Debevoise & Plimpton Private Equity Repo r t

Summer 2011 Volume 11 Number 4

The IPO Exit: WHAT’S INSIDE Investing in China: “Recent” Market Trends in IPOs 3 New Risks? of Sponsor Portfolio Companies Rehoboth Beach Reading: 6 Catching Up on Delaware Although it may seem like a dim memory in sponsors should be ready to make the critical Cases light of the recent public market performance, decisions that will ‘set up’ their portfolio during the 19-month period ended July 31, companies for the next realization. 7 GUEST COLUMN 2011, the public equity markets rebounded In our Summer 2005 issue of the Is Russia Ready for resoundingly, with a particular increase in Debevoise & Plimpton Private Equity Report, Serious Attention from sponsor-backed IPOs. Sponsor-backed IPO we published an article entitled “Selected Private Equity Investors? global activity doubled (in deal size) in 2010 Issues to Consider When Taking a Portfolio as compared to 2009 and continued on an Company Public.” In that article, we 9 Doing Business in the UK upward trend during the first six months of discussed the important decisions sponsors Under the Newly-Enacted 2011, with more than 20 sponsor-backed must make regarding the governance profile Bribery Act IPOs for Nasdaq and NYSE listed of IPO candidates. These decisions include Boosting EBITDA: companies, raising approximately $19.6 board composition and designation rights, 11 The Cost Savings billion. We expect that while many sponsors whether to qualify as a “controlled company,” will be contemplating dual track exit routes the treatment of veto, management fees Add-Back for several months, a number will be and other sponsor rights, and the type, Brick by Brick: (somewhat wistfully) anticipating the return combination and magnitude of any anti- 13 A Primer for Due of the IPO window for their portfolio takeover defenses to put into place for the Diligence in Each BRIC companies. When the market returns, newly public company. Country, Continuing with In the wake of the India robust IPO activity discussed above, we have Brazilian surveyed all sponsor-backed 15 Private Equity Funds: IPOs of Delaware Current Developments corporations completed in 2010 and the first seven ALERT months of 2011 that 17 FTC Implements resulted in proceeds in Revisions to the HSR

© 2011 Marc Tyler Nobleman / www.mtncartoons.com Nobleman Tyler Marc © 2011 excess of $250 million to Form assess how these issues were addressed. Our survey 19 UPDATE yielded 11 companies that New Proposal to Tax met our search criteria and Carried Interest as reflect the state of the Ordinary Income

CONTINUED ON PAGE 20 “Now, that’s a change of control.” Letter from the Editor

We all grew up thinking that an endless summer would be heaven, but collaboration between stakeholders, the government and domestic and the combined impact of the volatility in the markets and the brutal international investors. weather have us all longing for autumn. Although our summer issue is Our Asian colleagues caution that, notwithstanding the wide spread technically a bit late, it is uncanningly timely in light of both the use of "VIE" structures to address regulatory hurdles relating to foreign weather and the markets. ownership in certain industries, recent challenges by the Chinese In the current climate, the IPO exit strategy seems aspirational at government raise concerns as to the viability of such structures, best. However, it was not that long ago that sponsored-backed IPOs particularly in certain sensitive sectors, and at a minimum indicate that were making headlines and that is when we started our survey of these structures are likely to be subject to enhanced scrutiny and sponsor-backed IPOs in 2010 and the first half of 2011 to determine additional risk for foreign investors going forward. how the governance profile of those companies looked after the IPO An ongoing focus of the Private Equity Report has been to keep you was completed. On our cover, we report on the results of our up-to-date on relevant legal developments in the courts and from comprehensive survey so that you will be poised for the next IPO regulators. In this issue, we feature a concise primer (together with a window. cheat sheet) on recent cases from Delaware focusing on directors’ Private equity is an ever more international asset class. In this issue, Revlon duties, takeover defenses and going private transactions. Every we continue our series on doing due diligence in the largest emerging director of a portfolio company will find the three minutes it takes to markets, or BRICs, with a focus on India. We caution potential read it well worth the time. We also provide an update on the UK investors in India to be prepared to untangle a web of related party Bribery Act, which finally became law this summer, and offer insight transactions, analyze complex litigation risks, and evaluate Byzantine on its practical implications for private equity firms and their portfolio land title issues as well as deal with targets largely unfamiliar with, and companies. (Beware—The UK Bribery Act is broader in many respects reluctant to fully cooperate in, the due diligence process. than the U.S. Foreign Corrupt Practices Act.) Finally, we alert our Brazil has been one of the largest areas of growth for private equity. readers to recent changes made to the HSR reporting form that expand We report on the differences between the expectations of Brazilian somewhat the burden of HSR compliance particularly for private investors and international investors in the negotiation of the terms for equity firms. Brazil-focused funds as well as on the ways in which inflation, currency If there are any issues that you would like to see covered in future fluctuations and capital controls play a role in fund terms. issues of the Report or any ways in which we can make the publication Elsewhere in this issue, our Guest Columnists, Alexander Pankov more useful to you or the other members of the private equity and Kirill Samsonov, co-founders of the Russian Private Equity community, we would appreciate hearing from you. Initiative, outline the Initiative’s efforts to promote growth in the nascent Russian private equity sector through education and Franci J. Blassberg Editor-in-Chief

Private Equity Partner /Counsel Practice Group Members The Debevoise & Plimpton Franci J. Blassberg The Private Equity David J. Schwartz Guy Lewin-Smith – London Private Equity Report is a Editor-in-Chief Practice Group Rebecca F. Silberstein Dmitri V. Nikiforov – Moscow publication of All lawyers based in New Robert F. Quaintance, Jr. Stephen R. Hertz Hedge Funds York, except where noted. William D. Regner Debevoise & Plimpton LLP Kevin A. Rinker Byungkwon Lim Kevin A. Rinker 919 Third Avenue Associate Editors Private Equity Funds Gary E. Murphy New York, New York 10022 Jeffrey J. Rosen Marwan Al-Turki – London 1 212 909 6000 Ann Heilman Murphy Mergers & Acquisitions Kevin M. Schmidt Kenneth J. Berman – Washington, D.C. Managing Editor Andrew L. Bab Thomas Schürrle – Frankfurt www.debevoise.com Erica Berthou E. Raman Bet-Mansour – London Wendy A. Semel – London David H. Schnabel Jennifer J. Burleigh Washington, D.C. Paul S. Bird Andrew L. Sommer 1 202 383 8000 Cartoon Editor Woodrow W. Campbell, Jr. Franci J. Blassberg James C. Swank – Paris Sherri G. Caplan London Please address inquiries Richard D. Bohm John M. Vasily Jane Engelhardt 44 20 7786 9000 regarding topics covered in this Thomas M. Britt III – Hong Kong Peter Wand – Frankfurt Michael P. Harrell Paris publication to the authors or Geoffrey P. Burgess – London Niping Wu – Shanghai David Innes – London 33 1 40 73 12 12 any other member of the Margaret A. Davenport Geoffrey Kittredge – London Leveraged Finance Practice Group. E. Drew Dutton – Hong Kong Frankfurt Marcia L. MacHarg – Frankfurt Katherine Ashton – London Michael J. Gillespie 49 69 2097 5000 All contents © 2011 Debevoise Anthony McWhirter – London William B. Beekman Gregory V. Gooding Moscow & Plimpton LL P. All rights Jordan C. Murray David A. Brittenham Stephen R. Hertz 7 495 956 3858 reserved. Andrew M. Ostrognai – Hong Kong Paul D. Brusiloff David Innes – London Richard D. Robinson, Jr. Pierre Clermontel – Paris Hong Kong James A. Kiernan III – London Gerard C. Saviola – London Alan J. Davies – London 852 2160 9800 Antoine F. Kirry – Paris Peter Hockless – London Shanghai Jonathan E. Levitsky 86 21 5047 1800 Investing in China: New Risks?

