Private equity in UK (England and Wales): market and regulatory overview

A Q&A guide to private equity law in the UK (England and Wales).

The Q&A gives a high level overview of the key practical issues including the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.

To compare answers across multiple jurisdictions visit the Private Equity Country Q&A Tool.

This Q&A is part of the global guide to private equity. For a full list of jurisdictional Q&As visit


Market overview

1. How do private equity funds typically obtain their funding?

The principal sources of investment in 2013 were:

  • Pension funds. These accounted for the largest type of investor. Investment by pension funds increased to 26% in 2013, up from 18% in 2012. The vast majority of this funding came from overseas.

  • Sovereign wealth funds. These accounted for the second largest type of investor, representing 17% compared to 22% in 2012.

  • Funds of funds. 13% of overall investment in 2013 came from funds of funds. This figure remained unchanged from 2012.

  • Banks and insurance companies. This decreased to 11% in 2013, down from 12% in 2012.

  • Corporate investors. This decreased to 4%, down from 12% in 2012.

  • Private individuals. This remained relatively stable at 4%, compared to 6% in 2012.

2. What are the current major trends in the private equity market?

PE deal flow in the UK and Ireland declined somewhat in 2014, when compared with 2013. PE and VC firms closed 1,349 deals in 2014, down from 1,473 deals in 2013. Intra-year, UK and Irish PE deals declined from 399 in the second quarter, to only 303 in the fourth.

In the light of a buoyant stock market and low interest rates, PE firms concentrated on exits in 2014. On the buy-side, there has been a general perception that high-quality assets are becoming harder to source and buyers have to fight hard for those that do.

3. What has been the level of private equity activity in recent years?


The level of UK private equity (PE) and venture capital (VC) fundraising nearly doubled from GB£5.9 billion in 2012 to GB£11.2 billion in 2013.


In 2013, the UK accounted for more than a quarter of European buyout volume and value with 243 deals valued at EUR18.6 billion.


Between 2011 and 2013 the amount per calendar year invested in the UK by PE and VC funds was from GB£6.5 billion to GB£4.2 billion. The greatest UK investment in 2013 was in industrials, which saw investment of GB£863 million. This was followed by investment in consumer services, valued at GB£793 million. Investment in technology was valued at GB£787 million, with investment in healthcare of GB£660 million in 2013. Regionally, investment in 2013 was greatest in London, with GB£1.6 billion. The second highest level of investment by region was in the East Midlands, which saw investment of GB£540 million in the same year.


The total value of UK divestments by PE and VC funds in 2013 was GB£12.9 billion. The most significant type of divestment by value was trade sales, accounting for just over GB£2.0 billion. Sales to other PE or VC firms were just under GB£2.0 billion. Funds benefited from improved UK equity capital market conditions in 2013, with over GB£1.5 billion raised from flotations (up from GB£297 million in 2012). The UK saw 30% of total European exit value, in 2013, an increase from 15% in 2012.



4. What recent reforms or proposals for reform affect private equity in your jurisdiction?

AIFM Directive

The transitional provisions that effectively postponed the impact of the alternative investment fund managers directive (AIFM Directive) came to an end in July 2014. The AIFM Directive regulates managers of alternative investment funds, which include private equity (PE) funds (subject to some limited exemptions). Included among the many compliance requirements imposed by the AIFM Directive are some provisions that will apply specifically to PE. For example there are:

  • Notifications to be made when significant stakes are taken in unlisted companies (or if such stakes are disposed of).

  • Requirements surrounding the acquisition of control of unlisted companies, relating to, for example:

    • preparation of various communications and disclosures;

    • establishment of time-limited safeguards against the erosion of capital (asset stripping); and

    • production of development plans and policies in relation to such portfolio companies).

  • Requirements on due diligence needed during the investment process.

The AIFM Directive also regulates the marketing of alternative investment funds in the European Economic Area (EEA). It provides for a marketing "passport" throughout the EEA where both the manager and the fund are EEA based, which can unlock pools of capital in jurisdictions previously inaccessible due to restrictive local marketing laws. However, where one or other of the fund or manager is established outside the EEA, marketing in some jurisdictions has become more difficult than it was previously.

5. What tax incentive or other schemes exist to encourage investment in unlisted companies? At whom are the incentives or schemes directed? What conditions must be met?

Venture capital trusts (VCTs)

A VCT is a listed company that encourages individuals to invest indirectly in a range of small, unquoted trading companies.

For a company to qualify for tax relief as a VCT, various conditions must be met, including:

  • No more than 15% (by value) of its investments can be in a single investee company (other than another VCT).

  • At least 70% (by value) of a VCT's investments must be shares or securities in qualifying holdings (broadly speaking, small unquoted companies).

