THE ROLE OF THE FINANCIAL ADVISER, ACCOUNTANT AND LAWYER IN THE PRIVATE EQUITY PROCESS. THE PROFESSIONAL COSTS IN THE PRIVATE EQUITY PROCESS.
THE ROLE OF ADVISERS IN PRIVATE EQUITY
The financial adviser (like Unifinn), accountant and lawyer have essential 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.
(a) The Financial Adviser’s Role in Private Equity
The primary role of the financial adviser, for example 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 advisers. The precise nature of the role varies from situation to situation but typically includes:
- Undertaking an initial appraisal of management’s financing proposition.
- Providing 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 per the requirements of the private equity firms.
- Advice on the 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 following reasonable accounting policies and with due regard to the publicly available information.
- Make advice on the most appropriate capital structure to be used to fund your proposal.
- Make 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 have been appropriately 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.
(b) The Accountant’s Role in Private Equity
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. 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 – is 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.
The Role of Tax Adviser
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
- 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.
- Share option plans are properly set up.
- The advantage is taken of appropriate plant and machinery, industrial buildings and research & development capital allowances.
- 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.
(c) 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 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.
Investors’ rights agreement
Specifies the rights of the private equity firm with regards to the investment.
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. An indemnity is as a promise to indemnify, ie. to reimburse the investors in respect of a designated type of liability if it arises.
Loan stock or debenture agreements
A statement of the terms under which these forms of finance are provided.
Documents that formalise the conditions of employment of key members of the management team.
Contains all the key information disclosed to the private equity firm on which the investment decision has been based. The directors mustn’t 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
A lawyer appointed by the management will review the Offer Letter (the heads of agreement or Term Sheet) from the private equity firm and, together with your financial adviser, will help you to negotiate acceptable terms. The management 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 negotiate 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 (which under the Companies Act 2006 can now be unrestricted unless the articles express otherwise) and the powers of its shareholders and directors. Under the CA 2006 when a new company is registered it must supply to Companies House a memorandum of association, but this is a simple form containing only the names and addresses of the subscribers and (in the case of a company limited by shares) the number of shares taken by each.
The company must also have articles of association which can be based on the CA 2006 new Model Articles (one for private companies and one for public companies) although private equity investment articles will need to be fairly bespoke. 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 attached to the company’s shares following the private equity investment.
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 might not be possible, due to contravention of Company Law, or where it is agreed that each party bears its own costs.
Ensure that you agree to the basis of costs before any work commences. In particular, ensure that you have a 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 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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- Private Equity term sheet (offer letter)
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- The advantages of private equity over senior debt
- Stages of venture capital funding
- World’s top 10 private equity firms
- Private Equity Investment Strategies
- Top sources for startup funding
- Leveraged Buyouts
- Private Equity
- Mezzanine Financing
About the author
Dileep K Nair
Mr Dileep is currently the managing partner of Unifinn Capital Global and an advisor to the investment banking and corporate finance world. He is a mentor, entrepreneur, business advisor and investment banking expert with an overall 19 years of experience in investment banking, retail banking and corporate finance and business management. He handled a wide range of corporate finance transactions, including private equity funding, private debt, venture capital, angel investing, M&A, LBO etc worldwide.