Private equity in United States

Market and Regulatory Overview

Reform

USA (National/Federal)

A Q&A guide to private equity law in the United States.

The Q&A gives a high-level overview of the key practical issues including the level of activity and recent
trends in the market; investment incentives for institutional and private investors; the mechanics
involved in establishing a private equity fund; equity and debt finance issues in a private equity
transaction; issues surrounding buyouts and the relationship between the portfolio company's managers
and the private equity funds; management incentives; and exit routes from investments. Details on
national private equity and venture capital associations are also included.

Market overview

1. What are the current major trends in the private equity market?

The private equity (PE) fundraising market remained robust at the start of 2020 with a total of 3,524 PE
funds in the market, consistent with the number of PE funds in the market at the start of 2019. 1,679 PE
investment vehicles with a North American focus raised over USD460 billion in capital commitments in
2019. In 2019 the 50 largest funds raised USD320 billion, or 55% of all capital raised, match the amounts
raised by the top funds in 2018. (2020 Preqin Global Private Equity & Venture Capital Report:
https://www.preqin.com/insights/global-reports/2020-preqin-global-private-equity-venture-capital-
report) (2020 Prequin Report.)

At the end of 2019, the market view for deploying PE fund capital remained bullish. A November 2019
survey reporting that 91% of fund managers planned to deploy at least the same amount of capital in
2020 as they deployed in 2019, with a majority expecting to increase capital deployment. At the same
time, the vast majority of investors and managers responding to the survey expected investor appetite
for PE in the North American market to remain steady or increase. (Prequin Report; Pitchbook Q1 2020
US PE Breakdown.)

Sponsor-led recapitalisations, which introduce new buyers and provide an exit opportunity for some or
all limited partners who are seeking liquidity from existing funds nearing or at the end of their original
terms, continue to garner interest as funds look to extract greater value from mature portfolios. (Preqin
North American Focused Secondaries Fundraising March 2020 Report.)

While 2020 may ultimately look quite different from such expectations due to global impacts of COVID-
19, anecdotal evidence from the early days suggest that many funds continue to fundraise and attract
new capital, even in the difficult market environment. One survey conducted in late March 2020 found
that although a significant minority of investors have indicated that they plan to reduce exposure to PE
in 2020, a much larger number do not plan to reduce allocations. However, many investors are still
considering the impact of the current market environment on their PE allocations for 2020. (Private
Equity International Covid-19 Study: Investor sentiment in light of Covid-19.)

Sponsors continue to hold closings on existing funds in the market, but some sponsors indicated that
they expect a longer fundraising period and a majority of sponsors launching new funds anticipate some
amount of delay. At the same time, a vast majority of surveyed sponsors cited low asset valuations as a
reason to expect greater deal activity, and nearly a third of sponsors planned to seek greater flexibility in
their investment mandate from investors. (Private Equity International Covid-19 Study: How will Covid-
19 affect GPs?)

2. What has been the level of private equity activity in recent years?

Fundraising

In the first quarter of 2020 PE fundraising had only a minor slowdown, even with disruption in the
market. During such period, 46 funds closed on USD45.2 billion, which met previously anticipated
projections. (Pitchbook Q1 2020 US PE Breakdown.) While traditional fundraising can be expected to be
dampened throughout the rest of 2020 given the global economic uncertainty caused by COVID-19, such
market stresses and opportunities may lead to further focus on sponsor-led restructurings and an
increase in "top-up" vehicles to support existing portfolios and special opportunity vehicles to take
advantage of new opportunities beyond historical investment objectives.

Investment

The aggregate number of deals closed decreased slightly, from 5,345 transactions in 2018 to an
estimated 5,133 in 2019. Further, aggregate deal value decreased 7% from 2018. (Pitchbook 2019
Annual Private Equity Breakdown.) Activity in 2020 is more likely to be focused on finding opportunities
at attractive valuations due to market dislocations.

Transactions

The median valuation-to-EBITDA multiple of 10.9x documented in 2019 decreased from the 2018 level
of 11.5x. There was also less leverage involved in the deals, as the median debt-to-EBITDA multiple
decreased from 5.7x to 5.0x. (Pitchbook 2019 Annual Private Equity Breakdown.)

Exits

Exit activity slowed in 2019, with PE firms realising an estimated 1,035 investments worth USD318.2
billion. This represents a 16.5% year-over-year decrease in exit volume and a 28.0% year-over-year
decrease in exit value. In 2019, secondary buyouts were the main exit path and accounted for the
largest percentage of PE-backed exit value since at least 2009.

This trend of increasing secondary buyouts is likely to continue as PE firms look for both liquidity and
deal flow in the current market environment. By contrast, the IPO market remained weak and was one
reason for the decline in the overall 2019 exit value, with IPOs increasingly concentrated as an exit
option primarily for large companies, with median exit size for IPOs more than doubling between 2018
and 2019 as it reached USD979.1 million.

Exits are likely to decline throughout 2020 as sponsors are likely to wait for pricing to normalise to avoid
selling portfolio investments at large discounts. IPO activity in particular appears likely to be negatively
impacted. (Pitchbook 2019 Annual Private Equity Breakdown; Pitchbook Q1 2020 US PE Breakdown.)

Funding sources

3. How do private equity funds typically obtain their funding?

The primary sources of funding for PE funds in the US are:

Public pension funds.

Endowments/foundations.

Funds-of-funds.

Sovereign wealth funds.

Corporate pension funds.

Banks and other financial institutions.

Government agencies.

Insurance companies.

Wealth managers.

Family offices.

High net worth individuals.

Funds-of-funds.

