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 multi-jurisdictional guide to private equity. For a full list of jurisdictional Q&As visit

Amanda Onions, David Harrison, Andy Treavett and Amelia Stawpert, Hogan Lovells International LLP*

Market overview

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

The market continued to show a broad investor base in 2012 and overall there was a marked increase in fundraising compared to 2011. However, the level of non-UK investment in UK-based funds dropped significantly to 27% (from 69% in 2011 and 56% in 2010). The principal sources of investment were:

  • Sovereign wealth funds. These accounted for the largest type of investor, representing 22% compared to 1% in 2011.

  • Pension funds. Investment by pension funds decreased to 18% in 2012 from 24% in 2011, with less than 40% of the sums invested coming from overseas (a marked change from 2011 when 75% came from overseas).

  • Funds of funds. 13% of overall investment in 2012 came from funds of funds. This showed a decrease against the 2011 figure of 25%, although it remains higher than the figure of 11% for 2011. The vast majority of funding in this category came from overseas.

  • Banks and insurance companies. This remained at 12% (the same as in 2011), but with a significant shift towards UK-origin funding instead of overseas funding.

  • Corporate investors. Entirely originating from the UK, this increased from 7% in 2011 to 12%.

  • Private individuals. This remained relatively stable at 6%, compared to 7% in 2011.

The statistics used in this article are sourced from the BVCA Report on Investment Activity 2012 and the BVCA Performance Measurement Survey 2012.

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

The performance of the UK private equity market has been significantly influenced by UK economic factors, with declining levels of investment in 2012. This was broadly reflective of the mixed economic data that emerged during that year and continued stress associated with problems in the Eurozone. This was offset by a recovery in the market during 2013 as fears relating to the Eurozone receded and economic performance indicators charted an uptrend, in parallel with equity markets.

The resurgence of the equity markets in the latter part of 2012 and in 2013 is the biggest recent trend, but private equity also performed well as an asset class during this period, with:

  • Overall ten year internal rate of return (IRR) at an average of 15% in 2012, compared to an average IRR of 12.3% for the FTSE All-Share index during the 2012 period.

  • An annualised IRR of 11.5% for 2012.

Returns were much stronger in 2013 showing an annual IRR of 19.2%. Ten year returns also increased to 15.7% (against a FTSE All-Share return of 8.8%) and the 'since-inception' returns for 2013 showed a slight increase at 14.1% against the 2012 figures but remained consistently close to the 15% level which has benchmarked that measure over the last decade. The main feature of 2013 were the venture capital funds with annualised returns for 2013 of 22.9%.

The overall decline in investment activity from GB£18.6 billion to GB£12.2 billion in 2012 was largely accounted for by investment overseas halving compared to 2011. However, venture capital as a class fared better, with the amount invested in venture capital as a whole rising to GB£708 million from GB£492 million in 2011, and the amount in overseas venture capital doubling to GB£365 million compared to 2011. By comparison to 2011, the value of investment in later stages decreased. Investment continued to be focused primarily in the UK and then in Europe.

Regionally there were a number of increases in total investment amounts, including in London and the South East, which continues to dominate the UK market with about 58% of total investment deployed in this region in 2012. Significant improvements in investment levels were also recorded in the South West of the UK, the North East and in Wales, while investment levels in Scotland and Northern Ireland both fell during the same period.

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


The amount raised in 2012 was significantly greater than in 2011, with GB£5.9 billion raised compared to GB£4.2 billion. However, this remains lower than the 2010 total. There is some optimism about future fundraising prospects as a result of these figures.


In 2012, the amount of investment deployed by UK funds overseas was GB£6.5 billion, a significant decrease of some 50% on the level of investment in 2011. In the UK market, the most active sectors for investment were industrials (25% of total investment), healthcare (21%), consumer (16%) and financials (15%).


The level of investment in respect of buyouts and buy-ins in 2012 increased slightly to 46% (from 45% during 2011). Expansion stage investment accounted for another 26%. The secondary market saw static levels of investment relative to the previous year at 17% of total investment.


