Private equity and acquisition finance in Hong Kong
As a leading international financial centre, Hong Kong is a preferred private equity hub.
Private equity involves professional investors using their own funds and debt to invest in private entities, with a view of providing capital to support the growth of the target business. The ultimate aim of the process is for the investor to generate returns to repay the debt and capital gains upon exit of the investment.
The role of advisors
When a target company is approached by a private equity firm, lawyers are involved to assist in the structuring of the transaction and the negotiation of the terms of the investment. Lawyers and tax advisors work together in order to determine the most suitable legal and tax structure for the contemplated transaction. The adopted structure typically depends on the parties’ jurisdiction of incorporation and financial flows involved. Upon the completion of a satisfactory due diligence, the negotiations with respect of the transaction documentation can start.
It is key for advisors to identify what’s at stake for the client – private equity fund, shareholders or senior executives of the target. That includes the target company’s value-adding assets and the potential deal breakers in the eyes of the investor. The role of a private equity lawyer is to assist its clients throughout the transaction and notably:
- drafting and negotiating the terms of the letter of intent and the non-disclosure agreement;
- coordinating legal due diligence (in-depth or red flags), liaising with the other advisors carrying out the financial, accounting and tax aspects of the due diligence and providing the client with a comprehensive understanding of the red flags identified;
- structuring the transaction, setting up a holding company and creating classes of shares, where appropriate;
- negotiating the transaction documents (share purchase agreement, warranties and indemnities, articles of association, shareholders’ agreement, employment contracts or service agreements for the managers, senior and mezzanine loan and securities). Particular attention shall be brought to the complexities of hotly contested clauses: warranties and indemnities, limitations on liability, share transfer provisions, etc. The aim is to get the deal to close satisfactorily, not at all costs.
A new venture
The acquisition of a controlling stake in a business marks the commencement of a new venture whose rules are set out in the shareholders’ agreement. What distinguishes private equity firms from individuals is the fact that they really take steps to develop the target company’s business. These steps include:
- providing expertise in order to back the management team on the delivery of the agreed business plan;
- implementing corporate governance policies designed to align the interests of all stakeholders (namely shareholders, senior executives, employees, customers, etc.), creating a shared stake in the company’s results;
- creating incentivisation mechanisms for key staff members: it is crucial to identify key employees and officers and to implement a solution to retain them and to motivate long-term value creation. A share option plan gives its beneficiaries the right to access the company’s share capital if performance conditions are satisfied and the beneficiary remains part of the team. The set-up of an employee benefit trust can be envisaged in parallel to create a separate pool of actions. As the organisation of a company is in constant motion, the entering into of an agreement containing call and put options between the company and each beneficiary is often a condition precedent to the issue of share options. It enables the company to repurchase the shares in case of termination of the beneficiary.
A private equity investor typically exits the investment after a holding period of 3 to 5 years. Exit scenarios (IPO, transfer to existing shareholders, sale to a new buyer, etc.) shall be anticipated during the investment process, in order to give the parties certainties as to exit options available.
Acquisition finance is the funding used for a private equity transaction. The most common forms of acquisition finance are:
- debt finance, consisting of loans from authorised institutions, deferred consideration, vendors rolling over by taking an equity stake in the holding entity, etc.; and
- equity finance, notably convertible notes and preferred shares issues.
When an acquisition is financed using debt, the lenders will require security from the borrower. Within the scope of a leveraged buyout (LBO), securities are taken on the assets of the target company. The lender usually requires a charge over the shares of the target company.
How can we help?
We combine our corporate law knowledge with practical business and commercial acumen to assist our clients throughout the negotiation of their transaction. Our team has experience drafting and reviewing the full set of documents involved. We represent our clients during negotiations with other parties’ counsels. We provide our clients with practical legal advice, to make the deal go through while protecting our clients’ interest. We always bear in mind to anticipate issues that may affect the relationships between the partners in the future.
Depending on the scope of the transaction, we can offer fixed fees for the legal due diligence, the preparation of certain transaction documents and the creation of securities such as share charges as well as legal opinion on the said securities. Considering the uncertainty as to the negotiations on such documents, our fees for negotiating and preparing amendments of the transaction documents are based on time spent. Post-completion work is generally invoiced on a daily rate taking in consideration the mixed legal and administrative nature of the many steps involved to ensure the update or registration required are effective.