The mood among private equity lawyers is bullish. Fundraising activity is at peak levels. ‘Dry powder’ (sums yet to be invested) reached a record high of $954bn in September 2017, almost $100bn higher than the amount recorded at the beginning of the year, research by data provider Preqin shows.
‘Private equity is extremely buoyant at the moment,’ says Latham & Watkins partner Huw Thomas. ‘We’re seeing record amounts of cash raised and deal activity is at its highest level since the financial crisis.’ Apollo Global Management recently secured $24.7bn for the largest ever buyout fund and CVC Capital Partners collected €16bn for the biggest fund ever raised by a European manager. Other megafunds such as SoftBank’s Vision Fund and Blackstone Infrastructure I are targeting $100bn and $40bn respectively.
The total value of PE investments in European companies reached its highest level for any quarterly period since the financial crisis, Thomas notes. It jumped 50% to €42.9bn from €28.6bn, making it the highest for a decade, according to the Q2 2017 Private Equity Barometer of SL Capital Partners. The market cooled in the third quarter, but deal volumes and values remain at historically high levels.
Private equity is medium- to long-term finance given in return for an equity stake in potentially high-growth and often unquoted companies. Since the financial crisis, low interest rates and cheap debt have boosted capital-raising by private equity funds as institutional, sovereign and other investors look for higher returns. ‘The returns private equity can generate have attracted a huge amount of money,’ confirms Travers Smith senior partner Chris Hale. ‘The private equity industry now has record amounts to invest. The enormous amount of liquidity has also helped push prices in the M&A world to record levels.’ Consider, for example, the $18bn sale of Toshiba’s memory chip business to a Bain Capital-led consortium, announced in September.
‘It has also enabled larger private equity houses to launch different products such as debt funds,’ Hale adds. ‘A number of private equity houses are now multi-asset managers as a result.’
The knock-on effect is felt beyond funds and M&A practices. ‘The main story of the past 18-24 months has been one of continuing loose monetary policy,’ says Thomas. ‘It has allowed many PE funds to take advantage of historically favourable terms to refinance their portfolio companies, which has benefited our bank and bond finance practices.’
Greater regulatory scrutiny of the financial services sector since the crisis has not spared private equity investment firms, or ‘sponsors’, which raise and manage funds on behalf of the investors.
‘Overall, the sector is subject to much more extensive regulation than it used to be, in terms of how private equity funds are managed and how sponsors can raise capital,’ says New York-based Andrew Nussbaum, partner at Wachtell Lipton Rosen & Katz. For example, changes in EU rules have had ‘implications for sponsors who do limited transacting in Europe, but may have a few European investors in their fund’, Nussbaum says. He points to the Alternative Investment Fund Managers Directive, which monitors and supervises risks posed by alternative investment fund managers, including managers of hedge funds, investment trusts and private equity firms.
What services do lawyers provide to the private equity sector? Legal advice is required in three main areas: setting up and raising money for the funds; transactions; and, increasingly, regulation.
‘At the moment, private equity houses are, if anything, accelerating fundraising exercises in order to take advantage of the huge liquidity flowing into the sector from investors and, in some cases, to conclude fundraising before Brexit, buying time to work out how to respond to it,’ Hale says.
With the supply of cash exceeding the supply of assets, prices are as high as ever. ‘It has been a good time to be a seller,’ Hale adds. ‘The focus of our private equity work over the last 18 months has been more on the sell than the buy side.’ Secondary, or even tertiary deals, whereby PE firms sell to each other, have become an increasingly preferred option for firms exiting an investment (the other methods are IPOs or corporate acquisitions). Travers Smith was one of the legal advisers in the ‘tertiary’ buyout of Civica for just over $1bn.
A few private equity firms are finding it relatively difficult to utilise the funds they have available because of the relatively buoyant state of the market
— Tony Williams, Jomati
‘A few private equity firms are finding it relatively difficult to utilise the funds they have available because of the relatively buoyant state of the market,’ says consultancy Jomati’s principal Tony Williams. ‘This means that buying businesses cheaply is more difficult. Quite a number of transactions over the last year have actually been second-stage private equity investments.’
‘On the deal side, there is now much more transactional activity within the funds themselves,’ says MacFarlanes partner Christopher Good. ‘Investors now regularly buy and sell stakes in private equity funds on the secondary market.’
Despite high levels of committed capital, Nussbaum observes: ‘What you don’t see as much of now are the mega private equity deals, north of $5bn. Most of the deals in the US and Europe are on a much more modest scale.’