In the Fall 2010 issue of the Debevoise & indicate which industries fall into this Because the Chinese regulations (namely Plimpton Private Equity Report , we discussed “prohibited” category (and which are Circular 10) promulgated in 2006 have how China-based companies keen on listing encouraged, permitted or partially made it nearly impossible for Chinese outside China have been innovative in restricted). In addition, the Chinese companies looking to list outside China to adopting structures designed to address government limits foreign investment by set up the offshore holding company Chinese regulatory hurdles, including the prohibiting companies with foreign structure required for an offshore listing widely used variable interest entity (“VIE”) investors from obtaining permits to with direct ownership of the Chinese structure. Although long perceived as one conduct certain types of business. operating company, some companies have of the many “gray areas” of Chinese law, Naturally, with the ever-growing opted to use the VIE structure to over the past decade or so, companies using enthusiasm for investing in China and the circumvent the Circular 10 restrictions. VIE structures have not received real determination of Chinese companies to In the past decade, many Chinese negative attention from the Chinese seek foreign capital, it wasn’t long before a companies have successfully used the VIE government or the market. However, the seemingly acceptable work-around of this structure, often referred to as the Sina recent high profile challenges faced by foreign ownership limitation was developed. model after Sina.com successfully used the Buddha Steel and Alibaba Group, along The now prevalent VIE structure was structure for its U.S. IPO and NASDAQ with the even more recent news that initially introduced by internet companies listing in 2000. Nearly all offshore-listed government regulation of VIEs may be in the early 2000’s. Typically, under a VIE internet companies, including renowned under active consideration, remind foreign structure, a foreign holding company giants Sohu and Baidu, as well as hot IPO investors that these structures may be creates a wholly owned subsidiary in China newcomers Renren, Youku and DangDang, subject to increasing regulatory scrutiny in (which is a wholly foreign owned operate under VIE structures. These asset- China and could pose significant risks for enterprise, or “WFOE”). Instead of light internet companies have been investors. directly operating the restricted business or generally accepted as the model candidates Background owning equity interests in a company that for VIE structures, primarily because of the operates such business, the WFOE enters large number of precedents for the structure Chinese law prohibits foreign investors into a set of contractual arrangements with in the internet industry. Despite their from directly investing in certain industries, an operating company organized in China popularity with foreign investors, largely such as publishing, gaming and the internet (the so-called VIE) which allow the WFOE due to the fact that a VIE structure does sector. From time to time, the Chinese to obtain control over, and substantially all not require Chinese government approval, government publishes the “Catalogue for of the economic benefits from, the VIE. there has been no clear indication from the the Guidance of Foreign Investment” to United States and international government as to whether the structure accounting standards generally actually complies with Chinese law. permit (and require) the offshore Though obviously used as an avenue to Alan V. Kartashkin – Moscow Trust & Estate Planning holding company to consolidate circumvent restrictions on foreign Pierre Maugüé Jonathan J. Rikoon Margaret M. O’Neill Cristine M. Sapers the financial results of the VIE. investment or regulatory hurdles with Nathan Parker – London Employee Compensation Accordingly, the VIE structure respect to offshore listings, the Chinese A. David Reynolds & Benefits allows foreign investors to government has yet to take any overt Jeffrey E. Ross Lawrence K. Cagney Philipp von Holst – Frankfurt consolidate the financial and enforcement measures against the Jonathan F. Lewis

Tax Alicia C. McCarthy operating results of the restricted companies utilizing these structures. Thus

John Forbes Anderson – London Elizabeth Pagel Serebransky business without direct equity far, the strongest indication that the Eric Bérengier – Paris Charles E. Wachsstock

Andrew N. Berg ownership in the operating Chinese Government will issue a position The articles appearing in this Pierre-Pascal Bruneau – Paris publication provide summary company, thereby allowing foreign with respect to VIEs came during a Gary M. Friedman information only and are not investors to participate in restricted monthly news briefing earlier this month at Peter A. Furci intended as legal advice. Readers Friedrich Hey – Frankfurt should seek specific legal advice industries. which a spokesman for the Ministry of Adele M. Karig before taking any action with More recently, the VIE structure Commerce stated that the Ministry of Rafael Kariyev respect to the matters discussed in Vadim Mahmoudov these articles. Any discussion of has also been used to address a Commerce and other relevant agencies were Matthew D. Saronson – London U.S. Federal tax law contained in different regulatory issue in China. David H. Schnabel these articles was not intended or CONTINUED ON PAGE 4 Peter F. G. Schuur written to be used, and it cannot Richard Ward – London be used by any taxpayer, for the purpose of avoiding penalties that Summer 2011 Debevoise & Plimpton Private Equity Repor t page 3 may be imposed on the taxpayer l l under U.S. Federal tax law. Investing in China: New Risks? (cont. from page 3) collectively researching whether, and to law, which may not be sufficient or debating whether this marks the what extent, the VIE structure should be effective. Furthermore, the regulatory beginning of the end for VIEs or was a regulated. This notably vague and brief uncertainty regarding the validity of the more limited attack, possibly targeted at comment was issued just days after VIE contracts may impact the willingness the particular industry, reverse merger rumors began spreading in the Chinese of a court to enforce them. companies, or other unique circumstances. market that China’s securities regulator Companies employing the VIE One arguably distinguishing factor in the was applying pressure on the government structure are certainly aware of the various Buddha Steel case is that the company is to restrict VIE schemes. risks they face, as they routinely include a not engaged in an asset-light business such In addition to potential enforcement specific risk factor in their securities filings as the internet. A handful of internet action at some point, investors need to describing the potential issues. For companies with VIE structures have assess carefully certain related risks that are example, Renren’s offering document filed successfully completed U.S. initial public inherent in the structure. The contractual in April 2011 included the following offerings in the months following the arrangements that are the foundation of warning: “If the PRC government finds Buddha Steel case, including 21Vianet the VIE structure are infinitely more that the agreements that establish the Group, an internet data center operator, tenuous than outright ownership. structure for operating our services in and Renren, commonly referred to as Without direct shareholder rights and, China do not comply with PRC China’s facebook. thus, the ability to effect changes at the governmental restrictions on foreign Alibab a/Alipay board and management levels, operational investment in internet businesses, or if However, even among asset light internet control of the VIE is not absolute, these regulations or the interpretation of businesses, VIEs are not completely particularly if the VIE decides not to existing regulations change in the future, immune. Another curious incident was perform its contractual obligations under we could be subject to severe penalties or revealed in May 2011 as the events the VIE agreements with the offshore be forced to relinquish our interests in surrounding Alibaba and the disappearing holding company. Enforcement of the those operations.” act of Alipay unfolded. The situation VIE’s obligations would likely involve Buddha Steel developed when Yahoo Inc., a major substantial cost and would be subject to In March 2011, Buddha Steel, a China- shareholder of Alibaba, revealed in a the legal remedies available under Chinese based company that went public in the regulatory filing that unknown to them, U.S. by means of backdoor listing ( i.e. , a Alibaba had transferred the assets of its The contractual reverse merger with a U.S. shell leading online payment unit, Alipay, to a company), withdrew its registration Chinese company controlled by Alibaba’s arrangements that are the statement for a U.S.$38 million chief executive and acclaimed underwritten public offering in the U.S. entrepreneur Jack Ma. foundation of the VIE The company stated in a press release that According to Alibaba, in response to a they were advised by local governmental recent PRC regulation enacted by the structure are infinitely authorities in China’s Hebei Province that Chinese banking authorities, which stated more tenuous than their VIE agreements “contravene current that only domestically-owned enterprises Chinese management policies related to can obtain licenses for operating third- outright ownership. foreign-invested enterprises and, as a party payment systems, Alibaba decided to result, are against public policy.” (The transfer Alipay to a Chinese company ...Furthermore, the fact that this challenge arose at the local owned by Jack Ma with which Alibaba regulatory uncertainty rather than national level itself is had a VIE arrangement. However, Alipay indicative of a trend in China toward was still unable to obtain the license from regarding the validity of increased power and autonomy of local the banking authorities due to its VIE ties governments, which is further discussed with the partially foreign-owned Alibaba. the VIE contracts may below.) Alibaba then terminated the VIE Since this case occurred, lawyers, CONTINUED ON PAGE 5 impact the willingness of scholars, and other observers have been a court to enforce them.