A feature of 2013 was the return of the IPO as a viable exit route for private equity investors, with notable examples being the exits of Esure, Merlin Entertainment and Just Retirement. This compares favourably with performance in 2012, where the IPO exit route accounted for just 4% of total UK exits by value.

Significantly, exits to trade buyers continued to account for the largest proportion of overall UK exits during 2012/13, as these participants returned to the market to make strategic acquisitions.



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

AIFM Directive

Perhaps the most significant and controversial regulatory change to affect the UK private equity market is Directive 2011/61/EU on alternative investment fund managers (AIFM Directive). The AIFM Directive emerged as a response to international pressure for regulation of the industry, despite protests from the British Private Equity and Venture Capital Association (BVCA) that such regulation is unnecessary and will have a detrimental effect.

The AIFM Directive requires private equity funds and fund managers to:

  • Maintain transparency in relation to portfolio companies and employees.

  • Produce development plans and policies in relation to portfolio companies.

  • Make proposals for managing conflicts.

Fund managers must also comply with a number of ongoing obligations in respect of the management and operation of funds, and many will be required to seek FCA authorisation in respect of activities they perform that are within the scope of the AIFM Directive. Further, marketing UK funds in the EU and marketing non-EU funds in the UK is now subject to increased regulation.

The AIFM Directive limits the private equity industry's purported asset stripping practices by placing restrictions on:

  • Reductions of share capital.

  • Redemption of shares.

  • Acquisitions of shares.

  • Distributions.

The restrictions are limited to the early part of an investment and apply for a period of two years from completion of an acquisition.

Bribery Act 2010

The Bribery Act 2010 (Bribery Act) came into force on 1 July 2011. Under the Bribery Act, an organisation can be liable for the acts of associated persons. For private equity firms, this could include its portfolio companies. Therefore, it is important for private equity 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 both the:

  • Portfolio companies controlled by the firm.

  • Private equity firm itself.

A suitable risk assessment and due diligence enquiries regarding compliance with the Bribery Act (and any other applicable anti-corruption legislation, such as the US Foreign Corrupt Practices Act) should also be undertaken when making new investment decisions, including appropriate warranties and covenants to support the responses to such due diligence.

City Code on Takeovers and Mergers

See Question 17.


Tax incentive schemes

5. What tax incentive or 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 company listed on the London Stock Exchange (LSE) and is similar to an investment trust. It encourages individuals to invest indirectly in a range of small, unquoted trading companies whose shares and securities are not listed on a recognised stock exchange. VCTs are exempt from corporation tax on any gains arising on the disposal of their investments.

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

  • Its ordinary shares must be admitted to trading on an EU regulated market (Directive 2004/39/EC on markets in financial instruments).

  • Its income must derive wholly or mainly from shares or securities.

  • It must not retain more than 15% of the income it derives from shares and securities.

  • 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 any investment in shares and securities made by the VCT must be in ordinary shares with no preferential dividend or redemption rights (eligible shares).

  • At least 70% (by value) of a VCT's investments must be shares or securities in qualifying holdings, that is, companies that:

    • have a permanent establishment in the UK;

    • do not raise more than GB£1 million in any 12-month period under the VCT scheme;

    • carry on qualifying trades. Most commercial activities are qualifying trades, but some activities (such as farming, operating hotels, dealing in land, shares or securities, property development, financial activities or providing legal or accountancy services) do not qualify. Due to EU state-aid restrictions, trade in relation to ship building and coal and steel production is also excluded;

    • satisfy other requirements relating to the use of monies raised, including that the monies are used for the purpose of its trade and at least 70% of any SEIS investment must have been spent;

    • are unquoted (companies whose shares are dealt solely on the Alternative Investment Market are unquoted for these purposes);

    • are not controlled by another company;

    • have under GB£15 million of gross assets immediately before the VCT invests and under GB£16 million immediately afterwards;

    • have fewer than 250 full-time (or part-time equivalent) employees;

    • are not firms in difficulty, as defined for state-aid purposes.

  • The VCT's investments in securities must not be guaranteed by a third party.

  • At least 10% (by value) of shares or securities held by a VCT in each investee must be eligible shares.

A private individual investing in a VCT receives:

  • Relief from capital gains tax (CGT) on the sale of the shares (but no relief where the shares are sold at a loss).