The largest investors based on capital invested in PE in 2019 were public pension plans (35%), sovereign
wealth funds (12%), insurance companies (12%) and private sector pension funds (11%). Family offices,
private sector pension funds and wealth managers have all seen proportional increases in investment
mandates in PE. By contrast, funds of funds have been less active in their searches for new managers in
2019 than in prior years. (2020 Prequin Report.)

Tax incentive schemes

4. What tax incentive or other schemes exist to encourage investment in unlisted companies? At whom
are the incentives or schemes directed? What conditions must be met?
There is generally no available tax incentive or other scheme to encourage investment in unlisted
companies.

Fund structuring

5. What legal structure(s) are most commonly used as a vehicle for private equity funds in your
jurisdiction?

The most commonly used vehicle for PE funds is the Delaware limited partnership, which gives limited
liability to the investors who are limited partners in the limited partnership. The fund's sponsor, or an
affiliate, typically acts as the general partner and has unlimited liability for the limited partnership's
obligations.

A Delaware limited liability company (LLC) may be used instead of a Delaware limited partnership.
However, the LLC is far less popular. There are disadvantages to using an LLC, particularly for funds that
invest outside of the US or which have non-US investors. The two primary drawbacks are:

LLCs are not recognised as tax transparent in some jurisdictions.

In some jurisdictions, investors and LLCs may have difficulty accessing the benefits of tax treaties.

Both limited partnerships and LLCs are generally treated as tax transparent for US tax purposes. While
every US state can be used as a jurisdiction in which to form a limited partnership or an LLC, Delaware is
generally considered the best choice because of its well-thought out and well-developed statutory
regime and, partly because so many fund sponsors choose Delaware, its well-developed body of case
law.

Some PE funds, due to the nature of their investors or the focus of the fund's investments, are organised
offshore. The Cayman Islands is the most typical offshore jurisdiction for a PE fund with a broad
investment mandate. Funds organised in the Cayman Islands generally provide a similar level of limited
liability to investors to that provided by a Delaware vehicle. Funds with a narrower geographic focus are
often organised in other jurisdictions.

6. Are these structures subject to entity level taxation, tax exempt or tax transparent (flow through
structures) for domestic and foreign investors?

PE funds in the US (or offshore with a US fund sponsor) are typically treated as partnerships for US tax
purposes, regardless of whether they are organised as limited partnerships or LLCs. The fund itself is
then generally not taxed in the US, with the exception in certain instances of taxes resulting from
partnership audits. Instead, the fund's income flows through to each investor and is taxable at the
investor level. The character of the income also flows through to the investors so that capital gains
realised by the fund maintain that character in the investors' hands. The flow-through tax treatment
applies to both US and non-US investors. However, other jurisdictions may impose taxes on investors'
income and even on the fund itself.
7. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in
your jurisdiction as being tax inefficient (whether by not being recognised as tax transparent or
otherwise)? What alternative structures are typically used in these circumstances?

Almost all non-US entities can elect to be treated as a partnership and to be tax transparent for US tax
purposes. In some circumstances, fund sponsors may wish to use a non-tax transparent investment
vehicle to allow investors to avoid US filing requirements and tax obligations. If so, the entity itself must
make the required US filings and tax payments.

Fund duration and investment objectives

8. What is the average duration of a private equity fund? What are the most common investment
objectives of private equity funds?

PE funds generally seek to achieve significant long-term capital gains by acquiring a controlling interest
in a number of private investments and then improving the management and operations of those
companies. The typical term of a PE fund is ten years (often with a right granted to the sponsor to
extend for up to two years). Capital is drawn down from investors during an investment period of
generally three to six years, with an investment period of five or six years being the most common. The
manager uses the remainder of the term to increase the value of the portfolio investments and seek exit
opportunities. Additional capital may be called down after the investment period to meet any additional
capital needs of existing portfolio companies and to pay expenses of the PE fund. Difficult exit
environments often result in many fund extensions or restructurings.

Recently, there has been an uptick in sponsors exploring "evergreen" funds or other funds with longer
lifespans that would minimise the frequency and/or duration of future capital fundraisers. However,
these funds remain a relatively small percentage of the overall market.

Funds continue to have broad enabling language to make investments of any type, but coupled with
certain investment limitations relating to topics such as concentration, geography and investments in
public equities and certain other asset classes that may be overridden by approval of investors and/or
advisory committees. Outside of the very large funds raised by established sponsors, PE funds are
increasingly targeting a specific industry or set of industries as the primary investment strategy.

Fund regulation and licensing

9. Do a private equity fund's promoter, principals and manager require authorisation or other licences?

As a result of the Private Fund Investment Advisers Registration Act of 2010, which was signed into law
as part of the Dodd-Frank Act, an investment adviser to a private fund is likely to have to register with
the US Securities and Exchange Commission (SEC) (or, where assets under management are less than
USD100 million, one or more state regulatory authorities). Certain exemptions exist for venture capital
fund sponsors and sponsors of PE funds who have less than USD150 million in assets under
management. Some non-US sponsors with limited presence in the US may be able to use this exemption
even if they have more than USD150 million in assets under management in total. Sponsors relying on
these exemptions are known as exempt reporting advisers and still have certain reduced filing
obligations with the SEC.

Also, if a PE fund trades even one commodity interest contract or holds itself out as being able to do so,
the sponsor of the fund will be deemed a commodity pool operator (CPO), and the adviser to the fund
will be deemed a commodity trading adviser (CTA). Without an exemption, any CPO or CTA must
register with the US Commodity Futures Trading Commission (CFTC) and become a member of the
National Futures Association. Many PE and venture capital funds can rely on the CFTC Rule 4.13(a)(3)
"de minimis" exemption by filing an annual notice of exemption with the National Futures Association.