page 4 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Investing in China: New Risks? (cont. from page 4) contracts, essentially breaking the ties which Beijing seems to have largely involved in a sensitive or highly-regulated between Alibaba and Alipay, and de- accepted, might be challenged, and that industry in China. Even though there are consolidating Alipay from Alibaba’s different rules will apply depending on many successful asset-light internet financials. which local government is overseeing the companies whose VIE structures have not Mr. Ma said that he believed particular company. In light of the been challenged, the Alipay case and the terminating the VIE contracts was the significant attention the Buddha Steel and recent comments by the Ministry of right decision given that the VIE structure Alipay cases received, and the recent Commerce demonstrate that even asset- remains unapproved by the Chinese comments by the Ministry of Commerce, light structures are not bullet proof. It is government and that Alipay could not the Chinese government will hopefully too early to tell whether and when the otherwise acquire the necessary license to move to address the uncertainty Chinese government will start to regulate enable it to operate legally. Yahoo claimed surrounding the validity of VIE structures VIEs. Investors in China should keep an that the transfer of Alipay to Mr. Ma’s by simply clarifying the legal status of eye out for further developments, if only private company was not approved by VIE’s, but unless and until that occurs, to honor the Chinese adage that warns Alibaba’s board and was not disclosed to investors in these structures will have 空穴来风未必无因 (“the wind does not Alibaba’s investors until March 2011. cause for concern. blow from a cave for no reason,” which Four months after the dispute arose, The Buddha Steel and Alipay cases roughly translates as “where there is smoke Yahoo and Alibaba resolved the issue in a indicate that the Chinese government may there may be fire”). Foreign interest and deal that at the moment appears to have completely ban the use of VIE structures involvement in China will only increase as appeased all parties, guaranteeing Alibaba in certain sectors. With respect to China continues its rise as a major world a $2 billion to $6 billion payment upon Buddha Steel, it should be noted that player, and it will be more important than the occurrence of a liquidity event by China is the world’s largest steel producer ever for foreign investors to proceed with Alipay, such as an initial public offering. and consumer, and almost all major caution as they take advantage of the Alipay has also secured the necessary Chinese steel producers have some many opportunities China has to offer. license. government ownership. It is not Edward Drew Dutton surprising then that China has heavily Implication s/Conclusion [email protected] regulated its steel industry, a key pillar of While the Buddha Steel and Alipay its economy, and may, therefore, be Niping Wu situations may not definitively foretell sensitive to how companies like Buddha [email protected] VIEs’ fate, they certainly highlight the Steel are structured and to the extent of need for foreign investors to understand, foreign involvement. Likewise, the and Chinese regulators to clarify and government’s regulation of online address, the risks associated with It seems unlikely that payment platforms like Alipay, which led investments using the VIE structure. to Alibaba spinning off the company, the Chinese government These cases serve as a clear reminder that could be considered consistent with the the risks associated with VIE’s (and similar government’s considerable oversight of its will enact regulations legal “gray areas” in China) should not be banking industry. While China is still underestimated. systematically developing the legal framework governing Although it is still too early to tell the online payment industry, the whether the Chinese government will prohibiting VIE industry’s involvement with the sensitive enact regulations systematically financial and banking sector certainly structures, but there prohibiting VIE structures, there may well makes it a likely target for heightened be increased scrutiny of these companies, may well be increased government scrutiny. perhaps by local authorities, as was the Foreign investors who are involved in case in Buddha Steel. The growing scrutiny of these any VIE arrangements should carefully independence of local governments clearly assess the related risks with experienced companies.... increases the risk that these structures, counsel, particularly if the company is

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 5 Rehoboth Beach Reading: Catching Up on Delaware Cases

On the off chance that your summer beach Grades , which looked at the Health Grades a board can use a poison pill to “just say ‘no’” reading did not involve plowing through a board’s decision to agree to a sale to a private to a fully financed cash tender offer made to stack of opinions of the Delaware Court of equity sponsor without a pre-signing market well-informed target stockholders; and Chancery, we offer this brief review of cases check, and Del Monte , which discussed the Krieger v. Wesco Financial Corp. , which arose decided over the last year or so that are likely process leading up to Del Monte’s sale to a from a going-private transaction between a to be of interest to the private equity consortium of private equity sponsors. Taken publicly traded company and its controlling community. together, these cases show that while stockholder, which discussed the standard of Three of these cases review the conduct of Delaware courts give broad latitude to target scrutiny applicable to such a transaction target company directors under the Revlon boards in structuring a sale process, they take when there are robust procedural protections doctrine, which imposes upon directors a a closer look when the buyer is a financial for the minority stockholders. duty to seek the best price reasonably sponsor, particularly in the absence of a pre- William D. Regner available in a change of control transaction. signing market check. [email protected] Those cases are Dollar Thrifty, which The other two cases cover areas that have reviewed the Dollar Thrifty board’s decision long been fertile ground for M&A litigation: Dmitriy A. Tartakovskiy to sign a merger agreement with Hertz, the Airgas case, which arose from Air [email protected] including deal protection provisions, without Products’ long and ultimately unsuccessful giving Avis a chance to bid; Forgo v. Health takeover battle for Airgas, considered whether

Case What It Held Why It Matters Dollar Thrifty Dollar Thrifty’s directors did not breach l Affirms concept that Revlon does not mandate an auction (Del. Ch. Sept. 8, 2010) their Revlon duties by signing a merger process, and that boards have broad discretion in agreement with Hertz without trying to structuring a sale process induce Avis to make a higher bid or by agreeing to include deal protection l Acknowledges that boards can consider risk of non- provisions in the merger agreement completion (including antitrust risk) in determining whether an offer is superior

Forgo v. Health Grades, Inc. Vestar tender offer for Health Grades l Suggests that courts will look more closely at an exclusive (Del. Ch. Sept. 3, 2010) allowed to proceed, but plaintiffs showed process resulting in a sale to a PE sponsor reasonable probability of success in proving their Revlon claim given exclusive sale l Reinforces idea that while they have broad discretion, boards process need sound reasons for selecting a particular sale process

Air Products & Chemicals v. Airgas Airgas directors did not breach their l Reminds that directors, and not stockholders, have (Del. Ch. Feb. 15, 2011) fiduciary duties by refusing to dismantle a authority to manage the corporation poison pill in the face of an all-cash, fully- financed and non-discriminatory tender l Upholds idea that companies can ‘just say ‘no’”—under the offer by Air Products right circumstances

Del Monte Del Monte directors, aided and abetted by l Demonstrates that target’s process problems can become (Del. Ch. Feb. 14, 2011) buyers, probably breached their fiduciary buyer’s problems duties by failing to provide adequate oversight of sale process where two bidders l Highlights Delaware court focus on financial adviser were permitted to bid jointly and the target conflicts and related disclosure (see also, Art Technology financial adviser conducting the sale both Group, Steinhardt and Atheros Communications cases) participated in buy-side financing and conducted go-shop

Krieger v. Wesco Financial Corp. Berkshire Hathaway’s going-private merger l Proves that Vice Chancellor Laster is willing to review (Del. Ch. May 10, 2011) with Wesco upheld under the business going-private deals under the deferential business judgment judgment rule, given duly empowered rule standard, if proper procedural protections are in place special committee and non-waivable majority-of-minority vote condition l Shows that the Delaware legal standard for going-privates remains unsettled, since other judges use different tests

page 6 l Debevoise & Plimpton Private Equity Repor t l Summer 2011

GUEST COLUMN Is Russia Ready for Serious Attention from Private Equity Investors?

