Private equity (PE) deals extend long downward trend. All segments of the European PE market suffered in 2022, with volume and value down across the board. Mergermarket and Intralinks reported that there were a number of challenges in 2022, including:

However, following a survey of 300 mergers and acquisitions (M&A) dealmakers in the second quarter of 2022, Mergermarket noted that PE deal makers were becoming notably more optimistic about their deal activity in 2023, with 64% of respondents expecting to undertake four or more deals over the next 12 months (2021: 36%). However, in reality, the first quarter of 2023 marked the fifth in an unprecedented string of quarterly pullbacks in PE investment. According to Bloomberg's Law Analysis, the second quarter of 2023 saw an increase in deal volume for PE investments as a whole. This was primarily driven by non-venture capital (VC) PE deals. The amount of capital invested by PE firms, excluding VC investments, increased in the second quarter of 2023 by about 39% as compared to the equivalent period in 2022, to USD155 billion, despite the total number of these deals decreasing by 14%, to 1,140, in the quarter. The increase is the first positive movement for PE deals since 2021, and it occurred despite a decline in the number of deals in the quarter.

Environmental, social, and governance (ESG). ESG issues have continued to gain traction with regulators, investors, suppliers, consumers, and employees. According to Mergermarket, the growing importance of ESG factors in deal making and deal processes accelerated during 2022, and 72% of deal makers surveyed confirmed that they expect ESG issues to receive more scrutiny in M&A due diligence processes over the next three years (2021: 48%). The ESG areas identified by respondents in particular included energy efficiency, greenhouse gas emissions and carbon management, water and wastewater management, labour standards, business ethics and transparency, data security and privacy, human rights and community relations, gender and diversity, and supply chain management. However, respondents also noted that the additional cost of ESG investigations, and a lack of clarity on ESG standards, can make processes less than straightforward.

Public market recovery relieves some pressure. According to Preqin, global public equity markets recovered in the first quarter of 2023, supported by fading recessionary risks in developed markets. However, this came amid volatility following the collapse of Silicon Valley Bank (SVB) and concerns over banking sector contagion. Preqin reports that going forward it expects PE secondaries deal flow to increase as the market begins to rebalance. This comes at a good time, given that investor appetite for PE secondaries strategies has started to translate into fundraising activity. In the first quarter of 2023, 11 secondaries funds closed at USD32.5 billion, already exceeding the full-year 2022 fundraising total of USD31.4 billion by 40 funds.

PE activity in 2023 has been dominated by take-private deals. According to a recent Ernst & Young article (see Ernst & Young: Private Equity Pulse - Takeaways from 1Q), take-private deals are taking centre stage amid continued macro volatility. The first quarter of 2023 saw PE firms announce deals valued at USD92 billion, a marked decline from the USD240 billion announced in the first quarter of last year, but roughly on par with the fourth quarter of 2022. Activity picked up as the quarter progressed, however, driven by large-scale take-privates. March 2023 saw more than USD62 billion in PE deals announced, versus just USD12 billion in January 2023. In particular, Ernst & Young reports that in the first quarter of 2023, tech-focused deals accounted for 50% of PE's total activity by value, up from roughly a quarter in the first three months of 2022.

Sovereign wealth funds lead private equity co-investment activity. Sovereign wealth funds (SWF) are taking the lead in co-investment activity as the slowdown in PE fundraising and deal making hurdles prompt limited partners and fund managers to team up on more co-investment opportunities. The value of PE co-investments involving SWF, pension managers, corporate investors, and family offices increased nearly 39% year over year in the first quarter of 2023 to USD42.3 billion, according to an S&P Global Market Intelligence analysis of recent co-investment activity by those four main private equity limited partner groups.

The figures below are from Preqin for 2021 to 2023.

Globally, 2022 saw 1,287 PE funds (2021: 1,847) raise an aggregate capital of USD639.2 billion (2021: USD732.1 billion), with an average fund size of USD692.9 million (2021: USD435.3 million). As at 4 August 2023, 469 PE funds had raised an aggregate capital of USD378.1billion, with an average fund size of USD616.3 million.

Globally, 2022 saw 1,911 VC funds (2021: 2,641) raise an aggregate capital of USD229.8 billion (2021: USD259.2 billion), with an average fund size of USD169 million (2021: USD140.6 million). As at 4 August 2023, 573 VC funds had raised an aggregate capital of USD65.1 billion, with an average fund size of USD130.1 million.

In the UK in 2022, 71 UK-managed PE funds (2021: 79) raised an aggregate capital of USD47.9 billion (2021: USD41.4 billion), with an average fund size of USD680.3 million (2021: USD710 million). As at 4 August 2023, 27 UK-managed PE funds had raised an aggregated capital of USD54.3 billion, with an average fund size of USD1,469.4 million.

In the UK in 2022, 55 UK-managed VC funds (2021: 59) raised an aggregate capital of USD7.5 billion (2021: USD8.8 billion) with an average fund size of USD190.2 million (2021: USD154.7 million). As at 4 August 2023, 20 UK-managed VC funds had raised an aggregate capital of USD2.7 billion, with an average fund size of USD111.3 million.

The figures below are from Preqin for 2021 and 2023.

