THSH Private Equity Roundtable Summary
On May 14, 2013, Tannenbaum Helpern Syracuse & Hirschtritt LLP held its inaugural Private Equity Executive Roundtable focusing on the evolving and emerging legal challenges facing the private equity (“PE”) industry. The Roundtable covered private equity issues in the compliance, regulatory, transactional and litigation areas. The Private Equity Roundtable series is limited in attendance to those who operate in the industry. It is focused on providing relevant educational information and tools to help firms manage legal exposure and risks. The following is a summary of the key points discussed at the event.
Private Equity Fund Manager Regulatory Considerations:
- New SEC registration considerations for PE fund managers: As a result of the Dodd-Frank Act, many PE fund managers now have to register as “investment advisers” with the SEC (unless they qualify for the limited “Private Fund Adviser” exemption).
- Advertising issues: PE fund managers should review their pitchbooks and other advertising materials to make sure they are not “cherry picking” or giving improper past performance results. All such advertising information must be substantiated with proper books and records. PE fund managers must also be cognizant of the limitations on the profitability of track records from previous firms.
- Broker/dealer issues: Fees paid to a “finder” relating to the sourcing of investors are likely deemed to be brokerage commissions that require registration as a broker-dealer. This has been an area of increased focus for the SEC.
- Other PE fund manager regulatory issues:
- Valuations: PE fund managers should ensure that their valuation procedures are being followed and applied consistently.
- Insider trading: This is another area of increased focus by the SEC.
- Conflicts of interest: PE fund managers should avoid “cherry picking” in the context of co-investments and should be wary of hiring “zombie” managers: managers who do not liquidate portfolios in a timely manner in order to maintain an income stream.
Private Equity: Current Practices, Trends and Issues
- Two-step mergers: Two-step mergers are those in which (i) the PE fund would make a tender offer for all outstanding shares in a target company, and then (ii) would acquire the balance of shares not tendered in the offer via a back-end merger, and allows the PE fund manager to commence the tender offer without prior SEC review. There is a proposed amendment to Delaware law permitting expedited two-step mergers. This would reduce costs for a PE Fund manager and eliminate the delay and uncertainty of a tender offer by streamlining the two-step merger process.
- “Multiple bidders” scenarios: Scenarios involving multiple bidders continue to be common in the PE industry:
- Auctions: Where there is sufficient interest in a target, sellers typically prefer auctions in which multiple bids are solicited to create a competitive bidding process to obtain the best possible terms.
- Club deals: In a club deal, bidders team up with other bidders to submit a joint bid. This enables, among other things, bidders to take part in a larger deal, reduce their risk, pool expertise and increase access to capital. Typically in club deals, bidders enter consortium agreements to govern the relationship of club members. Club deals may raise antitrust concerns. For example, based on the recent Dahl v. Bain case, we would recommend that club members be mindful about their internal and external communications and should document their reasons for not bidding as well as pursuing one deal over another to avoid antitrust implications.
- Co-investment: Co-investment allows multiple investors to invest in the same deal, typically without any fees. PE funds can use co-investment as a way to reward or attract lead investors or to enhance relationships with existing investors.
- Go-shops/No-shops: Bidders seek “go-shops” as they enable a bidder and a target company to sign up a deal prior to shopping the deal, and thereafter “go-shops” permit the target to shop itself for a limited time to satisfy the target board’s fiduciary duties and, where possible, to obtain a higher bid to maximize value. While a no-shop generally precludes a target company from soliciting bids, a window shop will allow a target company to respond to unsolicited bids and to walk away from a deal based on negotiated fiduciary outs, typically, among other things, for superior bids or unforeseen circumstances.
- Secondaries: The PE equity secondary market consists generally of a purchase of (i) investor interests and obligations in a fund, (ii) private equity fund portfolio investments, and (iii) side-pocketed investments.
- Reverse break-up fees: Reverse break-up fees are fees that the bidder pays if they walk away from a PE deal. PE funds seek to cap their damages for walking away. Accordingly, the challenge for the parties negotiating a reverse break-up fee is to balance the situations in which the fee is payable, against those in which the target can compel specific performance.
- Fund terms: A competitive investment environment has resulted in more favorable terms for investors (i.e., management fee waivers, suspension of investment period by vote)
Litigation Issues for Private Equity Fund Managers
- The importance of clear boundaries between fund and portfolio companies: PE fund managers should be careful not to go beyond “oversight” in supervising portfolio companies. Some recent bankruptcy and ERISA cases have sought to hold funds liable where the fund managers are deemed to have “de facto” control over a portfolio company.
- Portfolio company litigation:
- Pre-acquisition litigation assessment: What litigation will be needed to meet business objectives? Should any potential litigation affect the purchase price of a target?
- Planning for necessary litigation: One of the sources of value creation in acquiring a portfolio company is modifying key contracts. However, these changes frequently result in litigation. Before contracts are terminated, outside counsel should be consulted to determine whether the other party has breached any of its duties and/or how to approach termination and modification to maximize litigation and settlement leverage.
- IRR-driven approach: If the purpose of a portfolio company’s litigation is to modify key contracts, it is wise to manage the litigation in a way that is consistent with the economic goals. The litigation’s true objective often is not to win at trial, but to achieve a settlement that, with litigation costs, makes the contract modification one that improves the value of the portfolio company. If so, the portfolio should take only those steps necessary to change the settlement leverage, even if some helpful evidence will go unexamined.
For more information on the topic discussed, contact: