Summary of Markets and companies law , Dispense di Diritto

Scarica Summary of Markets and companies law e più Dispense in PDF di Diritto solo su Docsity! 1 “The anatomy of Corporate Law” Slide: Markets and company law, principles of international corporate law CHAPTER 1 What is Corporate Law? It’s a set of rules with different origins with common objectives. It aims: 1. To serve the society interests, as a whole 2. To advance the aggregate welfare of all who affected by firm’s activities. The law limits the system to permit it to be balanced and correct. The corporate law fills the gap of the agreements and the contract because they cannot predict the future. In USA we have different jurisdictions in different states, but similar because they have been always a federation. In UE we have very different jurisdictions because of the difficulty to apply one of them to another state. Traditional definition: increasing shareholders’ value BUT it has a social scope: increasing the wealth of all corporate stakeholders (shareholders, employees, suppliers, customers), with positive externalities on third parties. SOURCES OF CORPORATE LAW 1. National legislation 2. International conventions 3. Macro regional/federal laws and regulations (e.g. US federal laws and EU directives and regulations) 4. National case law (common law vs. civil law value of precedents) 5. International tribunal’s case law 6. Lex mercatoria: similar to the English common law, it’s the body of commercial laws evolved as a system of custom and best practises, in order to set rules on international relations. Ex. Non corporate law impacting companies: 1. Stock exchange regulations 2. Self-regulations (e.g. category statutes like the English City Code on M&A) 3. Bankruptcy and insolvency laws 4. Employments and social security laws 5. Criminal law 2 BASIS OF CORPORATION Business (incorporated) corporation have 5 basic legal characteristics: 1. Corporate legal status 2. Liability limited to contributions 3. Freedom to transfer shares 4. Unified management acting under the guidance of an administrative body 5. Ownership of the company in the hands of the equity suppliers In detail: 1. CORPORATE LEGAL PERSONALITY Main feature is its separate patrimony also called AFFIRMATIVE ASSET PARTITIONING
capacity of the company to have its own asset separated from those of others subjects (including the investors/shareholders). These can be attached only from company’s creditors Effects: • Priority rule: it grants to creditors of the firms a claim of the firm’s assets which is prior to the claims of personal creditors of the owners of the firms. • Rule of liquidation protection: the individual owners of the corporation cannot withdraw their share of firm assets at will, forcing partial or complete liquidation • Rules specifying to third parties the individuals who have authority to buy and sell assets in the name of the firm • Rules specifying the procedures by which the firm and its counterparties can bring lawsuits 2. LIABILITY LIMITED TO CONTRIBUTIONS Creditors are limited to making claims against assets that are hold in the name of the firm and they have no claim against assets hold in the name of shareholders.
creditors have a COMPARATIVE ADVANTAGE in evaluating and monitoring the value of the firm’s assets
owner’s personal creditors have a COMPARATIVE ADVANTAGE in evaluating the individual’s personal assets Shareholders’ limited liability has been introduced to incorporated entities only in the XIX century. Alike legal status for the company’s creditors, shareholders limited liability creates a guarantee for the shareholders’ personal creditors. The effect of this two protections allows to diminish the cost of corporate capital for both the company and the shareholders. Main consequence
access to financing, to incentive the fast growth of the economy. 5 appointment strategy, many jurisdictions rely increasingly on the trusteeship role of independent directors as pillars of corporate governance.  MANAGERIAL POWER OF CORPORATE BOARDS In single-tier jurisdictions such as the US, UK, and Japan, one board exercises the legal power to supervise and manage a corporation, either directly or through its committees.
concentrate decision-making power By contrast, in two-tier jurisdictions, monitoring powers are allocated to elected supervisory boards of non-executive directors, which then appoint and supervise management boards that include the principal executive officers who design and implement business strategy.
favour collective decision-making Both approaches to the management of large firms have potential advantages. But two considerations caution against generalizing about these advantages in our jurisdictions: 1. The extent of the distinction between the two board structures is often unclear. Informal leadership coalitions can crosscut the legal separation between management and supervisory boards; while supermajorities of independent directors and an independent chairman can give single-tier boards a quasi-supervisory flavour. 2. Labour codetermination in Germany, the most prominent two-tier jurisdiction, weakens the supervisory board as a governance organ devoted exclusively to the interests of the shareholder class. The two-tier board structure facilitates strong labour participation in corporate governance in part because full access to sensitive information and business decision-making can remain with the management board, thereby mitigating potential conflicts of interest on the supervisory board.  NOMINATING DIRECTORS: All of our core jurisdictions apart from the US allow shareholders to nominate directors. Ordinarily the board proposes the company’s slate of nominees, which is rarely opposed at the annual shareholders meeting. But in most jurisdictions, a qualified minority of shareholders can contest the board’s slate by adding additional nominees to the agenda of the shareholders’ meeting. In contrast to this model, however, insurgent shareholder in the US cannot place nominees on the company’s proxy or on the agenda of the shareholders’ meeting as of right, but must instead solicit their own proxies and distribute their own solicitations to contest the company’s slate of nominees.
Our core jurisdictions other than the US follow a MAJORITY-VOTING RULE, under which directors are elected by a majority of votes cast at the shareholders’ meeting.
By contrast, the statutory default in the US is a plurality-voting rule, under which any number of votes suffices to elect a nominee to a board seat.
Another important aspect of the voting system comprises the RULES that regulate the DISTRIBUTION OF VOTING POWER among classes of shareholders and between nominal and 6 beneficial shareholders. Corporate laws generally embrace the default rule that each stock carries one vote. But all jurisdictions permit some deviations from this one-share/one-vote norm, even while they prohibit or limit others. Thus, all of our core jurisdictions limit circular voting structures (most jurisdictions forbid subsidiaries from voting the shares of their parent companies) and vote buying by parties antagonistic to the interests of shareholders as a class.  POWER TO REMOVE DIRECTORS: Removal rights follow appointment rights. How? 1. By dropping their names from the company’s state 2. By failing to re-elect them. NB : power to remove directors before the end of their terms. British, French, Italian and Japanese law all accord shareholder majorities a non-waivable right to remove directors mid-term without cause. Our remaining jurisdictions provide weaker removal rights. The German default rule allows three-quarters of voting shares to remove a shareholder-elected supervisory board member without cause. The most important US jurisdictions treat the right to remove directors without cause as a statutory default subject to reversal or by disallowing removal without cause for classified boards.  FACILITATING COLLECTIVE ACTION: A final aspect of governance rules is the extent to which they empower dispersed shareholders. Diffuse stock ownership present shareholders with formidable collective action problems in attempting to exercise their control rights. Small shareholders everywhere can exercise their voice at shareholders’ meetings through one of three mechanisms: 1. Mail voting 2. Proxy solicitation by corporate partisans, 3. Proxy voting through custodial institutions or other agents. In some companies (like public ones) minority shareholders are protected. In small corporations are protected by law, in bigger ones they are a lot and can negotiate their position.  INDEPENDENT DIRECTORS: Among our core jurisdictions, the principal trusteeship strategy today for protecting the interests of disaggregated shareholders is the addition of independent directors to the board. Independent directors are board members who are not strongly tied by high- powered financial incentives to any of the company’s constituencies BUT who are 7 motivated principally by ethical and reputational concerns. That is, of course, our definition of a trustee. Trustee-like directors are widely considered to be a key element of good governance. In the US, they are most often seen as monitors of managers or controlling shareholders.  BOARD STRUCTURE AND INTERNATIONAL BEST PRACTICES Commentators tie good governance to a range of so-called best practises: size (small is better); committee structure (independent audit, compensation and nominating committees are good); independence from management, controlling shareholders, or both; and separation of the roles of board chairman and CEO (independent chairmen are good). CHAPTER 4 The Basic Governance Structure : Minority Shareholders and Non-Shareholders Constituencies MINORITY SHAREHOLDERS PROTECTION Adjustments to shareholder appointment and decision right can protect minority shareholders either by empowering them, or by limiting the power of controlling shareholders.  MINORITY SHAREHOLDER APPOINTMENT RIGHTS: Company law enhances minority appointment right by 1. Reserving board seats for minority shareholders 2. Over-weighting minority votes in the election of directors. An organized minority that selects only a fraction of the board can still benefit from access to information and, in some cases, the opportunity to form coalitions with independent directors. Of course, even without express authorization, shareholders agreements or charters can require the appointment of minority directors for individual firms. The law can achieve a similar result on a broader scale by mandating cumulative or proportional voting rules, which allow relatively large blocks of minority share to elect one or more directors, depending on the number of seats on the board. Moreover, lawmakers can further increase the power of minority directors by : 1. Assigning them key committee roles 2. Permitting them to exercise veto powers over certain classes of board decisions. 10 - GROUPS OF COMPANIES
Creditors are more vulnerable to shareholder opportunism
US, EU, Japanese listed groups should prepare consolidated accounts - THE ROLE OF GATEKEEPERS
They verify the quality of disclosure  THE RULE STRATEGY: LEGAL CAPITAL Corporate capital
initial contribution made by shareholders that can be increased by later contributions. 1. Minimum capital
minimum investment level EU : rules on initial minimum corporate capital for access to corporate form (not less than 25 000 euro) USA : there are different standards that companies must adopt to maintain a good level against their obligation. All our jurisdictions permit incorporation of a non public company without any minimum capital requirement. Only Italy requires a minimum capital of 10.000 €. 2. Distribution restrictions
company laws restrict distributions to shareholders to prevent assets dilution. a. debtor perspective = advantage: when there are multiple creditors, transaction costs are low b. creditor perspective = legal capital may no offer sufficient protection. 3. Loss of capital
EC law requires public companies to call a shareholders’ meeting to consider dissolution after a serous loss of capital. If net assets < statutory minimum capital, the company is put into liquidation. DISTRESSED FIRMS  THE STANDARD STRATEGY Standards are used to protect creditors. 3 categories to whom the duties are referred: 1. DIRECTORS
when the company is insolvent, directors may be held personally liable for net increases in losses to creditors. More intensive standards impose liabilities for negligently worsening the financial position of the insolvent firm. 2. SHAREHOLDERS
standards for holding shareholders liable for the debts of insolvent corporations. There are 3 principal tools: - doctrine of de facto or shadow directors - involves treating a person who acts as a member of the board; - equitable subordination = subordination of debt claims brought by controlling shareholders against the estates of their bankrupt companies; - piercing the corporate veil in extreme circumstances to hold controlling shareholders or the controller of corporate groups personally liable for the company’s debts 11 3. CREDITORS AND OTHER THIRD PARTIES
sometimes third parties are hiring a gatekeeper, in order to prevent one creditor from getting a better position  GOVERNANCE STRATEGY Two phases: 1) In the period of transition into bankruptcy; 2) to the control of firms in bankruptcy procedures  APPOINTMENT RIGHTS
creditors have the power to initiate a change in the control of assets of a financially distressed company by triggering bankruptcy proceedings. A consequence of bankruptcy is the removal of the board from the effective control of corporate assets and its replacement with an administrator or crisis manager: person appointed by creditors.  DECISION RIGHTS
a proposal of “exit” from the bankruptcy proceeding is initiated by the crisis manager subject to veto rights from creditors.  INCENTIVE STRATEGIES
the trusteeship strategy is more important for creditors; the reward strategy is more important for shareholders. Reasons: 1. there are differences in the payoff of creditors and shareholders; 2. there are problems in inter-creditor agency costs that arise when the firm moves under the control of creditors
because the value of assets is uncertain and creditors are usually grouped in different classes of priority. OWNERSHIP REGIMES AND CREDITOR PROTECTION Corporate law facilitates transaction between corporations and their creditors. There are legal strategies: - Regulatory strategies in relation to firms not in default - Governance strategies for firms which are in default. There are also some variations depending on “debtor-friendly” or “creditor-friendly” according to extent to which they facilitate or restrict creditor enforcement against a financially distressed debtor.  THE ROLE OF BANKRUPTCY LAW If there are few creditors
the corporate bankruptcy law need only perform the role of liquidating failed firms. If the dispersion of creditors increases
it’s difficult to adopt private solutions. We use governance strategies. 12  CREDITORS’ PROTECTION It’s a form of guarantee for all stakeholders undertaking a relationship with a company. EU vs USA: - EU: corporate capital. It is common to all EU (exception for UK) jurisdiction to set rules on initial minimum corporate capital to be maintained during the company’s life and distribution to the shareholders. There is discussion on the actual usefulness of such tool - USA: no rules specify requirements on corporate capital. Creditors are instead guaranteed through standards set for the actions of a number of players, which have sort of fiduciary duties vis-à-vis creditors. Protection to creditors is a specific instrument; however it is also a guarantee to third parties. Safeguards are also granted to internal and external subjects to the company. Depending on the sector the company operates, specific rules give specific protection. Protection may be given to the market in general when the company has a sufficiently big size and widespread ownership. CHAPTER 7 Fundamental Changes FUNDAMENTAL CHANGES What are the fundamental changes in the relationship among participants in the firm? Corporate law limits board if the corporate actions or decisions are large or create possible conflict of interests for directors. There are 2 significant characteristics associated with significant corporate transformation: 1. Size of a corporate action
the relative size of a corporate action increases the value of any legal intervention that increases the quality of the company’s decision making. 2. Risk of self-interest decision-making by the board.