Of the 711 (2021: 815) UK target acquisitions involving one or more PE funds as a buyer in 2022, the most popular sectors were:

As at 4 August 2023, of the 372 UK target acquisitions involving one or more PE funds as a buyer, the most popular sectors follow a similar pattern to 2021 and 2022, with 46 deals in software, 55 in financial services, and 60 in business support services.

Further, Preqin reports that of the 1,624 UK VC deals in 2022 (2021: 1,939), the most popular sectors were:

As at 4 August 2023, of the 751 UK VC deals made this year, the most popular sectors follow a similar pattern to 2021 and 2022, with 268 deals in software, 44 in internet, 65 in financial services, and 55 in biotechnology.

The figures below are from Preqin for 2021 and 2023.

Globally, 2022 saw 4,452 PE transactions structured as add-on investments (2021: 4,636) and 1,930 transactions structured as management buyouts (2021: 2,444). As at 4 August 2023, 2,132 PE transactions were structured as add-on investments and 741 transactions were structured as management buyouts.

Less common deal structures were growth capital deals, with 1,073 such transactions completed in 2022 (2021: 1,031) and take-private transactions, with 72 in 2022 (2021: 71). In the UK, these deal structures were also relatively consistent with global patterns in 2022, with 376 add-on transactions (2021: 390) and 151 buyouts (2021: 216) being the key transaction structures.

As of 4 August 2023, globally there had been 436 growth capital deals and 38 take-private transactions. In the UK, add-on transactions (188) and buyouts (73) were again the key transaction structures.

Globally, VC deals in 2022 saw a total of 28,981 transactions (2021: 33,953), the majority of which occurred at the seeding stage (2022: 5,956 and 2021: 6,790) and as Series A/Round 1 investments (2022: 5,025 and 2021: 6,051). As at 4 August 2023, globally there had been 12,483 transactions, most of which occurred again at the seeding stage (2,256) and during Series A/Round 1 investments (1,939).

The figures below are from Preqin for 2021 to 2023.

In 2022, there were 167 UK target PE exits (that is, a complete or partial divestment of a PE fund's stake in a UK target), compared to 217 exits in 2021. The exits involved, among others, 58 trade sales (2021: 59) and 62 secondary buyouts (2021: 92). As at 4 August 2023, there had been 97 UK target PE exits, including 24 trade sales and 32 secondary buyouts.

By comparison, 2022 saw 145 UK target VC exits compared to 170 exits in 2021. These were composed of, among others, 116 trade sales (2021: 98), 12 sales to the general partner (GP) (2021: 27), and four initial public offerings (IPOs) (2021: 16). As at 4 August 2023, there had been 76 VC exits, including 52 trade sales and 6 sales to the GP.

While PE and VC both refer to equity investments in companies that are not publicly listed or traded (or in the case of take-private transactions, cease to be publicly listed or traded), they differ in a number of key areas, including:

Funding sources for UK-managed PE funds vary depending on the type of fund. Preqin reports that in 2022 total UK PE and VC fundraising had reached USD53 billion, which comprised, among others:

The British Private Equity & Venture Capital Association (BVCA) reported in its 2022 report on investment activity that the main investors in UK buyout funds (the focus of this Q&A) were pension funds (contributing 33%), sovereign wealth funds (15%), and funds of funds (9%). Investors from outside the UK contributed about 72% of the total UK PE and VC fundraising.

The qualifying asset-holding company (QAHC) regime, introduced on 1 April 2022, is the primary incentive aimed at encouraging PE investment via UK holding structures. QAHCs have a favourable tax regime, both at the level of the QAHC and for the investors. QAHCs benefit from an exemption from:

Additionally, the QAHC regime benefits the investors in a QAHC by:

Additionally, there are a number of incentive plans, focusing on employee participation and earlier-stage investing, with the following schemes currently available:

The QAHC regime is directed at funds and asset managers to allow them to consolidate their operations in the UK. The other incentive plans mentioned above are directed at individual investors.

In order to qualify as a QAHC, a company must meet all of the following conditions:

The ownership condition requires that at least 70% of the company's investors be Category A investors. For the purposes of the QAHC regime, Category A investors include, among others, widely held funds and collective investment vehicles.

The activity condition requires that the main activity of the company must be the carrying on of an investment business, and any other activities that are undertaken by the company must be ancillary to that investment business, and non-substantial. Non-substantial is not defined for the purposes of the QAHC regime, but HMRC guidance states that generally, for an activity to not be carried on to any substantial extent, the quantum of possible profit from that activity should be sufficiently limited so that no potential investor in the company would have regard to it when deciding whether or not to invest. HMRC guidance states that the activity condition may be satisfied if the company is seeking investments but has not yet acquired any.

The investment strategy condition requires that the company's investment strategy does not involve the acquisition of traded or listed equity securities (with the exception of take-private acquisitions).

For a VCT to qualify for tax relief, various conditions must be met, which include:

The conditions for EIS status are similar to those for VCTs and include the following:

The conditions for SEIS status are broadly similar to those for EIS (see above), with two notable differences:

Limited partnerships (LPs) are the most common vehicle used by UK PE and VC funds. While English and Scottish LPs have been a popular option, in recent years the majority of UK PE fund sponsors have chosen to domicile their LPs in jurisdictions such as Jersey, Guernsey or Luxembourg, often reflecting the international nature of the limited partners. This appears to have remained the case despite the introduction in the UK in 2017 of the Private Fund Limited Partnership regime, which removed certain anachronistic features of the Limited Partnerships Act 1907 with respect to LPs structured as collective investment schemes.