A private individual investing in a VCT receives:

  • Relief from capital gains tax (CGT) on the sale of the shares.

  • Tax-free dividends on shares, subject to certain limits.

  • Income tax relief at 30% of the amount invested in newly issued ordinary shares in a VCT, subject to certain limits.

Enterprise investment scheme (EIS)

The EIS allows certain individual investors to invest in small companies directly rather than through a VCT. The conditions are similar to those for VCTs (see above, Venture capital trusts (VCTs)).

The investor must not be connected with the company at any time between two years before and three years after the issue of the shares.

Provided the shares are held for at least three years, the tax reliefs available include:

  • An income tax reduction calculated at 30% of the amount invested in shares (up to the investment limit of GB£1 million).

  • Deferral or rollover relief from CGT for gains realised on disposal of any asset, if the proceeds are reinvested in a qualifying EIS investment.

  • Capital gains on the sale of EIS investments are exempt from CGT.

Seed enterprise investment scheme (SEIS)

SEIS is broadly similar to EIS except that it is intended to give relief for investments in smaller companies, which are deemed to be higher risk (see above, Enterprise investment scheme (EIS)).

Points common to VCTs, EIS and SEIS

New rules were announced in the 2015 Budget that will, subject to State Aid approval, require that companies must be less than 12 years old when they receive their first EIS or VCT investment, except where the investment will lead to a substantial change in the company's activity. The 2015 Budget also capped the maximum amount a company can receive through VCT and EIS investment at GB£15 million, rising to GB£20 million for knowledge intensive companies.

Legislation will be introduced in the Finance Bill 2015 to exclude investments in companies that benefit substantially from subsidies for the generation of renewable energy from benefitting under the EIS, SEIS and VCT schemes from 6 April 2015.

A government consultation examining potential future amendments to VCTs, EIS and SEIS, including extending the reliefs to cover convertible loans was concluded in September 2014. The results of this consultation have not yet been published.

Social investment tax relief (SITR)

SITR was introduced in 2014 to encourage individuals to invest in social enterprises. Tax relief is available to an individual who subscribes for shares or makes a debt investment in a social enterprise that qualifies under the scheme.

Social venture capital trusts (social VCTs)

It was announced in the 2015 Budget that, subject to receiving state aid clearance, the government will set the rate of income tax relief for investment in Social VCTs at 30%. Investors will pay no tax on dividends received from a social VCT or capital gains tax on disposals of shares in social VCTs.

See also Question 10.


Fund structuring

6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction?

The choice of fund vehicle depends on a variety of factors, for example, the nature and location of the investments and an understanding of the investor base. In some cases the combination of factors means that an English limited partnership (LP) is a suitable vehicle, as it is tax transparent and thereby minimises leakage concerns. In other cases a transparent vehicle is not suitable and so, although an English LP may be used in some form and for some purposes in the arrangements, it is likely that alternative structures will be used in combination or as an alternative. For example, Scottish, Guernsey or Jersey partnerships all exhibit different qualities to an English LP, and so therefore provide for different tax outcomes.

While tax is a primary driver of legal structure and location, regulatory analysis following the AIFM Directive (see Question 4) is also necessary to ensure that the tax efficient structure that may be favoured does not inadvertently lead to problems with marketing or regulatory permissions.

7. Are these structures subject to entity level taxation, tax exempt or tax transparent (flow through structures) for domestic and foreign investors?

English and Scottish limited partnerships (LPs) are tax transparent for the purpose of UK taxation on income and chargeable gains. However, some foreign tax authorities (for example, France) do not recognise this tax transparency.

LPs established in other jurisdictions are generally treated as tax transparent for the purposes of UK taxation on income and chargeable gains. The approach of HM Revenue & Customs (HMRC) to the UK tax treatment of certain relatively new Jersey forms of partnerships is not yet certain.

Some investors, most commonly US tax-resident investors, can require an LP in which they invest to elect to be treated as a corporate for US tax purposes (certain entities can also elect to be disregarded as separate entities for US tax purposes).

If another non-corporate vehicle is used instead of an LP and qualifies as an offshore fund for UK tax purposes, then the entity is treated as a corporate entity for the purposes of UK taxation on chargeable gains.

8. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as being tax inefficient (whether by not being recognised as tax transparent or otherwise)? What alternative structures are typically used in these circumstances?

The following structures are not tax transparent and are not typically used for investment in the UK:

  • Delaware limited liability corporations (LLCs). A recent Court of Appeal decision confirmed that a particular Delaware LLC was not tax transparent. An appeal was heard by the Supreme Court in December 2014 and a decision is awaited.

  • LLCs established in other US states.

  • Luxembourg sociétés en commandite par actions (SCAs).

  • Luxembourg sociétés d' investissement en capital à risque (SICARs). These can be opaque or transparent depending on the structure used because SICARs can be partnerships or companies.

