Preface

The financial adviser, accountant and lawyer have important roles to play in the private equity process, both for the management team seeking finance and the private equity firm. It is often the case that the financial advisory role and the role of the accountant performing investigatory due diligence are performed by different teams within the same organisation. Your accountant may therefore be able to act as your financial adviser.

The financial adviser’s role

The primary role of the financial adviser in an MBO transaction is to provide corporate finance advice to either the management team or the private equity firm sponsoring the transaction. Your financial adviser will provide you with impartial financial advice, independent of the private equity firm and its own advisers. The precise nature of the role varies from situation to situation but typically includes:

• Undertaking an initial appraisal of management’s financing proposition.
• Advice on your business plan – critically reviewing and appraising your plan to ensure that it includes all the areas referred to in the business plan section of this Guide and that the business plan is framed and presented in accordance with the requirements of the private equity firms.
• Advice on valuation of the business and planning for the ultimate sale of the business and realisation of management and the private equity firm’s investment.
• Undertaking financial modelling – carrying out sensitivity analysis on the financial projections to establish that the forecasts make accounting and commercial sense. Checking that they have been prepared in accordance with reasonable accounting policies and with due regard to publicly available information.
• Advice on the most appropriate capital structure to be used to fund your proposal.
• Making introductions to appropriate sources of private equity with investment criteria that match your business proposition and a business style that should be right for you. If your business is a highly attractive investment opportunity for private equity firms, this may include organising an “auction” or a “beauty parade” of private equity firms to compete for the right to finance your company. The financial adviser will need to ensure that the terms of the FSMA – see pages 51-55 – are properly complied with in providing this service.
• Making introductions to appropriate sources of debt and other finance to help to fund the proposal.
• Reviewing offers of finance – reviewing the terms of the deal offered by the private equity firms and other finance providers and assisting in negotiating the most advantageous terms from those on offer.
• Assisting in negotiating the terms of the deal with the private equity firms and banks and with the vendor.
• Project managing the transaction to minimise calls on management time and disruption to the business.
• Providing other advice, at a later stage if required, on the flotation of your shares on a stock exchange, or their sale to another organisation, or other such transactions.

The accountant’s role

The primary role of the accountant acting on behalf of the private equity firm, in an MBO transaction for example, is to undertake investigatory due diligence, such as described on pages 37-38. The precise scope of the accountant’s role varies from situation to situation but typically includes:

• Reporting formally on projections.
• Undertaking financial and commercial due diligence – often a prerequisite to private equity investment. The accountant will also be able to make informal judgmental opinions on aspects of the plan to the benefit of both management and the private equity firm.
• Undertaking pensions, IT or environmental investigatory work and due diligence.
• Providing audit, accounting and other advisory services.
• Planning your tax efficiently – help management obtain the maximum benefit from the tax system, whether the aim is for a public flotation or to remain independent, and to minimise tax liability on any ultimate sale of equity.
• Valuing your company’s shares – for tax planning and Inland Revenue negotiation.

Tax advice
The tax adviser will also help to ensure that, where possible:

• Tax relief is available for interest paid on personal borrowings to finance management’s equity investment.
• Potential gains on the sale of equity are taxed as a capital gain and not treated as earned income.
• Capital gains tax (CGT) is deferred on the sale of equity.
• Exposure to Inheritance Tax is minimised.
• Tax indemnities provided by the company directors and shareholders to the private equity firm are reviewed.
• Tax relief on professional costs in connection with an MBO, flotation or other exit is maximised.
• Corporate funding is structured to maximise tax relief.
• Tax due diligence procedures are properly carried out.

Your tax adviser can also explain the qualifying criteria under which personal investments can be made through the Enterprise Investment Scheme and in Venture Capital Trusts.

Under the EIS, individuals not previously connected with a qualifying unlisted trading company (including shares traded on AIM) can make investments of up to £200,000 in any tax year and receive tax relief at 20% on new subscriptions for ordinary shares in the company, and relief from CGT on disposal, provided the investment is held for three years.

For VCTs, which are quoted companies similar in concept to investment trusts, income tax relief is available at 40% on new subscriptions by individuals for ordinary shares in the VCTs. The maximum amount qualifying for relief is £200,000 each tax year. In addition, no tax is payable on gains realised on the disposal of shares in a VCT. As with the EIS, the minimum holding period is three years. Some of the tax benefits of VCTs have been eroded by the removal of tax credits on dividends and the introduction of taper relief on CGT.

If you require a chartered accountant or financial adviser with experience in the private equity field, see the “Associate Members – Professional Advisers” section within the BVCA’s Directory of members.

The lawyer’s role

Usually there are at least two sets of lawyers involved in the private equity process; one representing the management team and one representing the private equity firm. Other parties, such as bankers and other private equity firms, if acting as a syndicate, will each want their own lawyer involved.

The private equity firm’s lawyer
The lawyer is mainly concerned with ensuring that the private equity firm’s investment is adequately protected from a legal standpoint. The lawyer will draw up the various investment agreements, usually including the following:

• Shareholders’ or subscription agreements
  Documents detailing the terms of the investment, including any continuing obligations of management required by the private equity firm, the warranties and indemnities given by the existing shareholders, penalty clauses and the definition of shareholder rights.
• Warranties and indemnities
  Documents that confirm specific information provided by the directors and/or shareholders to the private equity firm. If this information turns out later to be inaccurate, the private equity firm can claim against the providers of the information for any resulting loss incurred.
• Loan stock or debenture agreements
  A statement of the terms under which these forms of finance are provided.
• Service contracts
  Documents that formalise the conditions of employment of key members of the management team.
• Disclosure letter
  Contains all the key information disclosed to the private equity firm on which the investment decision has been based. It is essential that the directors do not omit anything that could have an impact on that decision. The disclosure letter serves to limit the warranties and indemnities.

The management team’s lawyer
The management team’s lawyer will review the Offer Letter (Heads of Agreement) from the private equity firm and, together with your financial adviser, will help you to negotiate acceptable terms. The team’s lawyer will also, in due course, negotiate the investment agreements with the private equity firm’s lawyer and produce the disclosure letter, as well as negotiating any loan documents with the banker’s lawyer.

In the case of a new company, your lawyer can incorporate the company and draw up the Memorandum and Articles of Association, which govern the constitution of the company, its permitted activities and the powers of its shareholders and directors. Even in the case of an existing company, a new Memorandum may be required and new Articles almost certainly will be needed to document the dividend and other rights attaching to the company’s shares following the private equity investment. If you need to find a lawyer experienced in these areas, refer to the “Associate Members – Professional Advisers” section of the BVCA’s Directory.

Professional costs

In many cases, the costs of all the professional advisers will be borne by the company receiving the investment. The private equity firm will usually increase the funding provided to allow for these costs, so you and your team should not be “out of pocket” as a result, although you may be left with a slightly smaller equity stake. However, there are circumstances where this is not possible, due to contravention of Company Law, or where it is agreed that each party bears its own costs.

Ensure that you agree the basis of costs before any work commences. In particular, ensure that you have firm agreement as to who is to bear the costs in the event of the negotiations being aborted. Usually in this case the private equity firm will bear the cost of work commissioned by them and you will pay the costs of your own professional advisers.

Professional costs incurred by the financial advisors, accountants and lawyers employed by the management team and the private equity firm, like any service, need to be carefully controlled. There is a range of costs that will depend on the complexity of the transaction, but will typically be around 5% of the money being raised.

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