3. Pension funds: Pension funds in the UK can invest inprivate equity and venture capital according to the pru-dent man rule. Nevertheless, the 'Minimum FundingRequirement' imposed on UK pension funds distort theirinvestment decision-making and impedes them fromincreasing their allocation to the asset class.

4. Insurance companies: Insurance companies can investin private equity, without any quantitative restrictions. Inpractical terms, most have permitted exposure limits,within which they must operate.

5. Company tax rate: The company tax rate in the UK is 30 percent, which is above the overall average of 28.8 per cent.

6. Company tax rate for SMEs: The UK has special tax rates forsmall companies6.

7. Income tax rate for private individuals: The maximumincome tax rate for private individuals in the UK is 40per cent,which is below the overall average of 45.3 per cent.7

8. Capital gains tax rate for individuals: The UK has a capitalgains tax rate of 10 per cent,which applies to business assets heldfor at least two years, which is below the overall average of 16.3per cent .

9. Tax incentives for private individuals: Incentives for privateindividuals exist via taper relief (see above), the EnterpriseInvestment Scheme (EIS) and Venture Capital Trust (VCT),subject to certain qualifying restrictions.

10. Entrepreneurial environment

Private limited company: (Limited, Ltd)F A private limited company can be incorporated either within5-7 business days, or on a 'same day' basis; if an incorporationagent is used, even the standard incorporation may only take oneor two business days. This time is below the overall average of23.5 business days.F Depending on the approach used, typical administrative costsfor setting up a private limited company range from £20-808

(€28-114) for direct filings, or £150-300 (€212-425) if, for con-venience, an incorporation agent is used. This cost is below theoverall average of €1,638.F There is no legal minimum issued capital requirement for aprivate limited company in the UK. However, at least one share(usually £1) must be issued.

Public limited company: (Public Limited Company, PLC)F A public limited company can be incorporated on a 'same day'

139Appendix

6. Note: this position has changed with effect from 1 April 2004. Profits between £10,001 (€14,174) and £50,000 (€70,871) are taxed at a special rate, with a 19% small companies rate applying to profits between £50,000 (€70,871) and £300,000(€425,230). A special rate applies to profits between £300,001 (€425 230) and £1.5 million (€2.1 million), and profits beyond that are taxed at the full 30%.7. Business Assets: All employee shareholdings qualify as business assets, whether in quoted or unquoted trading or non-trading companies (provided in the case of a non trading close company controlled by five or fewer participators, that the share-holding does not exceed 10%). Any other investment in unquoted trading companies and shareholding of 5% or more in quoted trading companies will also qualify.8. Exchange rate 1 January 2004 (€1 = £ 0.7055, Pound Sterling).

LBO6.qxd 3/12/04 2:03 pm Page 139

The following is a non-exhaustive list and explanation of themeaning of legal or financial terms commonly used in corpo-rate transactions. This list is not meant to be a substitute forlegal advice nor should the explanation of the terms be usedas definitions in transaction documents.

425 scheme – Also known as a scheme of arrangement. Astatutory compromise between a company and its creditorsand/or shareholders under section 425 of the Companies Act1985. Again, a procedure where all of the company's creditorscan be bound by a majority decision of creditors. However,this differs from a CVA in that it is subject to significantcourt control and creditors must be identified into separateclasses, which can often be a difficult issue.

Administration (under Schedule B1 to the Insolvency Act1986) – The passing of control of a business to an adminis-trator appointed under the Insolvency Act 1986:(a) with the objective of rescuing the company; or(b) where it is not reasonably practicable to rescue the com-pany, with the objective of achieving a better result for thecompany's creditors as a whole than would be likely if thecompany were wound up (without first being in administra-tion); or(c) where it is not reasonably practicable to rescue the com-pany or achieve the result mentioned in (b) above, with theobjective of realising property in order to make a distributionto one or more secured or preferential creditors.

Administrative receiver – Also known as a scheme ofarrangement. A statutory compromise between a companyand its creditors and/or shareholders under section 425 of theCompanies Act 1985. Again, a procedure where all of thecompany's creditors can be bound by a majority decision ofcreditors. However, this differs from a CVA in that it is sub-

ject to significant court control and creditors must be identi-fied into separate classes, which can often be a difficult issue.

Administrative receivership – The control of the whole orsubstantially the whole of a company's assets or business byan administrative receiver appointed by the holder of a qual-ifying floating charge with the purpose of realising the assetsof the company and applying the proceeds in repaying thesecured debt.The Enterprise Act 2002 prevents the holder ofa ‘qualifying floating charge’ from appointing an administra-tive receiver subject to certain exceptions.

Administrator – A licensed insolvency practitioner who isappointed to control a business as an administration underPart 2 of and/or Schedule B1 to the Insolvency Act 1986.

AIM – The Alternative Investment Market of the LondonStock Exchange was established in 1995 to replace theUnlisted Securities Market. This market has been tailored tosuit smaller companies with lower market capitalisations byhaving admission requirements which are less stringent.

Blue Book – See Takeover Code/The Code.

Bought deal – Used when a deal-maker provides all of thefinance needed for a buy-out deal and then sells on or syndi-cates part of the funding to other investors at a later stage.Bought deals are often used by the larger providers of financewhen speed or confidentiality is particularly important.