EXTRAORDINARY TRANSACTIONS are • High scale transactions compared to the company’s size; • A transaction which evaluation shall not be too technical as discretion on the pursuit is made by shareholders • Transactions which may cause a conflict of interest for managers; • Mergers (de-mergers) and acquisitions • Disposal of assets • Capital increase (or decrease) • Creation of new shares 1 Corporate Governance A practical perspective What is Corporate Governance? Corporate Governance: - is the system by which business corporations are directed and controlled - deals with the distribution of responsibilities among different participants in the corporation such as the board, managers, control systems - includes the procedures monitoring the decision process and the management. PURPOSES OF CORPORATE GOVERNANCE: 1. Holding the balance between: o economic and social goals o individual and communal goals 2. Align as nearly as possible the interest of individuals, corporations and society 3. Facilitate effective entrepreneurial and prudent management that can deliver the long- term success of the company. PRINCIPLES OF GOOD CORPORATE GOVERNANCE: 1. Accountability
company managed in the best interests and assets safeguarded 2. Transparency and quality of disclosure 3. Attention to the spirit and the letter of regulation
prevalence of substance over form 4. Balancing of powers and controls
concentration of power and influence 5. One size DOESN’T fit all
NOT one single structure good for every company at every stage, in every country and industry. WHY IS C.G. GETTING SO IMPORTANT? A GEO-POLITICAL PERSPECTIVE: “The proper governance of companies will become as crucial to the world economy as the proper governing of countries” Why? Some data: - Of the 100 largest economies in the world, 52 are companies. - Over 70% of world trade is controlled by just 500 companies. - In 2002, almost a third of world output came from 200 companies. 2 REGULATION FRAMEWORK The corporate governance framework for companies listed in EU is a combination of legislation and soft law, including recommendations and corporate governance codes. o UK
PRINCIPLE-BASED APPROACH rather than a more rigid tick-box approach o Italy
MIXED SYSTEM where legislation and soft law NOT always coincide 3
EU legislation transposed to National legislation country specific regulation for companies and listed companies is the framework that constitutes the mandatory minimum standard listed companies have to adhere to.  CORPORATE GOVERNANCE CODES OF GOOD PRACTICE They are adopted at national level
set out standards of good practice in relation to board composition and structure, leadership and effectiveness, remuneration, accountability, relations with shareholders, transparency and internal controls. Directive 2006/46/EC promotes their application by requiring that listed companies refer in the corporate governance statement to a code and that they report on their application of that code on a “comply or explain” basis. e.g. DELAWARE GENERAL CORPORATION LAW : it’s the Statute governing corporate law in the U.S State of Delaware. Over 50% publicly traded corporations in US and 60% of the Fortune 500 (ranks corporations by their gross revenue) are incorporated in the State.  TRANSFER OF GOOD PRACTICES 1998
Cadbury Report (UK) : set out the need to identify a senior non-executive lead director as reference and coordination point for independent directors. It also stated the preference for the separation of CEO and Chairperson roles. These provisions appeared in the Italian corporate governance code in 2006. 2006
Norway passed a gender quota law. The provision was then added to many codes in Europe, then became law in some countries. Now Commissioner Reding is proposing a gender quota EU directive. DRIVERS OF CORPORATE GOVERNANCE SETTINGS 1. Cultural and legal frameworks
self-regulation and market based sanctions to govern corporations VS hard legislation and statutory enforcement (common law/civil law) 2. Type of ownership (dispersed vs concentrated) and of shareholders (banks, families, pension funds, institutional investors,…) 3. Company specific drivers related to industry, lifecycle and complexity of business. BOARD OF DIRECTORS (BoD):  ROLES The board LEADS a company
key to its success (or failure!) 1. Set the company’s strategic aims
develop the firm’s strategy and conduct day-to day business 6 Common view is that the two roles should not be combined as this would not concentrate too much power in one person. Italy
61% of Chairmen have delegated powers; 30% of companies: CEO duality.  Independent Directors1 Non-executive directors (NED) are directors without powers; in some countries they coincide with independent directors (dichotomy insiders/outsiders). Italy
NEDs can be either independent (34%) or non-independent (35%), in relation to their professional or personal ties with the controlling family or with the issuer in general. UK
70% of directors are independent. They are meant to balance the exec’s power and weigh in board’s decisions, in particular on matters in which the interests of the executives and those of the shareholders diverge (e.g. remuneration, related party transactions, internal controls). They are also expected to contribute to the performance of the duties the board is in charge of (particularly as members of a unity board). Independent directors can make a very positive contribution to the board and the firm. Codes and regulations increasingly rely on them as protection against wrongdoing of management and sound business decisions.
champions of good governance! 1 Independence = lack of circumstances that might affect the director’s judgment. There are however several circumstances that might affect the judgment but are difficult to codify (what about friendship?) 1 “Mergers and Acquisitions” Slides: M&A CHAPTER 1 Structuring Fundamentals REASONS FOR ACQUISITION Intrinsic value is created if the combined businesses generates an increase in aggregate cash flow.
Acquisitions should be additive = the combined business is worth more than the separate businesses.  ADVANTAGES: 1. Economies of scale
by lowering the average manufacturing cost or by elimination of redundancies in the organization. 2. Time to market
extending a product line where: a. it is cheaper or faster for the buyer to purchase the product line and its underlying technology rather than develop it independently b. the buyer cannot develop it independently 3. Combination of customer and supplier
a company buys a supplier to reduce the risk of dependence on an outside supplier 4. Product line diversification
to balance risk 5. Defensive acquisitions
because the acquirer may be facing a severe downturn in its business and the acquisition will alleviate the cause of this downturn. 6. New and better management 7. Acquisition of a control premium BASIC ACQUISITION STRUCTURES 1. STOCK PURCHASE = the buyer purchases the outstanding capital stock of the target directly from the target’s shareholders. If the target is a private company: stock purchasing agreement signed by the buyer and the target’s shareholders. In a public company, this is effected by tender offer: the buyer makes a formal public offer directly to the target’s shareholders. Where the buyer is offering to pay in stock, a tender offer is called an exchange offer. 2. MERGER = the target is merged, pursuant to the applicable state merger statute(s), with the buyer OR merged with a subsidiary of the buyer that has been formed for the purpose of 2 effecting the merger. After the merger, either the target or the buyer can be the corporation that survives the merger (surviving corporation). Alternative
two steps acquisition: the buyer first acquire through a stock purchase a majority of the target’s outstanding stocks, then follows that up with a squeeze-out merger approved by buyer as majority shareholder. 3. ASSET PURCHASE = all or a selected portion of the assets of the target are sold to the buyer or a subsidiary of the buyer. In an asset purchase, all or a selected portion or none of the liabilities and obligations of the target are assumed by the buyer. Most state statutes require shareholder approval of a sale of “all or substantially all” of the assets of the target. In each of these cases, the purchase price may be paid in cash, stock or other equity securities. Sometimes a portion of the purchase price is paid on a deferred basis tied to the subsequent performance of the acquired business = earnout. STRUCTURING PARAMETERS Principal structuring parameters that determine which the appropriate acquisition structure is: 1. Tax Acquisition can be done on both a tax-free (tax deferred) or taxable basis. The deferral (not elimination) of the tax is realized by shareholders when corporations combine in transactions that meet certain requirements = reorganization (or tax-free reorg) provisions. In order to qualify as a tax-free reorganization, a significant portion of the acquisition consideration must be voting stock of the buyer. The portion of the acquisition consideration that is not stock is called boot and its receipt is taxable. The target’s shareholders want to avoid a deal that creates double tax – that is, taxation first at the corporate level and then at the shareholder level.
NOT a tax efficient transaction. Double tax happens in an ASSET PURCHASES, that’s why they are relatively rare. In the buyer’s perspective, the principal tax: tax basis that he receives in the target’s assets. He wants a step-up: higher tax basis in depreciable/amortizable assets which allows greater depreciation deductions. ≠ carryover basis: assets have the same tax basis in the hands of the buyer as they did in the hands of the target
in a tax-free deal. In a STOCK PURCHASE the target pays no tax and therefore double tax is avoided. 2. Corporate law The corporate law parameters for an acquisition start whether the buyer wants to, or is forced to, acquire selected assets of the target and whether the buyer wants to avoid the assumption of certain or all liabilities of the target. Considerations:  Where buyer wants to acquire the entire business, ASSET PURCHASE structures are generally not used since there’s double tax and they are more complex mechanically. 5 Since there’s a lot of subjectivity in all of the valuation methodologies, bankers usually express value as a range: market value is somewhere between the minimum value a seller is willing to accept and the maximum value a buyer is willing to pay
Fair market value is the range in which informed and willing buyers and sellers would buy/sell the business. For private company: more difficult
NO reference public market trading price, NO audited financial statements, may play games for tax purposes.