Post-2008, PE firms have ‘shied away from $10-$20bn public company buyouts and are leaning much more towards carve-out transactions or partnering with corporates,’ Nussbaum explains. Toshiba’s $18bn deal is the exception to the rule in size terms, but not in other respects; it is only for a portion of the Japanese multinational’s overall business and is ‘heavily structured’, including with equity financing from corporates such as Apple and Dell. ‘Ten years ago, Bain would have found some co-investors on the private equity side to do the deal, as opposed to going to corporates,’ Nussbaum asserts. Wachtell Lipton Rosen & Katz, whose clients include the Carlyle Group, TowerBrook and BC Partners, recently advised Siris Capital on the acquisition of US-based Synchronoss Technologies Inc’s cloud software subsidiary Intralinks Holding, in a deal worth about $1bn. The firm also acted as corporate counsel to Apollo Global Management in its $5.1bn buyout of communication and network infrastructure provider West Corp.
Pointing to another sector trend, Hale says: ‘In 2017 there has been a slight uptick in public-to-privates, a type of deal which has been rare since the financial crisis.’ This is when a quoted company leaves the stock exchange and becomes privately owned. ‘Travers Smith has worked on more public-to-privates this year than it has for quite some time.’ For instance, it advised Bridgepoint-owned Element Materials Technology Group on taking Edinburgh-based industrial material testing business Exova private, in a deal worth £620.3m.
There is a lot of interest in Germany, which is seen as a safe haven. There is a lot of competition among funds for German assets
— Thomas Schulz, Noerr
PE firms are also increasingly pursuing ‘buy-and-build’ strategies – acquiring an established platform company and then adding on similar businesses to accelerate growth and maximise returns, explains Thomas Schulz, partner and head of Noerr London. A recent example saw the Munich-based firm advise Payleven Holding on the merger of the Payleven group with SumUp, two mobile payment providers backed by venture capital firms, and with combined annual revenue of more than €1bn.
‘Many of the deals we are doing now are buy-and-build platforms,’ says David Higgins, a Freshfields Bruckhaus Deringer partner. The magic circle firm advised Europe’s Cinven and Canada Pension Plan Investment Board on the acquisition of Hotelbeds, a ‘bedbank’, from Tui Group (for €1.165bn); and on their subsequent purchase of the Kuoni hotel booking service GTA, which is to be combined with Hotelbeds, pending merger control filings and approval. Freshfields advised on the tax, financing and antitrust aspects of the deal.
Competition law is becoming an increasingly important part of legal services to private equity clients. ‘As you get bigger, you have to think carefully about the antitrust implications of what you are doing,’ says Higgins. ‘You are more like a consolidator, so you really then need to have top antitrust advice.’
What legal services firms provide to private equity is also dictated by other factors. ‘The financing has become a lot more complicated than it used to be, when you’d have one bank involved and you’d just go and loan some money,’ Higgins adds. Today, depending on the size of the deal, there is an array of financing methods ranging from multiple banks to mezzanine and sovereign wealth funds, to equity and high-yield financing, plus the foreign exchange aspects of cross-border deals. ‘We see a lot more alternative capital providers. Big pension funds and sovereign wealth funds are now providing debt,’ Higgins adds.
The rise of new financing mechanisms has been driven in part by the US Federal Reserve, Higgins observes. Under the Volcker rule, which came into effect in July 2015 and is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, there are restrictions on banks owning hedge funds and private equity assets (although the rule is being amended by the Trump administration). Leveraged lending guidelines introduced in 2013 limit the ability of banks to lend to heavily indebted companies.
‘On the fundraising side, the explosion in the number of private fund debt providers is significant,’ says Good. Macfarlanes helped Alcentra, a specialist fund manager based in London and Los Angeles, to raise its most recent $4bn direct lending fund. ‘Those sorts of fund managers will be competing with banks in lending to private equity,’ moving into the space left by retrenching banks, he says.
‘As deals get more complex and faster, we are seeing a change in what might be required – specialist sector knowledge, tax advice or regulatory input, for example – together with a demand for services to be more joined up within service firms so that the lawyer acts almost like an extension of the client,’ Good says.
‘It’s not just getting the deal done,’ explains Nussbaum. For example, lawyers now spend more time making sure that the portfolio company, which is the company the private equity fund invests in, is ‘well set up in terms of risk management, governance and contingent liability exposure’.
Nussbaum adds: ‘There is a more active participation by many limited partners in the investment that sponsors find.’ Institutional and other investors put money in the funds as limited partners, but now (through ‘co-investments’) as limited partners they purchase stakes directly in portfolio companies alongside the sponsors with a view to maximising returns. As a result, lawyers are increasingly called in to negotiate and structure ‘upstairs’ agreements, which govern the relationships of sponsors and co-investors.