10. Are private equity funds regulated as investment companies or otherwise and, if so, what are the
consequences? Are there any exemptions?

Investment company status

Any issuer that is engaged in investing or trading in securities is considered an investment company and,
as a result, must register as an investment company under the US Investment Company Act of 1940
(Investment Company Act) unless an exception is available.

There are two exceptions to registration as an Investment Company which PE funds often use:

The fund has outstanding securities that are beneficially owned by fewer than 100 persons (section 3(c)
(1), Investment Company Act). Various look-through rules apply in calculating whether a fund has 100
investors.

The fund has outstanding securities which are owned exclusively by persons who are qualified
purchasers at the time of acquisition (section 3(c)(7), Investment Company Act).

Qualified purchasers are:

Natural persons, family-owned companies and trusts with at least USD5 million in investments.

Companies that own and invest at least USD25 million.

If using the 3(c)(7) registration exemption for funds where all the investors are qualified purchasers,
there is no limit on the number of investors that a fund can have, although the Securities Exchange Act
of 1934 requires registration for any class of securities held by 2,000 persons in total or 500 persons who
are not accredited investors.

In addition, an issuer engaged in a public offering must register the offering.

Registration of securities issuance

If the securities are offered by an issuer in a transaction that does not involve any public offering, there
is no need to register. In general, to qualify as a non-public offering under the safe harbour of Regulation
D:
The offering must be private and must not involve a general solicitation.

The issuer must have a substantive relationship with each prospective investor before the offering and
must have knowledge of an investor's suitability to purchase interests in the private offering.

There cannot be any advertisement, article or notice, or any communication in any newspaper,
magazine or similar media or any radio and television broadcast, that has the purpose or effect of
offering or selling the fund.

The purchasers of securities generally must be accredited investors, with no more than 35 non-
accredited investors purchasing securities in the offering.

Issuers must also take precautions regarding their websites. Issuers should restrict internet pages that
provide access to private offerings of securities to prospective investors.

The concerns regarding general solicitation do not apply to offerings relying on Rule 506(c) of Regulation
D. Under Rule 506(c), a transaction may qualify as a non-public offering even if the issuer engages in
"general solicitation" and "general advertising".

An offering can maintain the exemption under Rule 506(c) so long as all the following conditions are
satisfied:

The issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.

All purchasers of securities are accredited investors, either because they come within one of the
enumerated categories of persons that qualify as accredited investors or because the issuer reasonably
believes that they do at the time of the sale of securities.

The integration and resale restriction terms of Rules 501, 502(a) and 502(d) are satisfied.

However, such general solicitation may affect other exemptions applicable to the fund or its sponsor.

Because of the 2013 "bad actor" amendments to Rule 506, an offering involving "felons" or "bad actors"
cannot rely on Rule 506 for exemption from registration.

11. Are there any restrictions on investors in private equity funds?

There are special rules limiting non-US investors' involvement in obtaining oil and natural gas leases
from the US Government.

12. Are there any statutory or other maximum or minimum investment periods, amounts or transfers of
investments in private equity funds?

There are no statutorily prescribed maximum or minimum investment periods. Depending on the nature
of the PE fund, investment periods generally range from three to six years, with five or six years being by
far the most common. Depending on macro-economic situations, funds may have a difficult time
deploying capital and, as a result, may seek extensions of investment periods from their investors. This
can generally be accomplished with an investor vote.

Alternatively, funds may deploy capital very quickly and may end the investment period early to begin
fundraising for a successor fund.

There are no statutory limits on investment transfer amounts. However, if fund interests are transferred
to investors who do not meet statutorily prescribed conditions for a registration exemption, that
exemption may be lost. In addition, in certain cases the flow-through tax treatment of the fund vehicle
may be lost if, as a result of transfers, the fund is considered a publicly traded partnership. Fund
sponsors must be careful to ensure that fund interests are not transferred so as to cause these types of
problems. As a result, fund documents usually prohibit transfers without the consent of the fund
sponsor and generally require a number of conditions to be met to permit a transfer.

To avoid regulation under the Employee Retirement Income Security Act of 1974, fund sponsors may
also need to limit the number of pension plan and similar types of investors in the fund and therefore
typically control transfers to these types of investors.

Concerns about creditworthiness and money laundering also generally cause fund sponsors to perform
due diligence on each new investor in a fund, similar to the type of diligence performed on the initial
investors in the fund.

13. How is the relationship between the investor and the fund governed? What protections do investors
in the fund typically seek?

In the typical PE fund, the fund sponsor or its affiliate serves as general partner or managing member
and, in that capacity, controls almost all activities of the fund. Investors are generally not involved in the
operations of the fund. Some of the more common protections investors seek are:

Inclusion of an advisory committee made up of representatives of investors, whose approval is required

for certain conflicts of interest, valuations and other matters.

Investment parameters which cannot be exceeded without investor (or sometimes advisory committee)
approval.

The ability to remove the general partner (or managing member) for cause or sometimes even without
cause.

The ability to terminate the fund for cause or without cause.

The ability to terminate the investment period early, if the key persons running the fund are no longer
devoting sufficient time to the fund or for other causes.

The investor vote required to remove the general partner or terminate the fund or the investment
period without cause may be as high as 85% to 90%, but is more commonly 75% to 80%.
Investors also often seek more detailed reporting and notices to obtain comfort through receipt of
disclosure and relying on such disclosure to moderate sponsor decision-making where governance
protections are limited.

Interests in portfolio companies

14. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio
company? Are there any restrictions on the issue or transfer of shares by law? Do any withholding taxes
or capital gains taxes apply?