In addition to tax considerations (both for the target investor base and the PE fund's sponsor and its principals), other key drivers for the selection of a fund vehicle include suitability for making cross-border investments, provision of limited liability for investors and accessibility for the target investor base (see Question 10, Question 11, and Question 33). See also Question 7 regarding vehicles that are less commonly used.

LPs (whether English, Scottish or in a jurisdiction other than the UK) are generally treated as transparent for UK income and chargeable gains tax purposes. HMRC publishes a list of foreign entities opining on the transparency/opacity for the purposes of UK tax on income for constituent members. The list does not include all forms of foreign entities, particularly those legislated for recently. Ultimately, the question of transparent/opaque tax treatment primarily depends on:

Company structures are not commonly used by UK PE funds because they are generally treated as opaque for UK tax purposes and may result in an additional layer of taxation as they are taxable entities in their own right. This includes most foreign companies, US limited liability corporations (LLCs) established in most US states, and certain Luxembourg entities (such as partnerships limited by shares (sociétés en commandite par actions) (SCAs), civil companies (sociétés civiles) (SCs) and investment companies with variable capital (sociétés d'investissement a capital variable) (SICAVs)).

Certain types of foreign entities can, however, be structured as transparent for UK tax on income or chargeable gains purposes, such as Jersey property unit trusts, Luxembourg special limited partnerships (or SCSps), Cayman limited partnerships, Jersey limited partnerships and the Luxembourg VC investment companies (sociétés d'investissement en capital à risqué) (SICARs).

The position regarding Delaware LLCs is not entirely certain. While the UK Supreme Court stated in 2015 that a Delaware LLC under particular circumstances was tax transparent, HMRC's guidance still refers to LLCs as generally being opaque for UK tax purposes.

Historically, the average duration of a PE fund included in its partnership agreement was ten years, typically with an option to extend the term for two or three years. In recent years, PE funds have increasingly extended the term beyond ten years. This includes, for example, those focusing on infrastructure or special situations and funds with no termination date, such as evergreen funds and permanent capital vehicles. Others have set the primary term at 11 or 12 years before any permitted extensions, or pegged the period from the fund's final closing date (typically a year or more after its initial closing). This has also been reflected in the duration of investment periods (where five years was once standard, many sponsors are now proposing a six-year investment period).

Leveraged buyout funds, which constitute the majority of the industry by capital, typically seek capital gain (as opposed to income) and absolute returns (as opposed to seeking to outperform a particular benchmark). Some funds market themselves, whether formally or informally, as seeking to generate a return in a particular range or in excess of a particular level (usually expressed in gross and net internal rate of return (IRR) terms). In recent years, typical target returns for UK-managed European focused buyout funds have been in the 15% to 30% gross IRR range.

Typically, broader investment objectives are effectively delineated by the fund's investment restrictions, which serve to direct its investments towards those sectors in which the sponsor's investment team is seen as having particular expertise (for example, geographical, industry, target size and so on). In recent years we have seen an increasing number of social impact funds, which focus on ESG alongside their underlying financial objective (see Question 1).

PE firms require authorisation from the FCA where they carry on regulated activity in the UK by way of business (unless they are otherwise exempt). The regulatory permission(s) required by a UK PE fund manager differ depending on the structure selected.

For example, UK managers of alternative investment funds (AIFs) who are appointed to be alternative investment fund managers (AIFMs) must be authorised to carry out the regulated activity of managing an AIF. Authorised UK AIFMs are subdivided into full scope AIFMs and sub-threshold AIFMs. Sub-threshold AIFMs comprise authorised AIFMs of portfolios of AIFs, the value of whose assets under management does not exceed either:

Sub-threshold AIFMs are not subject to the full requirements under the Alternative Investment Fund Managers Directive (2011/61/EU) as implemented in the UK (AIFMD).

A common alternative structure is to have another firm appointed AIFM and then delegate portfolio management to a UK firm. This delegate, rather than needing the managing an AIF permission, will instead need permission to carry on the activity of managing investments, typically alongside certain other permissions such as arranging deals in investments.

UK managers of UK AIFs that are qualifying venture capital funds (RVECA Funds) meeting certain prescribed conditions under the RVECA Regulation (the UK version of the EuVECA Regulation ((EU) 345/2013)) need only register with the FCA, as opposed to obtaining full authorisation. Managers of RVECA funds are subject to specific requirements under the RVECA Regulation regarding, for example, conflicts of interest.

Persons in certain roles at authorised firms, such as partners (where the firm is a limited liability partnership) and the compliance officer, need FCA approval to carry out such functions. Other individuals, including the portfolio managers, may also need to be certified by the firm as being fit and proper, both initially and on an ongoing basis by the firm itself (see Question 19).

Pure promotional activity (that is, an activity that does not involve any regulated activity) will not necessarily mean that a firm needs to be FCA-authorised. However, such firms typically have permission to carry on certain regulated activities (in particular, arranging deals in investments).

UK PE funds established as LPs are not required to be authorised by the FCA. Instead, the regulation falls on the fund manager, that is, the PE firm (see Question 9).

However, a fund that is established in the UK and takes the legal form of an authorised unit trust (AUT), an investment company with variable capital (ICVC) or an authorised contractual scheme (ACS) must be authorised by the FCA. See also Question 11.