  • Foreign companies in general.

An LP is typically used instead of these entities. Where an offshore entity other than an LP is used, a UK investor's interest in that entity may constitute an interest in an offshore fund.


Investment objectives

9. What are the most common investment objectives of private equity funds?

The success of a private equity (PE) investment (and of a PE fund overall) is generally measured by two performance metrics:

  • Internal rate of return (IRR) (that is, the discount rate applied to any given future cash flows from an investment that would produce a net present value of zero).

  • Total money multiple.


Fund regulation and licensing

10. Do a private equity fund's promoter, principals and manager require authorisation or other licences?

Carrying on a "regulated activity" (which covers most forms of financial services), by way of business in the UK requires authorisation (absent an exemption) from the Financial Conduct Authority (FCA).

Private equity fund managers managing non-UCITS (Undertakings For The Collective Investment Of Transferable Securities) funds in the UK must be authorised by the FCA to carry on the regulated activity of "managing an AIF" (alternative investment fund). They may also hold permission to manage UCITS and carry on certain other regulated activities such as managing investments and advising on investments.

Authorisation is not required for pure promotional activity. However, in practice most entities engaged as promoters are FCA authorised firms with permission to carry on regulated activities such as advising on investments and arranging deals in investments.

Promotional activity is subject to the UK financial promotions regime, which restricts the types of investors to whom LP interests can be promoted. Generally, this means that LP interests can only be promoted to high net worth companies, investment professionals, and possibly (depending on the investment profile of the particular fund) certified high net worth individuals and certified sophisticated investors. In addition, the UK has implemented additional marketing conditions that apply to the marketing of AIFs (for example, pre-investment disclosure and ongoing reporting requirements).

11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?


A fund that is established in the UK and takes the legal form of an authorised unit trust (AUT), investment company with variable capital (ICVC) or authorised contractual scheme (ACS) must be authorised by the FCA.

Other types of funds (for example, limited partnerships (LPs)) are not required to be authorised by the FCA. The FCA regulates those conducting regulated activities (for example, the fund manager) and not the fund itself (see Question 10).

Depending on the fund's structure other rules and regulations may apply, such as the conditions for VCTs (see Question 5).


Offers of LP interests can generally be made without requiring an offering document that is compliant with Directive 2003/71/EC or a prospectus to be published when securities are offered to the public or admitted to trading (Prospectus Directive) by ensuring that the offer is exempt (most commonly by limiting the number of investors to whom it is marketed or prescribing a minimum or maximum investment amount).

12. Are there any restrictions on investors in private equity funds?

There are no restrictions on the identities of investors in PE funds that are LPs, outside of money laundering and KYC (know your customer) requirements. However, LPs can typically only be marketed to a limited class of persons (see Question 11).

13. Are there any statutory or other maximum or minimum investment periods, amounts or transfers of investments in private equity funds?

There are no statutory requirements on investment periods, amounts or transfers for private equity (PE) funds structured as limited partnerships (LPs). However, LPs are usually closed-ended, so do not allow redemptions. LP agreements typically provide for minimum subscription levels and limit transfers. See also Question 5.

As a general matter, investments into PE funds are relatively long-term commitments, with the life of a fund typically lasting for about ten years but potentially longer. Distributions to limited partners occur only when the fund's investments are realised.


Investor protection

14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek?

Private equity funds structured as English limited partnerships (LPs) are governed by a partnership agreement. The partnership operates through a general partner (GP), but the GP usually delegates management of the LP to a management company that contracts directly with the partnership. Individual investors may also negotiate side letter terms with the fund or co-invest alongside the fund in relation to specific investments.

Examples of protections that LP investors typically seek to negotiate include:

  • Investment restrictions, including restrictions on borrowing.

  • Regulation of conflicts of interest, in particular restrictions on raising competing funds.

  • Key person clauses.

  • Removal of the manager and the general partner (for cause or for no cause).

  • Clawbacks of incentive fees that have been paid in excess of the manager's entitlement.

  • The appointment of an investors' advisory committee.

Subject to these protections, investors are typically passive investors and have no management rights in relation to a fund. Any interference by investors in the management of an English LP may lead to investors losing their limited liability status.


Interests in portfolio companies

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? Are there any restrictions on the issue or transfer of shares by law? Do any withholding taxes or capital gains taxes apply?

Common forms

Private equity funds commonly invest through a combination of equity (in the form of ordinary and preference shares) and debt instruments (most commonly loan notes and payment in kind notes).

Advantages and disadvantages

The corporate advantage of loan notes over preference shares is greater interest payment and repayment flexibility. The interest accruing on a loan instrument can be paid to the noteholder in circumstances where a fixed dividend payable on a preference share may not be able to be paid due to a lack of distributable profits. Similarly, a loan note can be redeemed in circumstances where the redemption of preference shares is not permitted.