Break fee – A payment to be made by the seller to thebuyer if a competing offer for the target emerges and isaccepted in place of the original offer by the buyer. Thebreak fee acts as an inducement to encourage the buyer tomake the offer.

Appendix Two: Glossary


LBO6.qxd 7/12/04 5:48 pm Page 142

151Appendix

Jonathan AngellJonathan specialises in corporate law and mergers andacquisitions, particularly private equity. He has consider-able experience of, and advises a number of leading UK,continental European and US private equity firms in rela-tion to, all forms of private equity transaction. Jonathanhas particular expertise in relation to cross-border mergersand acquisitions.

Simon BeddowSimon Beddow has experience across a wide range ofcompany law matters including mergers and acquisitions,takeovers (including public to privates) and private equitytransactions. Simon has particular expertise in cross-bor-der merger and acquisition transactions.

Giles BoothmanGiles Boothman advises clients on a broad range of corpo-rate matters including mergers and acquisitions, privateequity investments and joint ventures. He also specialises innon-contentious reconstruction and insolvency law andadvises insolvency practitioners, companies in financial dif-ficulties and investors in troubled companies, particularlyfocusing on large reconstructions and insolvencies.

Charlie GeffenCharlie Geffen is head of private equity at Ashurst. Headvises many of the leading buy-out houses in the UK andthe US as well as domestic and overseas corporate clients,many of which are publicly quoted companies. He haswide experience of corporate and commercial activities,with particular emphasis on leveraged buy-outs, cross bor-

der transactions, fund raisings, mergers and acquisitionsand other corporate finance matters.

Richard PalmerRichard specialises in UK and international tax planning.His practice focuses on the tax aspects of corporate dis-posals and reconstructions, in particular structuring andfinancing cross-border buy-outs, mergers, acquisitions andjoint ventures. Most of these involve US, UK and otherEuropean corporates. He has considerable experience instrategic international tax planning involving Europeanholding companies and in advising companies on both UKinward and outward investment.

Nigel ParrNigel Parr specialises in all aspects of EU and competitionlaw particularly merger control. He has substantial experi-ence in dealing with the EC Commission, UK regulatoryauthorities, privatised utilities regulators and anti-trustauthorities in other jurisdictions.

Paul RandallPaul Randall is head of Employee Benefits and Incentives.He specialises in advising domestic and non-UK compa-nies on the design, implementation and operation ofemployee share schemes, onshore and offshore trusts, long-term incentive plans and all forms of bonus and incentiveplans. He has extensive experience of management buy-outs, mergers and acquisitions, takeovers, flotations, IPOsand reorganisations. His clients include FTSE 100 andother quoted companies as well as start-up, private andbuy-out companies.

Appendix Three: Ashurst Partner Profiles

LBO6.qxd 3/12/04 2:03 pm Page 151


Mark VickersMark Vickers specialises in UK and cross-border lever-aged finance transactions, particularly management andinstitutional buy-outs. He is one of the market's leadingexperts on the debt funding of public to private takeovers.He also has considerable experience of bid finance, seniorand mezzanine financing facilities, structured finance, andglobal syndicated lending.

Nigel WardNigel Ward is head of International Finance at Ashurst.He specialises in general banking law including acquisi-tion finance, European high yield, structured finance andrestructurings. He is a member of the banking law sub-committee of the City of London Law Society.

LBO6.qxd 3/12/04 2:03 pm Page 152

153Appendix

The Centre for Management Buy-out Research (CMBOR)was founded by Barclays Private Equity Limited andDeloitte at the Nottingham University Business School inMarch 1986 to monitor and analyse management buy-outsin a comprehensive and objective way.

The Business School is based in the state-of-the-art JubileeCampus, a 40-acre site approximately one mile from themain University Park campus. The campus also contains theSchool of Computer Science, the School of Education andthe National College for School Leadership.

As an independent body, CMBOR has developed a wide-ranging and detailed database of over 20,000 companieswhich provides the only complete set of statistics on man-agement buy-outs and buy-ins in the UK and continentalEurope. CMBOR also publishes regular reports on UK buy-out trends in its Quarterly Review, as well as the results ofspecialist survey and case study research on relevant issuesboth in buy-outs in the UK and Western Europe.The annu-al European Management Buy-out Review is produced tocomplement this, providing an analysis and review of buy-out trends throughout Continental Europe. Its newest pub-lication, Exit, provides definitive statistics and analysis onbuy-out exits.

In addition to its core research publications, CMBOR alsoundertakes bespoke research activity on a funded basis.CMBOR has carried out work for UK and international gov-ernment agencies, venture capitalists, banks and professionaladvisers. The Centre maintains an important international

network of academic and professional collaborators inWestern Europe, the CEE countries and North America.

Contact the Centre for Management Buy-out Research:

Andrew BurrowsDirector Tel: +44 (0)115 951 5494 Fax: +44 (0)115 951 5204 [email protected]

Professor Mike Wright Director Tel: +44 (0)115 951 5257 Fax: +44 (0)115 951 5204 [email protected]

Centre for Management Buy-out ResearchNottingham University Business SchoolJubilee CampusWollaton RoadNottingham NG8 1BBUnited KingdomTel: +44 (0)115 951 5493Fax: +44 (0)115 951 5204www.cmbor.com

Appendix Four: About the Centre for Management Buy-outResearch (CMBOR)

LBO6.qxd 3/12/04 2:03 pm Page 153