Offers of LP interests can generally be made without publication of a prospectus when securities are offered to the public or admitted to trading (under the Prospectus Regulation (EU) 2017/1129) by ensuring that the offer is exempt (for example, by restricting the offering to qualified investors only).

PE funds are generally viewed by sophisticated regulatory systems as high-risk investments, and consequently, marketing rules tend to restrict participation in PE funds to high net worth individuals and institutional investors. These funds are generally only marketed to professional clients for the purposes of the recast Markets in Financial Instruments Directive (2014/65/EU) (MiFID II), as implemented in the UK, to avoid the obligation to produce a Key Information Document to investors under the Packaged Retail and Insurance-based Investment Products Regulation ((EU) 1286/2014), as implemented in the UK.

RVECA Funds are subject to their own rules in relation to marketing. These funds can be marketed to professional clients (as defined under MiFID II) or other investors, such as high-net worth individuals, if they commit a minimum of EUR100,000 and state in writing that they are aware of the risks associated with the investment.

In addition, PE funds and their sponsors are, like any other financial institution, subject to know-your-customer and anti-money laundering rules and regulations, which effectively restrict participation in PE funds to those able (and/or willing) to satisfy the requirements of the fund's client due diligence process.

Finally, while PE fund documentation places few obligations on investors other than to pay their commitments on time, such documentation invariably restricts investors from disclosing confidential information received from the fund.

There are no UK statutory requirements as to the investment period duration. The duration (and the circumstances in which it can be terminated) will be set under the terms of the PE fund's constitutional documents and is therefore a matter for negotiation between the sponsor and the investors in the fund. Typically, a buyout fund has a four to five-year investment period and must deploy a minimum amount of total capital (for example, 75% to 80%) before the sponsor is permitted to terminate the investment period and raise another fund.

Investors do not typically have a right to exit the PE fund by way of redemption of their investment at net asset value. Any transfer of an investment to other investors typically requires the sponsor's consent.

The governance and economic terms of funds structured as LPs will be set out in a limited partnership agreement (LPA), which is often heavily negotiated at the outset.

Investors are typically asked to sign a subscription agreement, containing various regulatory and commercially driven warranties. The use of side letters, supplementing or, in some cases, modifying the LPA terms is commonplace and generally subject to a "most-favoured nations" provision in the LPA that permits the election of certain benefits negotiated by, and granted to, other investors in a side letter.

Protections sought by investors typically include:

UK PE funds most commonly invest in a portfolio company through a newly formed holding structure in a mix of:

The split varies in each transaction and will be modelled by the PE fund at the outset, to strike the desired risk/return balance. VC investors typically invest in a series of preference shares.

Management typically also participates in the capital structure (see Question 27).

The ability to issue shares in an English company is restricted by statutory pre-emption rights and directors' authority to allot, although these are rarely problematic in the context of a holding structure or when acquiring control of a company. Additionally, following an acquisition, the ability to issue and/or transfer shares is usually contractually limited in the articles of association (AOA) and any shareholders' agreement(s) (SHA) through pre-emption or other restrictions, and can also be restricted by third-party encumbrances over the shares, as well as by bankruptcy and insolvency law (if applicable). On exit, pre-emption provisions are typically waived in share purchase agreements (SPAs) and any encumbrances are typically released at completion. Recent tax restrictions may apply to highly leveraged holding structures, including the UK corporate interest restriction and UK anti-hybrid rules.

Share issues or transfers may fall within the UK's merger control and/or National Security and Investment regimes (see Question 33 on the parties involved and the nature of the transaction. In recent years, there has been a sharp increase in the number of active FDI regimes around the world and both new and existing regimes have been expanding the number of market sectors viewed as strategically important and subject to FDI scrutiny. Unlike merger control, FDI regimes typically do not require an acquisition of control or material influence, but instead apply to the percentage ownership being acquired (and can even apply to investments of as low as 3% in certain circumstances). Therefore, an upfront filing analysis and risk assessment should be conducted when planning transactions, including minority investments.

Additional notification/consent requirements may apply in certain sectors of the economy with licensing or pre-authorisation schemes. Such regimes may also place restrictions on shareholders, for example in the airline industry. Ministry of Defence approval may be required under contractual change of control provisions in UK defence contracts.

Other notable controls (albeit rarely used in practice) include:

Withholding tax can apply to a fixed coupon paid pursuant to an unsecured loan note, subject to certain exemptions. In particular, this can include cross-border interest payments which are not otherwise fully relieved from UK withholding tax under a relevant double tax treaty.

One such exemption is the Quoted Eurobond Exemption (QEB). If a debt meets the requirements to be a Quoted Eurobond, then tax does not need to be withheld on interest payments in respect of that debt. The requirements are that the debt must be (a) a security issued by a company, (b) carry the right to interest, and (c) be listed on a recognized stock exchange. Accordingly, PE fund structures will often list debt securities to avail of the QEB.

In certain circumstances, interest on securities is paid by payment in kind (PIK) notes rather than cash. While this provides an obvious cashflow advantage to the borrower, withholding tax on interest applies equally to PIK notes as for cash (although it does not apply if interest is simply added to the outstanding principal amount). There is generally no withholding tax on UK company dividends.

