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

Amanda Onions, Andy Treavett and Sarah Stewart*, 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 2010. The level of non-UK investment in UK based funds remained at 56% (the same as in 2009). The principal sources of investment were:

  • Pension funds. Investment by pension funds increased to 25% in 2010 from 18% in 2009, with half of the sums invested coming from overseas.

  • Funds of funds. 11% of overall investment in 2010 came from funds of funds. This showed a decrease against the 2009 figure of 18% with the split between UK and overseas funds of funds remaining similar to the previous year.

  • Banks and insurance companies. Banks and insurance companies contributed only 9%, a decrease against the 2009 figure and only 3% of the overall investment by banks and insurance companies came from overseas.

  • Government agencies. The overall investment by government agencies remained unchanged in 2010 against the previous year at 6%. There was an equal split between domestic and overseas investment in this category.

  • Private individuals. The level of investment raised from private individuals remained unchanged at 5%.

  • Sovereign wealth funds. The new feature of the 2009 investor base was the 6% contributed by sovereign wealth funds. This dropped to only 1% in 2010.

The statistics used in this article are sourced from the BVCA Report on Investment Activity 2010 and the BVCA Performance Measurement Survey 2010.

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

After a difficult few years, the private equity market saw a significant improvement against a struggling economy in 2010, which continued into the first quarter of 2011.

Performance of private equity funds was strong compared with other investment classes, with:

  • Overall ten year internal rates of return at an average of 14.6% in 2010, compared to an average of 13.1% in 2009.

  • An annualised internal rate of return of 18.6% for 2010.

Investment activity also improved in 2010, with both buyouts and development capital showing substantial increases in the total amount invested against 2009.

Venture capital was not as strong, with a level of caution evidenced by a fall in the total amount of investment against the 2009 figures (from GB£454 million in 2009 to GB£313 million in 2010 (as at 1 November 2011, US$1 was about GB£0.6)).

However, this was more an indication of awareness of risk than a lack of appetite for the sector itself, as the number of deals remained relatively consistent, with a slight increase against the previous year (479 in 2010 against 429 in 2009).

Regionally there were a number of increases in total investment amounts, including in London. However, the greatest improvements were seen in Northern Ireland and the South West of England. UK private equity funds (or non-UK domiciled funds where a UK office acted as lead adviser) continued to make the majority of their investments overseas.

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


Improvements in fundraising during 2010 were not as great as those in investment activity. However, with overall funds of GB£6.6 billion being raised in 2010, this was an improvement on the 2009 low of GB£2.9 billion, against the background of a struggling economy.

During the recession, many private equity firms remained focused on their current portfolios and with few viable opportunities, many retained cash. Therefore the need for further fundraising was limited.

Given the intensity of the recession, it is likely that a recovery in the fundraising aspects of the private equity industry will continue to be behind improvements in investments, at least in the short term.


In 2010, 60% of UK funds were invested overseas (a decrease from 62% in 2009), with the majority of that in mainland Europe.


In the UK, 58% of the total amount of private equity investment in 2010 was in respect of buyouts and buy-ins. Expansion stage investment accounted for another 20%. The secondary market saw improved investment, with an increase to 11% of total investment from 3% the previous year.


UK divestments totalled GB£9.7 billion in 2010 (GB£3.9 billion in 2009). The biggest proportion of divestments came from trade sales (accounting for 23%).



4. Are there any proposals for regulatory or other reforms affecting 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.

  • The AIFM Directive came into force on 21 July 2011. Member states have until 22 July 2013 to implement the AIFM Directive into domestic law.

The AIFM Directive limits the private equity industry's purported asset stripping practices by placing restrictions, in certain circumstances, 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 implemented by both the:

  • Portfolio companies controlled by the firm.

  • Private equity firm itself.

Suitable due diligence enquiries regarding compliance with the Bribery 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 schemes exist to encourage investment in unlisted companies? At whom are the 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 an amount above 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 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 and do not raise more than GB£2 million in aggregate in any 12-month period under the:

      • VCT scheme;

      • Enterprise Investment Scheme (EIS) (see below); and

      • Corporate Venturing Scheme (CVS) (as CVS is not available for new investments after 31 March 2010, it is not considered here).

    • 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;

    • 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£7 million of gross assets immediately before the VCT invests and under GB£8 million immediately afterwards;

    • have fewer than 50 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 where the shares are sold at a loss he is not entitled to relief).

  • Tax-free dividends.

  • Income tax relief at 30% (for shares issued after 6 April 2006) of the amount invested in new ordinary shares in a VCT. There is a limit of GB£200,000 (since 2004/5) 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 (three years for shares issued before 6 April 2006), 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 a qualifying trade (see above, Venture capital trusts (VCTs)).

  • Not be controlled by another company.

  • Have fewer than GB£7 million of gross assets immediately before the investment and fewer than GB£8 million immediately afterwards.

  • Not raise more than GB£2 million in aggregate in any 12-month period under the:

    • VCT scheme;

    • EIS scheme; and/or

    • CVS.

