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Focus on Private Equity – April 2014

McDermott Will & Emery has released the April 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries.  Articles in this issue include:

Private Equity Firms Face Potential Liability Under Plant Closing Laws
Private equity firms risk potential liability for Worker Adjustment and Retraining Notification Act violations. Case examples demonstrate the need for proactive activity management, including observing corporate formalities, establishing and filling the director and officer positions of all entities, permitting the operating company management to make the decisions regarding employment terminations and plant closings, and clearly communicating and documenting these activities, to help avoid or quickly exit litigation.
Read the full article.

Incentivising Management Across the Pond
U.S. private equity investors are increasingly looking outside the domestic market and into the United Kingdom and Europe to deploy dry powder.  As the buy-out market in the United Kingdom heats up, U.S. private equity investors should be aware of tax-efficient structures to deliver equity incentives to U.K. resident management teams in order to maintain a competitive edge. In this article, we’ll explore the significant negative consequences of issuing U.S.-style stock options to U.K. resident management teams and the significant tax savings that can be obtained with restricted stock, enterprise management incentive options and structuring incentive equity to obtain Entrepreneurs’ Relief.
Read the full article.


Equity Investors: Be ForeWARNed

The Worker Adjustment Retraining and Notification Act (WARN Act) requires certain employers to give employees 60 days’ notice of plant closings and mass layoffs.  The goal of the WARN Act is to “provide workers and their families transition time to adjust to the prospective loss of employment, to seek and obtain alternative jobs and, if necessary, to enter skill training or retraining that will allow these workers to successfully compete in the job market.”  Employers who violate the WARN Act are liable to affected employees for up to 60 days of compensation and benefits.

On December 10, 2013, the Second Circuit in Guippone v. BH S&B Holdings LLC addressed whether a holding company (HoldCo) and certain investors (Investors) should be deemed “employers” under the WARN Act, and thus liable for violations thereof.  The Investors created various entities to purchase and manage Steve & Barry’s Industries, Inc., which it acquired out of bankruptcy.  HoldCo served as the holding company and sole managing member of another entity (Holdings), which employed the plaintiff and putative class members.  After the acquisition, Holdings experienced its own financial issues and subsequently filed bankruptcy.  On the same day of the bankruptcy filing, Holdings began sending WARN Act notices and termination to employees.  The plaintiff in Guippone filed a complaint against HoldCo and the Investors seeking damages on behalf of the terminated employees.

The Second Circuit adopted the following non-exclusive factors from the Department of Labor regulations to determine whether related entities are “single employers” under the WARN Act: (i) common ownership, (ii) common directors and/or officers, (iii) de facto exercise of control, (iv) unity of personnel policies emanating from a common source and (v) the dependency of operations.  Although equity investors are typically shielded from WARN Act liability, the court held that these five factors should also be applied to determine whether equity investors who exercise control over an operating company’s decision to terminate employees should be subject to WARN Act liability.  The court clarified that application of the five factors requires a fact-specific inquiry, no one factor is controlling, and all factors need not be present for liability to attach.

Ultimately, the court affirmed the district court’s order granting the Investors’ motion to dismiss, but reversed the district court’s order granting summary judgment in favor of HoldCo, instead finding that the evidence would have allowed a jury to conclude that Holdings was so controlled by HoldCo that it lacked the ability to make any decisions independently.

This case has important implications for private equity funds and other equity investors.  Although the Second Circuit dismissed the case with respect to the Investors, it did so only because the plaintiff had not presented sufficient evidence to satisfy the five-factor test for determining single players.  The implication that equity investors could find themselves liable for WARN Act claims serves as a reminder to current or future investors to ensure that legal separateness exists, is vigilantly enforced and that the company’s executives retain operational autonomy, especially with respect to closings [...]

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Key Takeaways from McDermott’s 2014 HPE Symposium

The eighth annual McDermott Will & Emery Healthcare Services Private Equity (HPE) Symposium was held on March 12-13, 2014, at the JW Marriot Marquis in Miami, Florida. McDermott’s Health and Private Equity practices hosted a record crowd of over 350 top private equity professionals, investment bankers and company management teams from around the country. Speakers from a variety of sectors shared their insights and experiences on the state of private equity investing in health care services. Some of the key takeaways included:

  • Operating partners of private equity (PE) firms believe that add-on acquisitions and cost-saving efficiencies will provide the most value appreciation for existing health care services platform businesses for the next 12 months;
  • Most panelists believe that prospects for growth in the health care sector over the next three to five years vary significantly by sector, with health information technology and post-acute care trending towards higher growth during that span;
  • Panelists remarked that successfully integrating add-on acquisition targets and sourcing the appropriate add-on acquisition targets are the most important factors in completing successful add-on acquisitions;
  • Lenders asserted that the leveraged loan market continues to be strong in health care deals and explained that the continued and increased presence of alternative lenders has helped drive middle market activity; and
  • While the growth in health care expenditures in the United States has slowed for a fourth consecutive year, different theories exist as to the causes behind the bending of the cost curve in this $2.8 trillion industry.