Capital gains tax or corporation tax on chargeable gains (as applicable) can arise on the sale of shares. However, individual investors may be able to benefit from Business Asset Disposal Relief (BADR) (formerly Entrepreneurs' Relief) and/or Investors' Relief if the relevant conditions are satisfied (see Question 28). Other investors within the scope of corporation tax may be able to benefit from the UK participation exemption (known as the Substantial Shareholding Exemption), subject to meeting applicable conditions.

Stamp duty is payable by the purchaser following the transfer (not the issue) of shares or marketable securities at the rate of 0.5% of the value of the consideration (broadly defined) for the shares.

It is common for buyouts of larger private companies to take place by auction, especially if the sale is by a PE firm. However, bilateral PE deals are also relatively common as are pre-emptive bids by bidders attempting to win an auction before it starts or ahead of the final round.

In an auction context, the seller and its advisers control the process and the rules are typically set out in non-disclosure agreements (NDAs) and one or more process letters which can extend to restricting bidders' contact with finance providers, the target and warranty and indemnity insurance (W&I Insurance) brokers. Bidders are typically required to sign an NDA before receiving an information memorandum and confidential information about the target. Steps may also need to be taken to limit or phase the disclosure of commercially sensitive information, and guard against infringing the laws on anti-competitive information exchange (as would be the case for bilateral transactions involving actual or potential competitors, or companies active upstream and downstream of one another). These steps could include "clean team" arrangements, where only specified advisers and other individuals outside of the competing team are granted access to sensitive documents and information.

An auction transaction typically involves two or more bidding rounds, with selected bidders being provided access to an online data room of diligence information, vendor due diligence reports and draft transaction documents prepared by the target's advisers.

The sale of private companies in the UK is less regulated than for public companies. The Companies Act 2006 (CA 2006) sets out the overarching regulatory framework applicable to private companies in the UK.

Other notable legislation/rules that may apply include:

Before the COVID-19 pandemic, buyouts of listed companies in the UK were becoming increasingly common. According to data from Preqin, there were ten UK take-privates in 2019 (2018: nine). Although UK activity dropped in 2020 (with just two take-privates), the number of UK take-private transactions had rebounded sharply in 2021, with 15 take-privates. As noted in Question 1, deal activity struggled in 2022 (with six UK take-privates). In the second quarter of 2023, appetite for buyout and growth strategies has declined slightly, compared with the same period in 2022. As of the end of the second quarter of 2023, 73% of PE investors are expected to target buyout strategies in the next 12 months, compared with 79% in the same period last year (see Prequin: Private Equity Q2 2023: Preqin Quarterly Update).

Rather than enter into a take-private transaction, public companies may consider raising funds non-pre-emptively through private investment in public equity transactions (PIPEs). (For further information, see Practice Note, PIPE Transactions.) PIPEs have traditionally not been a common feature of the UK market for a number of reasons, including regulatory restrictions placed on listed companies and investment restrictions set out in the terms of the PE fund. Preqin reports that there were a total of four UK PIPE transactions in 2022, down from 12 in 2021.

As noted in Question 15, the sale of listed companies in the UK is more heavily regulated than private companies. Depending on the target's place of incorporation and residence, the form, structure and timetable of takeovers may be governed by the City Code on Takeovers and Mergers (Takeover Code). The Takeover Code is administered by the Panel on Takeovers and Mergers, for which it has certain statutory powers of enforcement.

In addition to the legislation that applies to the sale of private companies, the following legislation and rules may apply to public transactions (depending on the transaction structure and the parties involved):

The principal documents produced on the acquisition of a private company typically include:

The principal transaction documents depend on whether the takeover is structured by way of a contractual offer or a court-approved scheme of arrangement. There are a range of rules (including, primarily, the Takeover Code) governing transactions involving public companies which regulate, among others, the information that must be supplied to shareholders in the offer document or the scheme document (as applicable). While the majority of transaction documents on a private company acquisition are confidential, a number of documents on a public company acquisition must be publicly disclosed (including the offer document/scheme document). For more information, see Practice note, Takeovers: overview.

The following forms of contractual protection can be requested by a buying PE fund, depending on the nature of the sales process and the identity of the seller:

In the context of take-private transactions, the Takeover Code includes a general prohibition on certain offer-related protection measures for bidders, including break fees and conditionality (subject to limited exceptions, for example regarding merger control and regulatory approvals).

As noted in Question 21, PE firm appointees typically constitute a majority of the directors of the holding company for a portfolio company (with the right to have its appointees appointed throughout the group). The remaining directors will typically be senior executives in the portfolio group.

The CA 2006 codified certain common law and equitable duties of directors of English and Welsh companies (which may include de facto directors and shadow directors) which are owed to the company. The seven general duties include, among others, to act within powers, to promote the success of the company, to exercise independent judgment and to avoid conflicts of interest. As part of the duty to promote the success of the company under section 172 of the CA 2006, directors must act in the way they consider, in good faith, is most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard, among other matters, to the likely consequences of any decision in the long term, the interests of the company's employees and the impact of the company's operations on the community and the environment. A director also owes an equitable duty of confidentiality to the company, but this is not codified by the CA 2006 and may overlap with certain codified duties, such as the duty to avoid conflicts of interest. If a director is employed by the company, they also owe certain duties to the company, including in respect of confidentiality.