  • Have fewer than 50 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 loan capital and 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 acquired by the investor must be both:

  • Ordinary shares with no preferential 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 on or after 6 April 2011 (up to the investment limit of GB£500,000, for the tax year 2011/12), with a minimum investment of GB£500 in any one company in any one tax year.

  • 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).

Proposed changes

Subject to Parliamentary and state-aid approval, changes to EIS and VCT schemes are proposed in the Finance Act 2012. The following changes will apply to shares in investee companies issued on or after 6 April 2012:

  • The annual amount which an individual can invest under the EIS is to be increased from GB£500,000 to GB£1 million.

  • The maximum amount which a company can raise under EIS and VCT is to be increased from GB£2 million to GB£10 million.

  • The size of eligible companies under EIS and VCT is to be increased so that they can have fewer than 250 employees (rather than the current 50) and the gross assets of the company can be up to GB£15 million before the investment (rather than the current GB£7 million).


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 taxed, tax exempt or fiscally transparent 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, in 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 not being tax transparent (in so far as they invest in companies in your jurisdiction)? What parallel domestic 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 recent upper tribunal decision of HMRC v Hanson FTC/39/2010 (formerly known as Swift) confirmed that a particular Delaware LLC was not tax transparent. It is not yet known whether the taxpayer will appeal this decision.

  • LLCs established in other US states (although note HMRC v Hanson 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 Services Authority (FSA) (or its anticipated successor organisations, the Financial Conduct Authority and/or the Prudential Regulation Authority) to the extent that they carry out regulated activities. Most private equity fund managers conduct regulated activities such as operating a collective investment scheme, managing investments and arranging deals in investments. Promotion of a fund is possible without authorisation 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 FSA authorised. Additionally, any employees or officers of authorised firms that carry out key functions in a firm must also be individually authorised by the FSA.

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 FSA 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 FSA regulates 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, high net-worth companies and sophisticated or high net-worth individuals (if certified as such).


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 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 regulate transfers.

For VCTs and EIS 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.


Interests in portfolio companies

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? What are the relative advantages and disadvantages of each? Are there any restrictions on the issue or transfer of shares by law?

Common forms

Private equity funds commonly invest through a combination of equity (in the form of ordinary and preference shares) and loan 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 and the ability to do the deal quickly.

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 was not the case during 2010/11. 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.

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 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 is proposing more stringent measures which will affect private equity firms looking to invest in public companies. These measures include the abolition of break fees.

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?

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 common, fixing the date of economic transfer of the target before completion and avoiding the need for completion accounts. However, 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. 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.

Restrictive covenants

Private equity funds also look for restrictive covenants from the sellers in order 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 bye-laws?

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.

During 2010/11, 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 inter-creditor 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 (limits of GB£5 million for disposals before 6 April 2011, GB£2 million for disposals before 23 June 2010 and GB£1 million for disposals before 6 April 2010 also apply).

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£120,000 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 2008, the relevant period of ownership for CGT entrepreneurs' relief purposes (assuming the qualifying conditions are met, which may be rare in a portfolio company) begins on the acquisition of shares following exercise of an EMI option.

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).

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.


Exit strategies

31. 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 subject to a lock-up period (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.

  • 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.

  • 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 Victoria Rodley, Suzy Penney and Aaron Burchell 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 470 members, comprising over 230 private equity and venture capital firms and more than 220 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.

Published guidelines. The BVCA produces the International Private Equity and Venture Capital Valuation Guidelines (in conjunction with the Association Française des Investisseurs en Capital and the European Private Equity and Venture Capital Association) and the BVCA Reporting Guidelines.

Information sources. See website above.

Contributor details

Amanda Onions

Hogan Lovells International LLP

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

Qualified. England and Wales, 2002

Areas of practice. Private equity; M&A.

Recent transactions

  • Acting for Exista ehf on its restructuring.
  • Acting for Ares Capital of Europe in a number of co-investment opportunities including LK Bennett and Expotel Group.
  • Acting for Dunedin Capital Partners on the acquisition of Rathbone Jersey Limited.
  • Acting for Douglas Bay Capital PLC on the sale of Laxey Logistics Limited.
  • Acting for Citi Infrastructure Investors on the US$1.5bn acquisition of 75% of DP World's Australian port terminals business.

Andy Treavett

Hogan Lovells International LLP

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

Qualified. 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.
  • Advising the Australian Government Future Fund on its investment in Birmingham's Bull Ring Shopping Centre.
  • Acting for the senior syndicate in relation to the restructuring of the Pearl Group.

Sarah Stewart

Hogan Lovells International LLP

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

Qualified. England and Wales, 2006

Areas of practice. Investment funds.

Recent transactions

  • Advising Henderson Global Investors on a UK limited partnership fund acquiring central London office space.
  • Advising on the establishment of a GB£1.5 billion leveraged fund of private equity funds domiciled in Guernsey.
  • Advising the Australian Government's Future Fund on its acquisition of a partnership interest in the owner of Birmingham's Bull Ring Shopping Centre.
  • Advising institutional clients, particularly pension schemes on their investments into private equity and other funds.

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