The audience was highly intrigued by the panel discussions, asking many questions of the panelists and continuing the discussions during the networking breaks and lunch. The attendees were also entertained at lunch by the keynote speaker of the conference, Joshua Foer, U.S. Memory Champion and author of the New York Times bestselling book, Moonwalking with Einstein, who shared his fascinating insight on improving ones memory through exercising the mind.

The 2014 McDermott Will & Emery HPE Symposium was once again a tremendous success and remains a go-to event for all of those desiring to gain a deeper understanding of the complex legal and business issues involved with investing in the health care services industry.

Insights for Driving Value Through Operational Performance of Private Equity Investments

The 13th annual Beecken Petty O’Keefe & Company Private Equity Conference took place on Friday, February 21st.  McDermott, a lead sponsor of the event, hosted a panel of leading, mid-market private equity (PE) funds to discuss how their operationally-focused strategies drive value as they pursue new investments.  Moderated by McDermott partner and private equity lawyer Larry Bronska, the panel included senior deal makers from Sterling Partners, RoundTable Healthcare Partners, Blue Sea Capital and AUA Private Equity.  Speaking to a packed house, the group shared their insights and experiences.  Some of the key takeaways included:

  • Operating partners of PE firms often play a significant role in front-end diligence and the courting of target management teams.
  • The most effective deal execution teams include integrated efforts of both the fund’s investment professionals and the operating professionals.
  • Identified cost savings and operating improvements often lead to more competitive valuations and better outcomes as a potential buyer.
  • Limited partners of PE funds expect that there will be a positive correlation between strong fund operating capabilities and fund investment performance.

The panel topic and discussion seemed to be of great interest to the event attendees.  It led to a number of questions from the audience at the end of the program and a series of private conversations afterward.  Given the competitive investment environment presently faced by PE firms, it makes perfect sense that there is a great deal of curiosity about the various forms of operations-focused strategies being implemented by PE firms.

If you would like to learn more about this panel discussion, please feel free to contact Larry Bronska at

Alternatives to Typical Private Equity Funds: Search Funds and Fundless Sponsors

We are frequently asked about the differences between a traditional private equity fund, a search fund and a fundless sponsor.

Many investors are familiar with the traditional private equity model in which a fund raises a pool of committed private capital, which it has a right to call for future acquisitions.  That capital is then invested over a five- to seven-year horizon in multiple portfolio companies.  The goal of these traditional private equity funds is to return the capital to their investors with a significant return on investment.  In the traditional private equity scenario, limited partners are not allowed to pick and choose between portfolio investments, although there may be some opportunities for limited partners to make additional deal-by-deal co-investments.  Typically, private equity principals take on an advisory, non-operational role with their portfolio companies.

Search funds are specialized “micro” private equity funds that are formed generally by one or two individuals for the specific purpose of acquiring one target company that the principals of the search fund then operate.  Search fund principals initially raise “search capital” of approximately $500,000 that allows them a period of time – typically 18-24 months – in which to search for an acquisition target.  At the time the Search fund is ready to purchase a target company, it returns to its initial search-stage investors (and also to other equity investors) seeking the required equity contribution to complete the acquisition.  Search funds usually seek lower-middle market acquisition targets that fall below the radar of traditional private equity funds.  Search fund principals take on high-level day-to-day management positions within the acquired portfolio company, effectively running the business from and after the closing.  Search fund principals receive a salary from the portfolio company and also earn a carried interest on the equity investment that financed the acquisition.

Another variation on the private equity investment vehicle is a fundless sponsor.  As its name suggests, a fundless sponsor is a private equity professional or group that searches for acquisition targets first, then shops those acquisition targets to known sources of equity capital.  Many traditional private equity funds are willing to invest in transactions that are shown to them by fundless sponsors.  However, because private equity sponsors will often attempt to negotiate an economic split that is less favorable to the fundless sponsor, fundless sponsors many times aim to find sufficient sources of equity capital to prevent any one source from having significant negotiating leverage.  Fundless sponsors will sometimes maintain a role with the target company after the acquisition is consummated, often in the form of a board seat, but are usually not involved in the day-to-day operations to the same extent as search fund principals.

Private equity comes in many different forms and sizes, and with the growth of private capital, search funds and fundless sponsors are becoming more commonplace in the middle market today.

If you have questions about our search fund practice, please contact Sam Wales (+1 202 756 8126), Raam Jani (+1 312 984 7681) or Eric [...]

