As management terms converge, deal teams must still navigate cross-border differences in ratchets, put and call options, and management warranties.
French and UK private equity firms are increasingly looking across the Channel for attractive buyout opportunities. Cross-border transactions involving French and UK sponsors have grown steadily since the global financial crisis, with an uptick in activity in recent years. According to PitchBook, French sponsors bought 33 UK-headquartered companies last year, the highest volume at any point in the past decade. Meanwhile, UK sponsors acquired 56 French-headquartered companies in 2018, up from 34 companies 10 years ago. The long history between the two nations continues to facilitate a strong level of deal flow.
Given the prevalence of pan-European management advisors and the increased number of cross-border deals, cross-pollination of deal terms is occurring. While we expect management equity terms in France and the UK to continue to converge, specific conditions under local tax regimes mean that there are still key areas of distinction. In our view, sponsors considering a buyout across the Channel must carefully navigate differences in the treatment of management equity terms in each jurisdiction. In a sellers’ market, appealing to management can help to win a deal. However, sponsors should proceed cautiously and avoid a one-size-fits-all approach, taking note of the following key developments.
Across Europe, the prevalence of equity ratchets has remained fairly constant over the last four years, with 38%, 42% , 40%, and 37% of European deals including an equity ratchet in 2019, 2018, 2017, and 2016 respectively, according to the sixth edition of the Latham & Watkins Private Equity Market Study. However, UK deal teams should note that in France, structuring ratchets has become more difficult in recent years. The French tax and social administrations have placed more focus on ratchet schemes, making ratchets increasingly challenging to arrange. It is now common for ratchets to be structured using preferred shares valued by third-party appraisal on the initial investment date, rather than equity warrants. As a result, UK-style sweet equity schemes, and the use of bonus shares (i.e., shares issued for free in accordance with the French regulations in relation thereto), are becoming more common in French management incentive structures, a trend that we expect to continue.
Put and Call Options
While the categorisation of leavers is reasonably consistent between France and the UK — 55% of UK deals and 58% of French deals provide for more than two categories of leaver (i.e., provide for intermediate leavers, in addition to good and bad leavers) — the treatment of such leavers is another key point of difference for deal teams to note. In France, the sponsor’s call option over a leaver’s shares often extends to all securities held by the leaver. This approach is less typical in the UK, although this is beginning to change, particularly in the case of a bad leaver. Management requests for put options, meanwhile, are significantly more common in France than in the UK, especially in competitive auction processes where French management teams often request put options in the event of a manager’s death or illness, although sponsors continue to strongly resist these requests.
Management warranties are a common feature in UK deals, providing comfort to PE buyers on items such as diligence reports, business plans, and management questionnaires. Such warranties tend to be capped at between 1 and 2 times gross salary. French management teams, on the other hand, tend to strongly resist giving such warranties, especially in competitive auction processes. However, in our experience, French management teams sometimes give confirmations that due diligence reports and business plans are accurate, but on a limited or no liability basis – providing potentially valuable information for UK deal teams.