Common forms

PE funds commonly take an interest in a portfolio company that provides for a threshold financial return
that the portfolio company must achieve for the holders of residual interests to obtain any benefit from
their interests in the portfolio company. This often takes the form of convertible preferred stock, in
which the preferred stock has a set dividend and liquidation preference that must be returned to the
holders of the preferred shares before the holders of common shares receive anything. The convertible
preferred shares convert into common shares at specified ratios, allowing the holders of the preferred
shares to obtain ownership interest in the common shares if they wish to do so.

Variants of this include combinations of two (or more) types of interests, for example:

Notes and warrants to obtain common stock.

Non-convertible preferred stock and common stock issued together.

Non-convertible preferred stock issued with warrants.

Restrictions

There are generally legal restrictions on the transfer of any of these securities, as well as in certain
instances extensive contractual restrictions on the ability to transfer interests in a portfolio company.
Typically, these securities cannot be marketed or sold publicly without the portfolio company first
registering the securities with the US Securities and Exchange Commission (SEC). However, PE funds may
often sell the securities they hold in a portfolio company to other sophisticated buyers under applicable
transaction exemptions.

Application of withholding taxes or capital gains taxes

Depending on the facts and circumstances of a particular portfolio company investment, US or non-US
withholding taxes and/or capital gains taxes may apply. The applicability of such taxes depends on a
number of factors, including:

The jurisdiction in which the investment is made.

The manner of exit from the investment.

Whether gains are derived from current income or on sale of the asset.

The use of holding companies.

The availability of tax treaties.

The tax characteristics of the ultimate beneficial owners.

Whether an applicable taxing authority taxes indirect transfers, which is more regularly a concern in the
People's Republic of China and in India.

For many investments in portfolio companies, structuring alternatives may be available to partially
mitigate the applicability or amount of capital gains tax and/or withholding tax.

Buyouts

15. Is it common for buyouts of private companies to take place by auction? If so, which legislation and
rules apply?

Buyouts of private companies commonly take place by auction. A financial adviser is often engaged by
the seller to manage the auction process. The financial adviser seeks to narrow the number of potential
bidders to a limited number of likely buyers. This group of potential buyers is then asked to submit final
bids. The seller may enter negotiations with one or more of them. There is no legislation that generally
governs sales of private companies other than anti-fraud and anti-trust rules. Certain industries or
sectors may have specific rules relating to ownership of assets or companies, including private
companies, in the applicable industry or sector.

16. Are buyouts of listed companies (public-to-private transactions) common? If so, which legislation
and rules apply?

Buyouts of listed companies (public to private transactions) are common.

A public-to-private transaction requires compliance with a number of Securities Act rules including those
governing proxy contests or tender offers (depending on the method used for the acquisition) and
disclosure rules. If the target company is established in Delaware (which is common), or in states which
follow Delaware common law, and the target's directors determine it is in the best interests of the
company to be sold, the directors may have a fiduciary duty in certain instances to obtain the best price
for the target company. As a result, targets seek and generally obtain the ability to terminate acquisition
agreements if they receive a superior offer (at the cost of paying a break fee).

Care must also be taken to follow process-related requirements, created by both statute and case law
(for example, providing the required notice to shareholders and complying with charter and bye-law
provisions).

Target companies must also adhere to the rules of the exchanges they are listed on, although these
generally do not pose much of a problem if other legal and regulatory requirements are being met.
There are two principal forms an acquisition of a US public company can take:

A one-step transaction, involving a proxy solicitation and a vote of the target's shareholders to approve
the merger, which then takes place after the solicitation and vote.

A two-step transaction, involving a tender offer by the buyer, followed by a merger after the buyer
acquires voting control of the target's stock directly from its shareholders in the tender offer.

One-step transactions can take a great deal longer than two-step transactions. Historically, one-step
transactions have been PE sponsors' preferred route, despite the additional amount of time they
involve. More recently there has been an increased use of two-step transactions involving a tender
offer.

Principal documentation

17. What are the principal documents produced in a buyout?

Regardless of whether a public to private acquisition is one-step or two-step, the principal agreement is
a merger agreement between the target company and the acquisition entities formed by the PE
sponsor. The merger agreement is necessary because it is almost impossible to locate every single
shareholder in a public company, and the merger agreement eliminates the need to do so.

In a private acquisition, the principal agreement is one of the following:

A merger agreement.

An equity purchase agreement.

An asset purchase agreement.

The type of agreement depends on the transaction structure, which depends on numerous factors. In a
private acquisition, there may be additional agreements between the seller(s) and the PE sponsor
dealing with ancillary matters such as real estate leases, escrow arrangements, transition of services and
so on.

The acquisition entity, the PE sponsor's fund and/or the management team may, in connection with the
agreements for acquisition and funding of the acquisition entity, enter into other agreements, including:

Equity commitment letters.

Debt commitment agreements.

Guarantees.

Subscription agreements.

Equity contribution agreements.

Shareholders' agreements.

Registration rights agreements.

Employment agreements.

Non-competition agreements.

PE sponsors generally provide the seller with an equity commitment letter from the relevant fund. The
equity commitment letter is the fund's binding commitment to provide the equity capital to the
acquisition entity. Alternatively, a seller may insist on a direct guarantee from the PE fund. If the sponsor
has agreed to a no-financing condition transaction (see Question 18), the guarantee also ensures that
the seller can collect the reverse break fee in the event of a triggering termination event.

Buyer protection

18. What forms of contractual buyer protection do private equity funds commonly request from sellers
and/or management? Are these contractual protections different for buyouts of listed companies
(public-to-private transactions)?

Buyer protections in a private acquisition generally include:

Representations and warranties. Buyers typically obtain representations and warranties from the seller
covering both the entity or assets being sold and the ability to sell them.

