Client Alert

Getting PE Deals in the UK Across the Line, Part 2: Alternative Approaches

June 2021

A company that has rapidly reached exit stage may have received investment from a number of different sources and will often have a wide shareholder base comprising friends and family, management, ex‑management, VCs, and other institutions. When an acquirer comes along, aggrieved minority shareholders may consider holding out for better deal terms, leaving investors with additional hurdles to overcome to successfully complete a transaction. Some shareholders may even be untraceable. Drag along provisions provide one answer, but there are alternatives to consider if a drag along does not work.

This article is the second of a two part series. Also read the first part, “Getting PE Deals in the UK Across the Line: Drag Alongs”.

Need for Certainty

To ensure that all shares are transferred with minimal risk, a well-prepared target company will be able to contact all shareholders and will have maintained accurate records (including contact email addresses). Communication and preparation are key to ensuring a smooth and efficient transaction.

PE portfolio companies are usually adept record keepers (and their shareholders tend to be, in most cases, a PE house, perhaps a co-investor and the management team), so secondary transactions are not likely to encounter issues with hold-out shareholders or very large cap tables (unless their history is particularly complex). However, start-ups and scale-ups that have never been through a buyout process before are not likely to have ever needed to significantly tidy up their cap tables. They are also unlikely to have needed to communicate with all of their shareholders and in addition, receive responses back from all of them. A target company may believe it has the ability to gets its shareholders on board after signing, but in reality, if it has grown quickly and attained investment from a number of different sources, it will have a large, unwieldy, shareholder base. With large disparate shareholder bases, a target company might sometimes need to delay completion while it gets its house in order.

Other Considerations to the Drag Along

If a company is able to drag along a few minority shareholders it will often do so (or at least use the provision to encourage the minorities to sign the transaction documents). If drag along provisions are unenforceable, impractical or too risky to employ, alternative approaches will be needed. There are a number of alternatives in the UK to enforcing (or seeking to enforce) drag along provisions that are briefly worth mentioning:

Share Buyback/Compulsory Transfer

Subject to the relevant requirements of the UK Companies Act 2006 (CA 2006), target companies may wish to buy back the shares of certain minority shareholders whom they suspect may cause problems, to avoid having to engage with them under the time pressure imposed by a sale process. This can occur in anticipation of any future sale, and should be before a sale process begins. Note, however, that share buybacks will only be possible if the target company’s underlying documents (e.g., the articles of association) contain provisions allowing share buybacks. In addition, in order to do this, a target company would need to have a fairly good idea about who might cause an issue on a sale.

Most well-drafted shareholders’ agreements and articles of association will contain compulsory transfer provisions, which mean that in the event someone leaves a company and they are a bad leaver (of some sort) they may (if an election is made, or sometimes automatically) need to transfer their shares to another person, an employee benefit trust (or similar), or back to the company as a share buyback. These provisions may be structured in different ways, but they are usually drafted because a company needs to control its shareholder base, in anticipation of a future sale, reorganisation, or key shareholder decision.

Statutory Squeeze-out

A squeeze-out right is the right to acquire any remaining minority shareholdings (i.e., the right to squeeze the remaining minority shareholders out of the target). To trigger squeeze-out rights, certain conditions must be met and there must first be a takeover offer for a company. Under the CA 2006, a takeover offer is an offer to acquire all of the shares of a target, or, if there is more than one class of share, all of the shares of one or more classes. To exercise squeeze-out rights, the bidder for the target must have acquired, or unconditionally contracted to acquire, not less than: i) 90% of the shares in the target; and ii) where the shares are voting shares, 90% of the voting rights in the target. If there is more than one class of share, the threshold applies separately to each class of share.

If these thresholds are met, the bidder can activate the compulsory acquisition procedure under the CA 2006. The bidder must serve compulsory acquisition notices on minority shareholders within a certain timeframe (within six months of the date of the offer for private companies) to exercise its squeeze-out rights. These rights can be helpful where it is impractical to have all the shareholders of a target sign up to the share purchase agreement, although, in practice, a squeeze-out is often still relatively difficult to implement.

Scheme of Arrangement

This is a statutory procedure in which a target comes to an arrangement with all or some of its shareholders to accept a buyout proposal. The statutory procedure is set out in the CA 2006. It requires that an application is made to the court to sanction a shareholder meeting to approve the buyout proposal. The arrangement is binding on all of the shareholders if it is approved by: i) 75% of the shareholders voting at the meeting; and ii) the court.

Schemes of Arrangement are generally rare in the M&A context, as a drag along or squeeze-out procedure will usually be available to a bidder. If, however, a drag along is impractical and it is preferable to the bidder not to use the squeeze-out procedure, or if it has been unable to achieve the 90% squeeze-out threshold due to a large number of unresponsive shareholders, then a Scheme of Arrangement is a useful alternative. This is because only actively voting shareholders are taken into account for the requisite 75% approval threshold, rather than all of the shareholders eligible to vote. It would not matter that some shareholders could not be contacted.

Key Takeaways

For a buyer looking to acquire a company in the UK, particularly any company that has recently experienced very high growth, it is important to keep in mind potential problems associated with a large shareholder base where drag-along provisions may not work.

In summary:

  • Target companies and their majority shareholders should keep open channels of communication with all shareholders to ensure that on a sale, those shareholders can be reached. This will instil confidence in the business and help ensure an efficient process (without the need for any squeeze out process or scheme of arrangement).
  • Target companies should engage with disgruntled shareholders early to buy back their shares if that has not already been done.
  • Buyers should look into the shareholder base of target companies and ascertain whether or not they believe all shareholders will be able to be reached.
  • If a shareholder base is very large, buyers should be prepared to structure their transaction as a takeover offer to be able to squeeze out minorities, or anticipate the need (and cost) of going to court to approve a scheme of arrangement.

This article is the second in a two part series. Read the first part, “Getting PE Deals in the UK Across the Line, Part 1: Drag Alongs”. 

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