Another advantage, subject to adequate structuring, is that a portfolio company may be able to claim a tax deduction on interest due on the loan notes. The extent to which a tax deduction may be obtained is restricted to interest on a level of debt that would be obtainable from a lender unconnected with the equity investor.

From a tax perspective, withholding tax may apply for debt investments but there is no UK withholding tax on dividends paid for equity.

Equity investments are generally subject to capital gains tax on the sale of the investment. However, investors may be able to benefit from entrepreneurs' relief in certain circumstances.


Any issue of shares is subject to statutory pre-emption rights unless these are expressly disapplied. There are generally no restrictions by law on the transfer of shares (subject to insolvency and bankruptcy laws, encumbrances that may exist over the shares and, of course, contractual restrictions).



16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply?

It remains common for buyouts of private companies to take place by auction. However, the perception of auctions as being the method of choice for private equity (PE) exits is less prevalent than it was in the middle of the last decade.

The auction process is controlled by the seller, with its lawyers producing a sale agreement on which a selected group of bidders comment. The success of a bid is based primarily on price but also on certainty of funds, the ability to execute the deal quickly (including any required conditionality) and the acceptability of comments submitted on the draft sale and purchase agreement.

Auction bidders entering into consortium or similar arrangements with potential buyers of the same asset should give careful consideration to any competition issues that may arise as a result of these arrangements. In particular, "bid-rigging arrangements", which are a criminal cartel offence under the Enterprise Act 2002. In bid-rigging arrangements one party bids and the other does not, or both parties bid subject to these arrangements, in circumstances where the seller is not aware of the arrangements.

17. Are buyouts of listed companies (public-to-private transactions) common? If so, which legislation and rules apply?

UK public-to-private activity remains relatively low. According to the Takeover Panel, which is the body that oversees takeovers of public and listed companies (and related activities) in the UK, there were a total of 33 successful UK takeovers leading to a change of control in the year to 31 March 2014. Examples include Hg's offer for Allocate Software plc, Vista Equity Partners' offer for Advanced Computer Software Group plc for GB£725 million and TPG Capital LLP's offer for Prezzo plc for GB£303.7 million, both announced in November 2014.

Public to private transactions are subject to more stringent regulation than a standard private company acquisition. The acquisition of a publicly listed company is governed principally by the City Code on Takeovers and Mergers (City Code) but also by:

  • Listing Rules (comprising the Disclosure and Transparency Rules, the Prospectus Rules, the Combined Code on Corporate Governance and the Admission and Disclosure Standards) and the Model Code on Directors' Dealings.

  • Companies Act 2006.

  • Financial Services & Markets Act 2000.

  • Criminal Justice Act 1993.

  • EU Directive 2004/25 on takeover bids.

  • EU Regulation No 596/2014 on market abuse.

The Takeover Panel introduced a number of significant changes to the City Code in 2011, including the imposition of an outright ban on all "offer related arrangements", which include:

  • Any agreement to pay a break fee, work fee or similar.

  • The agreement to any no-shop undertaking by the target company or any other form of exclusivity.

  • Any agreement to provide matching rights in the event of a competing bid or any other form of deal protection for the bidder.

The changes also introduced a mandatory 28 day "put up or shut up period" following the public naming of a potential bidder, on the expiry of which (unless the potential bidder can persuade the target company to seek an extension of time from the Takeover Panel)‎ that potential offeror must either:

  • Announce a firm intention to make an offer that constitutes a binding commitment to make the bid and requires funding to be available on a committed and certain funds basis at the time of the announcement.

  • Withdraw (with the consequence that the potential bidder will be prohibited from making a bid for that target company for six months subject only to certain very limited exceptions).

These developments have been widely regarded as being disadvantageous to private equity bidders, due to:

  • Their preference for cost protection against a failed bid.

  • Their general disinclination to make hostile bids.

  • The longer lead time, which results from the requirement for significant levels of bank funding.

Principal documentation

18. What are the principal documents produced in a buyout?

The principal documents produced in a buyout are the:

  • Sale and purchase agreement (between the buyer and the seller).

  • Disclosure letter.

  • Tax deed.

  • Investment agreement or shareholders' agreement (between the private equity investor, the management shareholders and the holding company in the investment group).

  • Articles of association of the holding company.

  • Service agreements for the senior managers.

A leveraged buyout also has banking documents comprising a facility agreement and security package (including an inter-creditor agreement).

There may also be a loan note instrument if the investor is taking loan notes as part of its investment or if part of the consideration payable for the target is in the form of loan notes in the investee company.

Buyer protection

19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management? Are these contractual protections different for buyouts of listed companies (public-to-private transactions)?