Interim operating covenants. Buyers typically require covenants from the seller requiring the seller to,
between signing and closing:

operate the business as usual; and

not enter into certain transactions without the buyer's consent.

Closing conditions. Buyers also typically obtain closing conditions, including:

receipt of required governmental and third-party consents by the seller;

no material adverse change in the target entity;

receipt of buyer's debt financing;

compliance with covenants by the seller; or

a bring-down of seller's representations and warranties.

Post-closing indemnification provisions. The seller must usually indemnify the buyer for breaches of the
seller's representations, warranties and covenants. This may also include specific indemnities for pre-
closing taxes, known environmental issues and other matters. Sellers typically require buyers to agree to
a basket cap, so that small amounts are not indemnified, and a cap on potential indemnity claims. There
is also typically a reasonable survival period, during which the buyer can bring an indemnification claim
post-closing. Indemnification baskets, caps and the corresponding survival periods are usually highly
negotiated.

Typically, a PE sponsor does not seek any special protections from the target's management team. If the
target's management team is selling equity in the transaction, members of the team normally share pro
rata in any post-closing indemnification obligation and escrow hold-back.

PE funds' obligations to close are sometimes not subject to their receipt of debt financing. In exchange,
funds negotiate for a cap on the total damages payable to the seller if they fail to close due to a failure
to receive their debt financing or for any other reason. The cap typically takes the form of a reverse
break fee payable by the fund. These reverse break fees are typically a small percentage (2% to 3.5%) of
the total transaction value, or may be slightly more if the sponsor fails to close for any reason other than
a failure to obtain debt financing. In these deals it is common to have provisions barring sellers from
being able to seek specific performance to force the closing, even if all conditions to the buyer's
obligations to close the deal have been satisfied.

In a public to private transaction, there is typically no post-closing indemnification or other post-closing

protections, so buyers rely on interim operating covenants and the no-material-adverse-change closing
condition as their key protections.

19. What non-contractual duties do the portfolio company managers owe and to whom?

The principal non-contractual duty that portfolio company managers owe the target company is the
common law duty of good faith and loyalty. This duty of loyalty prohibits management from
disadvantaging the company for their own benefit or pursuing company opportunities for themselves.
The duty of loyalty generally requires disclosure to the board of directors once an opportunity involving
the target company presents itself. Management representatives on the board of directors usually
withdraw from board deliberations concerning these opportunities to avoid conflict of interest.

20. What terms of employment are typically imposed on management by the private equity investor in
an MBO?

Beyond typical employment terms such as title, term, compensation (including incentive compensation),
benefits, termination and severance, the most important employment terms typically imposed on
management by a PE sponsor are non-competition, non-solicitation and confidentiality terms.

State law governs employment contracts and so the enforceability of non-competition clauses can vary
widely from state to state. Most states will enforce a non-competition clause that is reasonable in scope
(considering restrictions on types of employment, geography and duration), although some states (such
as California) will not enforce non-competition clauses due to them being against public policy.

Non-solicitation clauses typically cover employees, customers and suppliers. The scope of these clauses
often does not extend to general solicitations through mass-media that are not targeted at any
particular person or group.
Confidentiality obligations are typically broadly drafted, although they may be constrained by certain
regulatory requirements such as in relation to laws and rules protecting whistleblowers.

21. What measures are commonly used to give a private equity fund a level of management control over
the activities of the portfolio company? Are such protections more likely to be given in the shareholders'
agreement or company governance documents?

In a single sponsor transaction, the PE sponsor typically controls all the fully diluted equity of the
company other than that owned by management (usually 10% to 20%). As a result, the sponsor has both
voting and economic control over the business.

The PE sponsor and the other equity holders generally enter into a shareholders agreement that gives
the sponsor the right to nominate a majority of the company's directors, and includes a voting provision
under which all parties to the agreement agree to vote in favour of the sponsor's board nominees.
Shareholders' agreements also usually contain provisions, such as drag-along rights, that give the
sponsor control over exit transactions.

In consortium transactions, or in a transaction where there are one or more significant minority
investors, the shareholders' agreement may include provisions requiring a super-majority vote that gives
the minority a veto over certain fundamental transactions, such as financings, significant add-on
acquisitions, sales of significant assets and exit transactions. In consortium transactions there is often
also a desire to place such voting provisions and the provisions relating to the nomination and election
of directors in the company charter, which is often more difficult to amend than a shareholders'
agreement.

Debt financing

22. What percentage of finance is typically provided by debt and what form does that debt financing
usually take?

The percentage of financing typically provided by debt depends on the size of the transaction and how
much debt can be obtained under prevailing market conditions.

The fundamental different types of debt financing used in buyout transactions are:

Senior secured first and/or second lien financings.

Subordinated mezzanine financings.

Senior secured bonds.

Unsecured senior or subordinated bonds.

Convertible and other hybrid debt financings.

A senior secured financing is senior to the borrower's other debt and a significant portion of the
borrower's assets serve as collateral. Such financings consist of one or more term loan facilities that are
used to finance the acquisition and a revolving credit facility that is used for working capital. The extent
to which these types of debt are used depends on:

Availability.

The size of the overall financing.

The costs of each type of financing.

The fund sponsor's preferences among the types of debt financing available.

Lender protection

23. What forms of protection do debt providers typically use to protect their investments?

Security

Debt providers typically protect their investments by obtaining security interests in the borrower's
assets and by obtaining guarantees from the borrower's subsidiaries, secured by the relevant
subsidiaries' assets.

There are a number of contractual and structural mechanisms that are also used by debt providers. Debt
providers can contract with each other to subordinate one class of creditors to another class. The two
groups can agree that one group will not have any rights in an insolvency proceeding until the other
class of creditors has been repaid in full.