  • Tax-free dividends.

  • Income tax relief at 30% of the amount invested in new ordinary shares in a VCT. There is a limit of GB£200,000 on the amount in relation to which relief can be claimed for any one tax year, and shares must be held for a minimum of five years, or relief will be withdrawn.

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. To qualify the investee company must:

  • Have a permanent establishment in the UK.

  • Be unquoted.

  • Carry on, and use the funds raised for, a qualifying trade and have spent at least 70% of any SEIS investment (see above, Venture capital trusts (VCTs).

  • Not be controlled by another company.

  • Have fewer than GB£15 million of gross assets immediately before the investment and fewer than GB£16 million immediately afterwards.

  • Have fewer than 250 full-time (or part-time equivalent) employees.

  • Not to be a firm in difficulty, as defined for state-aid purposes.

  • Meet certain other requirements.

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. Broadly, investors are connected if they:

  • Hold or are entitled to acquire more than 30% of the share capital, the issued share capital of the company or the voting power in the company.

  • Control the company.

  • Are an employee, partner or director of the company, unless they are an unpaid director or business angel (see Question 29).

The shares must be issued to the investor and must be both:

  • Ordinary shares with no preferential dividend (where the right to the dividend depends on a decision of any person or is cumulative) or redemption rights.

  • Fully paid up in cash on issue.

The issuing arrangements for the shares must not include any arrangements:

  • For a pre-arranged exit.

  • That protect investors against the risks of making the investment.

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

  • 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, but loss relief (against income or capital gains) can be claimed on a disposal of shares at a loss (less any income tax relief given).

Seed Enterprise Investment Scheme (SEIS)

SEIS is broadly similar to EIS except that it is intended to give relief for investments in smaller companies. Key differences from EIS are:

  • The investee company must:

    • carry on a new qualifying trade;

    • have fewer than GB£200,000 of gross assets before the investment and fewer than 25 full-time (or part-time equivalent) employees;

    • not have any existing EIS or VCT investment;

    • not raise more than GB£150,000 under SEIS and any other state aid scheme.

  • The tax reliefs are:

    • an income tax reduction calculated at 50% of the amount invested in shares (up to the investment limit of GB£100,000);

    • deferral or rollover relief from CGT for gains realised on disposal of any asset, if the proceeds are reinvested in a qualifying SEIS investment (50% of the reinvestment sum, subject to a GB£100,000 cap);

    • capital gains on the sale of SEIS investments are exempt from CGT, but loss relief (against capital gains only) can be claimed on a disposal of shares at a loss (less any income tax relief given).

Points common to VCTs, EIS and SEIS

The maximum amount a company can raise under EIS, SEIS, VCT and any other state aid schemes is GB£5 million.

Various anti-avoidance provisions apply to all of the schemes, including the denial of relief where they are used as part of arrangements with a main purpose of obtaining the relevant relief.


Fund structuring

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

Private equity funds that target institutional investors are most commonly established as limited partnerships (LPs), particularly English LPs. Scottish LPs are commonly used to provide separate legal personality where this is desirable. Guernsey LPs and Jersey LPs can also provide separate legal personality and both are also used to provide additional benefits such as greater flexibility as regards distributions of capital and access to lower tax rates. These lower tax rates may also be accessed through appointing an offshore general partner for a UK registered LP.

Due to the restrictions on marketing to retail investors that are not high net-worth individuals (see Question 11) and various tax incentives, retail investors generally invest through VCTs (see Question 5, Venture capital trusts (VCTs)).

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 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 Jersey SLPs and ILPs 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 (such as a fond commun de placement (FCP) or other contractual arrangement) 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). The Court of Appeal decision of HMRC v Anson [2013] EWCA Civ 6 (formerly known as Swift) confirmed that a particular Delaware LLC was not tax transparent, although permission has been granted for this to be appealed to the Supreme Court.

  • LLCs established in other US states (although note HMRC v Anson above).

  • 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?

Investments into a private equity fund are a relatively long-term commitment with the life of a fund lasting for about ten years but potentially longer. Distributions to limited partners will only happen when the fund's investments are converted to cash. The success of the fund is measured by its internal rate of return (IRR).


