Published: September 2004

The UK LBO Manual

Written & researched by Published by

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Development of the UK private equity market
Andrew Burrows and Mike Wright, Centre for Management Buy-out Research*
Introduction
Since the development of highly leveraged transactions
involving listed companies in the US in the late 1970s, buy-
outs have become an international phenomenon. In Europe,
the UK led the way with activity levels growing rapidly in the
early 1980s. The Continental European buy-out market first
saw growth later in the decade, with France and the
Netherlands in particular seeing considerable buy-out activi-
ty, whilst Germany has been slower to develop but has
recently become more important.
Buy-outs have been an important feature of the privatisation of
state assets during the transition from communism to a market
economy in Central and Eastern Europe since the beginning of
the 1990s.The need for major restructuring in Japan and Korea
has given an impetus to buy-outs in the Far East with buy-outs
now spreading in significant numbers to Asia.
Definitions
Management buy-outs (MBOs) involve the acquisition by
incumbent management of the business where they are
employed, with the purchase price being mainly met by a
private equity/venture capital firm providing significant
amounts of equity and/or banks providing debt.
Management buy-ins (MBIs) are a similar form of transac-
tion but differ in that the entrepreneurs leading the transac-
tion come from outside the company. A hybrid buy-in/man-
agement buy-out (BIMBO) combines the benefits of exist-
ing internal management and the contribution of external
entrepreneurs; these transactions have developed to address
the shortcomings of pure MBIs where asymmetric informa-
tion problems faced by outsiders contributed to significant-
ly higher failure rates than for MBOs.
Leveraged buy-outs (LBOs) are typically led by specialist
financiers whose executives take direct equity holdings in
the acquired corporation but with the vast majority of the
funding for the purchase being in the form of debt.
Incumbent management may play a marginal role in put-
ting the transaction together and in equity holding and may
even be replaced. If they are heavily involved, the transac-
tion may be termed a leveraged management buy-out
(LMBO). Similar to LBOs, investor buy-outs (IBOs) have
developed where private equity groups initiate and lead the
transaction, but with the degree of leverage being substan-
tially less. Other variants include MEBOs, where manage-
ment and employees both provide equity. The initial buy-
out transaction may be used as a platform for further acqui-
sitions, a so-called buy-and-build or leveraged-build-up
strategy. Such deals are typically aimed at consolidating
fragmented industries.
UK private equity market development
The UK buy-out market began to develop strongly in the
early 1980s and by the end of the decade a first peak in
market value of £7.5 billion was reached (see Chart One).
Following the recession of the early 1990s, market value
began to recover from 1994, reaching a new peak of £23.9
billion in 2000, before declining to £15.3 billion in 2002. UK
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The structure of leveraged buy-out transactions 15

Acquisition One Newco, two Newcos, three Newcos, four

What is the transaction?
This element of a private equity transaction is familiar to all
M&A practitioners. It concerns the acquisition of the com-
pany, business, assets or group of companies, businesses and
assets in which the private equity funds are to invest. The
subject matter of the acquisition, whatever its nature or com-
position, is referred to as the 'Target'.
Much time and effort is spent, particularly in the larger private equity
transactions, in making sure that the acquisition and financing structure
is as tax efficient as possible (see chapter five ‘Structuring an LBO – UK
tax aspects’). This may well result in 'Newco' being more than one com-
pany - often up to (and sometimes more than) four distinct companies.
Where this is the case, the roles and responsibilities of those separate
Newcos (and the documentation to which they are a party) are set out
below.
Involvement in Party to
Newco Transaction

'TOP' NEWCO (Pure) equity finance from Subscription agreement

Who are the parties? (a) private equity fund and Articles
(b) management Warrant instrument1
Service agreements2
One party to that acquisition transaction will clearly be the
NEWCO 2 Loan stock/DDB from
current owner of the Target, in its capacity as a seller. private equity fund Loan stock/DDB instrument
Typically, on a private equity transaction, the buyer is a new (and, if relevant,
management)
company ('Newco'), some form of special purpose vehicle -
NEWCO 3 Mezzanine finance from Mezzanine loan documents
i.e. a company formed specifically for the purpose of making mezzanine bank(s) High yield/securitisation
the acquisition. Depending on the nature of the acquisition High yield/securitisation documents
finance, if relevant
and related financing transactions, Newco may of course be
'BOTTOM' NEWCO Senior debt finance from Senior loan agreement
more than one legal entity; for these purposes, however, it is senior bank(s) Security documents3
assumed that Newco is only one company, incorporated in Buyer under acquisition Acquisition agreement
agreement4 Acquisition documents
the UK (but see also inset box 'One Newco, two Newcos,
three Newcos, four'). TARGET

What are the relationships between the parties?

Seller and buyer will enter into a contractual relationship in
the form of an acquisition agreement.
This structure is shown in Chart One:
The position can become more complicated on a secondary buy-out (or,
even worse, a tertiary buy-out). The same financing structures may be repli-
cated resulting in eight, or 12, or sometimes more (!) Newcos in a chain,
as each private equity fund buyer puts in place its own tax structuring on
top of the previous structure.