Debt providers can also obtain structural seniority by extending debt to an operating company
subsidiary of a holding company, rather than to the holding company itself. Lenders at the operating
level are repaid before creditors with a claim at the holding company level, because the operating
company subsidiary must satisfy all of its debt claims in an insolvency proceeding before the holding
company receives whatever value is left as a result of its holding equity in the subsidiary.

Contractual and structural mechanisms

Contractual covenants also provide lenders with some protection. Such covenants can include
obligations to maintain the financial health of the borrower as well as other negative and affirmative
covenants. Lenders can also be protected by keep-well arrangements under which fund sponsors agree
to provide the borrower with capital in certain situations.

Financial assistance

24. Are there rules preventing a company from giving financial assistance for the purpose of assisting a
purchase of shares in the company? If so, how does this affect the ability of a target company in a
buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in
the context of private equity transactions?
There is no prohibition on a company giving financial assistance in connection with the purchase of its
own shares. Courts can void guarantees and security given by a target company if a fraudulent transfer
has occurred (such as a transfer of assets when the transferor is insolvent). Creditors in leveraged
buyout transactions often rely on the guarantee provided by the acquiring fund that the borrower and
its subsidiaries will be solvent after the buyout transaction, including any debt resulting from the
transaction and the provision of any guarantees and security.

Insolvent liquidation

25. What is the order of priority on insolvent liquidation?

Most portfolio companies in need of bankruptcy relief use the provisions of Chapter 11 of the
Bankruptcy Code, regardless of whether the goal of the proceedings is the liquidation of the business or
the reorganisation of the business as a going concern.

The statutory priorities for repayment are:

Secured claims, to the extent of the value of the underlying collateral.

Administrative claims (generally, claims that arise after a bankruptcy is commenced and before the
effective date of the plan of reorganisation).

Priority claims (for example, certain claims for unpaid wages and taxes).

General unsecured claims.

Equity.

A senior secured creditor with liens on a material portion of a debtor's assets may agree to be effectively
subordinated to the payment of a predetermined portion of administrative and priority claims, as the
price of liquidating through Chapter 11. This is because a Chapter 11 liquidation can be more
advantageous for the senior secured creditor than simply foreclosing on its collateral.

In a bankruptcy proceeding, the rights of any single holder, including rights relating to priorities of
distribution, can be waived by an affirmative vote of a majority of holders (that is, two-thirds in amount
and one-half in number) within the same class. Inter-creditor and subordination agreements are
enforceable in a Chapter 11 proceeding to the same extent as outside of bankruptcy.

A court can also subordinate one creditor's claim to another creditor's claim (or the claims of all other
creditors) if it is shown that the creditor has engaged in inequitable conduct (for example, fraud or
breach of fiduciary duties) that resulted in an injury or disadvantage to the other creditor(s). If so, the
subordinated claim is treated as lower in priority than the claim to which it is subordinated, but the
subordination does not affect its treatment in relation to any other claim or to equity.
Additionally, a court will look past the form of debt to determine its substance and may recharacterise
debt as equity (and treat it as lower in priority than all claims) if this is determined to be the economic
substance of the transaction.

Equity appreciation

26. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants
or options?

It is possible for a debt holder to participate in the appreciation of equity value through convertible
securities such as rights, warrants or options, but it is not very common in US buyout transactions. Debt
holders generally do not participate in the equity in large transactions. In small and middle-market
transactions, it is common for mezzanine lenders and hedge funds to invest alongside the equity
participants in the equity rather than receiving warrants or other convertible securities, although in
some transactions, share purchase warrants are a part of the overall financing provided by the debt
holders.

Portfolio company management

27. What management incentives are most commonly used to encourage portfolio company
management to produce healthy income returns and facilitate a successful exit from a private equity
transaction?

The most common management incentives used to encourage portfolio company management are:

Share options.

Restricted shares.

Other share-based awards.

A combination of these.

In small and middle-market transactions, incentive plans commonly account for 10% to 15% of the fully
diluted equity. Incentive plans are relatively smaller in larger transactions and commonly account for
between 5% and 10% of the fully diluted equity. Incentive awards are usually subject to both time-based
vesting (for at least some portion of the awards) and performance-based vesting. Performance-based
vesting is usually based on the sponsor's return on its investment.

Restricted stock is sometimes used to allow the recipient to gain favourable tax treatment by electing to
be taxed on the fair market value of the common share grant at the time of grant and to pay income
taxes at ordinary income rates, with appreciation generally taxed at capital gain rates on realisation.

Senior managers may also be required to invest in the transaction, either through a direct cash
investment or through the rollover of their current equity holdings in the target company. The structure,
nature and amount of such required investment depends on individual circumstances. Sponsors
generally work with managers to try to design equity rollovers in a tax-efficient manner.

28. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

Corporations can offer incentive share options (ISOs). ISOs are taxed at capital gains rates when the
shares are sold if certain requirements are met. No tax is due when they are exercised and therefore the
issuer is not entitled to a tax deduction. To achieve capital gains treatment, the shares must be held for
both:

Two years following the ISO's grant date.

One year after the ISO is exercised by the manager.

Companies are limited in the amount of ISOs they can grant and as a result ISOs are not widely used.

Portfolio companies that are operated in a pass-through form can grant managers profits interests in
exchange for performing services for the company. These profits interests generally represent the right
to a share of the venture's future profits and are treated as capital gains at the level of the manager, to
the extent that the underlying income is a capital gain. This differs from ordinary income from the
exercise of non-qualified share options or the vesting of restricted shares without a section 83(b)
election. When the portfolio company is sold, the gain is typically treated as capital gains at the level of
the manager.

