Private equity investment normally involves a fund managed by a general partner or investment manager, with capital provided by limited partners such as institutional investors, family offices and other professional investors. The fund invests through a special purpose vehicle, often a company created for a particular acquisition. This separates the acquisition from other investments in the fund and provides a framework for allocating ownership, financing and returns.
The acquisition vehicle usually funds the purchase through a combination of investor equity and debt. This is commonly described as a leveraged buyout. The debt may include senior lending and other forms of acquisition finance, while the equity is divided between the fund and, in some transactions, the existing management team or other co-investors. The balance between debt and equity affects control, financial risk and the return available to equity holders.
The investment agreement sets out the rights attached to each class of shares. Ordinary shares generally participate in value according to their proportionate ownership. Preferred shares can provide priority on distributions or sale proceeds, subject to the agreed terms. Shareholders’ agreements and the company’s articles of association typically address voting rights, board appointments, reserved matters, transfers, information rights and exit arrangements.
Management participation is often structured through an equity rollover, direct investment, growth shares or an employee share option scheme. An equity rollover allows sellers or managers to reinvest part of their sale proceeds in the acquiring structure. Growth shares and options are designed to link future participation to an increase in the company’s value. The documents must address vesting, leaver provisions, tax treatment and what happens when an individual leaves the business.
A transaction commonly involves a term sheet, due diligence reports, a share purchase agreement or asset purchase agreement, financing documents, disclosure materials and new constitutional documents. The share purchase agreement records the acquisition terms, including warranties, indemnities, conditions and completion arrangements. The investment and shareholders’ documents then govern the relationship between the fund, management and other investors after completion.
The agreed exit route may be a sale to another investor, a trade sale, a refinancing or an initial public offering. Exit provisions often include drag-along and tag-along rights, transfer restrictions and processes for resolving disagreement over a proposed sale. Harper James advises on corporate and M&A, fundraising, banking and finance, and employee share schemes, areas that can arise in private equity transactions under the laws of England and Wales.