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High Growth Segment

Fast-growing companies, particularly technology companies, have been looking to the US public markets rather than those in the UK for equity financing.  In fact, there have been no initial public offerings of European technology companies on the main market of the London Stock Exchange (LSE) since 2010. As a response to this, the LSE announced the creation of a new High Growth Segment (HGS).

The HGS is designed for mid-sized European companies that need a public platform and better access to financing in order to continue their growth.  It is also anticipated that it will provide a transitional route for companies to the UK Listing Authority’s (UKLA) Official List.


The HGS sits outside the UKLA’s Official List and is, therefore, not subject to the Listing Rules.  However, it does have the status of an EU Regulated Market and is subject to various EU financial services directives, including the Prospectus Directive, the Market Abuse Directive and the Transparency Directive.  In addition, HGS companies will have to comply with the HGS rules and the LSE’s Admission & Disclosure Standards with respect to the provision of information.

Eligibility Criteria

At the point of admission to the HGS, the company must:

  • be actively engaged in trading good and/or services (companies engaged, for example, in mineral resources at an exploration stage are ineligible);
  • be incorporated in a state within the European Economic Area;
  • control the majority of its assets;
  • offer equity shares of UK or other European trading businesses;
  • be a revenue generating business with  a compound annual growth rate (CAGR) of 20 percent  over a three year period.  This growth is based upon CAGR using a four year range of financial data;
  • have a minimum free float of 10 percent in public hands with a sufficient number of shareholders to ensure an orderly and liquid market;
  • have a free float value of at least £30 million (the majority of the £30 million must be raised at admission to the HGS);
  • have published a prospectus in relation to the securities to be admitted to the HGS that must have been approved by the Financial Conduct Authorty (FCA) or other European Economic Area (EEA) equivalent authority; and
  • provide a non-binding indication that it intends to apply for admission to the UKLA’s Official List.

In addition, a key adviser must be retained at admission to the HGS on an on-going basis for specific matters.  Key advisers must: (i) be an FCA authorized person; (ii) have, inter alia, sufficient prior relevant experience and skill to satisfy the LSE that they are suitably competent to perform the role; and (iii) have in place adequate controls which will allow them to carry out their role in accordance with the rules of the HGS.

This can be seen as a response to the Jumpstart Our Business Startups Act, which introduced a similar regime in the United States.  The LSE also hopes high-growth companies will be dissuaded from seeking a listing on NASDAQ where companies can already take advantage [...]

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AIFMD: More Than Just a Box Ticking Exercise

As you will no doubt be aware, the alternative investment fund industry is experiencing a serious shakedown in the European Union. The Alternative Investment Fund Managers Directive (AIFMD) comes into effect on July 22, 2013. It seeks to harmonize the European regulatory regime for managers of alternative investment funds, including private equity funds. Its extensive reach means that even funds based outside of the EU could potentially be affected. Funds and fund managers would be wise to ensure their house is in order to avoid non-compliance. We have noted a few points which bear thinking about.

Who is your fund manager?

  • Funds are required to nominate a single fund manager, external or in-house, who will be responsible for AIFMD compliance.
  • Unlike the Dodd-Frank Act, the AIFMD provides a distinction between manager and adviser. The former provides investment management services whereas the latter provides administration, marketing or other non-regulated services.
  • External fund managers may also be Undertaking for Collective Investment in Transferable Securities (UCITS) management companies.

Where is your management based?

  • The AIFMD looks to substance over form, meaning that letter-box entities are likely to be ineffective as the legislation will look through structures to locate the day-to-day running of the fund.
  • The proportion of management operations based in the EU is relevant to whether the manager is caught by the AIFMD.
  • The transfer of management operations to a non-EU jurisdiction is an option. Yet, this would only avoid the AIFMD if the fund is not marketed in the EU.
  • Parallel structures can separate AIFMD-affected and non-affected funds. It is crucial to maintain genuine distance between the structures to avoid bringing the non-EU fund under the scope of the AIFMD.

Have you taken into account all of the funds that will be affected

  • If a fund manager becomes authorized, all of the funds that they manage (current and future) are likely to be subject, wholly or partially, to the AIFMD.
  • Before or upon authorization of a manager, it is advisable to consider the effect on all applicable funds and any changes in management before applying for authorization.

Delegation of manager functions

  • Existing managers must notify the authorities of any delegation to third parties, prior to such delegation.
  • It is advisable to keep records to show that the delegation is objective and the delegate is fully qualified and capable of undertaking the tasks. A system to ensure the effective supervision of such delegation is recommended.

Process in the UK for private equity funds?

  • Funds need only comply with limited disclosure obligations if they meet the following three criteria:
    i)  Manage an aggregated value of assets of less than €500 million;
    ii)  Manage only unleveraged funds; and
    iii)  Do not allow redemption in the first five years.
  • Private equity funds tend to fall within the scope of the above. As such, those funds need only comply with: a) the requirement to register with the Financial Conduct Authority (FCA) from July 22, [...]