Bills have been introduced in Congress several times over the last few years that propose to tax the
carried interest earned by managers of PE and hedge funds at ordinary income rates (they currently
receive capital gains treatment). The recent Tax Cuts and Jobs Act of 2017 imposed a three-year holding
period requirement to tax carried interest at more favourable long-term capital gain rates.

29. Are there any restrictions on dividends, interest payments and other payments by a portfolio
company to its investors?

So long as the dividend payments are in accordance with the portfolio company's charter and
contractual obligations, the payment of dividends by a solvent company is generally unrestricted. State
laws generally prohibit the payment of dividends by a company that is a going concern if after giving
effect to the distribution, the company would not be able to pay its existing and reasonably foreseeable
debts, obligations and liabilities.

30. What anti-corruption/anti-bribery protections are typically included in investment documents? What
local law penalties apply to fund executives who are directors if the portfolio company or its agents are
found guilty under applicable anti-corruption or anti-bribery laws?

Investment documents may include protections regarding the Foreign Corrupt Practices Act (FCPA). The
FCPA generally prohibits fund executives from offering or giving bribes to a "foreign official", "foreign
political party or party official", or any candidate for foreign political office, to obtain or retain business
opportunities. The FCPA generally applies to:

US persons, including US companies, controlled subsidiaries and affiliates of US companies, and citizens,
nationals and residents of the US, wherever located.

In certain circumstances, non-US persons, including non-US companies and non-US citizens outside the
US.

The US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) both enforce
the FCPA. Violators of the FCPA may be subject to both criminal and civil penalties. In criminal cases,
firms are subject to a fine of up to USD2 million per violation of the anti-bribery provisions. Individuals
are subject to a fine of up to USD100,000 and/or imprisonment for up to five years, per violation.
However, under the Alternative Fines Act, the fines imposed on firms and individuals can be much
higher: the actual fine can be up to twice the benefit that the defendant sought to obtain by making the
corrupt payment. In civil actions, a fine of USD10,000 can be assessed for each act committed in
furtherance of the offence, potentially making the total fine greater than USD10,000. Fines imposed on
individuals must not be paid by their employer or principal. In addition, persons or firms found in
violation of the FCPA can be barred from doing business with the US Government and can be ruled
ineligible for export licences.

Investment documents may also include protections from the UK Bribery Act (Bribery Act). The Bribery
Act is similar to the FCPA, which criminalises the payment of bribes to foreign officials. However, the
Bribery Act is more expansive in three ways:

Most significantly, the Bribery Act imposes a strict liability criminal offence that applies to any company
with ties to the UK that fails to prevent an associated person (that is, anyone performing services on the
company's behalf) from paying a bribe. The only defence to liability is if the company can prove that it
had adequate procedures in place to prevent the bribery from occurring.

The Bribery Act does not contain any exceptions for facilitation payments or relatively insubstantial
payments made to facilitate or expedite routine governmental action.

The Bribery Act criminalises purely commercial bribery that is unconnected to any public or
governmental official, unlike the FCPA.

Additionally, investment documents may include protections regarding the OECD Convention on
Combating Bribery of Foreign Public Officials in International Business Transactions (Convention). The
Convention applies to the bribing of foreign public officials. The Convention applies irrespective of,
among other things:

The value of the advantage and its results.

Perception of local custom.

Local authorities' tolerance of these payments.

The alleged necessity of the payment in order to obtain or retain business or other improper advantage.

The convention applies as soon as an offer or promise is made, whether directly or through
intermediaries, and applies even in cases of a third party beneficiary. Penalties are specified by each
country but are comparable to FCPA penalties. Many countries specify unlimited fines and ten years'
imprisonment.

Exit strategies

31. What forms of exit are typically used to realise a private equity fund's investment in a successful
company? What are the relative advantages and disadvantages of each?

Forms of exit

The three most common forms of exit used to realise a PE fund's investment in a successful company
are the:

Sale to a financial buyer such as another PE fund.

Sale to a strategic buyer.

Initial public offering (IPO).

Sales to financial buyers or strategic buyers can take the form of either a sale of the company or of
assets. It is also possible to have a carve-out sale in which a portion of a successful company is sold or
even, on rare occasions, brought public.

Private sales, whether to financial or strategic buyers, are significantly more common than IPOs. The
viability of an IPO depends to a great extent on market conditions.

Advantages and disadvantages

The advantage of an IPO is that it is possible to realise significantly greater value in the long term.
However, in most IPOs the fund sponsor does not sell most (or any) of its shares. Instead, newly issued
shares are sold to the public. As a result, even with a successful IPO, the fund sponsor still has market
risk in relation to its shares in the company, as well as the continued business risk of operating the
portfolio company.

Although greater value may be realised over the long term from an IPO, the private sale is by far the
more common exit strategy. The advantage of a private sale is that the PE fund sponsor realises all the
value of the sale immediately and no longer has to deal with either business or market risk in relation to
its investment.
Sales to other PE fund sponsors remain a particularly common form of exit. From a fund investor
perspective, a sale to another PE fund may mean there is no exit at all if the investor is also invested in
the acquiring fund.

32. What forms of exit are typically used to end the private equity fund's investment in an
unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

Forms of exit

The two primary forms of exit used to end a PE fund's investment in an unsuccessful company are to sell
the company (an asset or a stock sale) where the equity holders do not receive anything, or to enter into
voluntary bankruptcy.

Advantages and disadvantages

The bankruptcy procedure is preferred because the buyer gets clean title to all the assets and the seller
is assured of having no remaining liabilities. In a sale of the company outside of bankruptcy, no matter
how strong the contractual arrangements may be, the seller is always left with the possibility that
liabilities may remain its responsibility.