Fund regulation and licensing

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

Promoters and fund managers must be authorised by the UK Financial Conduct Authority to the extent that they carry out regulated activities. Most private equity fund managers conduct regulated activities such as managing an alternative investment fund (being an AIFM for the purposes of the AIFM Directive), operating a collective investment scheme, managing investments and arranging deals in investments. Promotion of a fund is possible without authorisation of the promoter (in its capacity as such) if it is to a limited class of investors (see Question 11). However, it is easy to stray from pure promotion into regulated activities such as advising and/or arranging, and in practice most promoters are FCA authorised. Additionally, any employees or officers of authorised firms that carry out key functions in a firm must also be individually authorised by the FCA.

Firms seeking authorisation must meet threshold conditions (which involves an assessment of the firm's suitability and resources) and maintain minimum levels of regulatory capital. Firms must comply with the FCA Handbook of Rules and Guidance on an ongoing basis.

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


The FCA (and the AIFM Directive) regulate those conducting regulated activities, that is, generally the managers and advisers and not the fund itself. Depending on the fund's structure other rules and regulations may apply, such as the conditions for VCTs (see Question 5).

LP interests cannot be marketed to the general public, but only to a limited category of investors including investment professionals and high net-worth or sophisticated companies and individuals (if certified as such), subject in some cases to an assessment of suitability of the investment for the investor.


Offers of LP interests can generally be made without requiring an offering document that is compliant with Directive 2003/71/EC on the 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). Funds that are listed on a regulated market, for example VCTs, must usually issue a prospectus in accordance with the Prospectus Directive requirements.

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

There are no restrictions on the identities of investors in private equity funds that are LPs, although LPs can only be marketed to a limited class of persons (see Question 11). Investors in VCTs must be at least 18 years old.

13. Are there any statutory or other limits on 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 funds structured as LPs. However, LPs are usually closed ended, so do not allow redemptions. LP agreements typically provide for minimum subscription levels and limit transfers.

For VCTs, EIS and SEIS shares, see Question 5.


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 LPs are governed by a partnership agreement. The partnership is usually managed by a management company that contracts directly with the partnership. Individual investors may also negotiate side letter terms with the fund and its manager.

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

  • Investment restrictions, including restrictions on borrowing.

  • The appointment of an investors' advisory committee.

  • 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.


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, but sometimes a combination of loan notes and payment in kind notes).

Advantages and disadvantages

The advantage of loan notes over preference shares is the greater 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 might 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.


Any issue of shares is subject to statutory pre-emption rights unless these are expressly disapplied.



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. This 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 do the deal quickly (including any required conditionality) and the level of comments submitted on the draft agreement.

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

Despite previous expectations that public to private transactions would increase, this has not been the case, with the market for these types of deals continuing to remain relatively muted. Public to private transactions were most popular in 2006/7 when they represented a large proportion of buyouts globally. However, because there is potential for dramatic fluctuations in the market (such as in 2007) having an equally dramatic effect on the investment, many private equity firms view public to private transactions as risky investments. This caution is influenced in part by deals such as Terra Firma's investment in the EMI Group, which saw Terra Firma lose its investment of approximately GB£1.7billion. The recent changes to the regulatory regime governing public to private transactions (see below) has also increased the risk profile of these types of transaction for private equity bidders.

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:

  • The Companies Act 2006.

  • The Financial Services & Markets Act 2000.

  • The Model Code on Directors' Dealings.

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

  • The Criminal Justice Act 1993.

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 provision of director irrevocable undertakings.

  • The agreement to any no-shop undertaking by the target company.

  • Any agreement to provide matching rights in the event of a competing bid.

The changes also introduced a mandatory 28 day "put up or shut up period" following the public naming of a potential offeror, on expiry of which that offeror must either:

  • Announce a firm intention to make an offer.

  • Withdraw (unless the target company agrees to join that potential offeror in seeking an extension from the Takeover Panel).

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 the requirement for significant levels of bank funding necessarily entails.

While it is difficult to judge the overall impact these changes have had on the appetite of private equity sponsors to engage in public to private transactions, it is easy to conclude that the additional complexity which they have introduced is unwelcome.