Completion accounts and locked box accounts

In a buoyant buyout market controlled by sellers (and in particular in auction sales), buyer protection is focused on due diligence, as warranties are likely to be limited. In an auction sale a locked box mechanism is also common, fixing the date of economic transfer of the target before completion and avoiding the need for completion accounts. However, where it is possible to negotiate for their inclusion, completion accounts remain an important price adjustment mechanism and protection for the buyer, allowing for an upward or downward adjustment of the purchase price based on a statement of the financial position of the target at completion.

Warranties and indemnities

Private equity (PE) funds typically look for warranty and indemnity protection from both the seller in the sale and purchase agreement and management (to the extent different) in the investment agreement or a separate warranty deed. Warranties from the seller are typically operational warranties, while those from the management are often limited to future performance, projections and the business plan. Where management give operational warranties, these are often given on an awareness basis with a relatively low limit on the amount of damages that may be recovered on a breach. The purpose of warranties given by management is generally viewed as being to encourage full disclosure of relevant matters, rather than constituting a meaningful risk allocation exercise.

A tax deed providing an indemnity in respect of pre-completion tax obligations is also commonly expected.

On secondary or tertiary buyouts, where the seller is also a PE fund, the availability of warranty and indemnity deal protection is much more limited as PE funds will not usually offer business warranties or tax indemnities (although these may still be available from the incumbent management team). In these circumstances, warranty and indemnity insurance is becoming more prevalent to at least partially make up for any shortfall in the protection available to the bidder.

Restrictive covenants

Private equity funds also look for restrictive covenants from management or corporate sellers, to preserve the target's goodwill. PE sellers are rarely, if ever, willing to give restrictive covenants on a sale.

Listed buyouts

The contractual protection available on listed buyouts is extremely limited. While an offer document will generally contain a large number of conditions precedent relating to the state of the target business, the Takeover Panel (see Question 17) will very rarely permit these to be invoked in order to prevent the takeover from occurring.

20. What non-contractual duties do the portfolio company managers owe and to whom?

The statutory duties imposed on company directors are codified in the Companies Act 2006 (Part 1, Chapter 2). Directors must act in a way they consider in good faith and likely to promote the success of the company for the benefit of its members as a whole. They must also exercise independent judgement and reasonable care, skill and diligence. The Companies Act 2006 widened the circumstances in which a shareholder can bring a derivative action (in the name of the company) against an offending director, although a director's duties remain owed to the company.

21. What terms of employment are typically imposed on management by the private equity investor in an MBO?

The principal areas for concern for a private equity investor are:

  • Garden leave and notice. A manager is required to remain employed but not work during a period of garden leave. This is expensive for the company but effective (and difficult to resist by the manager) in ensuring that the manager does not join a competing business during the period of garden leave, taking with him his commercially sensitive knowledge. The length of notice period is typically dependent on the seniority of the manager.

  • Restrictive covenants. A manager may be subject to a number of restrictive covenants (both for his obligations under the investment agreement and his employment contract). These typically comprise:

    • non-compete obligations;

    • non-solicitation obligations (in respect of employees, customers and suppliers);

    • confidentiality obligations.

    The length and reach of restrictive covenants needs to be carefully considered to ensure that they are enforceable.

  • Grounds for summary dismissal. The investment agreement may contain cross defaults so that a breach under that agreement terminates the service agreement and vice versa, leading to enforced sale of the equity.

22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders' agreement or company governance documents?

The principal ways in which private equity (PE) funds exert a level of management control are through the investment agreement and the holding company articles. The extent of control is a matter of commercial agreement but typically includes:

  • Board representation and quorum. This can be anything from a single seat on the board to board control through a number of nominations, including that of the chairman. In addition there may be a requirement that the portfolio company's board is not quorate without the attendance of the fund-appointed director(s).

  • Information rights. PE funds are likely to require information rights in addition to any rights its board nominee(s) may have. This often includes information on the company's performance against projections and the likely achievement of banking covenants. This sits alongside the fund's right to appoint external advisers to examine the company's books and records.

  • Consent rights. PE funds will require consent rights for a number of actions and/or omissions of their portfolio company including:

    • changes in its business;

    • acquisitions and disposals;

    • issues of shares, options or rights to acquire shares or the redemption of shares;

    • undertaking or defending litigation;

    • increasing the remuneration or benefits available to senior employees;

    • increasing indebtedness;

    • changes to constitutional documents;

    • capital commitments.

  • Exit. A PE fund will require discretion over exit timing and execution (assuming it is a controlling investor).


Debt financing

23. What percentage of finance is typically provided by debt and what form does that debt financing usually take?

Historically, private equity transactions have been structured with a combination of debt and equity, the comparable proportions of each being driven by market conditions and the relative cost and availability of debt, with debt funding typically making up 60% to 75% of the overall financing.