In the context of an MBO, directors may be permitted to disclose certain confidential information in respect of the company to potential investors, if all recipients of the information are bound by confidentiality agreements.

Other than certain small companies, all companies must prepare a strategic report that informs members how they have performed their duties under section 172. From 1 January 2019, all public and private companies (excluding medium sized companies) that are required to prepare a strategic report must include a "section 172 statement" within it, describing how the directors have had regard to the matters set out in section 172 and how the company has met these requirements.

The company itself can take any enforcement action against directors for a breach of their duties. However, in certain circumstances, an individual shareholder (or group of shareholders) can bring a claim on the company's behalf against a director for a breach of their duties (a derivative action).

Portfolio companies may be subject to other regulation depending on their industry. For example, senior managers of FCA-authorised firms will have certain obligations placed on them beyond the CA 2006.

In an MBO the PE fund will typically focus on:

While a PE fund's managers do not typically exercise day-to-day control, they will want close involvement in the portfolio company's business strategy, material decisions and wider corporate governance. The PE fund's interests are usually protected through the constitutional documents of the portfolio company and/or its holding company and in the SHA with the shareholding managers (perhaps more extensively where the constitutional documents are publicly filed).

The PE fund typically seeks to ensure that:

PE transactions have historically been funded through debt and equity financing. Depending on a number of factors, for example the strength of credit, the size of the deal, geography, industry sector, market conditions and the PE fund backing the acquisition, the percentage of external debt will range between 50% to 80% of the overall financing package (but will vary on a case-by-case basis). In the UK, interest payments on such debt are generally deductible against the borrower's liability to corporation tax, subject to certain requirements, limits and restrictions.

Acquisition financing is typically arranged by banks and other financial investors and takes the form of underwritten loan agreements, which are often syndicated post-completion to further debt investors. These loans typically have limited conditions-precedent (CPs) to funding, primarily relating to the bidding vehicles as opposed to the target group, with the lenders deriving their protection (as with the bidder) from the target-related conditions in the SPA. The CPs in the acquisition loan agreement should be capable of satisfaction under the sole control of the bidder to ensure that the financing will be capable of being drawn when required to complete the acquisition (that is, certain funds), as it is highly unusual for the SPA to contain a financing condition.

Acquisition loans usually comprise one or more separate facilities, for example a revolving credit facility, an amortising term loan facility, a bullet-repayment term facility and an acquisition or capex facility. Increasingly, the high-yield market has been tapped to provide acquisition financing. The often high liquidity of that market provides more flexible covenant packages (compared to those found in loans) and more adaptable cost of finance considerations. In such cases, the acquisition financing is consummated using an acquisition bridge facility, which must be refinanced within a year with the proceeds of the high-yield bond issuance or a standard term loan facility.

There has been an increasing convergence between traditionally more conservative loan terms and covenants to the inclusion of the type of terms, covenants and operational flexibility found in high-yield bonds. A good example is covenant-lite financing transactions (no maintenance covenants or only a springing leverage covenant relating to the revolving credit facility).. They do, however, have financial incurrence covenants that prescribe the operational flexibility of the credit but do not result in a default if actual leverage is greater than the prescribed threshold, which would be a typical approach in the high-yield bond market. It is common for loans in all but the lower-mid-market to be covenant-lite or, at worst from the borrower's perspective, covenant-loose (maintenance covenants are limited to a financial leverage covenant).

Borrower-favourable loan terms have become a theme of recent years, with loan agreements often providing very significant operational flexibility to the borrower, including grower baskets (linked to growing earnings before interest, taxes, depreciation, and amortisation (EBITDA), but which do not decline if EBITDA decreases), equity cure provisions, limited information provision requirements and EBITDA add-backs.

Another common structure is a unitranche facility, which is normally provided by a debt fund or other non-bank alternative lender and which comprises a blended tranche of senior and junior debt with a single interest rate.

The increasing competition from the alternative lenders is making it easier for borrowers in the lower- and mid-market to win flexibility and sponsor/borrower-friendly/high-yield-style terms from banks that were traditionally the preserve of top tier sponsors and/or deals.

In the majority of transactions, lenders require security and cross-guarantees (upstream in respect of holding companies, downstream in respect of subsidiaries and also in respect of other affiliates in the group) from the borrower and material members of the target group, once acquired. The security package usually comprises fixed and floating charges over all of the material assets of the operating group and share security over the material subsidiaries, the bidding vehicle (Bidco) and its holding company.

Whether a subsidiary is deemed a material subsidiary, and therefore obliged to provide security, is typically linked to the percentage of EBITDA that the relevant subsidiary contributes to the group's consolidated EBITDA or the total assets owned by that subsidiary as a percentage of the group's consolidated total assets. Consideration should be given to corporate benefit questions and whether an entity can provide security or guarantees to support debt incurred for its or a group member's acquisition. England and Wales is a permissive regime in terms of corporate benefit and upstream guarantees, meaning that companies and directors can construe corporate benefit broadly and grant upstream and cross guarantees in support of other members of the group, subject to limited statutory exceptions (such as financial assistance, in a public company context).

Subordination. Multiple creditors can agree the ranking of competing claims through structural or contractual subordination:

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

Covenants. Loan agreements contain:

For top-tier sponsors, it is unusual to see financial maintenance covenants, other than financial covenants relating to the revolving credit facility only and which "spring" into place on certain trigger events (for example, leverage reaching a certain level). Other transactions could also be similarly covenant-lite or covenant-loose.

