A Guide to Private Equity

Whether or not you are an aspiring commercial lawyer, the word private equity (PE) should not be of any unfamiliarity. It is the process in which a PE firm, using funds it raised or borrowed, acquires a company.

The company being acquired is called a TargetCo. After acquiring the company, the PE firm invests in its growth. This is then followed by the PE firm’s ‘exit’, which is to sell the company at a higher value than when it purchased it, profiting off the difference. In this article, I shall provide a brief chronology of a law firm’s role in a PE deal.  

Initially, the law firm must clear any potential or existing conflicts of interest. Then, a non-disclosure agreement is required to be signed by all parties to prevent leaks of information leading to market reaction. An engagement letter is then exchanged between the law firm and the client, which could be the PE firm, the sponsor (ie a bank), or the TargetCo, outlining the scope of work, responsibilities, fees, and timeline of the project.  

After that, due diligence begins. Due diligence is the close scrutiny of TargetCo in an attempt to evaluate its suitability for acquisition. Things such as ongoing litigation or debt will be looked for, and if it brings more liability than opportunities for the PE firm, it will likely reconsider. When a lawyer acts for the PE firm, they will receive the legal vendor due diligence report (LVDD) from TargetCo’s counsel and is able to access a virtual data room where all documents about TargetCo is released.  

The first thing law firms must do is to identify and agree on the scope of due diligence with their client, instead of reviewing everything, which is quite likely to be impossible! Then a report summarising findings from due diligence, alongside important issues, will be sent to the client for review.  

If everything meets the client’s expectations and no issue is present, then the acquisition documents are signed. Those include:  

- Share Purchase Agreement (SPA): a document that governs all terms and conditions including buyers, sellers, purchase price, warranties and conditionality 

- Disclose letter: qualifies the warranties by disclosing information that may prove warranties incorrect, protecting TargetCo from future liability. 

- MIP Term Sheet: an important document that outlines the management plan for TargetCo following acquisition, whether the original owners will remain and if so, what incentives they would be given. 

- Debt-documents: Most PE deals are backed with debt, borrowed from the

sponsor, which is banks such as HSBC. 

Lastly, if the deal operates as a bid, which is where the TargetCo chooses the PE firm, there will be a period where the law firm waits for either confirmation or rejection. If confirmed (winning the bid), there will be a signing and closing. It is important to realise these two are distinct stages in a deal and should not be confused. Signing creates a legal obligation on the parties to complete the deal, and closing is where money is exchanged and shares transferred.  

So that is it, the company is successfully transferred to the PE firm, and what remains is for them not to mess up and sell the TargetCo in 6-7 years.  

Of course, this is only a brief outline, and it goes way deeper than this. One interesting aspect I did not mention is the way that the deal is structured. For mainly tax reasons, a triple NewCo stack structure is employed. This prevents PE firms from acquiring TargetCo directly, with three entities, Topco, Midco, and Bidco, in between the PE firm and TargetCo, each serving a different function.