Chart One: Structure of an acquisition agreement 1

If there is mezzanine debt finance, and that mezzanine has a warrant enti-
tlement - see ‘Debt’ below.
2
If new service agreements for management are to be put in place –
see ‘Equity’ below.
3
In addition, other Newcos may, and each Target will, be party to the
security documents – see ‘Debt - What is the required documentation?’ below
4
There may be multiple 'bottom' Newcos, for example, there may be
Newcos in each jurisdiction, on a cross-border transaction, to make the
acquisition in the relevant jurisdiction and/or to borrow the senior bank debt.
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44 The UK LBO Manual

Chart One: Buy-out structure - overview

The classic capital structure for a UK leveraged buy-out senior and mezzanine debt

equity (ordinary/preference shares

+ subordinated loan stock)
Parent guarantee and security

equity/intercompany loan

Vendor purchase price Newco guarantee and security

Senior debt
mezzanine debt Intercreditor
deed

y
rit
secu
and
ntee
ara
Target Target gu

guarantee and security

Opcos

Each company in the target group will then grant guaran-
tees and give security over all of its assets in favour of
the lenders as security for the loans which the lenders have
provided.
The giving of the guarantees and the security by target and
its subsidiaries will constitute financial assistance within sec-
tion 151 of the Companies Act 1985. This means that before
the guarantees and security can be given, the target group
will need to go through the financial assistance whitewash
procedure set out in sections 155 to 158 of the Companies
Act 1985. Essentially this involves each director of each
member of the target group swearing a statutory declaration
of solvency which is reported upon by the auditors.
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48 The UK LBO Manual

Chart Three: European high yield bond structure

Topco/HYB High yield

issuer Key features:
F Vertical structural subordination of high yield bond but
bond holders
pledge of Holdco shares
subordination is 'unlocked' against Holdco by upstream
guarantee.
intragroup loan of
tee F Subordination of intragroup loan i.e. no repayment of
bond proceeds aran
e d gu intragroup loan until senior debt has been repaid; interest
inat
subord equal to high yield interest provided no senior default
(179 payment block if senior default + 120 to 180 day
standstill before bondholders can pursue claims after
Senior default under high yield bond indenture/trust deed).
Holdco
security and downsteam guarantees lenders F Holdco guarantee the 120-180 days after high yield
payment default.
F Bondholder recourse to Opcos via guarantee (i.e. pari
passu with secured creditors of Opcos) but subordinated
of course to senior.
F Enhanced guarantee release mechanics, based on fair
value protection: HY required to give up guarantee on
sale provided at fair value.
guarantees and
(for senior only) security
Opcos

The terms of typical high yield debt and the associated doc-
umentation are different from those of a traditional mezza-
nine loan agreement. There will be a trustee for the note-
holders and an 'indenture' constituting the notes (rather
than a loan agreement). There will also be an offering mem-
orandum which is prepared with a detailed business
description and description of the notes being offered
together with financial information on the group. There is a
minimum feasible deal size for high yield of around £100
million (although deals have been seen in sterling (relative-
ly rare) as low as £50 million). High yield therefore tends to
be used only on the larger transactions.
If high yield is being utilised on a transaction then, because
of the lead time involved in preparing the necessary offer-
ing memorandum and soliciting interest from noteholders,
there is an eight-week period (at least) involved in getting
the note issue away. This means that the high yield element
of the transaction needs to be bridged by mezzanine bridge
finance - usually provided by the underwriter of the high
yield issue. The terms of the bridge to a high yield can
become complex, because the bridge provider needs to leg-
islate for the contingency of the high yield not happening.
If a European high yield bond is to be sold not only into
Europe but also to investors in the United States, to tap
into the huge investor base there, then careful consideration
will need to be given to US regulatory requirements. A cru-
cial consideration is whether or not the high yield notes are
to be registered with the US Securities and Exchange
Commission (SEC) or whether reliance is going to be made
on exemptions in Regulation S (offerings outside the US
not requiring SEC registration) and Rule 144A (offerings
to 'qualified institutional buyers'). An issuer offering high
yield bonds in the United States also needs to consider the
mandatory provisions of the US Trust Indenture Act 1939.
Some senior lenders are more comfortable with traditional
mezzanine funding rather than high yield, because there is a
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54 The UK LBO Manual
Chart Six: Basic 'whole business' securitisation structure
Swap
counterparty
Issuer/Borrower
loan facility
Borrowers/Opcos
(and guarantors
and security
providers)
term advances
guarantees and
security
interest in them) to a special purpose vehicle, which then issues
bonds to investors. Typically, the proceeds of the bonds are
applied to repay either bridging finance put in place to bridge
the procedural process of issuing the bonds, or to refinance exist-
ing forms of traditional senior and/or mezzanine debt.The prin-
cipal and interest payments due on the bonds are funded out of
the cashflows generated by the underlying assets. In recent years,
a wide range of assets have been securitised - mortgages, credit
card receivables, royalties from record sales, Formula One media
revenues, etc. However, the concept has been extended to the
cashflows generated by the business of an operating company -
the concept of 'whole business securitisation'. The technique of
whole business securitisation has been used on London City
Airport (airport revenues), Wightlink and Red Funnel (ferries),
Welcome Break and Roadchef (motorway service stations),
Madame Tussauds (waxworks), Rank Hovis McDougall (food-
stuffs) and the Really Useful Theatre Group (theatres).
Liquidity facility
provider
notes
Issuer Noteholders
note issue gross
proceeds
Security
security over all rights of Issuer under
Issuer/Borrower Facility Agreement, trustee
and all other documents and guarantees and
security for them and any Issuer cash accounts
Asset-based finance
Asset-based financing techniques enable borrowers to raise
funds against debtors via factoring or invoice discounting
arrangements and often incorporate an element of funding
against stock, property, existing plant and machinery and other
business assets. Typically, the amount of asset-based finance
that a lender will make available will be a proportion of the
value of 'eligible assets' e.g. 80 per cent of eligible stock and
receivables. The eligibility criteria will be set by the lender
to exclude damaged or obsolete stock, bad or doubtful
debts and other impediments on value.
Asset-based finance can be an attractive alternative to sen-
ior debt on smaller leveraged buy-outs particularly if the
underlying business is growing quickly. In conventional
cashflow-based leveraged lending, the senior lenders need
to monitor the performance of the business regularly to
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58 The UK LBO Manual