It is unlawful for a public company (or any of its subsidiaries, including private subsidiaries) to provide financial assistance for the purpose of assisting a purchase of its shares (subject to certain limited exceptions) (sections 677 to 683, CA 2006). However, once acquired, a public company can be re-registered as a private limited company. Security and guarantees can then be given subject to there being sufficient corporate benefit to doing so. The rules on financial assistance no longer apply to private companies in relation to the purchase of shares in itself or another private company.

Certain other jurisdictions also have financial assistance regimes and/or corporate benefit limits on the ability of companies to give upstream guarantees or security. Therefore, if there are material target group subsidiaries in those jurisdictions, the financing aspects of the acquisition structure may need to reflect these local-law requirements.

The CA 2006 sets out purpose exceptions, unconditional exceptions, and conditional exceptions to the financial assistance regime. For further information, see Practice note, Financial Assistance.

Debt providers take priority over shareholders in the distribution of assets on insolvent liquidation. A secured debt provider also takes priority over an unsecured debt provider. Any structural hierarchy must also be considered. The order of priority is as follows (in each case, to the extent funds are available):

A debt holder achieve equity appreciation, via a number of instruments. A convertible loan note allows the notes to be converted into equity in the future (potentially on a specific event and typically at a discount to future funding rounds) instead of the noteholder receiving the return of their principal plus any applicable interest. A debt provider can also be issued warrants and/or options, at the time the debt is provided, that entitle the holder to acquire shares in the company at a predetermined fixed price until the warrant or option's expiry date or within a specific exercise period.

While a number of incentivisation plans can be established, including share options and certain HMRC-approved and unapproved plans, a typical management equity plan in a PE context in the UK includes:

Aspects of the above also feature for founders and managers in a VC context. Further incentivisation mechanisms for management also include:

There are certain reliefs that may be available depending on the structure of the transaction. While not strictly a relief, it is also common to reduce the tax burden to managers by granting them equity interests with a low initial value (such as growth or hurdle shares). This involves some complexity both around valuation and ensuring that increases in value are respected as capital gains and taxed at a lower rate.

Employees and officers will generally be taxable (at income tax rates) on the difference between the market value of securities they receive and the amount they pay for those securities.

There is a longstanding memorandum of understanding (MoU) between the BVCA and HMRC (see BVCA: Memoranda of Understanding), which effectively operates as a safe harbour for the valuation of management's equity investments. In particular, the MoU specifies the circumstances in which HMRC will agree that managers have acquired their shares whether through the rollover or as sweet equity for initial unrestricted market value/market value (as applicable).

The following requirements must be met to benefit from the MoU:

Additionally, any ratchet provisions that apply must meet the further requirements set out in the MoU.

Should all the above requirements be met, HMRC accept that the price paid for the managers' shares would be equal to the initial unrestricted market value of the shares, where such shares are restricted, or the market value if they are unrestricted shares.

Should an employment related security be acquired for below the unrestricted market value of such security, income tax (at higher rates than capital gains tax) will be payable on either:

Accordingly, should the MoU apply, and the price paid by the managers equal the initial unrestricted market value of the interest, any disposal proceeds will be taxable as a gain, and therefore attract capital gains tax at a rate of 28% (as opposed to income tax, payable at a rate of up to 45%).

From 11 March 2020, BADR provides managers with a lifetime allowance of GBP1 million of capital gains on qualifying business disposals on which tax is charged at 10%. Gains realised in excess of the allowance are charged at the normal capital gains tax rates (currently 20% for higher-rate taxpayers).

BADR is available on a disposal of shares (or securities, including certain corporate loan notes) by a manager if, throughout the two years before the disposal, all of the following apply:

Shares issued on exercise of EMI options (see below) may qualify for BADR even if they are not part of a holding that represents 5% of the shares in the company.

EMI share options can, subject to certain conditions, be granted to management or employees of the company whose shares (or those of a qualifying subsidiary) will be placed under option. Qualifying companies broadly consist of small and medium sized independent trading companies.

For an individual, the tax advantages of an EMI option include the following:

A company can grant EMI options over shares with an aggregate market value at the grant date of up to GBP3 million. Each manager can hold unexercised EMI options over a maximum of GBP250,000 worth of shares.

A number of other tax-advantaged employee share schemes exist in the UK for managers to invest in their employing group. These include Share Incentive Plans (SIPs), Sharesave Schemes (Save as you Earn Schemes or SAYEs), Employee Shareholder Status (for gains on the disposal of employee shares acquired before 1 December 2016) and Company Share Option Plans (CSOPs).

Broadly, these provide for the grant or purchase of company shares or options over shares without giving rise to an income tax or NI contribution liability, provided that the manager retains those shares or options for a set period and subject to certain conditions.

Restrictions on dividends, interest payments and other payments by a portfolio company to its investors include the following:

A PE fund could be convicted of a criminal offence under section 7 of the UK Bribery Act 2010 (UKBA) if an associated person bribes another person intending to obtain or retain business, or an advantage in the conduct of business, for the PE fund. An associated person can be any person performing services on behalf of the PE fund, which can include a portfolio company (or any officer/employee of it). A PE fund will have a defence if it had in place adequate procedures designed to prevent associated persons from committing bribery.