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For Private Equity Investors, Section 1202 May Be Worth Another Look

As many deal professionals are painfully aware, the federal capital gains tax rate (in most cases) rose from 15 percent in 2012 to 23.8 percent in 2013.   In light of this tax rate increase, it is now more crucial than ever for deal professionals to creatively structure their investments in order to maximize their after-tax return.   One method available to mitigate the effects of the capital gains tax rate increase is to qualify an investment under Section 1202 of the Internal Revenue Code.   The article linked below, authored by Daniel N. Zucker and Jeffrey C. Wagner, describes the requirements and potential benefits of qualifying an investment under Section 1202.

For Private Equity Investors, Section 1202 May Be Worth Another Look

The American Taxpayer Relief Act of 2012 extended some of the more significant benefits of Internal Revenue Code Section 1202, which permits eligible noncorporate taxpayers to exclude from taxable income a specified percentage of any gain from the sale or exchange of qualified small business stock held for more than five years.

To read the full article, click here.

Venture Funds: Don’t Fear the LLC

It has long been the case that venture funds (classified as partnerships for tax purposes) have insisted that limited liability companies (LLCs) taxed as partnerships convert to C corporations prior to the consummation of a venture financing.   Most commonly, there are three rationales given for this requirement: (1) certain venture fund limited partners are tax exempt institutions or foreign investors and prohibit the venture fund from allocating Unrelated Business Taxable Income or Effectively Connected Income to such types of limited partners that likely would result from an investment directly into an LLC, (2) venture funds are focused on the potential of a future initial public offering (IPO) and the most common vehicle to an IPO is a C corporation and (3) executive talent expects to be issued stock options and are not familiar with the more complex equity issued by an LLC.

Perhaps though it is time to revisit this long held investment philosophy.  Showing flexibility in investment structure may make a venture fund more attractive to the founders of an LLC then other funds less willing to be creative.  Often times founders of LLCs wish to retain the flow through tax treatment benefits they receive, especially in an early financing round after which the founders will retain a significant ownership percentage.  The tax benefits received by the founders as a result of maintaining the LLC structure include: (1) the founders pay a single level of tax on the profits of the business (in a C corporation there are two levels of tax on the distributed profits of the business, which would result in less after tax distributions to the founders) and (2) the active founders can often utilize the losses of the business on their individual returns thereby offsetting other gains they may have.  There are other tax benefits of the LLC structure as well.  If there is a sale of a company structured as an LLC, then the company may be able to deliver a partial step up in the basis of the LLC’s assets to an acquirer, which has real economic value.  And contrary to the commonly held belief that the new management team that the venture fund plans to attract expects to be issued stock options, the LLC has a more tax efficient way of issuing management equity in the business, through profits interests, and this gives management the potential of capital gains rates on gains rather than ordinary income, which arises with respect to stock options.

And LLCs aren’t so bad for venture funds.  First, these days there are a lot fewer IPO exits for venture funds than there used to be and a sale of the business has become a more common path to liquidity.  Second, as mentioned above, an LLC will provide a better structure for delivering at least a partial step in the basis of the LLC’s assets to an acquirer thereby potentially delivering more exit value.  Third, LLCs are creatures of contract unlike corporations and this allows the venture fund [...]

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Welcome to McDermott’s Corporate Deal Source Blog

Where have all the transactions gone?  The first quarter has quietly passed by.  Just a few weeks ago, looking through the pipeline, one could see almost unimpeded to the other side, relatively empty as the bankers say.  But hope exists, as suddenly activity seems to be reemerging.  We call it letter of intent flow (more poetically, LOI Flow).  The beginnings of real transactions.  Concurrently with these beginnings, we launch our inaugural Corporate Deal Source Blog.  And perhaps timing is on our side and we are well positioned to ride the next wave of deal activity from its very beginning.

We set out here to provide commentary, not intended for other lawyers, but for our clients and those we hope will find benefit from becoming our clients.  Our goal is to dialogue as much as one can in the blogosphere and that our followers will help drive our content through comment and suggestion.  The Corporate Deal Source Blog aims to be a professional, yet light-hearted source of pertinent information.  Some posts will be pithy updates of the LOI Flow, announcements and important releases; others will be more comprehensive analysis of meaningful changes in law, pitfalls in transacting globally or recent trends in private equity buyouts.  We will also cover issues affecting family office direct investing, corporate finance, real estate transactions and other topics of interest.  But all well tied with a common theme: deal-making and the people who make them.

With that, we invite you to follow Corporate Deal Source—a must for any true deal-maker.  We promise to excite as much as any band of lawyers possibly can.