The financial assistance whitewash procedure - sections 155 to 158 of the Companies Act 1985
'Financial assistance' will not be unlawful if the fol-
lowing requirements are satisfied:
F The company giving the financial assistance is a
private company (as opposed to a public company)
provided it is not a subsidiary of a public company
at the level of the company being acquired or below.
F The company giving the assistance has positive
net assets which are not reduced by the giving of the
financial assistance (or if they are reduced, the
reduction is only to the extent of the company's dis-
tributable profits).
F Where the company giving the financial assis-
tance is not a wholly-owned subsidiary of another
company, the giving of the financial assistance is
approved by the shareholders of the company by
special resolution (75%) at a general meeting of
the company. (Where the financial assistance is
being given by a company in respect of an acquisi-
tion of shares in a holding company of that compa-
ny, a special resolution must also be passed by the
members of that holding company and any interme-
diate holding company between it and the compa-
ny giving the financial assistance, except, in each
case, where it is a wholly-owned subsidiary). Any
special resolution must be filed with the Registrar of
Companies within 15 days after having been
passed.
F All the directors of the company proposing to give
the financial assistance must swear a statutory dec-
laration in the prescribed form confirming that, in their
opinion, immediately following the date on which the
financial assistance is proposed to be given there will
be no ground on which the company could then be
found to be unable to pay its debts and the company
will be able to pay its debts as they fall due in the 12
months immediately following such date.
F Where the shares acquired or to be acquired are
shares in a holding company of the company giving
the financial assistance, all the directors of that hold-
ing company and of any intermediate holding com-
pany must also swear a statutory declaration.
F The directors' declaration must have annexed to it
a report from the company's auditors confirming
that, having enquired into the company's affairs, they
are not aware of anything to indicate that the opinion
of the directors in the statutory declaration is unrea-
sonable in all of the circumstances. It must be filed
with the Registrar of Companies within 15 days after
being sworn.
F The time limits relating to the giving of the financial
assistance must be observed. These are:
l Where a special resolution of a company is
required, the resolution must be passed on the same
date as the date of the directors' statutory declaration
or within the week immediately following that date
(i.e. it cannot pre-date the date of the directors' dec-
laration).
l Where a special resolution approving the giving of
the financial assistance has been passed, share-
holders holding in aggregate not less than 10% in
nominal value of the company's issued share capi-
tal can apply to the court to have the resolution set
aside (shareholders who voted in favour of the reso-
lution do not have the right to object).
l Where a special resolution is required to approve
the giving of the assistance, the assistance cannot
be given until the expiry of four weeks after the date
on which the special resolution was passed unless
all of the members voted in favour of the resolution.
This is to allow shareholders holding not less than
10% in nominal value of the company's issued
share capital (or any class of it) (other than those
who voted in favour of it) to apply to the court to can-
cel the resolution.
l The financial assistance must be given before the
expiry of eight weeks after the date on which the
directors of the company giving the assistance swear
their statutory declaration or, if earlier, the date on
which the directors of any relevant holding company
have sworn their declaration.