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).

  • Investment agreement (between the private equity investor and the management).

  • Investee company's articles of association.

  • Service agreements for the senior managers.

A leveraged buyout also has banking documents comprising a facility agreement and security package. 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 a loan note 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

In a buoyant buyout market dominated by auction transactions and controlled by sellers, buyer protection is focussed 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 funds typically look for warranty and indemnity protection from both the seller in the sale and purchase agreement and management 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 business plan. A tax deed providing an indemnity in respect of pre-completion tax obligations is also common.

On secondary or tertiary buyouts, where the vendor may well also be a private equity fund, the availability of warranty and indemnity deal protection is much more limited. In these circumstances, private equity bidders also commonly consider obtaining warranty and indemnity insurance coverage to at least partially make up for any shortfall in the protection available to them.

Restrictive covenants

Private equity funds also look for restrictive covenants from the sellers, to preserve the target's goodwill.

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

The statutory duties imposed on company directors and codified in the Companies Act 2006, state that a director must:

  • Act in a way he considers in good faith and likely to promote the success of the company for the benefit of its members as a whole.

  • Avoid conflicts of interest.

  • Act within his powers and in compliance with the company's constitution.

  • Exercise independent judgement.

  • Exercise reasonable care, skill and diligence.

  • Not accept any benefits from third parties.

  • Declare interests in proposed transactions or arrangements with the portfolio company.

Although directors' statutory duties are owed to the company, the Companies Act 2006 extended the circumstances where a shareholder can bring a derivative action against an offending director.

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, taking with him his commercially sensitive knowledge.

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

    • non-compete obligations;

    • non-solicitation obligations (in respect of employees and/or customers);

    • confidentiality obligations.

  • Grounds for summary dismissal. The investment agreement may contain cross defaults so that a breach under that agreement terminates the service agreement.

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?

Private equity funds exert management control in a number of ways and at a number of levels, principally through the investment agreement. The extent of control is a matter of commercial agreement between the parties 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. Private equity 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. Private equity funds may require consent rights in respect of a number of actions and/or inactions 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.


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. However, the current economic climate has seen some all-equity deals where bank debt has been scarce and debt multiples of only two to three times earnings before interest, taxes, depreciation and amortisation (EBITDA) have become common.

Growing confidence in the market has meant that debt multiples in attractive deals, have increased, where debt of four times EBITDA can be achieved.

Currently, the senior debt is typically provided by two or three banks, so that the banks are reducing their risk. Since the UK tax system 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 senior facility, mezzanine, working capital or other revolving facility, and some asset finance, if appropriate. In addition, although less common, there may be high yield instruments such as bonds 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 aims to protect its position through security and guarantees from the borrower and each material trading subsidiary of the post-acquisition group. This security typically includes fixed and floating charges over all of the assets and undertakings of the trading group, along with cross-guarantees between each of the group companies.

Contractual and structural mechanisms

Debt providers aim to avoid exposing themselves to competition with one another on an insolvent liquidation and accordingly look for subordination between themselves. This can be achieved either structurally or contractually:

  • Structural. Structural subordination is achieved by inserting an intermediate holding company or a number of intermediate holding companies into an acquisition structure. This places the senior debt in the lower acquisition vehicle, with any higher yield debt instruments or shareholder loans higher up the acquisition structure. Any payments up the structure are only made once the senior debt is paid through distributions by the acquisition vehicle. This is common in UK transactions.

  • Contractual. Alternatively, debt providers contractually subordinate their respective debt through an intercreditor agreement, determining contractually the ranking of security and often prohibiting the payment of dividends or redemption of share capital until the debt, both senior and mezzanine, has been repaid.


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 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. Common forms are:

  • Shares. Shares in the investee company are acquired for a nominal amount and give capital appreciation on a successful exit.

  • Ratchets. Ratchet mechanisms, which increase management's proportionate share of the equity on a successful exit, provide enhanced rewards in circumstances where threshold performance levels are exceeded.

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

With effect from 6 April 2011, the Finance Act 2011 introduced anti-avoidance legislation aimed at preventing third-party arrangements (including employee benefit trusts) which provides benefits to employees and associated persons as a means to avoid or defer liabilities to income tax and social security payments.