Growing confidence has meant that debt multiples in attractive deals have increased; debt of five or six times EBITDA (earnings before interest, taxes, depreciation and amortisation) can be achieved on larger deals. However, regulatory pressures have had an impact over recent months in curtailing how aggressively leveraged buyouts are structured and the leveraged multiples that can be achieved. As the UK tax system generally favours debt over equity (or dividends) this will also have a bearing on the debt/equity structure of a transaction. The form of the debt is generally a mixture of term debt (which may be senior, second lien or mezzanine) and a working capital line (typically structured as a revolving facility).

Recent trends include unitranche loans (in substitution for senior and mezzanine loans) increasingly provided by a range of institutional investors on covenant-lite terms but at higher pricing. The high yield bond markets have been strong over recent years and provide another form of debt on larger deals. Other debt instruments, although less commonly provided by third-party lenders, include PIK (payment-in-kind) notes or debt instruments convertible into equity (for example, warrants or preferred equity certificates).

Lender protection

24. What forms of protection do debt providers typically use to protect their investments?


A debt provider will typically require security and cross-guarantees from the borrower and material trading subsidiaries of the post-acquisition group. The security granted will usually include fixed and floating charges over all of the assets and undertakings of the trading group.

Contractual and structural mechanisms

Debt providers can subordinate competing claims between themselves (senior v mezzanine) or with other creditors (debt providers v equity providers) on an insolvent liquidation either structurally or contractually (or both together):

  • Structural subordination. This is achieved by inserting an intermediate holding company or a number of intermediate holding companies between the acquisition vehicle and the private equity fund. Senior debt is lent to the acquisition vehicle and any higher yield debt instruments or equity funds are lent to those intermediate companies higher up the acquisition structure. Any payments up the structure are only made once the senior debt is paid.

  • Contractual subordination. This is achieved by putting in place an inter-creditor agreement, the terms of which can determine, contractually, the ranking of security between debt and equity providers. It will often prohibit the payment of dividends or redemption of share capital or repayment of equity loans until the external debt, both senior and mezzanine, has been repaid.

It is common to have both structural and contractual subordination in UK transactions.

Financial assistance

25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions?

There is no longer a prohibition on a private company providing financial assistance for the purchase of shares in itself or in another private company. However, the giving of financial assistance for this purpose by a public limited company remains prohibited (sections 677 to 683, Companies Act 2006). Similarly, a private company is prohibited from giving financial assistance for the acquisition of shares in its public limited holding company.

Insolvent liquidation

26. What is the order of priority on insolvent liquidation?

In an insolvent liquidation the debt providers take priority over the shareholders in any distribution of assets. The order of priority (in broad terms) is as follows:

  • Any creditor holding a fixed charge over assets of the company.

  • The fees and charges of the liquidation.

  • Debts owed to preferential creditors (including wages owed for the four months immediately before the liquidation or occupational pension contributions).

  • Any creditor holding a floating charge.

  • Unsecured creditors.

  • Shareholders.

Equity appreciation

27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options?

A debt provider may seek to achieve equity appreciation through either convertible debt instruments (which automatically convert to equity on a particular event) or by acquiring options or warrants.


Portfolio company management

28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction?

A portfolio company's management are typically incentivised to maximise returns on a successful exit by providing them with an equity share in the company (and therefore aligning, to the extent possible, the interests of management with those of the private equity (PE) fund). Common forms are:

  • Shares. Share ownership takes the form of the institutional strip (that is, ranking equally with the PE fund) and sweet equity. Sweet equity is typically acquired for a nominal amount and gives capital appreciation on a successful exit. Ratchet mechanisms may also apply to the shares held by management.

  • Share options. Caution should be exercised when granting options, which may not be as tax efficient as other forms of equity-based incentivisation.

29. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

Reliefs and incentives depend on the structure of the transaction but the following are generally available.

Entrepreneurs' relief (ER)

ER gives managers an allowance of GB£10 million of capital gains on qualifying business disposals on which tax is charged at 10%. Gains in excess of the threshold are charged at the normal capital gains tax rates (currently 18% and 28%).

ER is available on a disposal of shares by a manager, provided that throughout a period of one year ending on the date of disposal the:

  • Company is a trading company.

  • Manager is an officer or employee of the company or a group company.

  • Manager owns at least 5% of the ordinary share capital of the company, which give the manager at least 5% of the voting rights; or the shares were acquired on or after 6 April 2012 as part of an Enterprise Management Incentive Scheme.

The GB£10 million allowance does not apply to past disposals and begins when the relief is first claimed. It is a lifetime allowance, and a tax rate of 10% can be claimed for any number of qualifying disposals that take place from 6 April 2008 onwards, until the cumulative limit of GB£10 million has been reached.