Separately, directors will generally only be personally liable under the UKBA if they are personally involved in the wrongdoing (for example, if they paid bribes or were part of a conspiracy to do so).

However, if the portfolio company is convicted under the UKBA it could materially impact the value of the PE fund's investment resulting from, among other things, the potential termination of material contracts, large fines (uncapped but can be tens or hundreds of millions, depending on the case) or reputational risk. Therefore, PE funds can seek to:

In relation to a PE fund's fundraising stage, certain types of investors can seek side letter assurances that the sponsor and the fund will not breach applicable anti-bribery and corruption laws. Sponsors typically disclose details of their anti-bribery and corruption policies in the due diligence materials provided to potential investors.

A PE fund typically looks to exit a successful investment after three to five years. The main types of exit are:

Advantages and disadvantages are:

There are fewer exit options available to a PE fund when a portfolio company is unsuccessful. It can choose to first restructure the external debt (which may involve additional funding provided by the PE fund), bring in new managers, reset any management incentivisation plan and then hold for a further period. The typical exit routes are:

Advantages and disadvantages are:

On 25 October 2022, the FCA published a consultation paper on a package of measures aimed at clamping down on greenwashing. Among other things, this includes the introduction of sustainable investment labels for funds and sustainability-related disclosure requirements. While primarily focused on managers of funds marketed to retail investors, certain elements of the proposed regime will impact managers of funds promoted to professional investors, such as PE funds. The FCA had originally planned to publish its new rules in June 2023, before delaying the publication until the third quarter of the year. Another postponement was announced in July 2023 stating that the rules will not be published until the fourth quarter of 2023.

The FCA introduced, on 1 January 2022, a new prudential regime for investment firms (including, for example, adviser/arranger firms and delegated portfolio managers). This included requirements relating to, among other things, regulatory capital, remuneration, and reporting.

The Register of Overseas Entities came into force on 1 August 2022. The new regime requires overseas entities that own UK property or land to declare their beneficial owners or managing officers. Overseas entities cannot buy, sell, transfer, or lease land, or create a charge against the land in the UK, unless they have first registered with Companies House. Overseas entities in scope who already owned property or land in the UK were required to register within a six-month transition period, ending on 31 January 2023. As at 7 March 2023, the UK government reported that over 26,000 overseas entities have registered with Companies House.

Similar to other jurisdictions, the UK has taken steps to strengthen and extend its national security screening capabilities.

On 4 January 2022, the National Security and Investment Act 2021 (NSIA) came into force and has since become a regular feature of transactions. The NSIA gave the UK government retroactive powers to call-in transactions for review that closed between 12 November 2020 and 4 January 2022.

The introduction of the NSIA gives rise to additional considerations for PE firms because it significantly widens the scope of investments and transactions that can be reviewed by the UK government on national security grounds in comparison to the previous regime (that was linked to the merger control provisions of the Enterprise Act 2002).

The NSIA introduces a "hybrid" regime, meaning that for certain transactions in specified sensitive sectors there will be a mandatory filing requirement (with approval required to be obtained before closing). For transactions that do not meet the mandatory filing requirements, there is also a voluntary regime. This exists because outside of the mandatory regime, the UK government's Investment Security Unit (ISU) has the power to call-in a transaction for review, after the fact, if it reasonably suspects that the transaction may give rise to a risk to national security. The ISU's call-in powers extend up to five years post-closing (reduced to six months from when the ISU becomes aware of a transaction). Therefore, in certain circumstances, making voluntary notification may be prudent, to obtain deal certainty (a voluntary notification forces the ISU to decide within 30 working days, from the date of a complete notification, whether to proceed with a review or declare no further action).

Under the NSIA, a mandatory notification is required if an investor (including a UK investor) acquires more than 25%, 50%, or 75% of votes or shares (or becomes able to block or pass a corporate resolution) in a qualifying entity that is active in the UK in at least one of the 17 sensitive sectors of the economy defined by the UK government. The qualifying entity must carry on the activity in the UK (this can include supplying into the UK).

The 17 sectors of the economy must be carefully analysed, as they are wide-ranging in their ambit. They are:

The consequences for missing a mandatory filing are severe and can include the following:

Once a filing has been made (and accepted as complete), the ISU has 30 working days to decide whether to call-in the transaction for in-depth review. The vast majority of cases are not called-in for in depth review and the ISU simply issues a decision stating that it will take no further action.

If a transaction is called-in for in-depth review, the ISU has a further 30 working days (extendable by an additional 45 working days) to issue a final order to either:

Since the coming into force of the NSIA on 4 January 2022 to 31 March 2023, 18 final orders have been issued by the ISU, made up of five prohibitions, ten conditional clearance decisions, and three decisions to take no further action.

Four of the five prohibition decisions issued during that period involve investors with a nexus to China (University of Manchester/Beijing Infinite Vision, Super Orange/Pulsic, Newport Wafer Fab/Nexperia, and SiLight/HiLight). The fifth prohibition decision (Upp Corporation/L1T FM Holdings UK) involved an acquirer co-founded by Russian investors.

While all prohibition decisions under the NSIA have involved Chinese and Russian acquirers, this has not been the case for the conditional clearance cases. For example, in Viasat/Inmarsat, the UK government imposed conditions on a deal involving a US acquirer of a UK target.