the bank may have to normalize financial prospects of the business to reflect the performance the buyer should expect. Principal valuation methodologies used by bankers: 1. Relative valuation : the business is valued based on the observable market value of comparable properties – comparable = similar size, similar products and similar risk profile. 2. Discounted cash flow valuation : measures what the investment is meant to return, considering the cost to finance it. Cash flow is usually projected out of 5 years or so since beyond that the numbers are usually speculative.  INVESTMENT BANK ENGAGEMENT LETTERS Both targets and buyers frequently use the services of an investment banker because they believe he adds net value by locating potential buyers, assisting in pricing the transaction, assisting in negotiating the agreements and bringing the transaction to a successful conclusion
universal practice and protective measure for the board. Issues: 1. Investment bank fee + appropriateness and size of a retainer: Targets should ask the banker for a list of fees they have charged in comparable recent transactions. Investment banks typically require a minimum fee for the engagement and a retainer, which can be significantly reduced or eliminated. If there’s a retainer, the target should always attempt to have it credited against the transaction (or success) fee and returned if the banker terminates the engagement. Investment banks usually seek: - To be paid at closing for the total deal value. - To expand the nature of their engagement in the engagement letter through a private minority investment in the target or a strategic relationship. Why? Because IB needs to protect itself in a situation in which the nature of the transaction changes during its duration. 2. Where there should be any exclusions from the fees: Targets should consider whether to request that certain buyer prospects be excluded from the fee or that sales prospects carry a reduced fee. Linked to: - Exclusivity
the firm is prohibited from discussing the transaction with potential buyers 6 - Tail clause
if an M&A transaction is concluded by the client within a specified period of time, then the banker is nevertheless entitled to its full fee.  CONFIDENTIALITY AGREEMENTS Other than the IB engagement letter, the confidentiality agreement between the buyer and the target is the first typically signed in an acquisition transaction. Why is confidentiality so important? 1. To protect target’s intellectual property rights
it must get anyone who’s to have access to its confidential information to sign this agreement before they’re revealed. 2. The target must realize that if the agreement is violated by a potential buyer in a failed acquisition, it will be extremely difficult and expensive to prove. A confidentiality agreement says 2 things: 1. The recipient of the confidential information agrees to keep the information confidential and not to disclose it to anyone other than on a need-to-know basis 2. The recipient agrees not to use the confidential information for any purpose other than in connection with the proposed transaction. Residuals clause = states that the info that stays in the head of the recipient’s personnel can be used for any purpose. Non-solicitation provision = potential buyers who get to know the target’s management are prohibited from soliciting it for employment if the deal doesn’t go through with them. Standstill provision = prohibits the buyer in a failed acquisition from accumulating stock in the market or commencing a hostile tender offer. Term of the agreement
clause: after a specified period of time, the confidentiality obligations no longer apply. 2. LETTERS OF INTENT = “memorandum of understanding” or “term sheet”. Document of pre-contractual phase. It sets out certain principles of the transaction so that the parties can confirm their mutual understanding on the main terms of the deal (e.g deal structure, price, conditions to closing,…). The need to draft the letter of intent may arise in order to obtain the BoD approval of the transaction or any governmental or other 3rd party approval or to notify 3rd parties. What should be included in a letter of intent? Target should try to get as much detail into it as possible: key economic points, money issues and legal points that have significant potential economic impact. It’s likely to be in target’s interest to raise all of the hard issues at the outset.  Assumption of the parties  Non-binding save for exceptions (e.g. exclusivity)
on a case-by-case basis 7  Object  Agreement on the main terms of the to-be-executed agreement  Duration  Criteria and rules for diligence activities  Mutual exclusivity or, more often, only in favor of the purchaser (binding undertaking)  Confidentiality (binding undertaking) Buyers also sometimes insist on a letter of intent because it contains a binding no-shop agreement = agreement of the target that it and its representative will not seek and will not enter into discussion with another bidder for a specified period of time (30-60 days). If the target receives a better offer or it’s convinced that it can get one, he must wait until the expiration of the no-shop. Letter of intent is NOT a universal practice, e.g. it is not required in public company acquisitions (avoid paper trail). Some argue it’s a waste of time. Why? Because of its brevity, it doesn’t raise all issues that appear in the definitive agreement. 3. STAY BONUSES AND OTHER EMPLOYEE RETENTION ARRANGEMENTS The acquisition process creates delicate employee-retention issues, as employees may want to leave before the acquisition is completed, thereby depriving the buyer of one of the assets it is buying and putting the deal at risk
issue of disclosure. Solution: define a purchase price adjustment pre- or post-closing if a specified # of employees quit within a certain period OR implement in advance provisions designed to avoid that. o Stay bonus programs : if the employee remains with the target until the closing of the acquisition, and/or through a specified transition period, the employee will be entitled to a specified % of the acquisition proceeds as a bonus, or will be entitled to a specified $ amount of bonus. o Golden parachutes : agreements entered into by public companies before an acquisition and provide that the employee becomes entitled to a payment if, after a change of control or acquisition of the public company, he is terminated. 4. BUSINESS AND LEGAL DUE DILIGENCE Due diligence = investigation that an investor/buyer undertakes of a prospective investee/target. It’s extremely important: it affects the buyer’s decision whether to invest in or acquire the target, on what terms and for what price. Areas: accounting, tax, legal, environmental. Purpose: to give the buyer a comprehensive view of the target business as well as a thorough knowledge of its strengths and weaknesses. Problems discovered: used by the buyer as bargaining chips for a reduction in the previously negotiated purchase price. Types: I. Business due diligence 2 In more detail, as for home country banking activity: 1. AUTHORISATION PROCEDURES Specific request to the competent authority including report on the kind of bank activities to be carried out and the bank’s structure chart. Authorisation: o Must be denied or granted within 12 months, at latest, from the request’s receipt o Can be revoked in the cases provided by the Directive. E.g. loss of the requirements Upon implementation of the banking union, authorization process must be supervised by European Central Bank.
QUALIFIED SHAREHOLDING Specific authorisation procedure for direct/indirect acquisition of “qualified” shareholding: o More than 5% o Increase of the existing qualified shareholding in a bank up to 10%, 15%, 20%, 33%, 50% o Control of the bank regardless of the shareholding Assessment of reputation and experience and financial standing of the acquiring/increasing entity. Upon implementation of the banking union, European Central Bank must assess notifications relating to transfer of qualified shareholding.
REQUIREMENTS
Financial standing: o Specific own funds o Initial share capital: not lower than € 6.3 mln
Program of activity
Directors compliance with honorability and professional requirements
Sound internal corporate, administrative and counting governance and clear liability structure
Identification of, and numbers of shares owned by, direct and indirect shareholders (individuals and entities) 2. SUPERVISION  SSM (SINGLE SUPERVISORY MECHANISM) Supervision on: o financial standing (e.g. own funds, solvency ratios, relevant loan (grandi fidi); o sound internal corporate, administrative and counting governance. Prudential Supervision (referred to “less significant credit institutions” 1 ): 1 Significant/Less Significant Credit Institutions:
Size 3 1. ECB = European Central Bank Main powers: a. Exclusive Competence 1. Authorisation/withdraw authorisation 2. Assess acquisition/disposal of qualifying holdings in credit institutions b. Competence referred to “significant credit institutions” 1. Supervise establishment of branch or cross border activities 2. Ensure compliance of potential requirements (exposure limits, reporting and disclosure of information) 3. Ensure compliance of government requirements (risk management, capital adequacy) 4. Stress tests 2. National / Local Competent Authorities Main powers: 1. Supervise establishment of branch or cross border activities 2. Ensure compliance of potential requirements (exposure limits, reporting and disclosure of information) 3. Ensure compliance of government requirements (risk management, capital adequacy) 4. Stress tests BANKING ACTIVITY IN EUROPEAN HOST COUNTRIES Leading Principles: o Freedom of establishment o Free service performance o Mutual acknowledgment Banking activity in host countries, after precautionary supervision and control by home country authorities, can be carried out by banks authorised in their home country: 1. DIRECTLY Notice by the bank to the competent home country authority indicating the kind of bank activities. The home country authority must deliver such notice to the competent host country authority within 1 month from the notification. o Total asset value exceeds 30 billion Euro o Ratio of assets exceeds 20% of Member State but not below 5 billion Euro
Importance for the economy of the Union
Significance of cross border activities. 4 2. THROUGH BRANCHES Notice by the bank to the competent home country authority indicating: o The European country to host the branch o Bank activities’ plan o The branch’s domicile in the host country and names of the branch’s managers. Home country authority must deliver notice to the competence host country authority within 3 months from the notification (save for specified reasons). The branch can start the activity after 2 months from the notification made by the home country authority to the host country authority or earlier, upon receipt of the relevant communication by the host country authority. RELATIONSHIP WITH EXTRA EUROPEAN COUNTRIES The competent authority communicates to the Commission and the European Banking Committee the authorisations granted to branches of banks with registered office in extra European countries. Branches of banks with registered office in extra European countries cannot benefit of a more favourable regime than branches of banks with registered office in European countries. Upon implementation of the banking union, European Central Bank will manage directly applications submitted by participating Member State relating to establishment of a branch or provision of cross-border services in a non-participating Member State. 3  STRUCTURE Pre-contractual phase: • The term sheet • The commitment letter • Nature of term sheets/commitment letter o Binding/Non binding o Pre-contractual arrangements or preliminary agreements a) Inferring an agreement and agreements to agree If bank discussed with potential borrower
there is a possibility of liability Law of agencies determines whether the bank’s officials had actual or apparent authority to bind the lender in purporting to approve a loan Circumstances: - Moneys may be paid over before a loan agreement is finalized: contract can be inferred from the conduct of the parties. Or there is a common understanding that the payments are contingent upon the conclusion of a loan agreement: they are immediately repayable if negotiations are to no avail. Contract may have retrospective effect - Loan document is signed but requires further agreement on particular matters: English law does not countenance agreements to agree, to negotiate, or to negotiate in good faith
assumption that negotiations are inherently adversarial but in fact there may be elements of co-operation
overlooks reality that business people are sometimes comfortable with an agreement to agree or to negotiate and that commercial contracting these days is frequently a process, necessarily completed in stages. b) Varying the agreement Maybe: more than one agreement. Ex: - Lending agreement is accompanied by a side letter, which can constitute a variation of the main agreement of a collateral contract, with terms different from those of the agreement, or that evidence a likely course of conduct by a bank, rather than one to which it is contractually bound. - There is a later, seemingly inconsistent, provision
court may be able to reconcile the provisions. In the case of an incompatibility, it may find that the original loan agreement has been varied. c) Commitment letters Product of negotiations
document which sets out the nature of the loan and terms to which it will be subject. 4 Terms to describe this document: offer documents, heads of agreement, commitment letters Become important when a borrower refuses to pay, or bank refuses to pay a fee or when one of the parties refuses to complete the more formal documentation Failure to reach agreement does not invalidate the earlier agreement. There are different types of commitment letter: legal character depends on nature.  Commitment letter subject to contract: will automatically be regarded as not being binding. Exceptional circumstances: parties agree to convert such a letter into a contract  Commitment letter subject to documentation: bank determines whether the final documentation is satisfactory (subjective test), not some reasonable person (objective test). So long as the bank acts honestly, the commitment letter is not uncertain. Even if the test is objective will not necessarily make the matter too indefinite for the court. The test is whether the commitment letter was intended to be binding, or whether a binding letter is consistent with the reasonable expectations of the parties. In determining this issue: - How the document is described is some indication - Whether the commitment letter contains a reasonably complete statement of the proposed terms is a good indication, but not determinative. - Reference may be made to the steps preceding, and subsequent to, the completion of the commitment letter. Just because a commitment letter is not binding does not mean that the expenses and fees mentioned in it are not payable.  PROVISIONS 1. “Financial Provisions” - Commitment/availability/drawn down - Purpose - Repayment and pre-payment (interest, fees, and principal amount) Interest: element of bank’s profit on a loan; Payment for the use of money or compensation. Interest is not payable for moneys not drawn down or repaid. In addition, bank is entitled to a front-end fee, a commitment fee and an indemnity for any costs and expenses and enforcing the agreement. Much commercial lending is at a variable rate of interest. A variable rate of interest will be at specified margin over the bank’s base (or prime) rate or over a market rate. The choice of base (or prime) rate require elaboration in the agreement of how it is to be calculated. A market disaster clause can be inserted in event that is not possible to obtain quotation on the interbank market
because there is no right in English law to interest in the absence of a source for determining it. Market- 5 disaster clause may obligate the parties to use their best endeavors to negotiate a new mechanism, failing which the bank has the discretion to set the rate. The borrower will be able to choose the period for which particular floating rate will obtain. 2. “Contractual Provisions” 1. CONDITION PRECEDENTS (condizioni sospensive) - disbursement Facility agreement may contain conditions precedent