to potentially significant civil liability for them. For a debt
provider, the consequences of a breach of the financial
assistance prohibition may include the invalidity of guar-
antees and security received by the lenders and further-
more any recovery of any money received by the lenders
pursuant to the guarantee or security may be invalid. For a
company, the consequences of breach may include a cross-
default/acceleration of loans triggered by the invalidity of
the guarantees or security.
There is a relaxation of the prohibition for private compa-
nies, provided that certain formalities are complied with;
this process is generally known as the 'whitewash proce-
dure' (see 'The financial assistance whitewash procedure').
Subordination
A typical UK leveraged financing structure will incorporate
senior secured debt, secured hedging exposure, secured mezza-
nine debt and/or other junior debt (for example (i) high yield
bonds, (ii) PIK (payment-in-kind) notes or (iii) vendor loans)
and unsecured investor debt. Although the loan and security
documents are obviously important because they stipulate the
facility terms (including the borrower's obligations and the
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74 The UK LBO Manual
Tax treatment of transaction costs
On a leveraged acquisition there will be a significant number
of transaction costs involved, ranging from advisers' fees to
bank arrangement fees, often totalling up to 5 per cent of the
total price of the deal. It is worth noting that the Revenue are
becoming increasingly hostile in disputing the tax deductibil-
ity of costs claimed as revenue deductions for corporation tax
purposes when such costs are, in reality, capital costs incurred
on acquisition. Costs which relate to the acquisition of shares
in the target (e.g. legal due diligence, negotiating the share
purchase agreement) will not be deductible and capital costs
generally are now precluded from relief by new rules in
Finance Act 2004.
Where costs can fall under FA 1996, section 84, being
“charges and expenses incurred by the company under or for
the purposes of its loan relationships and related transac-
tions”, such costs can be deducted in accordance with the
accounting treatment as and when the costs are amortised
under FRS4. These costs will include arrangement fees,
advisers' fees relating to the ‘financing’ side of the transaction
and issue costs incurred directly in connection with the issue
of a capital instrument as per FRS4. Typically, the amortisa-
tion period will be the full term of the bank debt, this being
the funding to which most of the acquisition costs will be
attributed. Some of the fees relating to the financing (e.g.
negotiation with finance providers) can be written off to the
profit and loss account and generate immediate tax relief.
Many of the transaction fees (particularly those of profes-
sional advisers) will carry VAT. This VAT can only be recov-
ered to the extent that it can be attributed to taxable supplies
made by the recipient. By and large the various Newcos will
not be making taxable supplies. The preferred method to
maximise VAT recoverability is to VAT group the UK
Newcos with the UK target companies (which in most cases
will make taxable supplies) effective from closing. This
enables the input VAT to be recovered by reference to the
output VAT of the target companies.
Tax objectives for management
Summary
Management will commonly participate in the equity of an
LBO and hold shares in Newco. They will generally want to
ensure that:
(a) there is no income tax charge on their initial acquisition
of shares and any subsequent growth in value; and
(b) any return on their investment is treated as capital (as
opposed to income) and, so far as possible, qualifies for busi-
ness asset taper relief for capital gains tax purposes.
This section considers the circumstances in which an
income tax charge might arise (and how such a charge can
be avoided) and the conditions which need to be satisfied
so as to qualify for business asset taper relief.
Initial investment
If an individual acquires shares at less than market value in
connection with his employment, he will generally be subject
to income tax on the difference between the amount paid for
the shares and their market value (taking account of any
restrictions which might be attached to the shares, such as bad
leaver provisions or restrictions on transfer). It will usually be
difficult to argue in the context of an LBO that management
have not acquired their shares in connection with their
employment. It is therefore essential to ensure that manage-
ment pay market value for their shares.
While, in the classic management buy-out model, manage-
ment might establish and acquire shares in Newco before
the institutional investors have committed their capital to
the project and the acquisition of the relevant target has
been agreed (and it is therefore possible to argue that Newco
is then a mere valueless shell), this may be more difficult to
achieve in the context of an institution led LBO.
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EC and UK merger control aspects of leveraged buy-outs
DID YOU KNOW? The way the test for referral to the
CC is now interpreted
Recent case law has indicated that the OFT has a wide margin of discre-
tion whether to refer, where the risk of a merger leading to a substantial
lessening of competition is believed to be more than fanciful but less than
50 per cent. Above a 50 per cent risk (i.e. the OFT believes that a sub-
stantial lessening of competition is more likely than not to result from the
merger), a reference must be made.
Under the EA 2002, the OFT may accept binding undertakings as an
alternative to making a reference to the CC.
of market share and the generation of synergies are precisely
the rationale for further investment in the same sector.
How will the OFT calculate turnover?
Even in the absence of a substantive overlap with existing
investee businesses, the turnover test can bring LBO activ-
ity within the EA 2002. Under the EA 2002, turnover is
calculated in a broadly similar fashion to under the
ECMR although it is only necessary to consider the
turnover of the target. The figures in the latest published
accounts of the target company will normally be sufficient
to measure whether the turnover test is met (unless there
have been significant changes since the accounts were pre-
pared).
What does the notif ication process entail?
There is no obligation to notify the OFT of transactions
caught by the EA 2002 thresholds (although a reference
can be made to the Competition Commission (‘CC’) at
any time up to four months from completion of a transac-
tion (or, if later, publication of the fact of the merger) and
the OFT will frequently write to parties upon hearing of
an acquisition to establish if it has jurisdiction). In addi-
tion, although satisfaction of the turnover test may result
in a transaction qualifying for investigation, this is, of
itself, unlikely to give rise to regulatory concerns in the
89
absence of material market share overlaps. Accordingly,
whether to notify for clearance essentially turns on an
assessment of the likelihood that the transaction would be
referred to the CC and, accordingly, notification is usually
necessary only where there is a risk that a transaction may
give rise to substantive competition concerns.
How will the OFT assess the transaction?
The OFT is under a duty to refer a relevant merger situ-
ation to the CC for further investigation where the OFT
believes that it is, or may be, the case that:
(a) a relevant merger situation has been created, or arrange-
ments are in progress which if carried into effect will result
in the creation of a relevant merger situation; and
(b) the creation of that situation has resulted, or might be
expected to result, in a substantial lessening of competi-
tion within any market in the UK for goods and services.
However, the OFT may decide not to refer a merger to the
CC if it believes that:
(a) the market(s) concerned is/are not of sufficient impor-
tance to justify a reference (which will rarely be the case); or
(b) any relevant customer benefits arising out of the merg-
er outweigh the substantial lessening of competition; or
(c) in the case of an anticipated merger, the arrangements
are not sufficiently advanced, or not sufficiently likely to
proceed, to justify a reference.
The OFT considers that a merger may be expected to lead
to a substantial lessening of competition when it is expect-
ed to weaken rivalry to such an extent that customers
would be harmed. This may come about, for example,
through reduced product choice, or because prices could
LBO6.qxd 3/12/04 2:01 pm Page 101
give a cash confirmation statement (see ‘Financing the offer and
certain funds’below), effectively means that the bidder's work on
due diligence, the equity financing documents and the debt
financing documents must be completed, and all such docu-
ments signed and reports issued, immediately before the offer is
announced. The costs of the deal are therefore largely incurred
whilst there is considerable deal risk remaining.
Documents
Offer documentation
The bid is effected not by way of a privately negotiated acquisi-
tion contract, but is announced by press release and formally
made to shareholders by way of an offer document. The offer
document constitutes a conditional contract between each
shareholder and the bidding vehicle, as well as being the docu-
ment where the bidder (and on a recommended deal, the target)
satisfies its obligations of disclosure under the Code.There are a
number of specific issues on a take private that arise on these
documents.
Responsibility statements
Rule 19.2 requires the directors of a bidder to take responsi-
bility for information contained in any document sent to tar-
get shareholders. On a recommended deal, some information
will fall to the target directors. This taking of responsibility
places potential personal liability on the persons named in
the statement.
Responsibility statement - bidder
In respect of the bidder, one issue that arises on take privates is
who on the MBO team, including the private equity house, is
named in the responsibility statement and how far up the chain
of ownership in the bidding structure the Panel will require this
taking of responsibility to extend. Recently, the Panel has
required the directors and partners of the private equity fund
manager to take responsibility for all information in the offer
documents (other than that relating to the target and its direc-
tors). It has also required the directors of the general partner of
Public to privates 101
the managed funds to take responsibility for the information
relating to it and those funds. It has not yet required the direc-
tors of the fund manager's parent, or the equity investors them-
selves, to take responsibility.
Responsibility statement - target
On a recommended take private offer document, there will
generally be two target responsibility statements. All target
directors will take responsibility for information in the docu-
ment concerning the target. In addition, the independent direc-
tors alone will take responsibility for any statement of advice to
shareholders on the merits of the offer (see note 3 to Rule 25.1).
Information disclosure - Rule 24
Rule 24 details the financial and other information required on
the bidder (as well as the target and the offer). More informa-
tion is required on the bidder if equity securities are offered as
consideration instead of cash; this will generally not be relevant
on a take private.
Take private offer documents, therefore, generally contain lit-
tle financial information on the bidder. The bidding vehicle is
generally newly set up and, so far, financial backers, funds and
the like have not had to disclose very much information. Often
only a brief narrative description of the structure of the funds
and the financing arrangements has sufficed.
Further information (in the form of contract summaries) as to
the equity and debt financing documentation will be required
to be included in the material contracts disclosures which form
part of the offer document.
Equity documentation
The equity documents on a take private differ in certain
respects from those on a private MBO.
Conditionality
The documents, due to the requirement for a cash confirma-
tion, should only be conditional on the offer becoming whol-
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106 The UK LBO Manual