The types of sectors private equity invests in further add to the complexity of the legal advice. Financial services, for example, has been a main investment target of late and lawyers say the trend will continue. US private equity firm Cerberus Capital Management earlier this month said it had taken a 3% and 5% stake in Deutsche Bank and Commerzbank, respectively.
Also in Germany, where bank margins are squeezed by technology and negative interest rates, Noerr last year advised Apollo Global Management-owned Bremer Kreditbank on the purchase of Bankhaus Neelmeyer, from Italy’s UniCredit Bank. This year Freshfields acted for a consortium of Blackstone, GIC and Massmutual in the buyout of Goldman Sachs’ stake in UK insurer Rothesay Life for an undisclosed sum. It also advised Hellman & Friedman and GIC on their €1.8bn agreement to buy Spain’s Allfunds Bank from Santander and Intesa Sanpaolo, among other shareholders.
‘It is quite good for the legal sector because buying a financial services asset is complicated. There is a lot of work around the regulatory side,’ Higgins says, pointing to the Allfunds Bank deal, requiring clearance from the Bank of Spain and the European Central Bank. In the UK, insurance firms and banks are regulated by both the Prudential Regulation Authority and the Financial Conduct Authority.
$954bn - Total amount of ‘dry powder’ (September 2017)
$24.7bn - Funds raised by Apollo Global Management
€42.9bn - Value of European PE-backed deals in Q2
$18bn - Sale of Toshiba’s chip unit to a Bain Capital-led consortium
$5.3bn - Sale of Scandinavia’s Nets A/S to Hellman & Friedman
Payment in full
Within financial services, private equity is also playing a key role in the consolidation taking place among payment processors as banks divest non-core assets.
‘Payment services is one sector where we have seen particularly high levels of PE interest,’ says Thomas. He points to recent deals including Latham advising a consortium led by Blackstone and CVC Capital Partners on its £2.96bn offer for Paysafe (the largest public-to-private deal under the UK Takeover Code since 2010); and Boston-based TA Associates on the acquisition of a minority interest in Interswitch, an Africa-focused digital payments service.
On Hellman & Friedman’s $5.3bn purchase of Scandinavia’s payment processor Nets A/S, Freshfields acted as the main counsel for the American PE firm, while Latham advised on the financial aspects of the deal. That is Europe’s largest leveraged buyout in the past five years. Nets will be acquired by Evergood 5 AS, a newly formed company controlled by funds managed and advised by Hellman & Friedman.
Business services and technology have been ‘particularly attractive for deals’, observes Hale, pointing to the buyout of Civica, a British seller of administrative software to the private and public sectors, an example that straddles both sectors.
PE is a global industry and it follows that legal firms with global reach are often best placed to support the sector. So where are the investments?
‘We have seen a lot of activity on the continent,’ says Thomas, highlighting the acquisitions of German fashion retailer Schustermann & Borenstein by London-based Permira; and Italy’s luxury brand Golden Goose and Derby-based air and defence industry supplier Pattonair by US-based Carlyle Group and Platinum Equity, respectively. Kohlberg Kravis Roberts, another US-based private equity group, reportedly plans to raise up to €5bn to invest across Europe.
Noerr acts for PE funds, including from the UK and the US, with a focus on Germany, central and eastern Europe. ‘There is certainly a lot of interest in Germany, which is seen as a safe haven. There is a lot of competition among funds for German assets,’ Schulz says. ‘We also see an increase in investments into central and eastern Europe.’
‘You have to look a lot harder to find the value-for-money assets, which means that people have started to look further afield to newer markets,’ says Higgins. He points to the Nets deal and the sale of Poland’s online auction business Allegro by South Africa’s Nasper to a consortium including Cinven, Permira and Mid Europa.
A geographical rethink is also being driven by Brexit. ‘In the sector we work in, which is the large-cap investors, the impact of something like Brexit means that [clients] slightly change their focus,’ Higgins says. ‘People aren’t doing many deals in the UK, but they are very active in Europe.’ The Financial Times reported last week that PE groups are now agreeing to cap their investments in the UK over Brexit-related fears.
Freshfields advised CVC Capital Partners on the €1.75bn acquisition of Dutch business service TMF Group; and the sale of Finnish insulation manufacturer Paroc in a deal valued at €700m. It also acted for Cinven, which agreed to buy a majority stake in Spain’s global berry supplier Planasa for €450m.