certain documents produced to the bank. Depending on the bargaining power of the parties, the bank may have a wide discretion to determine which documents must be produced as conditions precedent. Also be a condition precedent: representations and warranties are correct and no default is outstanding. Legal issues arise: • Whether they are conditions precedent to the agreement coming into effect, or conditions precedent to the bank’s performance under the facility. There is a binding contract as soon as the parties agree the terms but that the bank need not make the funds available. Advantage: the bank can claim the fees and expenses set out in the agreement. If the agreement doesn’t claim the fees, English law doesn’t recognize an action for reliance losses in anticipation of a contract. Bank can claim a quantum meruit for service performed. Even if the bank is successful with the latter, this will not necessarily be equivalent in amount to the fees and expenses set out in the agreement. • Whether the bank need co-operate so that the conditions precedent can be satisfied. Some conditions precedent will turn on the actions of third parties, and satisfying many conditions precedent is only in the hand of the borrower. Occasionally, the borrower is unable to fulfill a condition precedent, if that condition precedent can be construed as an agreement to agree, English court will not oblige the bank to act. If the condition precedent can be construed as imposing on the bank a duty to act, the bank will not only be liable in damages but may also be precluded from claiming that the condition has not been satisfied. 2. REPRESENTATIONS AND WARRANTIES - status, no conflict, no litigation In facility agreement there is an overlap between conditions precedent, representation and warranties. They concern: the borrower’s status, lawfulness of its entering the agreement, absence of any default. The borrower will make representations in the agreement on other matters, and that there are no legal proceedings in the pipeline which may have a material adverse effect on it. Where there is a syndicate of banks, there will also be representations about the accuracy of the information memorandum sent to potential members. Advantage common law: misstatement, omission, or failure to update will constitute default even in the absence of any reliance on the part of the syndicate bank. Representations and warranties perform an investigative role. Representations relate to the borrower as well as to its parent guarantor and to subsidiaries. Borrowers need to consider whether they can realistically make representations about other companies in the group. The agreement deem the representation to be repeated on each draw-down. 8 Security is an interest in property which secures the performance of an obligation (payment). The bank has right against the property
advantage if the borrower becomes insolvent. Personal security: a third party agrees to guarantee another’s debts, with the aim to support a borrower’s undertaking to repay. Security over personal property Security over real property: mortgages. Are almost universal
land is treated as the most valuable property to be proffered as security
equity implications. Rules governing mortgages over land are well established (extend to personal property). Security law
issues of public policy: 1. Implication for financial stability: people engaged in wholesale financial markets are enabled to manage counterparty credit and liquidity risk. 2. Role of security in inducing banks to lend in situations when they might chose to utilize their funds in other ways. In absence of security: commercial entity in financial difficulty may pay other obligation first rather than bank. Security lowers the cost of credit
in event of uncertain business’ solvency, security fosters rescue efforts: the lender feels secure and allows time; and with the lender in the driving seat, there is the increasing likelihood to carrying on or sold the business. Strong security has the opposite effect: bank is tempted to act hastily and recoup themselves too readily by selling assets. Favorable security law = advantage to lender, to the detriment (a discapito) of other interest in society
this is often overlooked because security law is treated in isolation. English law: favorable to those which take security
in event of insolvency, the sale of whole of the assets can realize the credit, to the detriment of unsecured creditors. Unsecured creditors voluntary accept the risk and demand a premium (higher price). Inequality of bargaining power when consumers give banks security
statute provide way to protecting ordinary customers. Consumer Credit Act imposes: security given in relation to a regulated agreement must be in writing; a mortgage or charge over personal property must be embodied in a regulated agreement and a copy supplied to the debtor. The weight of academic writing on security has been long criticized (formalism, impenetrability for non-layers)
moves to simplify personal-property security law culminated in Article 9 of the Uniform Commercial Code (UCC – USA), which requires: - Rational approach to defining security interests - Substance over form - Common set of rules for all security - Comprehensive system of registration of security interests. Article 9 has also proved a beacon for law reforms elsewhere: Canadian and New Zealand jurisdictions have adopt it. 9 On the contrary, Article 9 was rejected by English banks and City of London layers because considered unnecessary and costly. European Bank for Reconstruction and Development published a Model Law on Secured Transactions less elaborated than Article 9. According to the terminology of security: English terminology doesn’t clearly distinguish between the security agreement which creates the security and the property securing the obligation. The latter “property securing the obligation”, is called “collateral” by Article 9. (term not used by English lawyers). TYPE OF SECURITIES Article 9 adopt a unique framework for security over personal property. All other systems (common and civil law) have diverse security types, governed by its own rules: • Common law: flexible in what security can be created, what can cover, how it can be enforced. • Civil law: some countries sympathetic to new forms of security, other hostile. Objection: A debtor can give the impression of wealth, even if its assets are subject to security. Registration system for security can obviate this objection. Banks use different techniques to take security over personal property : - PLEDGE (movable assets/shares) = fundamental method of taking security in all jurisdictions
possessory security. English law enables the pledge to sell the collateral on default. Prerequisite to pledge is a transfer possession
has a limited scope. - MORTGAGE (real estate assets)
taken over intangibles (account receivables and contracts). o Legal mortgage: absolute assignment (claim) of ownership to the mortgagee bank, coupled with the right to have the property reassigned on repayment. If power of sale doesn’t arise, the agreement will confer it on the mortgagee. Legal mortgages can cover future property, but requires to be novus actus on the part of the mortgagor on obtaining the property contemplated by the contract and designed to implement the promise to secure it. o Equitable mortgage: constituted by an agreement for value to secure present and future property. On acquisition of the asset, the mortgage takes effect as from the date of the agreement. Involves a transfer of the collateral. Also mortgages have the prerequisite of transfer possession, but chattel mortgages never took in England because of obstacles to registering under the bills-of-sale legislation. Other forms of title finance have been used: hire purchase or leasing. - CHARGE (business) = agreement to appropriate the collateral in the event of default, to the satisfaction of the chargee’s claim.
taken over specific property! 10 1. PLEDGING GOODS AND DOCUMENTS Banks use pledge in financing dealers’ stock-in-trade and international trade. To obtain the possession of the collateral, the bank doesn’t have to taking actual delivery; a constructive delivery is sufficient (ex. Field warehousing). The goods are set aside in a separate part of the borrower’s premises, movement of it controlled by the borrower’s staff, temporally employed by an independent field-warehouse company acting for the bank. When goods are in custody of the third party (holds for a borrower), a pledge can be effected by the borrower ordering the third party to hold them for the bank. To recognize constructive possession, English law permits the pledge of documents, which by delivery can pass control of goods or an interest in contractual obligations. Their delivery is constructive delivery of the goods they represent
banks finance importers by taking security over bills of landing
releasing them under a trust letter, so the goods can be disposed of. 2. RECEIVABLES FINANCING BY WAY OF SECURITY Are the debts earned in conducting business. Banks are major participants in receivables financing. We have 2 methods: - Receivables financing is through the outright sale of a company’s receivables. The sale will be at a discount on the face value of the receivables. The company obtains immediate payment and indemnifies the bank against any losses. - Receivables financing is against the security of the receivables. Disadvantage: the security must be registered as a charge over the company’s book debts. Legal distinction between: outright sale of receivables and bank providing finance on the security of receivables. The latter: bank has right to payment and company right to redeem. Receivable financing by way of security can involve a pledge, charge or mortgage: • Pledge is impractical because it can only be used over a limited range of documentary intangibles. • A charge over receivables is a right to be paid out of the process; there is no transfer of the receivables and the bank cannot take action against the debtors. • Mortgage in receivables financing involves assignment: legal assignment or equitable assignment. Both receivables and proceeds can be assigned. No objection to assigning receivables to be generated in the future. The assignment will give the bank the power to enforce any of the receivables. Any moneys received by the company on payment of the receivables may be held on trust for the bank. In the agreement the company will make certain representations and warranties as to the nature of the debts being assigned. 3. SECURITY OVER CONTRACTS – PROJECT FINANCE Banks take security over the contracts a company has entered. Example: project finance. Security is defensive, especially when the project is in an emerging economy. The government 13 o Lex situs: influence to proprietary effects of a transfer of property, including that by way of security. Security and negotiable instruments should be determined by the lex situs. Approaches to lex situs:  Lex situs of securities is the place of incorporation of the issuer  Lex situs is the place where the security is situated. For registered securities, is the place where the register is kept. For negotiable securities, is the place where the pieces of paper representing the securities are. For immobilized securities (not registered) is the place where the securities are situated. For dematerialized securities, the concept of lex situs is artificial when applied to intangibles
applies the law of the place of the depository/settlement system. When legislation in jurisdiction provides that the applicable law is the law of the place of the relevant depository/settlement system maintaining the securities account
attract the lex situs rule
solution of the conflict of laws. o Lex domicilii: a foreign company can contract under English law to give floating charge over its English assets. The company has the power to grant a mortgage under the law of its place of incorporation, but doesn’t recognize the floating charge. Floating charge given by an English company may not be recognized by the law of a foreign jurisdiction
security should be taken in accordance with that law. The question of who can act for a company is regarded by legal systems as lex domicilii. o As for assignment
matters concerning are determined according to the proper law of the contract
determines how notice of the assignment is to be given to the other party/debtor, the effect of the notice. Mutual rights and obligations are determined by the proper law of the assignment 1 Syndication and Securitization 1. Syndication OBJECT Transfer of:
Contract (right/obligation)
Right
Claims SCOPE
Risk reduction
Profit from arranging activity REFERRED TO
Loan sales
Legal techniques o NOVATION (UK Law) Object : Substitution of original agreement with new agreement Transferability : Transferability of rights and obligations Impact on existing securities : Creation of a new security package o ASSIGNMENT Object : Contract or claims Transferability : Partial transfer of contract arguable in various jurisdictions (e.g. Italy) Impact on existing securities : valid upon the assignment, repetition of formalities for enforceability Disclosure : Disclosed / Undisclosed Tax aspects : To be assessed. o SUB PARTICIPATION Object : Transfer of risk Disclosure : NO Funded (cash reserve equal to the assigned commitment) / Unfunded (first demand guarantee for the borrower’s reimbursement obligations for a guaranteed amount equal to the assigned commitment). 2 2. Securitization OBJECT : Repackaging loans into securities SCOPE : Simplified transferability to investors BUYER
SPV = Special Purpose Vehicle
Investors through the issued Notes ISSUES
OBJECT : Transfer of existing claims
NOTIFICATION : Simplified formalities
SECURITY PACKAGE : Simplified formalities HOW DOES IT WORK?
Limited recourse obligations of the issuer vis à vis Noteholders
Segregation of the assets (no third party creditors enforceability)
Closed and self-standing structure
Favourable tax regime STRUCTURE 3 MARKET PLAYERS 1. ISSUERS 2. INVESTORS
different categories : professional/qualified vs. retail 3. INTERMEDIARIES = regulated professionals that provide to investors services directly or indirectly connected with investments in financial products. This means they purchase and sell shares and other securities on behalf of investors acting in the middle between offer and demand. All intermediaries’ activities are highly regulated and subject to authorizations. Why is the role of intermediaries important? Some examples: 1. Investors do NOT have time or resources to understand and search all market opportunities (advice) 2. Intermediaries promote offerings, which, without them, would have little chances of success (e.g. IPOs) 3. They create efficiencies in collective wealth management. Types of intermediaries: 1. Institutional investors: In Italy: SGR (create and manage investment funds) ; SICAV (Soc. 'Investimento a capitale variabile = stock company with the sole purpose of collective investment of the invested capital); pension and insurance funds (collective investment entities which invest in securities – OICVM). In the UK: asset management companies. 2. Investment firms : provide investment services to customers against payment of a fee. PURPOSES OF FINANCIAL REGULATIONS  Transparency  Accuracy and fairness  Stability to safeguard investors and the public in the interest of the good functioning of the market  Efficiency  Liquidity  Standards : customarily, the legal instrument behind the security is already governed by law and is already existing, but often financial market regulations derogate general principles and are subject to public control.  The investor is rarely in a position to fully comprehend the value of the security. Similarly the contract – per se a difficult document – which usually includes a transfer of money as consideration for the expectation of a return, needs the action of an intermediary. 4  Ordinary legal instruments are insufficient: contracts are not drafted ad hoc, often are just copy pasted, therefore good faith and accuracy are difficult to be implemented without a further public control SOLUTIONS 1. Maximum level of transparency and effective disclosure obligations. Creating rules (often also criminal) for market players to prevent: o conflicts of interest; o market abuses; o insider trading. 2. Checks and controls on market entrance and credit requirements for market players. REQUIREMENTS FOR PLAYERS ACTING IN REGULATED MARKETS  Personal requirements of administrative bodies
professionalism, honorability, absence of criminal charges  Economic requirements
patrimonial ratios, minimum capitalization thresholds, minimum floating capital  Transparency requirements
disclosure of information on relevant transactions, financial statements and balance sheets SUPERVISION AND CONTROLS 1. Prior to market access
regulators set criteria and to market access, regulators set criteria and requirements to be met by market players to access regulated markets 2. Simultaneous
ad hoc agencies are required to monitor the implementation of the above conditions. Players are also under surveillance by supervising authorities in the performance of their daily operations 3. Continuous
supervising authorities are entitled to carry out controls and inspections on regulated players at all times. 1 “IPOs and Equity Offerings” Slides: Security Offerings – Tender Offer CHAPTER 1 The Decision to Go Public In an offer of :
EQUITY (e.g. shares)  shares can be offered to the market through: capital increase or sale of existing shareholders
DEBT (e.g. bonds)  a corporation or a public body (government) can offer for subscription to the market the securities representing its debt. However, other securities may be object of an offering (e.g. warrants, derivatives). WHAT IS AN IPO? IPO (Initial Public Offering) = The offering through which shares of a company are placed to the market and listed. It marks the point when a company ceases to be privately held and becomes publicly traded. So, an IPO is the first sale of a company’s shares to the public and the listing of the shares on a stock exchange. In the UK, IPOs are often referred to as flotations or solicitations. When companies need more cash than provided by an IPO, they return to the stock market in secondary offerings or right issues. Offerings of shares are typically made through financial advisors, who have the responsibility to: 1. Place the shares with individual and institutional investors 2. Underwrite the non-allocated shares The issuer, its management and its stakeholders are subject to specific rules of the financial market. Public companies are subject to: 1. Public rules and not only private (=bylaws) 2. Controlling powers of public authorities PARTICIPANTS WITH COMPLEMENTARY OBJECTIVES 1. COMPANY
Maximize proceeds  high prices that will go even higher in the aftermarket and that minimize the dilution experienced by existing shareholders.