Chart One: Pros and Cons - Scheme versus Offer

The following chart is intended as a short-form summary of the advantages and disadvantages of two potential structures proposed as
ways to effect a bid. These comprise a scheme of arrangement (‘scheme’) of the target under section 425 of the Companies Act 1985
(as amended) and an offer for the target by the bidder (‘offer’) pursuant to the City Code on Takeovers and Mergers. This chart assumes
the scheme will involve a reduction of the share capital and re-issue to the acquiring company (not a transfer of shares to the acquiring
company).

Issue Scheme Offer

Stamp duty No stamp duty on a (reduction) scheme. 0.5 per cent of value of consideration is
payable in stamp duty.

Required approvals A majority in number representing 75 per cent of target shareholders
actually voting to approve scheme (with the resultant minority then
squeezed out by virtue of the court order).
Could go unconditional as to acceptances
at 50 per cent of target shareholders BUT
need 90 per cent of target shareholders to
accept to squeeze out minorities (and see
below).

Competitor intervention Historically seen as less flexible but there are recent examples Historically seen as more flexible if com-
(Debenhams, Canary Wharf) of schemes used in competitive situa- petitor intervenes (subject to time limits).
tions. Timing of intervention key; once shareholders approve, risk of Break/inducement fees can be used.
intervention reduced, although court unlikely to sanction until share-
holders have voted on a higher offer subsequent to EGM.
Break/inducement fees can be used.

Structural flexibility In complex deals, court can sanction variety of matters (e.g.s.151 Offer limited in scope to the acquisition of
financial assistance) simultaneously with the scheme (therefore not the target shares.
requiring any additional process).

Control of transaction Can usually only be used in recommended situation; needs signifi-
cant target input. Practical control matter for negotiation. Mutual
conditions can be used.
Controlled by bidder. Conditions nor-
mally at the discretion of bidder
(although in practice bidder not likely to
be allowed to invoke subjective business
conditions to withdraw).

Timing Timing subject to court dates; will be gap between announcing and Panel timetable; 60 days from posting
posting, EGM notice periods, then between EGMs and main court (maximum) to go wholly unconditional,
hearing. Court vacations can be significant. 21 days (minimum) possible.
Once scheme sanctioned, effective for 100 per cent of shareholders.