Of all of the major emerging markets, decided we needed a collaboration in consumer markets in the world, with the Russia has the least developed private order to improve the image of Russian largest consumer base in Europe and very equity industry. Yet, it has significant private equity, influence relevant attractive investment opportunities. We potential for development in a variety of legislation, and enable the flow of capital see no reason why the LP/GP structure, areas, ranging from health care to into Russian private equity funds. which has proven effective throughout the technology to financial services. And the world, shouldn’t work here. Who are the current members of the much-heralded Russian Direct Investment With that message in mind, we Initiative? Fund, a $10 billion vehicle, backed by the decided that rather than focusing only on Russian government and advised by some The Initiative has been supported by all the local market, we should cooperate of the biggest names in private equity, major players of this very small universe of with private equity groups outside of presents opportunities to co-invest GPs, including Baring Vostok Capital Russia to bring foreign capital into this alongside a government partner, which Partners, Alfa Capital Partners, Troika country. In March 2010, we co-hosted a should provide a greater degree of comfort Capital Partners, NRG Advisers, DaVinci, CONTINUED ON PAGE 8 to foreign private equity firms investing in and UFG Capital. And, we have a very Russia for the first time. Debevoise’s strong commitment from a number of Geoff Burgess, Geoff Kittredge and leading service providers and advisers in We launched [the] Kristina Chapala Barker recently had an this area including law firms, large audit opportunity to speak with Alexander companies and management consultants. Initiative to make [the Pankov and Kirill Samsonov, the co- We also believe it is important, in this still PE] asset class more founders of the Russian Private Equity very fragmented private equity ecosystem, Initiative (RPEI, or the Initiative), to learn to build relationships with government important, both in more about the burgeoning private equity regulators, trade unions and associations industry in Russia, as well as the representing both large corporations and monetary terms and in Initiative’s role in fostering its growth small and medium enterprises, the terms of impact on the through collaboration with government entrepreneurial community in Russia, and stakeholders and domestic and different industry-related groups like the Russian economy... international industry participants. Russian Union of Insurance Companies and the Russian Association of Banks. With [these] efforts RPEI was created in 2010 with the aim of facilitating the development of What measures/actions has RPEI and...the government’s private equity industry in Russia. What initiated/commenced so far to promote are the primary goals of the Initiative? Russia’s image as a safe market for interest in attracting foreign investment relative to other RPEI’s primary goal is to create a private emerging markets? foreign capital and raising equity industry in Russia, which is currently in its infancy and does not have First, we cannot say that Russia is a truly the profile of the Russian a unified representative body or forum. safe, comfortable market for foreign LPs at economy in general, we There are only about ten major Russian this time, and our objective is not to private equity sponsors; limited partners position it that way. Rather, we wish to expect very dynamic of local origin do not invest in this asset communicate to the broader global class, and the country is still below the investor community that Russia is one of growth in the Russian radar for most international investors. We the most dynamic and fastest growing private equity industry in the next two to five years. Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 7 Is Russia Ready for Serious Attention from Private Equity Investors? (cont. from page 7) seminar in London with the British Although nearly 20 years of private in large cities. Private Equity & Venture Capital equity investing is already behind us and Another area would be specialty Association on Russian private equity, and there have been some visible results, retail—in household goods, electronics, we hope to host similar events with other given the size of the Russian economy books, and other sub-segments, there are a European, U.S. or Asian associations. This and the many opportunities in the lot of opportunities. The Moscow and St. sort of marketing is a really important step Russian market, private equity is still in Petersburg markets are fairly saturated, but in bridging the gap in perception of how its infancy compared to emerging in regions where the market is not the markets work and what Russian markets such as Brazil, China, India, and consolidated, especially in Siberia and the private equity is all about. Vietnam. The generally accepted Far East, unstructured retail is still very estimate is that private equity investment dominant—a lot of open-air markets and What measures have been taken by as a percentage of GDP totals less than kiosks and other unstructured formats— RPEI to improve the visibility and 0.1%, well below most other private so on this front there is a lot of potential. availability of exit information and equity markets in Europe, Asia and the Given the ambitions of our authorities performance data to make a case for Americas. We launched our Initiative to to create an international financial center Russian private equity investors’ make this asset class more important, here, the financial services market will ability to deliver returns that outweigh both in monetary terms and in terms of definitely be given an additional boost. the risks? impact on the Russian economy, because Finally, another promising and young This is the primary mandate of the the growth potential here is really industry is technology. There are already Initiative’s information and statistic phenomenal. With our efforts and with some major success stories, including policy campaigning committee. Their the government’s interest in attracting Yandex, the largest online search engine in goal is to increase the transparency of foreign capital and raising the profile of Russia, and Kaspersky, a very high profile the Russian private equity market by the Russian economy in general, we antivirus software developer with a creating a comprehensive database on expect very dynamic growth in the minority stake owned by General Atlantic. the market, which simply does not exist Russian private equity industry in the What do you think are the main today. We have teamed up with next two to five years. concerns and challenges that deter Thompson Reuters to conduct the first In your opinion, what industries international private equity investors Russian private equity performance currently represent the greatest interest from investing in Russia? survey, pooling data from individual and potential for private equity GPs, from the launch of their funds and The most significant challenge is the investments in the region and will be the their first investments to 2010. Our intent perception. It is not really the state of the most active over the next 2-3 years for is to distribute the results to all major industry, because while it is new, it is private equity investments and exits? associations, large media companies and developing rapidly and presents some stakeholders in finance and private equity. Historically, private equity firms have great opportunities to explore. But there is Once we publish the data (in the fourth exploited opportunities in the consumer a lot of negative foreign press around quarter of 2011, we believe), many people sector, and the recent credit crunch Russia in general. Very few success stories will realize that the Russian market is actually has not changed this strategy so are really communicated to the investor really overlooked. If you look at Baring’s far. One emerging sub-sector in the community. Most people have heard returns, for instance, you see stellar consumer space is definitely health care. about DST, mail.ru and now Yandex, but growth and stellar IRR, especially given The consumer class is growing, people are there are a lot of other interesting cases their latest exit from Yandex, the largest becoming more demanding in terms of like Pepsico, McDonald’s, Ford, Coca- online company in Russia and one of the the level of services rendered by health Cola, UniCredit, and Ikea (in terms of largest in Europe. care institutions, and the state sector has profit per square meter, Ikea Russia is the no capacity to deliver this level of service most successful unit of Ikea globally), but How would you describe the current to the public. So, we are seeing spectacular very few people recognize how successful state of the private equity market in growth in private health care centers, such strategic players are in Russia. Of course Russia, its role in the economy of the as diagnostic labs, private nursing homes, country and its outlook? CONTINUED ON PAGE 24 and general health care facilities, especially page 8 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Doing Business in the UK Under the Newly-Enacted Bribery Act

The much-heralded UK Bribery Act of that this would make firms with a or other advantage to an FPO, even absent 2010 (the “Act”) has finally become “demonstrable business presence” in the UK any intent to induce the improper effective. It is a sweeping law that reaches subject to the Act’s jurisdiction. Therefore, performance of his or her duties. companies around the world and private equity firms or portfolio companies The government has assured the public criminalizes the offer, provision and that are organized in the UK or that engage that reasonable and proportionate business acceptance of bribes, both to public officials in the following types of activities are well- hospitality is acceptable if it is for a and, importantly, and in contrast to the advised to consider their exposure as they legitimate business purpose, such as better United States Foreign Corrupt Practices Act may be subject to the Act: presenting a company’s products or services, (“FCPA”), to private individuals. The Act improving its image or creating or l Operating an office in the UK; also imposes criminal liability on maintaining cordial relations with contacts. commercial organizations (including private l Regularly holding business meetings in Industry norms are relevant, although equity firms) for the new offence of failure the UK; spending that is too lavish or extravagant to prevent bribery by an associated l Fundraising in the UK; or may lead to an inference of attempts to person—the so-called “corporate offence.” improperly influence the recipients. It is, therefore, crucial that private equity l Having a UK-organized subsidiary or Companies may take account of what firms (and their portfolio companies) one that itself carries on business in the business contacts expect. For example, consider whether they could be liable under UK (unless the subsidiary acts entirely Director Alderman has stated that flying a the Act, and take appropriate steps to independently of the parent). senior individual from a sovereign wealth protect themselves. It is clear that many private equity firms fund business class and putting him or her We previewed the Act in the Summer 2010 are likely to be subject to the Act. For up in a good hotel would not be Debevoise & Plimpton Private Equity Report . example, a firm with portfolio companies problematic—though putting him or her That report described in detail the offences that have operations in the UK would be up for a month with family would be. In under the Act, the Act’s global assertion of subject to the Act, unless the firm has no, sum, hospitality is fine, but it must be jurisdiction, and the defence of “adequate or minimal, control or influence over the sensible; one rough test that has been procedures.” Since then, the UK portfolio companies (which is unlikely to be suggested is whether it would cause government has released further guidance the case other than where the firm holds a embarrassment if it were to be disclosed on regarding the Act, and Debevoise has minority stake). the front page of the Financial Time s or The hosted a round table between leading If a firm is subject to the Act, there are Wall Street Journal . members of the private equity industry and four particular areas of focus: (1) corporate Private equity firms are strongly advised Richard Alderman, the Director of the hospitality; (2) intermediaries; (3) responsibilit y to review their corporate hospitality policies Serious Fraud Office (“SFO”), the chief for activities of portfolio companies; and and practices, and, in particular, to ensure prosecutor of the Act. As a result, our (4) individual employees’ responsibilities. that corporate entertainment (particularly at understanding of how the Act will affect large-scale events, like investor conferences) private equity firms and their portfolio Corporate Hospitality is reported and tracked, and can always be Prior to the Act’s implementation, there was companies in practice has been greatly justified from a commercial point of view. great concern that it would ban or severely enhanced. limit corporate hospitality, particularly since Intermediaries Jurisdiction the Act, unlike the FCPA, criminalizes As a general matter, the most common The test of whether an act outside the UK commercial bribery as well as bribes of circumstance in which companies fall foul is subject to the Act varies according to the government officials (so-called Foreign of anti-corruption laws is when particular offence. In relation to the Public Officials or “FPOs”). The concern intermediaries, particularly, but not solely, corporate offence, it applies to companies was particularly acute with respect to those hired to do business with and partnerships “carrying on business” or a hospitality offered to FPOs, given that governments on a company’s behalf, pay “part of a business” in the UK. The UK Section 6 of the Act criminalizes the bribes. Private equity firms must take care Ministry of Justice has stated in guidance offering, promising or giving of a financial CONTINUED ON PAGE 10