The Budget 2015 narrowed the circumstances in which ER was available. For disposals before 18 March 2015, ER was also available for shares held in the holding company of a trading company: these "manco" structures were frequently used to allow taxpayers to qualify for ER despite holding less than a 5% indirect interest in the underlying trading company. The budget has also narrowed the circumstances in which it is possible to claim ER in relation to a disposal of assets privately owned by a taxpayer but used in a company or partnership's business.

Enterprise management incentive (EMI) options

A company can grant EMI share options to management of small and medium sized independent, qualifying, trading companies in the UK.

Each manager can only hold unexercised EMI share options over a maximum of GB£250,000 worth of shares.

The company can grant options over shares with an aggregate market value at the date of grant of up to GB£3 million.

For an individual, the tax treatment of an EMI share option means that:

  • The exercise of an option within ten years of grant does not give rise to a liability to income tax or social security obligations, subject to certain conditions.

  • On the sale of shares following exercise, the gain made over the value of the shares at grant (or the option exercise price, if higher) is a chargeable gain for CGT purposes (subject to a rate of 18% or 28% depending on whether the individual is a basic or higher rate taxpayer).

EIS relief

See Question 5.

Employee shareholder status

The employee shareholder status came into effect on 1 September 2013. It is aimed principally at fast growing SMEs and designed to allow companies to create a flexible workforce by allowing employees to exchange their employment rights in return for shares in their employer.

Employees agree to give up certain employment rights in consideration for a gift of shares (employee shares) worth at least GB£2,000 (actual or restricted market value on the date of acquisition). Gifts of employee shares over GB£2,000 are subject to income tax (first GB£2,000 should be income tax free). Gain on the future disposal of employee shares worth up to GB£50,000 (unrestricted market value on the date of acquisition) is exempt from capital gains tax.

Employees must give up certain statutory rights in order to qualify.

Other Employee Share Schemes

A number of other tax-advantaged employee share schemes exist in the UK that can be used by managers to invest in their own company. These include Share Incentive Plans (SIPs), Sharesave Schemes (SAYEs) and Company Share Option Plans (CSOPs). Broadly, these provide for the grant and/or purchase of shares or options over shares in the company without giving rise to an income tax or social security liability, provided that the manager retains those shares or options for a set period.

30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors?

Payments by a portfolio company to its investors are restricted by the terms of any inter-creditor deed or deed of subordination that regulates:

  • The company's ability to make payments to its investors.

  • The order in which payments to its investors can be made.

The Companies Act 2006 also regulates and restricts a portfolio company's ability to pay dividends, restricting payments to investors to sums that are lawfully available for distribution. The AIFM Directive also imposes "asset stripping" restrictions that apply for the first two years following the acquisition of control of a portfolio company.

31. What anti-corruption/anti-bribery protections are typically included in investment documents? What local law penalties apply to fund executives who are directors if the portfolio company or its agents are found guilty under applicable anti-corruption or anti-bribery laws?

Under the Bribery Act 2010, an organisation can be liable for the acts of associated persons. For private equity (PE) firms, this could include its portfolio companies. Therefore, it is important for PE firms to ensure that there are suitable anti-corruption policies, covering day to day business activities and also governing relationships with agents, consultants and sub-contractors, implemented by the portfolio companies controlled by the firm and the firm itself.

This imposes a significant level of risk on executives who are acting as directors of portfolio companies, particularly in cases where that company's business is focused on market sectors or geographies that have historically tended to exhibit higher degrees of corruption risk.

Sanctions available under this legislation include imprisonment and potentially unlimited fines.

Investment documents therefore typically contain both representations as to past behaviour and behavioural covenants. These covenants are usually geared towards ensuring that appropriate business procedures are followed, therefore improving the chances that an "adequate procedures" defence can be run if necessary.


Exit strategies

32. What forms of exit are typically used to realise a private equity fund's investment in a successful company? What are the relative advantages and disadvantages of each?

A private equity (PE) buyout fund typically looks for an exit between three and five years after its initial investment (although these hold periods are often longer in certain sectors, for example infrastructure). Common forms of exit include:

  • Initial public offerings (IPOs). Over the last 18 months, IPOs have become an increasingly common means of exit. The disadvantage of an IPO is that the PE fund is unlikely to be able to dispose of the entirety of its stake at the time of the IPO and will be subject to a lock-up period in respect of any retained stake (in order to prevent detrimental effects on the company's valuation as a result of the fund immediately selling its shares following the IPO). The cash return to the fund is therefore delayed and the fund may be exposed to adverse price variations between the IPO and the final cash realisation.

  • Trade sale. This is a simple exit with no significant disadvantage and with the opportunity to return cash to the fund immediately.

