Control Transactions in the UK Mid-Market
In a number of transactions in the UK mid-market in which we have been involved recently, we have noted a departure from the traditional private equity buy-out model, whereby the sponsor acquires 100% of the target and satisfies the consideration with a mixture of cash and paper issued by the acquiring entity. In transactions involving a partial acquisition of the target with some existing shareholders cashing out and others, typically management and their close affiliates, retaining a significant proportion of the equity, the rights afforded to the management team with respect to the governance and future exit of the target can be surprisingly different.
In such cases it is common for the continuing management team to retain a much larger stake in the target than would generally be the case in the traditional model. In such transactions the relationship between the management team and the sponsor tends to be more one of equals and this is reflected in the deal documentation as outlined below.
In the traditional model, management are generally asked to rely on the fact that their economic interests are aligned with those of the private equity house and other than basic minority protections, such as a tag right, they are offered little in the way of protection or control. In a control transaction it is common for the management team to seek certain limited protections. In control transactions we have seen, the management team has been afforded some degree of control against the sponsor taking certain fundamental actions without the consent of management, and indeed, in certain transactions we have seen the list of reserved matters over which management has a say goes much further and looks more similar to those that are required by a sponsor.
Another distinguishing factor of certain control transactions is that on occasion they can contain deadlock provisions with accompanying buy out rights (Texas shoot out/Russian roulette). These provisions would be highly unusual in a buy-out scenario where it is universally accepted that the investor is in full control especially in relation to an exit involving the target. The way in which these deadlock provisions are crafted can vary significantly, from fair market valuations at one end of the spectrum to Russian roulette provisions which are triggered when one party makes an offer for the other’s shares, and if this offer is not accepted the offeree must acquire the offeror’s shares for the same price per share.
In certain limited circumstance we have also seen control transactions featuring put/call arrangements with the investor in relation to management’s equity. These arrangements provide management with comfort that they can achieve full exit in the event that the company performs to plan. This is representative of the ‘growth capital’ view often taken on control transactions as opposed to the focus on a 3-4 year exit seen in more conventional transactions.
Whether or not a sponsor will be likely to accept such arrangements will clearly vary on a deal by deal basis but we have found that the sector in which the business operates can have a bearing on this. For example, a web-based trading based business will face few barriers to a full exit (assuming it is performing well) so may not be suitable for such an arrangement, whereas a financial services business (which would face various regulatory hurdles to achieve an exit and can be heavily reliant on key individuals) may be a more obvious candidate for a put/call arrangement to incentivise management to accept a partial exit in the knowledge that there is a mechanism for them to achieve a full exit in the future.
One further attraction of the control transaction model to a buy-out is the stamp duty transfer tax saving (in the UK which is charged at 0.5% of the market value of the shares disposed of and is payable by the purchaser) that can be achieved by acquiring only a proportion of the target entity.