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 9 Doing Business in the UK Under the Newly-Enacted Bribery Act (cont. from page 9)

to guard against such dangers, especially as could be different though if you were far resourced, well-considered, fully regards intermediaries dealing on their more actively involved in the management of documented compliance review. The SFO behalf with sovereign wealth funds or the company and were running it. ” The has offered to provide guidance to public pension funds. SFO assumes that most private equity companies that discover corruption Best practices should include a threefold firms are active and sophisticated investors problems during such pre-acquisition due approach to the hiring of intermediaries. who know what is happening in their diligence. First , thorough due diligence should be portfolio companies. This does not, Individuals’ responsibility carried out (and documented) in order to however, mean that wrongdoing at a Finally, private equity firm employees, understand who the intermediary is, what portfolio company will automatically be especially those who sit on the boards of services it will provide, and how it will attributed to a private equity firm that portfolio companies, should be aware that provide the services. Second , contracts owns a majority of it. Where the private section 14 of the Act provides that they with intermediaries should include equity firm did not know about the will be individually and criminally liable if appropriate safeguards, such as problems, the SFO will be unlikely to they consent to, or connive in, bribery at representations and covenants against ascribe responsibility to it (although the the portfolio company. Note that to improper payments; audit rights and portfolio company itself would of course “connive” is to be aware of what is going termination clauses are also particularly still have a problem). In addition, on and to provide tacit agreement even important. Third , firms must monitor holding a firm responsible for a bribe paid though there may be no active and oversee intermediaries’ activities, and by a third-party agent of a portfolio encouragement; “consenting” requires a must continually satisfy themselves that company might be difficult given the Act’s somewhat greater level of involvement. they know exactly what they are paying requirement that such payments be made Such employees, therefore, have an even for. These practices may be no different in order to obtain or retain business or a greater incentive to ensure that portfolio from those generally applied to guard business advantage for the private equity companies have a robust anti-bribery against FCPA risks, but the fact that the firm itself (rather than solely the portfolio culture. activities of intermediaries may now be company in question). scrutinized by the SFO, in addition to the Nonetheless, the SFO will expect Conclusion U.S. authorities, raises the stakes private equity firms to take some Taking appropriate action on all of the considerably. responsibility for good governance at their above measures would go a long way towards the implementation of the Responsibility portfolio companies, including fostering “adequate procedures” envisioned by the for Portfolio Companies an anti-corruption culture. Where possible, this would include reviewing, Act, which would provide private equity Possibly the most important and complex and, if necessary, revising or instituting, firms with an absolute defense if problems question for private equity firms arising anti-corruption policies at portfolio ever do arise at a firm, a portfolio company from the Act is whether a firm’s portfolio companies. Where that is not possible, or through any other associated persons. company is an “associated person,” thus firms should use their position of Private equity firms with any connection to making the firm itself liable for improper influence to recommend that such actions the UK should consult with their legal actions of the portfolio company. The are taken. If a firm finds that a portfolio advisors to determine whether the Act answer remains unclear, though it will company has followed or intends to follow applies to them, and if so, should move depend on the circumstances and the an improper course of conduct, and is quickly to establish such measures. precise relationship between the sponsor refusing to halt or remediate that activity, and the portfolio company. David Innes the private equity firm’s directors should As Director Alderman stated at the [email protected] seek counsel on whether it is appropriate round table: “ If this is simply a portfolio for them to stay in office. Karolos Seeger investment and your role is simply one of In order to minimize the risk of facing [email protected] owners, then employees and agents of the such situations, private equity firms company are not performing services for you Matthew Howard Getz should ensure that their standard pre- [and are therefore not associated persons]. It [email protected] investment due diligence includes a well- page 10 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Boosting EBITDA:

The Cost Savings Add-Back

The recent performance of the financial with, but is different from, the add-back While differing in this way, the two markets obviously engenders some based on permitted acquisitions or add-backs share a key feature: both uncertainty as to the near-term health of dispositions and the add-back for business adjustments are typically made on a pro the credit markets. But, assuming that optimization expenses or restructuring forma basis. negotiation of a credit agreement will not charges. Financial covenants—such as a leverage become a lost art, we will discuss in this ratio, an interest coverage ratio or a fixed Cost Savings Versus Permitted article a crucial aspect of that negotiation, charge coverage ratio—are typically Acquisitions or Dispositions which are the various adjustments that a calculated using inputs that are derived Credit agreements often permit a sponsor’s portfolio company can make to from the financial statements of the borrower to adjust its EBITDA to account net income in order to compute EBITDA. borrower— e.g. , indebtedness, EBITDA, for the EBITDA of an entity acquired by These adjustments always command a interest expense, and fixed charges. the borrower or of a line of business sold great deal of attention and discussion in Credit agreements typically define the test by the borrower. This adjustment the course of negotiations of leveraged period over which EBITDA and other sometimes makes it possible to take into acquisitions, as the impact of various items, such as interest expense or fixed account anticipated costs savings or events and circumstances can have a charges are measured, often a rolling four synergies resulting from the relevant significant impact on EBITDA quarter period (which may include an acquisition or disposition. (particularly in the current ecomomy) annualization mechanic for the first few The main difference between that and, thus, on a portfolio company’s ability quarters). In all cases, because EBITDA adjustment and a cost savings add-back is to meet applicable financial tests under and other items are determined over an the trigger. In its most open ended form, their credit agreements. entire test period, events that occur a cost savings based add-back is available One such adjustment that has been a towards the end of the test period may as a result of any specific action or particular focus of attention even prior to have a relatively modest impact on operational change that can lead to the recent dislocation in the financial EBITDA or the relevant item for the ongoing expense savings for a borrower markets is a pro forma add-back for cost period, and events that occur after the test and does not require that such change be savings—specific events that reduce the period will have no impact at all. Pro connected in any way to the acquisition expenses of the borrower on a recurring forma adjustments, however, enable or disposition of a business. For instance, basis and, therefore, can have a positive borrowers to treat certain events as if they cost saving add-backs could consist of impact on net income under credit had occurred at the beginning of a test recurring savings associated with the agreements providing for such add-backs. period, thereby giving effect to such elimination of employee redundancies, the This article focuses on this type of add- events for the entire test period regardless closure of a plant, the implementation of back to EBITDA and contrasts it with of when they actually occurred. In the a change in the supply chain or any other two other common adjustments to net context of an acquisition, this approach operating improvement. Actions of that income under credit agreements in the allows a borrower to add to its own sort are more solely within the control of leveraged acquisition context: the add- EBITDA the EBITDA of the acquired a borrower than an acquisition or sale of a back based on permitted acquisitions or entity for the entire test period as if the business, which necessarily involves a dispositions and the add-back for business acquisition had been consummated as of third party. A cost savings-based add- optimization expenses or restructuring the first day of such period, regardless of back to EBITDA can accordingly be a charges. when the acquisition actually closed in very attractive provision in a credit that period. In the context of the sale of a Distinguishing the Cost agreement, particularly for portfolio business, this enables the borrower to Savings Add-Back from Other company borrowers that expect to attain back out from its EBITDA calculation for Add-Backs business improvements principally the entire period the EBITDA of the line An add-back to EBITDA based on a cost through internal change instead of, or in savings program shares some features addition to, activity in the M&A market. CONTINUED ON PAGE 12