Build broad and stable ownership base  high valuation
Raise its profile 4 4. Ancillary benefits: flotation process forces a company’s management to formulate a clear business strategy for the first time  beneficial to the future success of the business
DISADVANTAGES 1. Increased disclosure: companies are required by stock exchanges, securities commissions and regulators to disclose information on a regular basis. 2. Costs of IPO : IPOs are expensive  direct costs (commissions, lawyers and accountants bills) + ancillary costs (corporate advertisings,…) + indirect costs of underpricing. 3. Separation of ownership and control 4. Potential loss of control 5. Perception of short-termism: investors and analysts focus exclusively on the current reporting period. 6. Meeting investor expectations REQUIREMENTS FOR LISTING 1. FORMAL REQUIREMENTS
Financial statements for recent years
Compliance of by-laws with free transferability principle and governance of listed companies
Offering document prepared in accordance with standards and regulations
Certain level of capitalization
Certain minimum level of floating capital (usually 25%) 2. SUBSTANTIAL REQUIREMENTS
Clear strategic vision
Ability to generate value = adequate return on shareholders’ investment
Consolidated competitive position
Excellent management
Efficient and effective management system
Communication and transparency toward external stakeholders
Corporate management in line with international best practice HOW TO GET LISTED An IPO has 3 fundamental characteristics: 1. Amount of global and floating offer 2. Capital increase VS Sale of existing shares 3. Public offering (offer to everyone) and Professional sale (offer made to qualified investors) 5 CHAPTER 2 The Players Large number of players, each having a specific role. Leading participant:  MERCHANT BANK or INVESTMENT BANK
In international offerings: lead bank = lead manager / bookrunner / global coordinator.
In UK: sponsor. It develops the structure of the offering, helps to appoint other participants, coordinates all aspects of the issue, leads the drafting of documentation, organizes the due diligence and verification process. In UK offerings, sponsor is also the primary underwriter 1 . Within an investment bank, the coordinating role is taken by a member of the Corporate Finance or Equity Capital Markets (ECM) group. ECM professionals specialize in the flotation of companies and their subsequent equity offerings. In most banks the ECM takes over the “project management” of the IPO, coordinating the input of the bank’s specialist departments and external advisors. Within the investment bank: The Syndicate Desk is where interests of the issuer and those of the investor must be balanced. HOW THE LEAD INVESTMENT BANK IS SELECTED Issuer or selling shareholders consider those criteria: 1. Industry experience  bank : substantial experience with IPOs and good familiarity with company’s business 2. Experienced analyst who must describe how the IPO should be positioned in order to appeal to the broadest base of investors 3. Individual bankers  company should feel comfortable with the ones assigned to the deal 4. Reputation and attention  well-known investment banks may not give smaller companies as much attention as less known ones, but the latter may not be able to provide the resources that a better known underwriter can. 1 Underwriters = Members of the offering syndicate. Interest of the issuer – represented by corporate financers SYNDACATE DESK Interest of the investor – represented by sales force 6 5. Distribution strength  appropriate international, institutional, retailer distr. capabilities 6. Aftermarket support  the underwriter should have a strong aftermarket price performance for the stock of companies it has recently taken public 7. Conflicts of interest COMMERCIAL BANKS VS INVESTMENT BANKS During the ‘90s, many commercial banks made significant investment in building up their investment banking capabilities. Their growth occurred by internal investment or acquisition. The banks wanted to capture high margin business to supplement the traditional low margin lending business. ≠ By the turn of the century, commercial banks were linking their willingness to provide debt finance with getting a piece of the high margin business. THE SYNDICATE
International / American practice The lead bank will assemble a syndicate of banks and brokers to assist in the selling of the offering. Syndicate members are usually selected on the basis of their ability to distribute shares to investors and to provide company research following the offering. The number of syndicate members will depend on: o Size of the offering. o Structure of the offering o Existing banking relationships the issuer may have. Aims of syndicate: o For regulatory capital requirements and risk-sharing purposes o To facilitate and broaden the distribution o To encourage research support and market making following the offering o Reciprocity
Traditional UK system The company hires one merchant bank to act as a sponsor of the offering and 2 it is a listing on the London Stock Exchange. The merchant bank deals with the UK Listing Authority (UKLA) = main regulator on behalf of the company. If the company is seeking a quote in the AIM (=Britain’s Alternative Investment Market), it must appoint a “Nominated Advisor” and ensure that there are 2 brokers willing to make a market in its shares. OTHER ADVISORS AND INTERESTED PARTIES 1. SOLICITORS /LAWYERS 9 Disadvantages international offerings: cost and complexity ; increased disclosure requirements ; flowback 3 3. REGULATION AND DOCUMENTATION Main documents to be drafted are the listing particulars (Europe) or registration statement (USA). They both contain a PROSPECTUS = document that is distributed to potential investors and that includes all the financial and non-financial information that potential investors require in order to make an investment decision. It must be both a selling document and a liability document (=meeting the disclosure requirements of the local regulator). While preparing the prospectus, investment bankers and their lawyers conduct a due diligence investigation (commercial, financial, legal status and condition of the issuer) which mitigates the potential liability of the issuer’s officers and directors. Supporting documentation: 1. Industrial plan  requirements: financial sustainability, coherence, trustworthiness 2. Evaluation document 4. MARKETING, PRICING AND ALLOCATION I. MARKETING ( 4 WEEKS – 4 MONTHS) : differing degrees of restrictions are placed on marketing activities of banks involved in the offering by local regulators. The US SEC is the most harsh, stating that only written marketing materials that can be used are the preliminary prospectus and prospectus itself. a. Pre-marketing period (grey market): companies increase or start corporate advertising b. Formal marketing period : documentation, telephone calls and visits by the syndicate’s research analysts to potential investors precede a “roadshow” by the company where it gets a chance to tell its story and investors size up the senior management. II. PRICE AND ALLOCATION : the company and its advisors set the PRICE of the new issue  approaches (explained later) : Book-building, Fixed Price, Auction/Tender Offer. When offers are oversubscribed, ALLOCATIONS of shares to potential investors can either be non-discretionary (pro rata basis or by a lot) or discretionary (issuer and its bankers have considerable latitude in determining which investors receive shares). 5. AFTERMARKET = Period immediately after pricing and listing of the shares. It’s vital : if a company does not get off to a good start, its shares may languish on the stock exchange and a company that requires further equity financing may find it difficult. Most US and international offerings undertake to stabilize the share price in the immediate aftermarket, using the GREENSHOE or OVERALLOTMENT OPTION : if demand is weak and the share price drops below the offer 3 Flowback = shares placed offshore are not held by long-term international investors, but return (=flowback) to the domestic market. 10 price, the lead manager can stop, or slow, the price decline by buying shares in the market. Existing shareholders in IPO companies are almost subject to lockup period : the length of time during which they are not permitted to sell any shares. Typically : 6 months. PRICE SETTING MECHANISMS 1. AUCTION – TENDER OFFER Tender offer = an offer to purchase some or all of shareholders’ shares in a corporation. The price is usually at a premium to the market price. Rationale : equilibrium between the principles that listed companies are contendable and the equality of treatment of all shareholders involved by the offering (they’re all at the same conditions). Principle of irrevocability. Least common form of price setting. Some auctions set a minimum price and invite investors to bid for shares at or above it. The final offering price is the CLEARING PRICE, at which all shares are allocated. If there’s insufficient demand at the minimum price, the auction can start again with a lower minimum price or the issuer can decide to cancel or postpone the offering. In other auctions, investors can produce multiple bids at different prices, creating their own demand curve. Why regulating tender offers? a. Limitations and specific rules on the freedom of single subject to acquire control of a listed companies b. Guarantees and safeguards for minority as well as transparency and stability of corporate control Types
Voluntary  initiative of promoting the offer comes exclusively from the offeror.