The legislation imposes a charge to income tax and social security payments under PAYE (that is, a system for withholding tax from payments to employees) when a relevant third party takes a relevant step in relation to relevant arrangements.

However, there are exemptions available for employee share plans, including for enterprise management incentive (EMI) options (see Question 29), but the impact of this anti-avoidance legislation must be considered when any share arrangement is operated in conjunction with an employee benefit trust.

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 or a holding company of a trading group.

  • 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 gives the manager at least 5% of the voting rights.

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 is reached.

Enterprise management incentive (EMI) options

A company can grant EMI share options to management if all the following apply (in the case of a company which is not a member of a group):

  • It is an independent, qualifying, trading company with a UK permanent establishment.

  • It has gross assets of no more than GB£30 million.

  • It has fewer than 250 full-time equivalent employees.

A company can seek advance clearance from the HMRC that it satisfies the requirements. Each manager can only hold unexercised EMI share options over a maximum of GB£250,000 worth of shares. Once this maximum has been reached, no further qualifying EMI options can be granted until three years after the last of those options was granted. The company can grant options over shares with an aggregate market value at the date of grant of up to GB£3 million. The grant of an EMI option must be reported to HMRC within 92 days of the date of grant. For an individual, the tax treatment of an EMI share option means that:

  • There are no tax implications when the option is granted.

  • The exercise of an option within ten years of grant does not give rise to a liability to income tax or social security obligations if:

    • the favourable tax treatment has not been lost through a disqualifying event; and

    • the employee buys the shares at a price at least equal to the market value they had on the day the option was granted.

  • If an EMI option is granted with an exercise price below the market value of the shares at the date of grant and is then exercised, income tax is payable on the excess of the aggregate market value of the shares at the date of grant over the aggregate option exercise price. If the aggregate market value of the shares at the date of exercise is lower than the aggregate market value of the shares at the date of grant, income tax is payable on the excess of the aggregate market value of the shares at the date of exercise over the aggregate option exercise price. The employing company must account for the income tax under PAYE and social security payments are also due, if the shares are readily convertible assets for tax purposes.

  • 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 (from 23 June 2010, this is subject to a rate of 18% or 28% depending on whether the individual is a basic or higher rate taxpayer). Since 6 April 2013, the relevant period of ownership for CGT entrepreneurs' relief purposes (assuming the qualifying conditions, excluding the 5% rule which has been relaxed for EMI options are met) includes the time an EMI option is held.

EIS relief

The EIS rules are tightly drawn (see Question 5) and relief is not generally available for an employee or manager investing in his own company unless he is a business angel. This exemption is very restricted but directors may qualify for relief if:

  • They are connected with the company only as directors of the company or subsidiary.

  • Any remuneration they receive or are entitled to receive is reasonable for their services rendered to the company as directors.

  • They subscribed for eligible shares at a time when they had never been either:

    • connected with the issuing company; or

    • involved (as sole trader, employee, partner or director) in carrying on its trade, business, profession or vocation (for example, as part of a buyout team).

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 the statutory rights to:

  • Make an ordinary unfair dismissal claim.

  • Receive a statutory redundancy payment.

  • Request time off for training.

  • Request flexible working (in most circumstances).

Employees must also agree to provide extended notice of return from maternity/adoption/additional paternity leave (16 weeks rather than eight/six).

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 which regulates the:

  • Company's ability to make payments to its investors.

  • 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 which are lawfully available for distribution. Further restrictions on payment are imposed by the AIFM Directive in the first two years following the acquisition.

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?

The UK Anti-Bribery Act 2010 (which came into force in 2011) contains far reaching liability provisions with wide extra-territorial scope. The provisions apply to companies or partnerships where any part of their business is conducted in the UK (irrespective of where any alleged wrongdoing took place and even if the business is headquartered outside the UK).

Significantly, a new "corporate offence" was also created which imposes strict liability on all companies and partnerships carrying on any part of their business in the UK for any act of bribery undertaken by their business. A business is liable unless it is possible to demonstrate that the company or partnership had "adequate procedures" in place to attempt to prevent that behaviour.