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 11 Boosting EBITDA: The Cost Savings Add-Back (cont. from page 11) of business that was sold (that is, for the impact of the relevant expenses. Put Regulation S-X under the Securities Act period of time prior to the sale when the differently, the one time expense is of 1933, as amended (“Regulation S-X”) business was still owned by the simply ignored for purposes of the or that are based on assumptions borrower), thereby improving EBITDA EBITDA calculation. By contrast, an approved by the Administrative Agent. to the extent the business that was sold add-back for recurring cost savings of Effectively, this would give the was generating negative EBITDA. the type described above enables a Administrative Agent control over all pro The add-back for cost savings borrower to increase EBITDA by forma adjustments that go beyond the operates in the same manner: the enabling the borrower to go back in time Regulation S-X standard. The relevant borrower can be allowed to add back the and give effect to a cost savings program provisions of Regulation S-X describe relevant cost savings on a pro forma basis with respect to the test periods prior to the circumstances in which pro forma as if the relevant action or program that its implementation. financial statements should be presented triggered the savings had been taken at The distinction between a cost in filings in the context of business the beginning of the test period in savings based add-back to EBITDA on a combinations, acquisitions and question. pro forma basis as compared to the add- dispositions and provide guidance to be back for business optimization and other considered in their preparation. Rule Cost Savings Versus Business restructuring charges is illustrated by an 11-02(b)(6) contemplates that pro forma Optimization Expenses and Other employer’s rationalization of its work adjustments to the income statement Restructuring Charges force. The one-time severance, retention shall include adjustments that give effect Business optimization expenses and and relocation costs potentially to events that are “(1) directly restructuring charges—such as one time associated with such a rationalization attributable to the transaction, (2) expected costs associated with (1) inventory may constitute “extraordinary, unusual, to have a continuing impact on the optimization programs, costs relating to and non-recurring items” and, registrant, and (3) factually closure or consolidation of facilities, (2) depending on the credit agreement in supportable.” By way of example, retention, severance or relocation costs, question, can be eliminated from the infrequent or nonrecurring items (3) system establishment costs and (4) calculation of a borrower’s EBITDA as included in the underlying historical excess pension charges—reduce net of the date incurred. In contrast, the financial statements of a registrant or income for the period during which they recurring cost savings associated with the other combining entities and that are are incurred. Under certain credit lower labor cost and other potential not directly affected by a transaction agreements, borrowers may be permitted synergies associated with the same should not be eliminated in arriving at to add back these expenses to EBITDA rationalization can, again depending on pro forma results. 1 under a separate, general add-back for the credit agreement in question, Limiting the pro forma adjustments “extraordinary, unusual or nonrecurring potentially be added back on a pro forma by reference to Regulation S-X would items.” Credit agreements also basis from the beginning of the considerably narrow the universe of sometimes include a specific add-back applicable test period, thereby increasing possible adjustments. Indeed, under for business optimization expenses and a borrower’s EBITDA for the test period Regulation S-X, the pro forma financial other restructuring charges of this kind. not just neutralizing such cost. information should illustrate only the Such a specific add-back eliminates the isolated and objectively measurable need to analyze whether or not the Types of Permitted (based on historically determined relevant expenses are of an “extraordinary, Adjustments amounts) effects of a particular unusual or nonrecurring” nature. The type of action or cost savings plan transaction, while excluding effects that Importantly, this type of add-back is taken into account for a cost savings rely on highly judgmental estimates of not applied on a pro forma basis. Rather, add-back is rarely defined with how historical management practices and these one-time expenses are added back specificity. operating decisions may or may not have to net income so that the relevant The Regulation S-X Standard expenses do not impact the EBITDA CONTINUED ON PAGE 24 Credit agreements sometimes try to limit calculation. So, the add-back provides permitted pro forma adjustments to those no benefit beyond neutralizing the 1 Division of Corporation Finance's Financial that would be permitted or required by Reporting Manual, Section 3230.4. page 12 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Brick by Brick: A Primer for Due Diligence in Each BRIC Country, Continuing with India

Our four-part series on doing due diligence uncommon for private companies to have recently starting making decisions in the world’s largest emerging markets, now stage the availability of documentation, available online, and there are known colloquially as BRICS, continues in such that the most sensitive materials initiatives to make land records this issue with a discussion of India. (whether related-party transaction available on the internet as well. documentation or otherwise) are However, these efforts are in a nascent Some of the themes that we have explored provided only at the end of the process, stage and do not currently ensure that in the first installment of this series, and sometimes in a very limited the information is accurate or covering China, are equally relevant in format. This access might consist comprehensive. India. For instance, tangled related party solely of having materials shown for a transactions and a general lack of Business Due Diligence fixed period of time to local counsel familiarity with, and reluctance to be only, without the ability to make l Foreign investment restrictions: Foreign subjected to, the due diligence process copies or even to take notes! Direct Investment (FDI) into India is also feature prominently in India. On the governed by, among other things, the l Internal organization: Indian other hand, Indian targets often present FDI policy of the Government of businesses are mostly promoter led and additional challenges, including assessing India, and the inflow and outflow of complex and costly litigation risks and family controlled and usually have their sorting through Byzantine land title in-house legal, compliance and issues. At the end of the day, performing accounting-related work being handled CONTINUED ON PAGE 14 business, legal and accounting due by a single department. Information diligence in India starts with an and knowledge regarding company appreciation of the unique characteristics matters are generally centralized (since While foreign investors are of many Indian businesses. the owners retain tight control), but it permitted to own 100% of can still take companies some time to Due Diligence Process gather such information. Companies businesses in most l Familiarity with due diligence process also routinely rely on chartered and requirements: While there is no accountants to take care of corporate sectors..., certain critical statutory definition of “due diligence” formalities. This can create issues with in India, contracting parties are corporate records, such as board or sectors (such as defense, expected to exercise diligence while shareholders’ meeting minutes, as well telecom, insurance and entering into a contract, and the law as the registry of share ownership and does not enable a party to avoid a transfers. energy) are subject to contract on account of a fraudulent l Availability of public search resources: misrepresentation if the aggrieved party foreign ownership caps Database searches, such as litigation had the means of discovering the truth and lien searches, that are widely and restrictions, and prior with “ordinary diligence.” Public consulted in the due diligence process companies in India are familiar with in western countries, are not available approval from the the due diligence process since Indian in India. Coupled with the broad securities laws require them to disclose Government of India or geographical span of the country, the certain information to the Securities various levels and hierarchy of courts Exchange Board of India. Private registration and approval and tribunals, the overlapping, but companies need much more guidance limited, jurisdiction of various courts from the RBI is required and are less willing to share information makes it an uphill battle to track such with outsiders. In fact, it is not information online. Courts in India before investing in these sectors. Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 13 A Primer for Due Diligence in Each BRIC Country (cont. from page 13)