à
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valuation is sometimes applied to the transferred shares,
such as the lower of the original issue price and the market
value at the transfer date. Where the cessation is for any
other reason (for example, death or redundancy), a valuation
based on market value at the transfer date is more common.
However, care needs to be taken with provisions which
force employees to transfer their shares at less than market
value. Depending partly on the price paid for the shares at
acquisition, this may result in the employees receiving an
income tax charge (and possibly corresponding PAYE and
NICs obligations on the company) on the disposal of the
shares on a proportion of their then market value, although
there are measures which can be taken to mitigate the
income tax liability.
How can a gain on share options or awards be
realised?
The employee will wish at some point to dispose of shares
acquired under equity incentive arrangements in order to realise
a gain. In the case of a private company, this may be achieved as
follows:
F the shares may be sold when the company becomes listed or
is bought;
F the shares may be acquired on a secondary buy-out;
F an internal market may be created (see ‘Can shares be held in
a trust?’ below);
F where appropriate, there may be a put option on to the par-
ent company.
Can shares be held in a trust?
An unlisted company which wishes to use existing shares to
satisfy share options and awards rather than issuing new
shares may establish an employee benefit trust (‘EBT’) the
Equity incentives 119
trustees of which are put in funds by the company or by out-
side borrowing to acquire shares in the company. These are
then held in trust until such time as they are distributed to
participants in one of the company's employee share plans.
Shares may be acquired by the trustees from share plan par-
ticipants on disposal and ‘recycled’ through the EBT. This can
be useful for unquoted companies where there is no ready
market in the shares.
The establishing company should be able to obtain a corpo-
ration tax deduction for contributions to an EBT but the
deduction will be deferred until a payment is made out of
the EBT which gives rise to a liability to income tax and
NICs.
What other considerations need to be taken into
account?
The following matters also need to be taken into account when
establishing an equity incentive plan.
Prospectus and f inancial promotion requirements
Under the Public Offers of Securities Regulations 1995
(‘POS Regulations’), when an offer of unlisted securities is
being made to the public in the UK for the first time, the
offeror must produce a prospectus which is made publicly
available for inspection for the duration of the offer period.
Although the POS Regulations do not contain a definition
of ‘public offer’, it is deemed to include an offer to any sec-
tion of the public in the UK.
The Financial Services and Markets Act 2000 (‘FSMA’)
restricts the promotion of investments and related activities.
However, both the POS Regulations and the FSMA restrictions
are subject to certain exemptions. For example, in the case of the
POS Regulations, in relation to an offer made to all employees
generally, an exemption applies where a private company offers
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Insolvency 129

role for unsecured creditors and that it is generally perceived as
a poor mechanism for corporate rescue.
LPA receivership/f ixed charge receivership
These are less commonly encountered than administrative
receiverships. This involves a receiver being appointed over a
particular fixed charge asset or assets of a company, often real
property or shares in a subsidiary, and typically where there is
no floating charge over the company's assets or where the
appointor has security over limited assets and wishes to enforce
security over those assets only. The receiver's powers derive
from the charge and to a limited extent from the Law of
Property Act 1925. Such receivers are appointed in a similar
way to administrative receivers and act to realise the relevant
assets for the benefit of the chargeholder.
Liquidation
pany, its directors, a creditor or shareholder on several
grounds (set out in section 122 IA 1986), most commonly
on the ground that the company is unable to pay its debts.
The Official Receiver will act as liquidator unless a liq-
uidator is appointed by creditors and shareholders.
A voluntary liquidation is commenced by a resolution of
the shareholders of a company and may be of two types:
F a members' voluntary liquidation (‘MVL’), which
requires the directors to swear a statutory declaration of
solvency within five weeks prior to the shareholders' reso-
lution; or
F a creditors' voluntary liquidation (‘CVL’), where no
statutory declaration of solvency has been signed. In a
CVL, a meeting of creditors must be held within 14 days
of the members' resolution.

In a liquidation, a liquidator is appointed for the purposes
of collecting in and realising the assets of a company and
distributing the realisations to satisfy, in so far as possible,
its liabilities, and to distribute any surplus to its sharehold-
ers (see Part IV IA 1986). A company may be wound up
compulsorily by the court or voluntarily.
The court may order that a company is put into compulso-
ry liquidation on the presentation of a petition by the com-
In a compulsory liquidation or a CVL, the creditors' choice
of liquidator prevails if different to the one chosen by the
members.
A liquidator has no power to carry on the company's busi-
ness except in so far as may be necessary for the beneficial
winding up of the company, but he has the power to dis-
claim onerous property (giving the contractual counterpar-
ty a right to prove for damages) and also has wide powers

Chart One: Spectrum of restructuring processes

ADDITIONAL ADDITIONAL COVENANT IBR MANAGEMENT SALES BOND SENIOR DEBT PRE-PACK RECEIVERSHIP LIQUIDATION
DEBT EQUITY WAIVERS? CHANGE / PROCESS TENDER DEBT FOR RECEIVERSHIP ADMINISTRA-
FINANCING? INJECTION? INCENTIVISA- OFFER / REFINANCING EQUITY TION
STANDSTILL TION SCHEME SWAP
HIGH
YIELD
ISSUE?
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Appendix 139

The United Kingdom (1.26) 5. Company tax rate: The company tax rate in the UK is 30 per
cent, which is above the overall average of 28.8 per cent.
The United Kingdom has a favourable environment in terms of:
6. Company tax rate for SMEs: The UK has special tax rates for
1. Fund structure: (Limited Partnership, LP) small companies6.