Trump is having a similar effect in the US, where ‘prices are quite high at the moment because there is a lot of capital’, Higgins adds.
PE firms are also investing in less over-valued markets such as Asia and the Middle East. ‘A lot of private equity is already looking at Saudi Arabia and discussing with the local government what areas they can finance,’ notes Schulz, referring to the Crown Prince Mohammed bin Salman’s plans to diversify the oil-dependent economy, including the IPO of Saudi Aramco, the country’s national oil company.
The Softbank Vision Fund, which is backed by Saudi Arabia and Japan’s Softbank, as well as other investors, including Apple, Qualcomm, Sharp, and the sovereign wealth fund of the United Arab Emirates, has so far raised $93bn to invest in technology business. Saudi Arabia’s Public Investment Fund has also committed a $20bn investment to Blackstone’s Infrastructure I.
There is a range of factors that may dampen confidence. One is too much money chasing too few deals, which means lower returns for private equity firms investing today. There is also the rise of ‘economic nationalism’, which could affect M&A transaction approvals across Europe, as governments and regulators adopt a more interventionist stance towards foreign ownership of nationally sensitive assets, Thomas observes.
‘One potential cloud on the horizon is the raising of interest rates in the US and UK which both makes debt finance more expensive and may make other assets more attractive,’ observes Williams.
Any clouds are unlikely to dampen spirits too much as long as PE firms sit on what are record amounts of cash. Furthermore, large assets are coming up for grabs, among them multibillion-dollar units of Unilever, Akzo Nobel and Sanofi. In an inflated market, PE buyers will need plenty of guidance, legal and otherwise, on how to spend it wisely.
Mushroom cloud of regulation
‘PE firms are paying increasing attention to the regulatory environment,’ says Matthew Dean, a London-based partner at Willkie Farr & Gallagher. ‘Increasingly [they] want their go-to firms to have in-house capacity on the regulatory front. In my view this is the biggest change in legal services.’
Dean highlights some of the main regulatory changes – past and present – affecting the sector, among them the Bribery Act 2010 and the Criminal Finances Act 2017, which came into force on 30 September. There is also the General Data Protection Regulation (GDPR) which is coming into force in May; and the Markets in Financial Instruments Directive II will be implemented in the UK from January. ‘While it will be on the periphery of traditional private equity, any hedge fund or PE firm buying or selling securities or debt will be affected,’ Dean asserts.
In the UK, the sector is primarily regulated by the Financial Conduct Authority. ‘A private equity fund is often structured as a limited partnership, with a manager appointed by the partnership’s general partner to manage the fund,’ explains MacFarlanes financial services partner Paul Ellison. Where the fund is managed in the UK, the manager has to be authorised and regulated by the FCA as an alternative investment fund manager (AIFM) under the Alternative Investment Fund Managers Directive (AIFMD), which was implemented in the UK in 2013.
Ellison says: ‘This brings with it ongoing governance requirements and the AIFM must meet certain regulatory obligations on an ongoing basis, including maintaining a minimum level of capital, and having appropriate policies and procedures to address compliance and anti-money laundering obligations,’ Ellison says. Precise requirements will depend on the funds under management by the AIFM, and whether the funds are leveraged or unleveraged and open- or closed-ended.
AIFMD contains a ‘passporting’ mechanism that allows an AIFM to market its funds elsewhere in the EU. ‘Depending upon the nature of any future deal agreed between the UK and the EU, Brexit may also have an impact on the regulation of private equity firms as their ability to rely on passporting rights under the [AIFMD] may fall away,’ Ellison says.
‘In recent years, the regulation applying to private equity has mushroomed and this trend is unlikely to stop, with Brexit adding to the likely complexity,’ says Travers Smith senior partner Chris Hale (pictured). The majority of private equity fund managers in Europe are headquartered in London, and their UK-granted licences allow them to operate across the EU. ‘One consequence of Brexit is that those with headquarters in London are likely to need to obtain a licence within a remaining member of the EU to continue to operate in the EU and raise money from EU-based sources.’ That means relocating staff to continental Europe.
Hale adds: ‘The issue being debated is how many. It will also mean that these houses will have to comply with two sets of regulations – the British and those set by the EU – whereas today they only have to comply with one.’
Aside from Brexit, the OECD-led Base Erosion and Profit Shifting initiative, which aims to increase tax transparency by bringing changes to international tax laws and treaties, is another regulatory change with ‘major implications’ for the sector, contends Latham & Watkins partner Huw Thomas.
Marialuisa Taddia is a freelance journalist