Mandatory  Anyone who holds a participation above threshold in a listed company has the obligation to promote tender offer on all outstanding shares of the same category at a price determined by the applicable law.  to ensure the equality treatment of all shareholders. BEST PRICE RULE : the obligation to align the price of the offer to the highest paid price by the offeror expands also to the 6 months following the end of the offer. Types : o GLOBAL TENDER OFFER : any person who, as a result of purchases, comes to own a shareholding exceeding the 30% threshold in a listed company, shall make (within 20 days) a public offer to all holders of shares issued by the company and concerning all the ordinary shares in their possession. o INCREMENTAL TENDER OFFER : the subject who already owns a participation between 30% - 50% in a listed company has the obligation to promote a 11 tender offer on all shares issued by the company if it carries out purchases exceeding the threshold of 5% in any period of 12 months. o DOWNSTREAM TENDER OFFER : the subject who : 1. Purchase a participation exceeding the threshold of 30% in a listed company A or the control of a non-listed company A 2. OR Purchase the holding by the company of a participation exceeding the threshold of 30% in another listed company B 3. OR Purchase the prevalence of the participation in B among the elements that constitute the assets of A  has the obligation to promote a tender offer also on company B o RESIDUAL TENDER OFFER Defensive techniques : placed by the company if the offer is considered hostile. Types: 1. Preventive : shark repellents and golden parachutes  anticipate the launch of a tender offer and may consist of: 1. Statutory provisions of qualified quorum for certain transactions or for the appointment and directors 2. Shareholders’ decisions regarding the disposal of valuable assets in case of tender offer 3. Recognition of relevant benefit to managers and advisers following a tender offer … SELL – OUT RIGHT AND SQUEEZE – OUT RIGHT 1. SELL – OUT RIGHT Any subject who, as a result of purchases or tender offer, comes to own a shareholding exceeding 90% in a listed company and does not restore a free float in the following 90 days has the obligation to buy the remaining portion of shares from anyone who requests so + the offeror who holds, as result of a Global tender offer, a participation at least of 95% in a listed company, has the obligation to buy the remaining shares from anyone who requests so. 2. SQUEEZE – OUT RIGHT The offeror who comes to hold, as result of a Global tender offer, a participation at least of 95% in a listed company and has declared in the offer document the intention to make use of the Squeeze - out right has the right to buy the outstanding shares within 3 months from the deadline for the offer’s acceptance. 1 Restructuring Overview Restructuring Process Overview REQUIREMENTS • Economic crisis of the debtor: structural distress of the debtor - likely pre-insolvency phase; • Insolvency of the debtor: structural incapacity of the debtor to fulfill his payment obligations. SCOPE Main scope
To make available to the debtor in a state of crisis/insolvent and his creditors a procedure to avoid a declaration of bankruptcy. Purposes: 1. Reorganization: mutual agreement on a plan to rescue the debtor’s business through the restructuring/reorganization of existing indebtedness; 2. Liquidation: liquidate the debtor’s assets in order to satisfy the creditors. CHARACTERISTICS Pending the procedure, no individual enforcement and/or precautionary action from the creditors (automatic staying). The payments/actions carried out pursuant to a restructuring plan are not subject to the effects of subsequent bankruptcy, if any. The debtor (directors) have no or at least limited civil/criminal liabilities for actions carried out pursuant to a restructuring plan in case of subsequent bankruptcy. OUTCOMES  Positive
settlement of the existing indebtedness and/or rescue of the business.  Negative
in case of no agreement on a restructuring plan, risk for the debtor to be declared bankrupt. PROCEDURE  Court supervised procedure: o Procedural/judicial model 2 o Supervision of the court  Out-of-court procedure: o Contractual and private model o Limited supervision of the court. Petition usually filed voluntarily by the debtor, but sometimes the creditors may file the petition or indirectly force the debtor to do it. Restructuring plan to be prepared by the debtor. Approval of the creditors or class of creditors based on unanimity or simple/qualified majority. EFFECTS  Automatic stay: pending the procedure, staying of all enforcement and/or precautionary actions (including continuation of the pending ones).  Control: the business remains totally under the debtor’s control, or is subject to supervision of court/creditors’ committee.  Pending contracts: debtor’s faculty to continue pending agreements and/or assume new agreements (with or without limitations). NEW FINANCE New finance usually necessary for the interim period required for negotiation/approval of the restructuring plan’s or the execution of an approved restructuring plan. New finance to be granted by the existing creditors, new creditors and/or shareholders. Protection (e.g., priority) to the creditors of new finance in case of bankruptcy, if any, of the debtor occurring after the restructuring. Corporate Perspective CRISIS OF A COMPANY PRELIMINARY EFFECTS  Delay of payments to be made to banks and suppliers  Potential delays of payments to be received  Increase of debt  Cash flow stress PAYMENTS (DUE) DELAYS  Suppliers: o Risk of breach of contracts o Risk of suspension of delivery of further goods/services o Potential termination 3  Bank: o Risk of breach of contracts (short term) o Risk of termination (long term) o Reduced/limited availability of new funding PAYMENTS (TO BE RECEIVED) DELAYS  Cash shortfall  Financial negative carry  Accounting loss in case of client bankruptcy DEBT 1. Increase of Debt, mainly short term:  Trade receivables financing  Bank account overdraft 2. Increase of finance costs short term (unsecured) is more expensive (higher interests rate fees) 3. New long term debt  Secured (to the extent possible) SHAREHOLDERS REMEDIES 1. Capital increase 2. Shareholders loans CONTRACTS  Contractual terms and condition analysis  Analysis of legal framework in case no written contract has been executed  Enforcement of rights / legal actions  Re-negotiations of contractual terms DIRECTORS Potential liabilities:  No prompt reaction to unfulfilled obligations by third parties  Excess of debt leverage and security granted  Company’s crisis not being limited but continuing 3 2. Off-balance-sheet debt treatment: a subsidiary controlled more than 50% by the parent company is consolidated on a line by line basis with the parent. Otherwise, the equity method of accounting is used whereby the investment in the subsidiary is shown as a one line entry. In this case debt is not reported on the parent company’s financial statements. 3. Leveraged debt: ability to finance a project using highly leveraged debt, without a dilution of existing equity. 4. Avoidance of restrictive covenants in other transactions: since the project financed is separate and distinct from other operations and projects of the sponsor, restrictive covenants (such as debt coverage ratios) can be avoided. 5. Favorable financing terms: more attractive interest rates and credit enhancement 6. Internal capital commitment policies: the rate of return goals of the project sponsor is improved with a PF which permits highly leveraged debt financing with a minimum of equity commitment 7. Political risk diversification: diversify the project sponsor’s global investments and effects of political risks beyond any independent project 8. Risk sharing: spreading the risk over all project participants
risk diversification 9. Collateral limited to project assets: the only collateral that must be pledge to the lenders 10. Lenders are more likely to participate in a workout than foreclose 11. Matching specific assets with liabilities: by segregating the assets of each individual project and matching them to the debt undertaken to finance them 12. Expanded credit opportunities: lower cost of borrowing based on the higher credit rating of the output purchaser.  DISADVANTAGES 1. Complexity of risk allocation: if a project is to be successful, risks must be allocated in an economically efficient manner among the project participants. 2. Increased lender risk: many project financing risks cannot be effectively allocated or the resultant credit risk enhanced. This high risk scenario
in higher fees charged by lenders 3. Higher interest rates and fees: than on direct loans 4. Lender supervision: results in higher costs 5. Lender reporting requirements – financial reporting, project operating info, reports on force majeure events, notices of default 6. Increased insurance coverage 7. Encourages potentially unacceptable risk taking 4 INTERNATIONAL PROJECT FINANCE = financing technique of bringing together development, construction, operation, financing and investment capabilities from throughout the world to develop a project in a particular country. Examples of facilities developed with project finance: Energy generation, pipelines/storage facilities/refineries development, mining, toll roads, waste disposal facilities, telecommunications.. Other financing alternatives to pf: government funding (loans, grants and guarantees), government investment, third party project participant financing, non-project finance structures, capital market financing, securitization of project revenue flows. DEVELOPING COUNTRIES The stability and predictability favored in project financings make structuring PF transactions difficult and expensive in developing countries of the world because of the complexity of risk allocation among multiple parties and the higher returns required to compensate parties for the risk involved. + Political security is uncertain
higher costs for insurance and equity/debt rates. THE LAW OF PROJECT FINANCE – Sources of PF Law and Standards 4 bodies of law need to be considered by a US lawyer: 1. US laws that regulate international transaction or disputes 2. Laws of foreign countries
local law must be examined to determine whether a form of organization is prescribed, whether a foreign entity can own real property in the host country; requirements for local investor participation…. 3. Public international law 4. Conflict of law rules that determine which laws courts or arbitral tribunals will apply to a dispute. + International Chamber of Commerce may need to be consulted if incorporated into commercial agreements used in the project. Lawyers in every country involved in a PF transaction must consider comparable laws in their countries. 3 general sources: 1. PF legislation and regulation developed by the host government 2. Standard contractual and financing requirements developed by the private sector 3. PF standards established by multilateral institutions
they can assist in reducing legal and political risks and thereby generate standards for financing. E.g.: UNCITRAL (United Nations Commission on International Trade Law) was chartered by the UN to remove barriers to trade among countries with diverse legal systems. PROJECT CANCELLATION Infrastructure projects in developing countries have been very successful in getting to financial closure and operation. Reasons : lack of consumer demand, consumer price sensitivity, corruption,… 5 CHAPTER 2 Project Finance Risks Risk = uncertainty in regard to cost, loss or damage. An important part of the successful closing of a project financing is the risk structuring process
risks are identified, analyzed, quantified, mitigated and allocated so that no individual risk threatens the development, construction or operation of the project in such a way that the process is unable to generate sufficient revenues to repay the project debt, pay operating expenses and provide an attractive equity return to investors.  CONTRACTING-OUT the process = allocating risks among parties in contract form. Risks in transnational PF may be classified in: 1. TRANSNATIONAL RISK 2. COMMERCIAL RISK + Residual risk : SPONSOR’S ECONOMIC RISK for the economic return expected from the operation. RISK MATRIX = convenient, organized tool used by PF participants for identifying the risk and understanding the allocation and mitigation techniques used. PARTICIPANTS Risk should be allocated to the party that is best able to control the risk or influence its outcome. In turn, he will demand compensation that is consistent with the magnitude of the risk assumed. SO the allocation of risks is generally determined on the basis of control over the risk, reward associated with that control, the role in the project and creditworthiness. TYPE OF RISK TAKER WHEN Development risks - Project sponsors - Development loan lenders Risks during the developmental stage are very high and include failure to obtain permits or other governmental approvals; public opposition to the project and weaknesses in the business framework of the deal. Design engineering and construction risks - Project sponsors - Construction loan lenders BUT each participant is concerned with whether the project will be constructed on Work changes, price changes, material shortages, …. The construction lender must be sure that the contractor’s obligations are of a “turnkey” nature, because sufficient funds 8 limit its risk exposure in the financing. The resulting group of lenders = syndicate; the lead bank that arranges this type of cooperation = arranging bank. b. Managing Bank: one or more banks in a syndicate to reflect the status of the bank as one of the major syndicate members. c. Agent Bank: bank responsible for administration of the credit and the collateral. It coordinates loan drawdowns, monitors covenant compliance by the borrower, issues and receives notices to and from the borrower, and is a clearinghouse for information. d. Engineering Bank: responsible for compliance with technical performance covenants and progress. It coordinates with technical consultants and project engineers and reports this info to the bank group. e. Security Agent: or collateral agent, is responsible for holding security interests as agent for the project lenders. 5. PERMANENT LENDER Several requirements: arrangement of sufficient debt to finance the total construction cost of the project. The permanent lender wants a project that is risk-free when the permanent loan is made available on the completion date. He is generally concerned with the economic value of the contracts, the legal adequacy of the contracts and the viability of the contracts in a loan workout environment. 6. BONDHOLDERS Purchase project debt in the form of bonds. Represented by a bond trustee = financial institution that acts as the representative for BH in managing the debt transaction. 7. INTERNATIONAL (MULTILATERAL) AGENCIES WTO, IFC (International Finance Corporation), regional development banks and other international agencies
significant support for projects financed in developing countries. 8. BILATERAL AGENCIES = DEVELOPMENTAL AGENCIES AND EXPORT-IMPORT FINANCING AGENCIES Designed to promote trade or other interests of an organizing country. They are generally nationalistic in purpose and nationalistic and political in operation. Funding: from their organizing government. 9. RATING AGENCY Provide credit ratings for the underlying debt. Typically involved in early stages. 10. SUPPLIER Provides raw materials, fuel or other inputs to the project in exchange for the market price, with acceptable excuses for non-delivery. 11. OUTPUT PURCHASER = purchaser of all or some of the product/service produced at the project. Its financial commitment depends upon how much interest it has in a long-term supply that is priced based on the project’s cost rather than market forces. This interest also determines to 9 what extent the output purchaser will be willing to provide credit enhancement, such as guarantees, to assist in the financing process. He desires firm price and quality, with a minimum of uncertainty. 12. CONTRACTOR = entity responsible for construction of the project at a fixed or predictable price, on a date certain, warranted to perform at agreed levels. It bears the primary responsibility in most project for the containment of construction-period costs (this is his main objective)