F The UK limited partnership is tax transparent for 7. Income tax rate for private individuals: The maximum
domestic investors' tax purposes. income tax rate for private individuals in the UK is 40per cent,
F The UK limited partnership provides international which is below the overall average of 45.3 per cent.7
investors with the ability to avoid having a permanent
establishment. 8. Capital gains tax rate for individuals: The UK has a capital
F A tax efficient capital investment or incentive for fund gains tax rate of 10 per cent, which applies to business assets held
managers can be incorporated. It should be noted that new for at least two years, which is below the overall average of 16.3
legislation introduced last year means that certain condi- per cent .
tions must be met to achieve capital gains tax treatment
for carried interest. 9. Tax incentives for private individuals: Incentives for private
F Management charges and carried interest are not liable individuals exist via taper relief (see above), the Enterprise
to VAT, subject to structuring so that the general partner Investment Scheme (EIS) and Venture Capital Trust (VCT),
and manager are in the same VAT group. subject to certain qualifying restrictions.
F There are no undue restrictions on the types of invest-
ments undertaken. 10. Entrepreneurial environment

2. Merger regulation: The notification of a merger (falling Private limited company: (Limited, Ltd)
under the national merger regulation thresholds) is voluntary, F A private limited company can be incorporated either within
although in practice the voluntary system of notification is 5-7 business days, or on a 'same day' basis; if an incorporation
frequently used for reasons of legal certainty. The merger agent is used, even the standard incorporation may only take one
authorities can investigate a merger on their own initiative. or two business days. This time is below the overall average of
23.5 business days.
3. Pension funds: Pension funds in the UK can invest in F Depending on the approach used, typical administrative costs
private equity and venture capital according to the pru- for setting up a private limited company range from £20-808
dent man rule. Nevertheless, the 'Minimum Funding (€28-114) for direct filings, or £150-300 (€212-425) if, for con-
Requirement' imposed on UK pension funds distort their venience, an incorporation agent is used. This cost is below the
investment decision-making and impedes them from overall average of €1,638.
increasing their allocation to the asset class. F There is no legal minimum issued capital requirement for a
private limited company in the UK. However, at least one share
4. Insurance companies: Insurance companies can invest (usually £1) must be issued.
in private equity, without any quantitative restrictions. In
practical terms, most have permitted exposure limits, Public limited company: (Public Limited Company, PLC)
within which they must operate. F A public limited company can be incorporated on a 'same day'
6. Note: this position has changed with effect from 1 April 2004. Profits between £10,001 (€14,174) and £50,000 (€70,871) are taxed at a special rate, with a 19% small companies rate applying to profits between £50,000 (€70,871) and £300,000
(€425,230). A special rate applies to profits between £300,001 (€425 230) and £1.5 million (€2.1 million), and profits beyond that are taxed at the full 30%.
7. Business Assets: All employee shareholdings qualify as business assets, whether in quoted or unquoted trading or non-trading companies (provided in the case of a non trading close company controlled by five or fewer participators, that the share-
holding does not exceed 10%). Any other investment in unquoted trading companies and shareholding of 5% or more in quoted trading companies will also qualify.
8. Exchange rate 1 January 2004 (€1 = £ 0.7055, Pound Sterling).
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142 The UK LBO Manual
Appendix Two: Glossary
The following is a non-exhaustive list and explanation of the
meaning of legal or financial terms commonly used in corpo-
rate transactions. This list is not meant to be a substitute for
legal advice nor should the explanation of the terms be used
as definitions in transaction documents.
425 scheme – Also known as a scheme of arrangement. A
statutory compromise between a company and its creditors
and/or shareholders under section 425 of the Companies Act
1985. Again, a procedure where all of the company's creditors
can be bound by a majority decision of creditors. However,
this differs from a CVA in that it is subject to significant
court control and creditors must be identified into separate
classes, which can often be a difficult issue.
Administration (under Schedule B1 to the Insolvency Act
1986) – The passing of control of a business to an adminis-
trator appointed under the Insolvency Act 1986:
(a) with the objective of rescuing the company; or
(b) where it is not reasonably practicable to rescue the com-
pany, with the objective of achieving a better result for the
company's creditors as a whole than would be likely if the
company were wound up (without first being in administra-
tion); or
(c) where it is not reasonably practicable to rescue the com-
pany or achieve the result mentioned in (b) above, with the
objective of realising property in order to make a distribution
to one or more secured or preferential creditors.
Administrative receiver – Also known as a scheme of
arrangement. A statutory compromise between a company
and its creditors and/or shareholders under section 425 of the
Companies Act 1985. Again, a procedure where all of the
company's creditors can be bound by a majority decision of
creditors. However, this differs from a CVA in that it is sub-
ject to significant court control and creditors must be identi-
fied into separate classes, which can often be a difficult issue.
Administrative receivership – The control of the whole or
substantially the whole of a company's assets or business by
an administrative receiver appointed by the holder of a qual-
ifying floating charge with the purpose of realising the assets
of the company and applying the proceeds in repaying the
secured debt. The Enterprise Act 2002 prevents the holder of
a ‘qualifying floating charge’ from appointing an administra-
tive receiver subject to certain exceptions.
Administrator – A licensed insolvency practitioner who is
appointed to control a business as an administration under
Part 2 of and/or Schedule B1 to the Insolvency Act 1986.
AIM – The Alternative Investment Market of the London
Stock Exchange was established in 1995 to replace the
Unlisted Securities Market. This market has been tailored to
suit smaller companies with lower market capitalisations by
having admission requirements which are less stringent.
Blue Book – See Takeover Code/The Code.
Bought deal – Used when a deal-maker provides all of the
finance needed for a buy-out deal and then sells on or syndi-
cates part of the funding to other investors at a later stage.
Bought deals are often used by the larger providers of finance
when speed or confidentiality is particularly important.
Break fee – A payment to be made by the seller to the
buyer if a competing offer for the target emerges and is
accepted in place of the original offer by the buyer. The
break fee acts as an inducement to encourage the buyer to
make the offer.
LBO6.qxd 3/12/04 2:03 pm Page 151
Appendix Three: Ashurst Partner Profiles
Jonathan Angell
Jonathan specialises in corporate law and mergers and
acquisitions, particularly private equity. He has consider-
able experience of, and advises a number of leading UK,
continental European and US private equity firms in rela-
tion to, all forms of private equity transaction. Jonathan
has particular expertise in relation to cross-border mergers
and acquisitions.
Simon Beddow
Simon Beddow has experience across a wide range of
company law matters including mergers and acquisitions,
takeovers (including public to privates) and private equity
transactions. Simon has particular expertise in cross-bor-
der merger and acquisition transactions.
Giles Boothman
Giles Boothman advises clients on a broad range of corpo-
rate matters including mergers and acquisitions, private
equity investments and joint ventures. He also specialises in
non-contentious reconstruction and insolvency law and
advises insolvency practitioners, companies in financial dif-
ficulties and investors in troubled companies, particularly
focusing on large reconstructions and insolvencies.
Charlie Geffen
Charlie Geffen is head of private equity at Ashurst. He
advises many of the leading buy-out houses in the UK and
the US as well as domestic and overseas corporate clients,
many of which are publicly quoted companies. He has
wide experience of corporate and commercial activities,
with particular emphasis on leveraged buy-outs, cross bor-
Appendix 151
der transactions, fund raisings, mergers and acquisitions
and other corporate finance matters.
Richard Palmer
Richard specialises in UK and international tax planning.
His practice focuses on the tax aspects of corporate dis-
posals and reconstructions, in particular structuring and
financing cross-border buy-outs, mergers, acquisitions and
joint ventures. Most of these involve US, UK and other
European corporates. He has considerable experience in
strategic international tax planning involving European
holding companies and in advising companies on both UK
inward and outward investment.
Nigel Parr
Nigel Parr specialises in all aspects of EU and competition
law particularly merger control. He has substantial experi-
ence in dealing with the EC Commission, UK regulatory
authorities, privatised utilities regulators and anti-trust
authorities in other jurisdictions.
Paul Randall
Paul Randall is head of Employee Benefits and Incentives.
He specialises in advising domestic and non-UK compa-
nies on the design, implementation and operation of
employee share schemes, onshore and offshore trusts, long-
term incentive plans and all forms of bonus and incentive
plans. He has extensive experience of management buy-
outs, mergers and acquisitions, takeovers, flotations, IPOs
and reorganisations. His clients include FTSE 100 and
other quoted companies as well as start-up, private and
buy-out companies.
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152 The UK LBO Manual