foreign capital is regulated by the exceedingly complex bureaucracy and l Corporate governance: Newly-listed Foreign Exchange Management Act, a regulatory system with seemingly companies in India and public 1999. While foreign investors are ambiguous and imprecise rules. Each companies above a certain prescribed permitted to own 100% of businesses sector has its own list of licenses and size have to comply with the listing in most sectors and can invest via the approvals that are required from both agreement of the stock exchanges, “automatic route,” which does not the central and state governments. which imposes certain U.S.-style require prior approval by either the Usually, a financially stable company independent director and audit Government of India or the Reserve that has been in business for a while committee requirements. However, Bank of India (RBI), certain critical will have its licenses and approvals in the reality is that independent sectors (such as defense, telecom, order, but there are many companies directors do not play the type of insurance and energy) are subject to that do not. proactive role that has become more foreign ownership caps and The undue red tape linked to common in the United States and the restrictions, and prior approval from doing business in India has prompted UK, and are very rarely willing to the Government of India or the World Bank to rank its economy present conflicting viewpoints from registration and approval from the 135th out of 183 world economies those favored by the promoters. RBI is required before investing in for “ease of doing business.” In Importantly, private companies are these sectors. In addition, wholly- response, the Government of India under no obligation to install any owned Indian domestic subsidiaries of and various state governments have corporate governance mechanisms. non-resident entities are treated as recently been aggressively trying to Legal Due Diligence foreign companies for FDI purposes. remove regulatory logjams by creating “single window clearances” for setting l Litigation: India has the world’s l Licenses and approvals: Companies up businesses in various non-critical largest backlog of cases with over 30 operating in India must navigate an sectors. These initiatives to more million proceedings pending before streamlined approvals should be the courts. It is estimated that an average lawsuit takes 15 years to get When investigating particularly helpful to companies operating in the infrastructure sector, resolved in India. When investigating pending litigation of the where development permits take more pending litigation of the target time than expected to obtain, if they company, foreign investors should target company, foreign can be obtained at all. keep in mind the potential delays and the costs of such delays (litigation l Corruption: Corruption remains a investors should keep in related legal costs are relatively high challenge of investing and doing when compared to other countries, mind the potential delays business in India. The risk is higher including even the U.S.), as well as in business sectors that operate under the unpredictability of court and the costs of such governmental concessions or decisions. It is worth noting, authorization (sectors such as real delays.... India has the however, that India does have a good estate, infrastructure, telecom and arbitration law, which is drafted along power). It should be noted that many world’s largest backlog of the lines of the UNCITRAL model large companies in India are State- and most companies typically include cases with over 30 million owned or controlled, and, therefore an arbitration clause in their business directors and employees of such proceedings pending agreements. companies are deemed to be before the courts. It is “government officials” under the l Labor laws: There are over 50 laws at Foreign Corrupt Practices Act and the the national level and several more at estimated that an average UK Bribery Act, with the result that the state level that govern and regulate payments made to them fall within the Indian labor market. These laws lawsuit takes 15 years to the laws’ restrictions. CONTINUED ON PAGE 26 get resolved in India. page 14 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Brazilian Private Equity Funds: Current Developments

As previously reported in this publication Brazilian Investor Effect of Inflation and Currency (see, “Coming to Brazil: The World Cup, The Considerations Movements Olympics and More Private Equity,” Spring Although Brazil has a relatively long- The rate of consumer inflation in Brazil, 2010 Debevoise & Plimpton Private Equity standing history of domestic private equity presently running between 6% and 7%, is Report ), Brazil has become an increasingly funds, the terms that Brazilian investors considered high, even for developing popular destination for private equity have historically commanded have not fully economies. Brazilian government efforts to fundraising and investment. Events since converged with the terms prevalent in the control inflation have relied mostly on that article was published certainly indicate international funds market. This interest rate increases, and the base interest that the trend is continuing. The latter part discrepancy is partly driven by regulation rate in Brazil (SELIC), currently at 12% of 2010 and the first half of 2011 witnessed and partly by market practice. The (recently cut from 12.5%), remains among successful closings of several Brazil-focused differences are especially pronounced with the highest in the world. High interest rates, funds with commitments exceeding $1 respect to Brazilian pension fund investors combined with the continued financial billion, and sources indicate that other funds in the area of fund governance. Brazilian torpor and low yields in developed in the capital-raising stage are seeking pension funds generally require investor economies, make Brazil particularly upwards of an additional $10 billion. The representation on fund investment susceptible to speculative “carry trades” in sponsors of these funds include both committees, which gives investors the which money is borrowed in foreign established and relatively new Brazilian ability to influence, and perhaps even currencies at low interest rates and then private equity firms, as well as U.S.-based and block, investments and exits. Rights of this converted into reais and invested in Brazil at international sponsors expanding operations nature are extremely rare in international high interest rates. into the country. funds. Sponsors seeking capital from These infusions of capital have had the The factors driving private equity interest Brazilian pension funds will not only need effect of causing the Brazilian real to in Brazil, such as the consumer spending to get comfortable with such arrangements appreciate, which in turn lifts asset prices and potential of its large and increasingly affluent themselves, but they will also need to limits to some extent the anti-inflationary population, its rich commodity resources, ensure that the non-Brazilian limited effects of increased interest rates. Because and stable democratic government, and the partners are ready to relinquish some appreciation of the real has serious implications relative maturity of its capital markets, investment control to other investors. for Brazil’s manufacturers and exporters, the remain compelling to many investors even as For this reason, among other tax and government has sought to control the the broader world economy falters. Two regulatory motives, it is typical that Brazil- appreciation by periodically purchasing recent trends in fundraising are of particular focused funds create separate investment dollars in the market and increasing the tax interest. First, it is becoming increasingly vehicles for international investors and on currency conversions ( Imposto sobre common for Brazil-focused funds to raise Brazilian investors, so as to allow greater Operações Financeiras , or IOF) with respect to capital both in Brazil and internationally, flexibility of operation in the fund designed fixed income investments with terms of less using separate vehicles for Brazilian investors. for the international investors. As Brazilian than two years, in an attempt to discourage In these cases, it is important for sponsors to fund sponsors have had increasing success “speculative” foreign investment. understand the potentially significant raising money on the global stage, some Such inflation, currency fluctuations and differences in expectations of Brazilian firms have attempted to move away from capital controls may enter into investor investors as compared to international limited taking commitments from local pension negotiations and affect fund terms in a partners. Second, certain broader funds in order to avoid these requirements; number of ways, as outlined below. macroeconomic trends in Brazil have it remains to be seen whether this bias will Tax on Currency Conversions. As attracted investor attention as of late and prompt the Brazilian pension funds, with described in our previous article, the most have begun to be reflected in the negotiation their significant investment power, to move common structure for private equity funds of fund terms, paramount among these being towards accepting more standard investing in Brazil is the Fundo de inflation and the fluctuation of the Brazilian international fund terms. Investimento em Participaçoes (FIP), which real against the U.S. dollar. CONTINUED ON PAGE 16

