The past two years have been a challenging period for private equity, with higher interest rates, subdued economic growth and political uncertainty all serving to suppress deal flow. However, as inflation continues to ease and long-awaited rate cuts begin to materialise, many dealmakers are entering 2025 with a sense of cautious optimism. The recent uptick in M&A activity in the United States suggests that this optimism may be well-founded.
Due to the recent dearth of private equity (PE) exits, median portfolio company hold periods are at an all-time high and, while the industry has found creative ways to address the liquidity needs of limited partners (LPs) (including through the use of partial exits and continuation funds),1 the continued demand from LPs for distributions points towards significant acceleration of exit activity in the coming year. Given the continued high levels of dry powder available to PE sponsors and the significant cash reserves accumulated by corporates during both the pandemic and the subsequent period of high interest rates, competition for attractive assets is expected to be fierce.
In this article, we examine some of the ways in which sellers can ensure that they are positioned to take full advantage of that competitive landscape to optimise terms and deal certainty.
Pre-Transaction Preparation
Early preparation and proactive process management are key. Anticipating what a buyer will need and using the pre-launch period to address it ahead of time will help shorten the overall transaction timeline and maximise competitive tension throughout.
So what should sellers think about while preparing for launch?
- Vendor due diligence. Many buyers will still be proceeding with caution and risk-averse investment committees are seeking ever deeper and earlier insight into target businesses. A thorough and targeted vendor due diligence process will help ensure that the key issues most likely to concern a buyer are addressed early on and, ideally, resolved. For issues that cannot easily be rectified or for contingent liabilities, it may be possible to find ways to mitigate risk, including by way of specific insurance policies.
- Hard-stapled W&I insurance. £1 liability caps accompanied by warranty and indemnity (W&I) insurance remain the industry standard. Where competition for an asset is expected to be fierce, and the transaction timeline condensed as a result, the seller may choose to encourage bidders to place the W&I policy (if any) after exchange. The seller may also wish to consider arranging a hard-stapled W&I policy on behalf of bidders (whereby the underwriter is chosen and the policy negotiated before bidders are introduced to the broker). This not only expedites the timeline but also gives bidders greater visibility on the level of cover available, thereby making it easier for them to delay playing the policy until after exchange.
- Merger control and foreign investment analysis. The increasing scrutiny of M&A transactions by governments and regulators using the powers available to them under ever broader merger control and foreign direct investment regimes continues apace. In that context, pre-screening of bidders (to better understand any issues that may arise and for whom they are likely to be more or less challenging) and early collation of the information that bidders will need to carry out their analysis will be crucial.2 Where strategic bidders are involved, clean team arrangements may also be required (in addition to confidentiality agreements) to reduce the risk of falling foul of antitrust rules. These should be put in place early to avoid disrupting the momentum of the deal.
- Term sheets. Term sheets can be a useful tool to assist with bidder selection and speed of execution: by facilitating early agreement on key issues, strategic use of term sheets can give sellers greater confidence in narrowing the field of bidders and can significantly shorten the period between bidder selection and exchange.
- Stapled financing / lender education. Although the outlook for the debt markets is starting to look more positive, where bidders’ ability to source debt finance on attractive terms is still expected to be limited, sellers may wish to consider arranging a stapled debt package or at least conducting a lender education process, so as to minimise execution risk and maintain competitive tension.
- Delivery of shareholders. Preparations should be made early to ensure that it is possible to deliver 100% of the company on completion. In most cases, this will primarily be a case of collecting powers of attorney, but thought should be given to whether other documentation or information is required from shareholders (such as know-your-customer and bank details) and care should be taken to ensure that any powers of attorney are broad enough to cover all likely eventualities, including any reinvestment into the buyer group. Where there are concerns regarding the ability to deliver one or more shareholders into the deal, thought should also be given early to whether there is a “drag along” mechanism that needs to be exercised and, if so, the steps required to do so.
Using the Gap Period
Once agreement on the key commercial terms of a deal has been reached, the seller (and, no doubt, the buyer) will typically want to proceed to exchange as soon as possible. Consequently, focusing only on the work streams that are essential to complete before exchange and making everything else a post-exchange (or even post-completion) action can be an attractive strategy. However, the importance of high-quality advice here should not be underestimated — a sophisticated legal adviser will ensure that contractual certainty and speed of execution are balanced appropriately and that any associated risks are mitigated effectively. Key topics to be considered include:
- Financing. If the buyer anticipates using debt finance, can this be arranged post-exchange, with the buyer obtaining and evidencing a suitably robust debt commitment from their chosen lender(s) or even agreeing to equity underwrite the purchase price in full at exchange?
- Equity wrapper. An equity wrapper allows parties to agree the key management equity terms at exchange with an obligation to agree the long-form equity documents by completion. When based on a suitably detailed and comprehensive term sheet, an equity wrapper can greatly aid speed of execution without introducing material uncertainty to the process.
- Sponsor reinvestment. Similarly, if a selling sponsor considers that it may wish to reinvest in the buyer group on completion, it is often best to structure this as an option, framed by reference to an agreed term sheet, which the sponsor can exercise in a short period following signing. Setting it up in this way prevents the process of documenting the reinvestment from distracting from the sale process and may be necessary if the sponsor doesn’t have sufficient time to decide whether or not to reinvest (or from which fund it will do so).
- Practicalities. A number of other work streams that are traditionally completed prior to exchange can, in the right circumstances, be bifurcated or even deferred in their entirety so as to be completed between exchange and completion. This includes simple logistical matters, such as the establishment of escrow arrangements, but it can also extend to more complex work streams, such as the establishment of acquisition structures and the production of the full transaction funds flow (beyond those aspects necessary to generate the outputs needed for the SPA and therefore required by exchange).
The coming year looks likely to present interesting opportunities for PE sponsors who are looking to realise their investments. Those that are well-prepared and strategic in their approach will be best positioned to capitalise on them.
George Weavil is a partner in Goodwin’s European Private Equity team based in London, UK. Hyo Lee is a knowledge & innovation lawyer supporting Goodwin’s UK corporate transactional practices.
[1] For more, see the Goodwin article “Meeting Liquidity Needs in the Face of Longer Hold Periods.”
[2] For a discussion on how sellers may address the uncertainty that arises in a (potentially prolonged) period between exchange and completion while such regulatory clearances are sought, see the Goodwin article “Rising Regulatory Screenings: Navigating the Transaction Process During Prolonged Longer Interim Periods.”
This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.