This imposes a significant level of risk on executives who are acting as directors of portfolio companies. This is particularly true in cases where that company's business is focused on market sectors or geographies which 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 fund typically looks for an exit between three and five years after its initial investment. Common forms of exit include:

  • IPOs. The disadvantage of an IPO is that the private equity fund may be unable to dispose of the entirety of its stake at the time of the IPO and may 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 cash realisation. Since the financial crisis, the fund management community has been wary of private equity sponsored IPOs and sceptical on proposed pricing, with the result that few such IPOs had been successfully launched. IPO exits by private equity funds in 2013 (Merlin Entertainment, Esure and Just Retirement) may mark the beginning of a change in this trend, particularly if equity market valuations continue to show buoyancy in 2014/5.

  • 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 private equity fund. However, the exiting fund is exposed to potential market embarrassment if the acquiring fund achieves a swift exit with a significant return. As securing an exit through traditional routes such as an IPO has become harder to achieve, secondary (and even tertiary) buyouts have become a more common feature of the private equity market.

  • Asset sales. These are less common 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. Again, there is an administrative delay between sale of the assets and the return of cash to the fund.

  • Portfolio sales. Portfolio sales where a private equity 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.

32. 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.

*The authors would like to thank Aaron Burchell and Kiran Khetia for their assistance in the preparation of this article.


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 and venture capital firms along with other professional advisory firms.

Principal activities. The BVCA is the industry body for the private equity and venture capital industry in the UK. It is a promoter and advocate for the industry and its members.

Information sources. See website above.

Contributor details

Amanda Onions

Hogan Lovells International LLP

T +44 20 7296 5609
F +44 20 7296 2001

Professional qualifications. England and Wales, 2002

Areas of practice. Private equity; M&A.

Recent transactions

  • Acting for Hawksford Holdings Limited on the acquisition of Key Trust Company Limited and Key Financial Services Limited.
  • Acting for the sellers on the sale of Leisure Pass Group.
  • Advising banks on the LBO of Parabis.

David Harrison

Hogan Lovells International LLP

T +44 20 7296 2917
F +44 20 7296 2001

Professional qualifications. England and Wales, 2002

Areas of practice. Private equity; M&A.

Recent transactions

  • Advising Investindustrial on the disposal of its stake in the Avincis Group to Babcock International Group Plc for an enterprise value of approximately €2bln

  • Advising Fosun International on the acquisition of a stake in Kleinwort Benson and related acquisition of BHF-Bank A.G.

  • Advising the owners on the disposal of an oilfield services business with operations in South Africa, Angola and Tanzania to an NYSE listed corporation.

Andy Treavett

Hogan Lovells International LLP

T +44 20 7296 2000
F +44 20 7296 2001

Professional qualifications. England and Wales, 2001

Areas of practice. Tax.

Recent transactions

  • Acting for the shareholders of James Dewhurst Limited on the sale of a substantial equity stake to AAC Capital Partners.
  • Acting for ABN Infrastructure Fund on the acquisition of Belfast City Airport.
  • Acting for QW Rail (an SMBC and NAB JV) on the procurement, leasing and financing of Bombardier trains for use by TfL on the NLR and ELR.
  • Acting for the senior syndicate in relation to the restructuring of the Pearl Group.

Amelia Stawpert

Hogan Lovells International LLP

T +44 20 7296 2000
F +44 20 7296 2001

Professional qualifications. England and Wales, 2008

Areas of practice. Investment funds.

Recent transactions

  • Advising a number of institutional clients, particularly pension schemes, on their investments into private equity, venture capital and other funds.
  • Advising Bilfinger Berger Global Infrastructure SICAV S.A. on its successful GB£212 million placing and initial public offering on the London Stock Exchange, and two further successful subsequent equity raises. Advising Lend Lease on the establishment of the Lend Lease PFI/PPP Infrastructure Fund, a GB£220 million private fund launched in conjunction with Dutch investor group PGGM.
  • Advising Hermes Real Estate Investment Management Limited (HREIML) on its acquisition from Westfield of a 50% stake in three shopping centres with a combined value of GB£400 million, giving HREIML full ownership of the centres.

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