Mark Vickers
Mark Vickers specialises in UK and cross-border lever-
aged finance transactions, particularly management and
institutional buy-outs. He is one of the market's leading
experts on the debt funding of public to private takeovers.
He also has considerable experience of bid finance, senior
and mezzanine financing facilities, structured finance, and
global syndicated lending.

Nigel Ward
Nigel Ward is head of International Finance at Ashurst.
He specialises in general banking law including acquisi-
tion finance, European high yield, structured finance and
restructurings. He is a member of the banking law sub-
committee of the City of London Law Society.
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Appendix 153

Appendix Four: About the Centre for Management Buy-out

Research (CMBOR)

The Centre for Management Buy-out Research (CMBOR) network of academic and professional collaborators in
was founded by Barclays Private Equity Limited and Western Europe, the CEE countries and North America.
Deloitte at the Nottingham University Business School in
March 1986 to monitor and analyse management buy-outs Contact the Centre for Management Buy-out Research:
in a comprehensive and objective way.
Andrew Burrows
The Business School is based in the state-of-the-art Jubilee Director
Campus, a 40-acre site approximately one mile from the Tel: +44 (0)115 951 5494
main University Park campus. The campus also contains the Fax: +44 (0)115 951 5204
School of Computer Science, the School of Education and andrew.burrows@nottingham.ac.uk
the National College for School Leadership.
Professor Mike Wright
As an independent body, CMBOR has developed a wide- Director
ranging and detailed database of over 20,000 companies Tel: +44 (0)115 951 5257
which provides the only complete set of statistics on man- Fax: +44 (0)115 951 5204
agement buy-outs and buy-ins in the UK and continental mike.wright@nottingham.ac.uk
Europe. CMBOR also publishes regular reports on UK buy-
out trends in its Quarterly Review, as well as the results of Centre for Management Buy-out Research
specialist survey and case study research on relevant issues Nottingham University Business School
both in buy-outs in the UK and Western Europe. The annu- Jubilee Campus
al European Management Buy-out Review is produced to Wollaton Road
complement this, providing an analysis and review of buy- Nottingham NG8 1BB
out trends throughout Continental Europe. Its newest pub- United Kingdom
lication, Exit, provides definitive statistics and analysis on Tel: +44 (0)115 951 5493
buy-out exits. Fax: +44 (0)115 951 5204
www.cmbor.com
In addition to its core research publications, CMBOR also
undertakes bespoke research activity on a funded basis.
CMBOR has carried out work for UK and international gov-
ernment agencies, venture capitalists, banks and professional
advisers. The Centre maintains an important international