He is concerned with the difficulty of predicting events that could result in delivery of a delayed project, at an increased price, that does not perform as expected. Rewards: increase in the construction price to include a risk premium + bonus payment. 13. OPERATOR = entity responsible for the operation, maintenance and repair of the project within the parameters of the agreed-upon performance levels and according to laws and industry practice. Operator wants to limit price risk
address it by agreeing to operate the project pursuant to a budget prepared by the operator and approved by the project company. 14. FINANCIAL ADVISOR Retained by the project sponsor to provide financial advisory services to the sponsor. Services include: preparing the information memorandum (detailed summary of project technical and economic feasibility, proposed financing structure and proposed terms, summary of the underlying project risks), providing advice to the project sponsor on the host country, currency concerns, and debt sources. 15. TECHNICAL CONSULTANTS Not direct participants. The Project Company or contractor has a license agreement with the technology owner for use of the technology. Sometimes he gives performance guarantees with respect to the technology provided. Retained to advise the project sponsor and lenders on highly technical matters, about which the latter have little knowledge. E.g. fuel consultants, insurance consultants, engineers, …. 16. PF LAWYERS Give specialized assistance to participants in risk identification and mitigation techniques. 17. LOCAL LAWYERS Assist in local legal and political matters, which are often coordinated by the PF lawyers. They also issue opinions on legal matters in connection with the financial closing process. 18. HOST GOVERNMENT = government of the country in which the project is located. It is typically involved in the issue of permits, licenses, authorizations and concessions. It also might grant foreign exchange availability projections and tax concessions. In some transactions, it is the borrower. It can be the owner of the project or can become the owner of the project at the 10 end of a specified period, such as in a build-own-transfer (BOT) structure. HG benefits on a short- and long-term basis from the success of the project:  Short-term
government can use the project for political benefits and for attracting other developers to a country.  Long-term
the successful project should improve economic prosperity and political stability by providing the needed infrastructure. 19. INSURERS They improve the risks inherent in project financings, whether casualty or political. They work closely to project sponsors and lenders to produce an insurance package that limits risks at an economical price. 20. OTHER GOVERNMENTS – EXPORT AND TRANSIT COUNTRIES A project may require the cooperation of other countries. Transit country = a country through which the output of the project must pass to ensure project success. CHAPTER 6 Project Finance Structures They are influenced by the risk appetites of the lenders and investors involved in the financing and by the economic condition of the host country. 3 macro varieties: 1. Nonrecourse financing 2. Limited recourse 3. Project output interest financing
purchase of an interest in the project output, which purchase price is used to finance the facility. 4. Commercial loan financing Funds are lent to the project company for the construction and operation phases of a project. Debt + interests + bank fees are repaid by the project company. 2 phases, either provided in two different agreements or a single agreement: a. Construction : the lender will disburse funds for the construction of the project. Funds are typically advanced as required under the construction agreement, predicated on the submission of appropriate disbursement requests with supporting documentation. Lack of operating revenues SO interest is capitalized. b. Operation : the permanent lender will advance the entire amount of the loan on one day. Interest paid on the debt and the amortization can begin. 5. Export credit financing debt repayment from the cash flow of the project 13 o Antitrust and restrictive trade practices considerations FACTORS THAT DETERMINE THE STRUCTURE TO BE USED 1. Need for leverage: 2. Grade of investment : projects that are financially strong, from the standpoint of financial expectations, may need less flexibility for additional equity infusions. 3. Tax laws and treaties 4. Project management: form of project ownership (e.g. partnership) may provide more management flexibility than a corporate form. 5. Accounting treatment and objectives 6. Lender preferences 7. Transferability of Equity interests: the more flexible an organization form is for equity transfers, the greater the pool of potential equity investors. HOST-COUNTRY INVESTMENT REQUIREMENTS Regulation of investment by foreign entities in a host country is determined by its local law  Ownership of real estate
some countries: requirements that no foreign entity own real property in the country. Solution: create structures such as trusts,…  Local participation
some countries may require a minimum level of local ownership in infrastructure and other projects. Control provisions.  Local formation of Project Company
some countries require that the project entity be incorporated, or formed if a partnership or other non-corporate entity, in the host country. The policy reason is based on nationalistic or political concerns. The project sponsors can also realize benefits through local formation in the host country. STRUCTURES  CORPORATION In the single-purpose corporate subsidiary, the sponsor incorporates an entity solely to develop, construct, own, operate and maintain a particular project at a specific site. Main reason for selection: limited liability for the actions of the entity
BUT forfeited if corporate formalities are not followed = piercing of the corporate veil. To avoid it: business of the subsidiary should be conducted by officers or representatives of the corporation in their name or capacity.  GENERAL PARTNERSHIP = a business entity created by and operated pursuant to contract, statute or both, in which all partners share proportionately in the management and income of the business undertaken. This structure does not afford nonrecourse or limited recourse liability. All partners must be willing to: 14 1. Assume the associated joint and several liability resulting from any negligent operation of the project 2. Be bound by the acts of another partner Main reasons for selection: the project sponsor has inadequate equity to pursue the project alone, all partner have similar tax positions and desire participation in project management and control. Great flexibility in management and control.  LIMITED PARTNERSHIP = similar to general partnership except that it has both general partners and limited partners. The general partner is liable for all the debts and obligations of the limited partnership; limited partners have liability limited to the extent of their capital contributions to the limited partnership BUT they exercise minimal management rights. Main reason for selection: useful for the contribution of equity by passive project investors  LIMITED LIABILITY COMPANY Liability of the members of the company is limited to the extent of their capital contribution. Each member shares in the project profits while enjoying the associated limitation of liability. Unlike a llp, the members need not to abandon management control to enjot the liability limitation.  JOINT VENTURE = combination of entities to achieve a common purpose. Great flexibility in managing and control. Main reasons for selection: the sponsor has no financial/management capability to participate in the project alone
join with others to combine resources and share risks. OR it may have all of the qualifications and skills to develop the project but lacks local country expertise or political contracts. Types: equity JV or contract JV, JV development agreement. Project Management: management or operation of a JV is usually controlled by the JV agreement. Managing partner selected to manage day-to-day activities under overall policy control of a managing body (management committee or operating committee). Conflicts of interest: among venturers who may have interests in pursuing other project. EUROPEAN ECONOMIC INTEREST GROUPINGS (EEIG) Designed to improve economic cooperation in the European Community. It is a business organization of other entities formed under the laws of Member States of the European Community, and that are subject to administration in different Member States. Each member of an EEIG is jointly and severally liable for the debts and obligations of the EEIG. Creditors are expected first to pursue their claims against the assets of the EEIG. DEVELOPMENT CONSORTIUM = group of large, well-capitalized corporations that collectively develop a project. Consortium agreement = relationship of the members and regulate day-to-day activities. 1 “Private Equity: Law and Practice” Slides: Private Equity CHAPTER 1 The Role of Private Equity Private Equity and venture capital describe equity investment in unquoted companies. It’s “not debt” funding invested in private companies. When? When the perceived level of risk, the time horizon associated with the investment or the sums required do not suit debt providers or the public equity markets.
Conditions that apply to companies at early stages or those operating in fast changing environments. Common mechanism to:  Finance separation of non-core assets from a parent company  Facilitate management succession in family-owned firms
“management buy-outs”  Delist firms from a stock exchange
“public-to-private transactions” Private equity providers become co-owners of the companies, sharing risks and returns. TYPES 1. INDEPENDENTS They usually manage the funds through fixed life limited partnerships (10 years; 10-30 limited institutional investor partners). Within this period: the funds invest the money committed and return these funds + any returns made.
Generally the investment is sold before the end of the fund. They raise these funds from external sources: pension funds, insurance companies, wealthy individuals and corporate investors. The independent acts as a general partner selecting and structuring investments in return for a management fee and usually a share of any upside on achieving capital gains. The upside share is referred to as carried interest. 2. CAPTIVES They obtain funds from parent organizations (usually financial institutions). Crisis: -5%. 3. SEMI-CAPTIVES Captives which raise funds from external investors. 10%-15% of all funds invested. NB. VENTURE CAPITAL TRUST (“VCTs”) = they are quoted and offer a private investor the prospect of a tax advantage and an opportunity to invest in venture capital. Publicly 4 which takes account of most of the individual preferences. Best way to achieve consensus amongst BA: be prescriptive in setting the investment framework. • Industry partnerships = corporate venturing
useful way of obtaining funding which would otherwise not be available. For early stage and start-up ventures, it’s the best alternative: they understand the nature of a related industry and see commercial advantage by backing the company. Problem: management team may lose both equity control and day-to-day control of the organization. + IP have views on whom the business should and should not be sold to. • Vendor finance Vendor deferred consideration: the vendor acts as a deferred lender to the transaction and allows the acquirer to pay the purchase consideration over a period of time. Unless some form of guarantee or security can be given on the deferred consideration, the risk factor in not accepting cash consideration may be too great, but the vendor may not have a choice. Vendor’s reward: commercial rate of interest on the fund deferred + premium. Deferred vendor consideration is also used as “price gap filler” to increase the price paid for the business, meeting the price gap between the vendor’s requirements and the abilities of the company to raise external finance. IMPLICATIONS FOR PRIVATE EQUITY  EQUITY “GIVE-AWAY” FACTOR Private equity is frequently provided as a package which will include ordinary shares with either redeemable preference shares or redeemable loan stock. Prerequisite of most venture capital investment: requirement to pay dividends on the ordinary shares and a dividend on the preference shares or interest on the loan stock. The ordinary shares owned by the private equity fund will tend to be designated as “A” ordinary shares or preferred ordinary shares. The venture fund may insist on a dividend expressed as a percentage of net profits before tax and this is known as the participating dividend. The redemption of preference shares or loan stock tends to be over a 3-6 ys.  THE INSTITUTIONAL RELATIONSHIP In accepting PE, management must respect a new code of rules as detailed in the share subscription agreement, new articles of association and new service contracts. Provisions are required to ensure that in the event of default a remedy can be achieved. Venture capital funds generally insist on a service agreement to govern remuneration and service contracts of the directors
designed to ensure that directors do not pay themselves more than agreed, thereby reducing profits attributable to shareholders as a whole and will cover matters such as pension and bonus arrangements. The agreements will have provisions to cover arrangements for the management to leave the company as either a “good” or “bad” leaver (negligence, incompetence, misappropriation of company funds). 5 o Provisions - if dividends and capital redemptions are in arrears, during them, the private equity firm can take control o Restrictions – relating to the purchase of significant capital assets, the acquisition of any companies or the ability of management to diversify into other trades without consent of the venture fund.
Venture capitalist needs to be consulted on significant developments within the company and updated of events that can affect the company’s performance.  PROS AND CONS Pros: 1. Case: management buy-out
private equity enables employees to obtain some degree of ownership and control of the company. 2. Case: existing business
PE accelerates the development of the investee company. 3. Private equity can strengthen an existing company’s balance sheet and cash flow. 4. Opportunity to obtain second round funding from the private equity firm. 5. A private equity firm as shareholders provides added credibility to the business. Cons: 1. Management: bound by the institutional rules and regulations 2. Complete freedom of operation ONLY within the confines of the agreed business plan 3. More accountability: non-executive director + provision of management information 4. Private equity firms are focused on exits at a time that suits them.  Choosing PE: TRADE-OFF “Speed Of Growth” – “Freedom Of Action And Accountability” CHAPTER 2 Raising Private Equity It can be a time consuming, expensive and unforgiving process for the potential investee company. MEETING THE INVESTMENT CRITERION Prior to entering the process of raising equity, it’s important to determine whether a proposition fits the profile of a typical private equity investment.