  • Secondary buyout. A secondary buyout involves a sale of a portfolio company to another PE fund. However, the exiting fund is exposed to potential market embarrassment if the acquiring fund achieves a swift exit with a significant return.

  • Asset sales. These are less common as a means of exit and are likely to be tax driven. A liquidation of the portfolio company following the sale of its assets allows the return of cash to the investors through a distribution on winding-up. There is an administrative delay between sale of the assets and the return of cash to the fund.

  • Portfolio sales. Portfolio sales where a PE fund sells a group of its investments to another fund are also relatively uncommon. They are often driven by the requirement to wind-up a particular fund. Certain PE funds specialise in making whole portfolio acquisitions from other funds.

33. What forms of exit are typically used to end the private equity fund's investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

Where the investment has been unsuccessful the options for the private equity fund are limited. It can sell at a loss if there is an interested party or the company may go into insolvent liquidation, which is an unattractive prospect for an investor who may have directors on the board whose actions may be scrutinised. More common in recent years have been pre-pack deals where a deal for the sale of the assets and business is reached before the appointment of an administrator.


Private equity/venture capital association

British Private Equity and Venture Capital Association (BVCA)


Status. The BVCA is a non-governmental organisation.

Membership. The BVCA has over 500 members, comprising over 230 private equity (PE) and venture capital (VC) firms along with other professional advisory firms.

Principal activities. The BVCA is the industry body for the PE and VC industry in the UK. It is a promoter and advocate for the industry and its members.

Information sources. See website above.

Contributor profiles

James MacArthur, Head of Private Equity

Herbert Smith Freehills LLP

T +44 20 7466 2662
M +44 79 1239 4343

Professional qualifications. England and Wales, 1999

Areas of practice. Private equity.

Recent transactions

  • Antin Infrastructure Partners on the acquisition of Westerleigh Group and on the purchase of a significant stake in the CATS pipeline and associated infrastructure.

  • Carlyle on the sale of a number of properties in their London real estate portfolio including the divestment of Millennium Bridge House by way of a corporate sale of the Jersey owning company and on the sale of Alban Gate to Blackstone, by way of corporate sale and in relation to the sale of Freeport Group.

  • Cabot Square Capital on a number of transactions including its acquisition of LeaseDirect Finance from Investec Bank, the MBO of Asset Alliance, a vehicle leasing business, the MBO of Henry Howard Finance and the sale of Signature Senior Lifestyle.

  • Hannam and Partners in relation to the purchase of MKM, a German manufacturing business, and the acquisition of Compact GTL.

Mark Bardell, Partner, Corporate

Herbert Smith Freehills LLP

T +44 20 7466 2575
M +44 78 1857 3382

Professional qualifications. England and Wales, 2001

Areas of practice. Mergers and acquisitions.

Recent transactions

  • Euromoney Institutional Investor on its acquisition of its strategic 15.5% stake in an ongoing joint venture with The Carlyle Group in relation to its US$700 million acquisition of Dealogic Holdings.

  • Sky on the GB£800 million sale of its controlling stake in its betting and gaming business, Sky Bet, to funds advised by CVC Capital Partners and ongoing joint venture and other commercial arrangements.

  • Lazard and Credit Suisse acting as financial advisers to the Independent Committee of the Board of ENRC in response to the GB£3.0 billion unsolicited bid and delisting proposal from a consortium comprising the founding shareholders of ENRC and the Ministry of Finance of the Republic of Kazakhstan.

  • VTB as lender and financial adviser to Essar Global Fund in relation to its successful takeover offer and US$2.0 billion acquisition of Essar Energy.

John Taylor, Senior Associate, Private Equity

Herbert Smith Freehills LLP

T +44 20 7466 2430
M +44 77 1454 0518

Professional qualifications. England and Wales, 2003

Areas of practice. Private equity.

Recent transactions

  • Antin Infrastructure Partners on the purchase of a significant stake in the CATS pipeline and associated infrastructure.

  • Blackstone Group International Partners on its acquisition of 25 North Colonnade, Canary Wharf.

  • Cabot Square Capital in relation to Blue Motor Finance and JBR Capital.

  • Carlyle Europe Estate Partners on the sale of the Freeport Group.

Sara Stewart, Senior Associate, Corporate

Herbert Smith Freehills LLP

T +44 20 7466 2036
M +44 78 0920 0992

Professional qualifications. England and Wales, 2004

Areas of practice. Tax.

Recent transactions

  • Joint venture between Pearson subsidiary The Financial Times with IE Business School to form a custom education business.

  • TSB Banking Group on its GB£1.3 billion IPO and listing on the London Stock Exchange.

  • Cazenove Capital on the GB£424 million recommended takeover by Schroders.

  • Blackstone Group International Partners on its sale of Chiswick Park.

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