In a voluntary bankruptcy, the portfolio company can sell all or substantially all of its assets with court
approval. It is unusual for such sales to result in any proceeds being paid to the equity holders, and some
classes of creditor may also receive proceeds equalling only a small percentage of their claims.

Reform

33. What recent reforms or proposals for reform affect private equity in your jurisdiction?

Potential expansions of access to private funds

In June 2019, the SEC published a release to solicit public comment on exemptions from registration
under the Securities Act, which suggests the SEC is willing to consider expanding investment
opportunities in PE funds and venture capital funds to retail investors. While no rule has been proposed
and no major change is imminent, the SEC's requests for comments on these topics suggest a willingness
to explore ways to expand the scope of investment opportunities available to retail investors, including
in particular:

Potential avenues for the development of registered "funds of funds" and feeder structures offered to
non-accredited investors.

Greater flexibility for investor-eligibility requirements to be satisfied through the involvement of

registered investment advisers or other financial intermediaries acting on behalf of non-accredited
investors.

In December 2019, the SEC voted to propose amendments to expand the definition of "accredited
investor", which is a central component of several exemptions from registration under the Regulation D
safe harbour that is used by most private funds to exempt their issuance of securities from registration.
The accredited investor concept in Regulation D was designed to identify (with bright-line standards) a
category of investors who do not need the protections of registration under the US Securities Act of
1933.

The proposed amendments would add two new categories of natural persons to the accredited investor
definition in addition to persons currently qualifying on the basis of meeting income or net worth
thresholds:

Those who hold certain professional certifications and designations or other credentials.

Those who are "knowledgeable employees" of a private fund and are investing in the private fund.

The proposed amendments would also expand the types of entities that qualify as accredited investors
to include, among others, registered investment advisers.

SEC guidance on adviser conduct standard and fiduciary duty

In June 2019, the SEC issued a final interpretation of the standard of conduct for investment advisers.
The SEC opted to issue "guidance" and declined to propose any specific rule text, stating its belief that
the principles-based approach to the relationship between an investment adviser and clients, rooted in
fiduciary principles "should continue as it expresses broadly the standard to which investment advisers
are held while allowing them flexibility to meet that standard in the context of their specific services".

The final guidance describes a two-pronged fiduciary standard that includes:

A duty of care.

A duty of loyalty, which had been long established in prior precedent.

The final guidance clarifies the disclosure-based nature of the Advisers Act fiduciary duty of investment
advisers, including investment advisers to private funds. The final guidance eliminates most of the
references to a "best interest" standard that had been included in proposed guidance in April 2018, and
instead clarifies that advisers have a duty to "eliminate, or at least to expose, all conflicts which might
incline an investment adviser—consciously or unconsciously—to render advice which was not
disinterested".

New Institutional Limited Partner Guidance

In 2019, Institutional Limited Partner Association (ILPA), an organisation of institutional limited partners
dedicated to advancing the interests of PE investors continued to release its guidance and views on a
variety of topics. In particular, the organisation released proposed best practices for general partner-led
fund restructurings in April, which were also incorporated into its "Principles 3.0" for the PE industry
released in June, which refreshed the Principles 2.0 released previously in 2011. The new Principles 3.0
continue to promote alignment, transparency and governance, maintain proposals for economic terms,
reiterate emphasis on reporting and disclosure, and incorporate other recent guidance on credit
facilities.

The Principles 3.0 also cover topics such as fund structure, key person provisions, and co-investment
allocation. In October, ILPA followed up on its past release of model subscription documents by
releasing a model limited partnership agreement. However, to date these documents have not been
significantly used within the industry.

Volcker Rule regulatory changes

In July 2019, federal financial regulatory agencies issued a final rule, which revises the Volcker Rule's
name-sharing restrictions applicable to bank-affiliated hedge funds and PE funds and excludes certain
community banks from the Volcker Rule.

The prior rule provided that a banking entity that organised and offered a hedge fund or PE fund could
not share the same name or a variation of the name with the fund. The name-sharing restriction now
permits a hedge fund or PE fund organised and offered by a banking entity to share the same name or a
variation of the same name as a banking entity that is an investment adviser to the hedge fund or PE
fund, if:

The investment adviser is not an insured depository institution, a company that controls an insured
depository institution, or a company that is treated as a bank holding company (BHC) for purposes of
section 8 of the International Banking Act of 1978 (IBA).

The investment adviser does not share the same name or a variation of the same name with any such
insured depository institution or company treated as a BHC for purposes of the IBA.

The name does not contain the word "bank".

COVID-19 Impact on the Industry

At the time of writing this guide, the global economy is grappling with the COVID-19 outbreak, with
many governments instituting mandatory business closings, public gathering limitations and restrictions
on travel. Although the long-term economic fallout of COVID-19 is difficult to predict, it has had and is
expected to continue to have ongoing material effects on the PE and venture capital industries. While
funds in the market continue to fundraise, it is unclear to what extent restrictions on activities will slow
new fundraising activity in the second quarter of 2020 and beyond. Already some institutional investors
have paused investment activities in some or all asset classes.

The current focus of many sponsors is ensuring the health of their portfolio companies, and some
sponsors are exploring annex funds and other opportunities to allow them to deploy additional amounts
of capital quickly either to support existing portfolio companies or to take advantage of new
opportunities in the market due to pricing fluctuations. The ability for private funds to draw on credit
facilities, both ones secured by subscriptions and NAV-backed facilities to bridge any capital needs has
become increasingly important.
Private fund sponsors should continue to test and ensure effective implementation of business
continuity and cybersecurity plans, which have been a regulatory focus in the recent past. Limited short-
term regulatory relief has been provided on an ongoing basis for upcoming filing deadlines, subject in
some cases to notice conditions.