4 criteria: 1. MANAGEMENT Good management team may perform well in a difficult situation but a poor management team leads to underperformance and failure. Reliance and trust have to be placed on the “day-to-day” guardians of the investment. The ideal management team is an experienced and balanced group of individuals. Key managers: the chief executive and the finance director. Large transactions: a balanced management team is the norm. ≠ smaller ones: alternative: appoint a non-executive director with experience in the relevant area. 6  Professional and balanced management team are a pre-requisite for the venture capitalist. 2. PAST PERFORMANCE To predict future success; it’s a further indicator of the qualities of the incumbent team. MBO gives management an opportunity to have freedom of thought and action and be owner-managers
this stimulates motivation to improve on past performance. MBO can transform an underperforming company’s fortunes by having a more committed management paying closer attention to those areas: o Rationalization of the overhead, both central and divisional o Improvements in product innovation and approach to marketing o Investment in new capital equipment (previously denied by the parent company). In reviewing ways to improve past performance the venture capitalists will be influenced by: maturity and prospects of the industry, production and plant facilities and competitive marketplace with low barriers to entry. 3. FUTURE PROSPECTS Past prospects = barometer, BUT a PE firm will ONLY benefit as a shareholder from future performance. To attract PE investment, a company should show progressive growth in generating good investment returns (dividends + ultimate realization of a capital gain). In reviewing future prospects, venture capitalists are influenced by factors: o Micro level
forward order book, number of customers and their prospects, stability of the customer base, ongoing capital expenditure requirements, … . o Macro level
industry prospects (in declining sectors, profit growth which is dependent on cost reductions rather than revenue increases: stronger venture capital interest) technology changes, barriers to entry (the more there are barriers, the more the predictability of future earnings, the more the PE is interested). 4. EXIT PROSPECTS The schedule for a typical venture capital investment is to exit in around 3-7 years
within its timeframe (10yrs) to maximize the investment returns.
Exits produce investment returns. Good fund performance will make fresh fund raising easier and the financial rewards to the managers greater. In assessing the exit prospects, venture capitalists consider: o Trade sales
quick and certain way to prove the company has a good track record o Share buy-back
option for an investee company to buy back their venture partners’ shares. o Floatation of the company
it gives the flexibility of a complete exit or of a gradual exit of publicly quoted stock over a period of time. 9 3. Business detail (products, customers, market position, SWOT analysis,…) 4. Management team 5. Financial summary 6. Finance required and purpose  FUND RAISING – phases: 1. Preparatory stage It requires the management team to:  Finalize and Know the BP
know the plan inside out.  Prepare for the meetings
a management team must interact effectively with each member assuming responsibility for their own particular discipline.  Select the funders 2. Initial market phase The fund or funds to be approached will be contacted initially by the corporate finance advisor, with the aim to prime the PE firm as to the nature and quality of the opportunity.  First meeting
the PE manager will be keen to expand on the content of the plan and a series of open questions will be asked to test their open and management’s understanding of the business and the key issues.  Internal case review
each week most PE firms hold internal meetings to talk about their investment opportunities. Purpose: to determine how these opportunities should be pursued or abandoned. 3. Getting to conditional offer The fund manager must become fully familiar with the business and its management prior to issuing an outline offer letter. This period of due diligence may include taking references on the management team, otherwise deals may fail. In this phase: great deal of info flow from the management to the PE fund manager. At the end, the venture capitalists will issue a conditional offer letter summarizing the terms for any proposed investment and containing: intended funding scheme + funding instruments proposed + required dividend/interest yields and equity rights. 4. Getting to completion It involves working exclusively with a preferred PE fund, to eliminate their pre- conditions (designed to highlight key areas which are required to be satisfied prior to completion), completing their due diligence (legal, confirm that the business has all the required assets and rights to trade and that all potential and contingent liabilities have been disclosed and assessed) and concluding their investment. The venture capitalists will require an investigating accountant who should: 10  Do a sensitivity analysis to identify the pivotal points of change by reviewing historical financial statements of the company  Focus on risk areas CHOOSING AN INVESTMENT OFFER Decision’s issues:  Investment offer terms and conditions: the equity % required by the venture capital  Deliverability: ensure that the PE can complete the deal on the required terms and within the required time.  Personal chemistry: a good working relationship between management team and intended equity partner provides a stable platform on which to develop the company.  Access to further funds: assess partner’s willingness/ability to inject 2nd round funding. CHAPTER 10 Articles of Association = the articles
a statutory contract which binds the company and its members to the same extent as if they were respectively signed and sealed by each member. While the enforceability of the articles is subject both by numerous principles developed by the courts and to the various statutory powers imposed on companies, the shareholder’s agreement is regulated by the law of contract. Aim: to regulate HOW: 1. Company is governed 2. Power/control is shared between shareholders and directors 3. Rights of ≠ classes of shareholders operate among themselves. They are a public document of the company which requires registration at Companies House. The Companies Act states that a company may alter its articles by special resolution. Any alteration has effect as if originally contained in the articles. RUSSELL V NORTHERN BANK DEVELOPMENT CORP LTD Venture capital is approached from the stand point of a passive investor or “sleeping partner”. The investor controls are reserved to the investor: he can veto any significant changes in an investee company’s businesses activities or operational strategies. The appropriate place for inserting the investor controls within the legal documentation is a matter of some contention and the case Russel v Northern Bank Development Corp Ltd (1992) has made the decision more complicated. Controls can appear in the articles of association or in the investment agreement or in both. According to the case Russel v Northern Bank Development Corp Ltd, there can be no contracting-out by a company in respect of its statutory powers. BUT rights may be entrenched in 11 articles either by using the concept of separate classes of shares to which are attached the rights which are sought to be protected or by increasing the voting power of specific shares in the article which embodies the special rights if and to the extent that a special resolution is proposed to alter that article, and so allowing the protected shareholder to prevent the passing of a special resolution if he/she wishes.  Class rights Managers shares are usually “plain vanilla” ordinary shares. ≠ Investors usually perceive preferred ordinary shares (= “A” ordinary shares). Together: equity shares. Separate classes are usually required to reflect the different rights that will attach to the different classes of shares. E.g. Investor: veto over changes to the memorandum and articles of association. An agreement between shareholders themselves not to vote their shares to change the articles of association, reduce capital ecc… will be enforceable if the company is not a party to that agreement but invariably the investee company is party to the investment agreement. If not all the shareholders are party of the agreement, it could be possible to get a voting covenant from each of the other shareholders (but that would be cumbersome) or to insert weighted voting rights in the articles so that to pass specific resolutions certain classes of shares will have more than one vote.
ensure that unwanted amendments cannot be passed without the agreement of the holders of those shares. Alternatively, if the controls are put in the articles of association and the investors have their own separate class of shares, the rights contained in this separate class will be class rights. MINORITY SHAREHOLDER PROTECTION Management advisors will wish to obtain a limited set of protections for management particularly if together they only represent a minority shareholding in the company. Most investors will not wish to provide management with any form of class rights because it would further their controls. The ability of management to secure class rights will depend on the strength of their negotiating position and ultimately their importance to the deal. The consent of the holders of the ordinary shares as a class shall be required to and accordingly the special rights attached to the ordinary shares shall be deemed to be varied only by: • Any alteration/reduction/increase of the authorized or issued capital of the company • The passing of the resolution effecting the amendment of the articles of association • The passing of a resolution for the solvent winding-up of the company • The application by way of capitalization of any sum in or towards paying up any debenture or debenture stock of the company • The capitalization by the company of any undistributed profits • The creation or grant of any option/rights to subscribe for shares or securities convertible into shares in the equity share capital of the company. 14 management team or PE house feels comfortable enough to give an incoming manager some equity. Generally, an EBT can be very attractive to private companies who wish simply to provide a means of incentivizing their employees by equity participation in the company. Main advantages: • EBT route avoids Newco having to redeem or buy back the shares • In certain circumstances, Newco can obtain a corporation tax deduction for monies which it donates to enable the trust to buy shares. 4. TRANSFER OF CONTROL If the transfer of a “controlling interest” would result from a transfer
include a clause: the proposed transferee should be obliged to extend to all other shareholders an offer to purchase their shares on like terms. Determining the controlling share depends on the share structure. If management hold more than 30% but less than 50% the controlling interest is likely to be 30%. Provisions should be included to facilitate the resolving of disputes as to the price to be offered by the offeror (independent expert acting at the joint expenses of the parties). He must determine the true consideration: in determining the value of shares, equity shares are normally treated on an equal basis and discounts and increments for minority and majority interests respectively are ignored. ≠ Preference shares
the offeror is obliged to purchase the outstanding preference shares for a price equal to the amount which the holders would otherwise have received on redemption. 5. FORCED SALE PROVISIONS A would-be purchaser would wish to acquire the entire share capital of the company. The investor will consider including a provision whereby if the institutional investor shareholders wish to accept the offer, the other shareholders should be obliged to follow suit and sell at the same price per share. This may be acceptable in a MBO with certain compromises because everyone is aiming for an early exit BUT unacceptable in a development capital investment.
Compromises: • Set a date when the investor can impose a sale • General meeting upon receiving an offer
majority of votes to sell Immediately upon receipt of the selling notice, the company shall give notice in writing (a “compulsory sale notice”) to each of the members and call a separate general meeting of the holders of the ordinary shares to vote upon an ordinary resolution to sell to the proposed purchaser upon the terms set out in the compulsory sale notice. If a majority vote in favor, then any member who has been served a compulsory sale notice shall sell his shares referred to it. If any of the members (“the defaulting members”) fails to comply with the terms of the compulsory sale notice, the company may receive the purchase money in trust for each of the defaulting members and cause the proposed purchaser to be registered as the holder of such shares. 15 INVESTOR DIRECTOR(S) The holders of not less than 50% by nominal amount of the issued preferred ordinary shares may by notice in writing addressed to the company appoint a director (investor director). A fee will be paid by the company for his services. He shall be entitled to all notices + to exercise voting rights + to nominate an alternate to be present at board meetings as his substitute. He owes fiduciary duties to the company and represent the interests of the institutional investor. RATCHETS = tools by which investors offer performance related stepped incentives in the form of equity to the management, to ensure all sides the best possible return on their investment. Not popular. WHY?
Too much technical details; to be effective the management must understand how it operates. Purpose : to re-distribute the equity cake in the light of certain contingencies within the prescribed timescale. Important: the objective must be understood by everyone at the outset. Aims:  Incentivisation
to incentivize the management team to work even harder to improve the performance of the company by maximizing the growth in value of their shares
push them to devote energies to max. both profit and capital gains  Evaluation
to fill the gap between what the management team and the investor believe the business to worth. The initial equity split would start off at a valuation put on the business by the investors, but if the profit targets or other performance related targets indicated by the management team in their business plan are realized, then they will ratchet upwards to reach their valuation.  Negotiating
management teams will look for an added value return in addition to their employment benefits. Some managers may accept substantial commission or bonus arrangements as added value, others will insist on a ratchet.  Exit
Often managers will be earning good incomes as company executives and so they may not want to drive the company towards an exit. To drive them towards an exit may require the prospect of a substantial gain that a ratchet can offer. Exit ratchets force a management team to achieve realization through 2 methods: a. Trade sale
if the purchaser issues consideration shares or loan notes then the market value of that consideration should be taken as being part of the sale proceeds rather than the part value or possible future value of those shares. b. Listing
the means of effecting the ratchet will be either by share transfers at set values or by the purchase by the company of some of the institution’s shares or by the non-conversion of a different class of share into ordinary shares.  Performance
in order for a ratchet to be successful, there must be a method of measuring performance.
achieved by measuring: 16 o Income flow = profit/interest received o Capital value (upon realization) o Timeframe (when the cash is received) These are the 3 key components to calculate the IRRs (Internal Rates of Return)
They give a comparison between the return the investor might reasonably expect to obtain if it invested in a particular company, compared with other investment opportunities. Calculating an IRR is a technique involving getting a discount rate by the investor to achieve a set IRR which, when applied to the cash flow to be received by the investor over the life of an investment, provides a discounted value for the total amount received. This value is then subtracted from the original cost of the investment to reducing NPV to zero.  Significant influence on IRR calculation is the assumed exit value and its timing.  Never be used as the sole measure of the feasibility of a transaction or of its cost because it can produce spurious results and does not seek to tell you that an investment for a longer period or a large amount at a lower IRR is more attractive.  Valuation difficulties a. Early realization: if the management feel the profit ratchet is going to trigger then they will simply hold out for a better price for those shares than the investor and if this price is not offer then they will simply not sell. b. Deferred and contingent consideration: i. Deferred consideration is consideration that is received with absolute certainty but at a later date. ii. Contingent consideration is contingent upon some future event. c. Warranty claims : the management take the benefit of the ratchet but also take the risk of warranty claims.