Answer ... The governance structure will be set out in the articles of association of Topco (and its subsidiaries) and an investment agreement between the private equity investor and management. If there are loan notes in the structure, a loan note instrument will also be constituted by the issuer.
The investment agreement will set out who will sit on the Topco board (typically the key executive directors, one or more non-executive investor directors and an independent chairman), and will include checks and balances to ensure that management run the business lawfully and within agreed parameters, including conduct of business covenants, investor information rights, investor consent rights and investor board appointment rights. Increasingly, there is also emphasis on conducting the business of portfolio companies in an ethical and sustainable manner, with an appropriate level of corporate governance.
Investor information rights will be driven by the private equity firm’s own reporting lines (eg, the need to pass on certain information to the underlying investors and compliance with the Walker Guidelines).
Being a public document, the content of the articles will be limited to key constitutional provisions, including details of:
- share capital;
- rights attaching to shares;
- restrictions on share transfers;
- board and shareholder proceedings; and
- shareholders’ rights against the company.
Under English law, the articles form a contract between the members and the company (ie, not a contract between members themselves); therefore, provisions regarding the checks and balances that a private equity investor wants to impose on management are included in the investment agreement.
Answer ... Having an investor director or investor directors appointed to the board of Topco and possibly other group companies is crucial to the private equity firm’s monitoring of the performance of its investment. Typically, the investor director(s) will have disclosure rights allowing the sharing of information acquired at board level with the wider investor group.
However, the position of an investor director can be complex in certain situations. Essentially, two parallel roles need to be balanced:
- acting as a representative of the private equity investor; and
- acting as a director of the investee group company.
Normally, the two roles are broadly compatible, as they both require that the investor director act with a view to maximising shareholder value; and although there is a statutory duty on directors to avoid situational conflicts of interest, there is also a statutory procedure for pre-authorising such conflicts in the articles. However, in circumstances of financial distress, this dual role can put the investor director at increased risk of being in breach of his or her directors’ duties. A common example of this is where further funding is being discussed at board level, but the investor director knows that the private equity investor will not provide further funding – the investor director’s duty to disclose relevant information to his or her co-directors conflicts with his or her wish not to disclose sensitive investor-side information. In potential conflict situations, it is important that investor directors seek legal advice on their own personal position.
Answer ... On a majority investment, the private equity investor will typically have broad appointment powers, including the right to appoint a majority of the board, and favourable quorum requirements to ensure that it controls the board of Topco and potentially other group companies; but given the sensitivities referred to above, investor directors rarely sit on all subsidiary boards. Decision making at the operating level therefore often lies with management, which is helpful in allowing them the autonomy they need to run the business on a day-to-day basis; but the private equity investor will want some control over key decisions to control its investment. This is achieved through the inclusion of investor consent rights in the investment agreement.
Most investor consents operate as a negative right (ie, the newcos and management agree not to take certain actions without the private equity investor’s consent). Such consent rights will cover, among other things:
- acquisitions and disposals (including, if applicable, protection against asset stripping for compliance with the Alternative Investment Fund Managers Directive (AIFMD));
- capital commitments;
- loans and borrowings of the group;
- employee remuneration and benefits;
- property disposals and acquisitions;
- changes to constitutional documents and share capital; and
- the appointment and removal of directors.
On leveraged transactions, an additional layer of veto rights will be introduced through the lender consent requirements as set out in the financing documents.
Where the private equity investor is taking a minority position, veto rights may be more streamlined, focusing on economic protection and fundamental strategic matters.
Answer ... To ensure that each group company and the target comply with applicable laws and regulations and principles of corporate governance (and, if applicable, the investor’s own policies and protocols in relation to investee companies), each newco and management will be required to undertake to comply with a pre-agreed list of positive covenants set out in the investment agreement, which usually includes:
- the maintenance of adequate insurance policies for the group;
- compliance with laws and licences;
- and compliance with group-wide policies (eg, anti-bribery and corruption, environment, health and safety and data protection policies).
A contractual right to receive regular information in relation to the business and access rights to the officers, employees and premises of the group allows the private equity investor to monitor performance of the investment and to ensure compliance with applicable laws, regulations and corporate governance obligations (eg, financial crime laws, the AIFMD and the Walker Guidelines), in addition to information that the investor directors, by virtue of their position on the board, may acquire and disclose to the investor group. In the absence of any specific information rights set out in the investment agreement, the private equity investor will be entitled to receive only the information available to any other shareholder as a matter of company law (ie, the annual accounts). Monthly management accounts, details of and changes to operating budgets and the business plan, and information relevant to assessing compliance with law and regulation and the minutes of all board meetings will typically be requested.