Legal due diligence in private equity transactions
by Zola Ndlovu
What is private equity?
“Private equity” is an investment in the equity of a non-listed company. A private equity investor is a shareholder of the company whose rights are not governed by the rules of a stock exchange. In terms of section 85 of the Companies and Other Business Entities Act [Chapter 24:31], a private company is defined as follows:
“private company” means a company other than a co-operative company, which by its articles—
(a) restricts the right to transfer its shares; and
(b) limits the number of its members to fifty, not including persons who are in the employment of the company and persons who, having been formerly in the employment of the company, were while in that employment and have continued, after the termination of that employment, to be members of the company; and
(c) prohibits any invitation to the public to subscribe for any shares or debentures of the company.
For that reason, prior to investing, a private equity investor or PE Fund will want to do its diligence in relation to a company they are targeting for the investment.
A private equity transaction
This typically involves an investment by a Private Equity fund in illiquid, non-public securities issued by a proprietary company or, in some cases, the acquisition of all of the shares of a listed public company followed by the delisting of that company. A PE fund, sometimes referred to as a financial buyer or sponsor, usually acquires a portfolio company to make a relatively quick profit on an investment (typically within five to seven years). The fund identifies one or more ways to increase EBITDA (to provide investors a snapshot of short-term operational efficiency) and build value in the portfolio company before realising a financial return by exiting the investment.
Why due diligence?
In order minimise and allocate risks as well as maximise value for the shareholders, due diligence is central to any private equity transaction. To successfully build value, the PE fund (commonly known as “the buyer”) must gather information about the seller (or sellers, as the case may be) and about the business or assets that are for sale, to put together an optimal structure and purchase price for the acquisition and a comprehensive business plan for the target company.
Although the seller occasionally conducts due diligence on the buyer, for example, where the buyer proposes to pay some or all of the purchase price by issuing shares, the due diligence process is usually more significant for the buyer.
Due diligence therefore involves examining various areas of a Target business before entering into a transaction. The goal is to develop an understanding of the business which will allow the private equity investor to identify and assess potential risks and to ascertain the capabilities of the Target.
The role of lawyers in due diligence
A private equity investor will rely on its legal advisers to conduct a thorough legal due diligence exercise in the Target prior to completing any proposed acquisition or investment. The private equity investor will want to ensure that it is afforded sufficient protection in the acquisition agreement or other legal documents in the event that the Target acquired does not perform as was envisaged in the business plan, or to mitigate any risks which may arise post-acquisition.
The key objective of legal due diligence is to enable a private equity investor to understand, and where possible, quantify any legal risks associated with completing the transaction. Due diligence can uncover a variety of issues, some of which are so serious that they lead to termination of the proposed transaction.
The nature and terms of the proposed transaction will determine how a due diligence is tailored. Areas covered in a legal due diligence typically include constitutional matters and accounts, customer and supplier contracts, licenses and consents, assets, employees and pensions, investigations, disputes and litigation and intellectual property.
We advise financial sponsors, investors, financiers, portfolio companies and management teams on international transactions. Our team covers the full spectrum of strategies, including infrastructure, private credit, venture capital and private equity.
We regularly act on deals at all stages of the investment life cycle – from initial investment to exit – and at all levels of the capital structure, including both equity and debt finance.
We are known for our technical expertise, our commercial pragmatism and attentive, client-focused service. We set ourselves apart by focussing on client relationships rather than on particular practice areas. This enables us to deploy smaller, but more versatile, teams, offer intensive partner engagement and deliver a seamless service that is carefully tailored to the needs of our clients and particular transactions.
- Together, we provide seamless advice that is clear, confident and commercial, but also advice that guides and leads clients towards a recommended solution.
- Communication and efficiency is key to the success of a private equity transaction. Whilst our approach is flexible, we will always be partner-led, with our personal relationships at the core of how we work with clients.
This article is provided for informational purposes only. For legal advice, please contact a legal professional.