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 15 Brazilian Private Equity Funds: Current Developments (cont. from page 15) permits foreign investors to invest in the of the real has been widely discussed, and investors typically receive a “hurdle” return equity of Brazilian companies and exit controlling it remains a primary focus of the on invested capital prior to the sponsor without capital gains taxes, so long as Brazilian government. After a protracted receiving carried interest. The typical certain requirements are met. Although period of appreciation against the U.S. hurdle rate applicable to U.S. and European exempt from capital gains taxes, investments dollar, the real has recently given back some funds (8%) is also seen in Brazil-focused from outside Brazil into a FIP are subject to of its gains in response to the recent cut of funds. However, recently, some investors the IOF. The IOF tax rate on FIP the SELIC rate (the Brazilian Central bank’s have questioned whether the hurdle rate investments was raised (as it turned out, overnight lending rate) and measures should be adjusted to reflect the relatively temporarily) from 2% to 4%, and then adopted by the government to reduce higher inflation in Brazil as compared to again to 6%, in October 2010. These currency speculation in the derivatives developed economies. Again, this concern increases caused consternation among market. Funds organized solely for relates to whether sponsors are being investors and sponsors, because the IOF is Brazilian investors are, of course, not rewarded for investment performance, as an upfront cost that is borne prior to any directly sensitive to dollar/real currency opposed to benefiting from inflationary actual investment being made. At a 6% fluctuations, as they are denominated in value increases. A number of variations IOF, $100 is drawn from investors, but reais. However, funds targeting have been used to address this concern. only $94 can be invested, requiring international investors typically have their One is just to raise the fixed rate, which has investment appreciation of more than 6% commitments expressed and funded in the benefit of simplicity, but may not solely to reach a “break-even” point. It is as dollars. These funds must convert the adequately address the potentially if Brazil imposes its own hurdle rate. dollars received from investors into reais to significant variation in inflation rates over Fortunately, the IOF rate for FIPs was acquire investments, and again from reais the life of the fund. Another approach is to reduced to 2% in December 2010, a level into dollars to make distributions to use a base fixed rate that could be increased viewed as sustainable given the attractive investors when investments are sold. by a variable amount tied either to the returns available in Brazil. Private equity Currency movements can impact the Brazilian inflation rate or to the amount by investors were also reassured by the fact that sponsor’s carried interest. If contributions which such inflation rate exceeds a fixed the reduction in the rate applicable to FIPs and distributions under the fund target level, measured over the fund’s term. was announced as part of a larger package distribution waterfall are measured in Conclusion designed to encourage long-term foreign dollars, even though fund investments are The private equity fundraising market for investment in Brazil, considered necessary in real-denominated assets, the carried Brazilian strategies is still hot. While it and desirable for the country’s economic interest will be affected by exchange rate remains to be seen whether Brazil’s tremendous development, as distinguished from the fluctuations between the time of acquisition promise will ultimately produce the high “speculative” short-term investing blamed and disposition of investments. In other returns sought by investors, the focus of for the real’s appreciation. words, the carried interest effectively sponsors and investors on Brazil, and the Some sponsors have questioned whether contains a “long” position in reais. Some negotiation of fund terms, will likely the IOF should be treated as a fund expense investors feel that sponsors should not be continue to intensify and new issues unique for purposes of the fund distribution compensated for currency movements if the to the Brazilian market will likely dominate waterfall, since the fund’s investors would real appreciates, while others worry that if negotiations between sponsors and both have incurred that tax in any event had they the real devalues, sponsors may be Brazilian and foreign investors alike. invested directly in Brazil. As an alternative, disincentivized to maximize portfolio the IOF could be excluded from the returns. In response, some Brazil-focused Erica Berthou investor’s capital base for purposes of funds are seeing investor requests to [email protected] determining distributions by the fund, compute the carried interest by measuring Jennifer J. Burleigh which has the effect of enabling the sponsor both contributions and distributions in [email protected] to earn carried interest earlier. Although reais, using the exchange rates prevailing at treatment as a fund expense appears to be the time of contributions and distributions, Peter A. Furci the more common approach, negotiation to reduce the impact of currency [email protected] around this point is likely to persist. movements on sponsor incentives. Currency Movements. The appreciation Inflation. As our readers know, fund page 16 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 ALERT FTC Implements Revisions to the HSR Form

Recent amendments to the pre-merger sheets for the filing party and its person or by its managing entity. 1 This notification regime under the Hart- unconsolidated U.S. subsidiaries, and change, which is intended to allow the Scott-Rodino (“HSR”) Act have (3) “base year” revenue data by NAICS antitrust agencies to analyze the holdings of somewhat expanded the burden of code. In addition, the amendment entities that are under common investment compliance for private equity firms, but reduces the sometimes burdensome management with the filing party, is the FTC scaled back some of the most requirement to provide a list of all specifically aimed at private equity firms controversial changes, which had entities controlled by the filing party to and other capital management groups (such engendered strenuous objections. On those located in the U.S. or having sales as master limited partnerships) whose August 18, 2011, the Federal Trade in or into the U.S. investments are typically made through Commission (“FTC”) implemented The less welcome changes include a entities that are under common long-anticipated amendments to the requirement that private equity firms management, but not under common Premerger Notification Rules and the and others provide information about control because no investor owns more than Notification and Report Form (the competitive overlaps between the a 50% interest. Under the HSR rules, “Form”) that is used to report certain acquired business and entities they which define “control” based on equity mergers and acquisitions under the HSR manage but do not “control” for HSR ownership, each private equity fund is Act. While many of the FTC’s purposes ( e.g. , portfolio companies of generally its own “ultimate parent entity,” modifications simplify preparation of affiliated funds), and a new Item 4(d), because it is not “controlled” by any limited the Form by removing outdated data which somewhat expands the scope of partner, general partner or manager. This and documentary requirements, others documents previously required to be means that a Form reporting an acquisition expand the burden of HSR compliance, provided under Item 4(c). by one such fund (or its controlled portfolio especially for private equity firms. Expansion of Information company) previously did not include any These changes had been in the works Requirement to “Associates” information relating to other funds under for a long time. The FTC proposed common management or those funds’ Private equity firms and other numerous amendments to the Form on investments. Such information might be of investment management organizations, August 13, 2010. During the public obvious interest to the antitrust agencies which previously reported information comment period, the FTC received a where, for example, a portfolio company of only about the particular fund (or other number of comments (including from a related fund is a competitor of the target entity) making an acquisition and that the Private Equity Growth Capital in the reported transaction, or where a fund’s portfolio companies, are now Council) objecting strenuously to related fund already holds a minority required to report certain information certain of the changes. Following about investments by other funds that CONTINUED ON PAGE 18 review of those comments, the FTC are under common management. The issued the final amendments, which revised Form includes requirements that 1 scaled back and revised some of the Although the revised HSR rules refer to the filing party provide limited management of “operations or investment decisions,” more controversial amendments. The information concerning “associates” that the FTC has informed practitioners that it will FTC has also indicated in subsequent overlap competitively with the target, narrowly interpret this rule to apply only to those meetings with practitioners that it will having the power to direct investment decisions. associates being defined as any entity (a interpret the amended rules narrowly. Providing non-binding investment advice is not “managing entity”) that has the “right, sufficient to make an entity or “associate.” First, the good news. Welcome directly or indirectly, to manage the... changes to the Form include elimination The FTC has separately clarified that an entity that investment decisions” of an acquiring of the requirements to provide (1) is a general partner of a partnership or managing entity, as well as any entity that has its member of a LLC is always a “managing entity,” copies of or internet links to certain “investment decisions, directly or but an individual who is a general partner of a SEC filings by the filing party and its indirectly, managed” by the acquiring partnership or managing member of a LLC will not controlled subsidiaries, (2) balance be considered a “managing entity” unless there is a separate contract giving the individual the right to manage the investment decisions of the entity.

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 17 Alert: FTC Implements Revisions to the HSR Form (cont. from page 17)

interest in the target company. competition, competitors or the potential Thus, the amendments impose new for sales growth or expansion into product 3. Item 4(d)(iii) calls for all documents information requirements with respect to an or geographic markets. The amendments “evaluating or analyzing synergies acquiring person’s associates. Revised Item add a new “Item 4(d)” to the Form, which and/or efficiencies” that were prepared 7 requires an acquiring party to report not requires submission of three categories of by or for an officer or director of only overlaps between it (and its controlled documents. This requirement largely either party (or their ultimate parent entities) and the target business in the codifies, but also somewhat expands, the entities) for the purpose of evaluating NAICS codes used to report U.S. revenues, FTC’s existing interpretation of Item 4(c). or analyzing the proposed transaction. but also, based on its knowledge or belief, Previously, documents discussing 1. Item 4(d)(i) calls for any confidential any such competitive overlaps between any revenue synergies were considered information memoranda (“CIM”) that of its associates (including their controlled responsive to Item 4(c), but was prepared by or for an officer or entities) and the target business. The new documents exclusively considering director of either party (or their ultimate Item 6(c)(ii) similarly requires the acquiring cost synergies were not. This parent entities) and that specifically party to disclose its associates’ minority amended provision now clearly picks relates to the sale of the acquired investments in entities making U.S. sales in up the latter, but excludes financial business, or, if no such CIM exists, any the same 6-digit NAICS industry codes as models that do not have stated documents given to an officer or the target business. 2 Item 6(c)(ii) also assumptions concerning synergies. director of the buyer that were meant to requires the acquiring party to report any serve the function of a CIM. Item 5 Revenue Reporting existing minority investment (of at least Revised Item 5(a) of the HSR Form 5%) that its associates may already have in 2. Item 4(d)(ii) requires documents expands the revenue reporting the target entity. prepared by “investment bankers, requirement to include all sales into the In the case of private equity firms, consultants or other third-party U.S. of products manufactured by the these changes mean that the HSR Form advisors,” during an engagement or for filing party’s foreign operations, whether filed by an acquiring fund must now the purpose of seeking an engagement, those sales are made directly or through a disclose not only the fund’s own for an officer or director of either party U.S. establishment. The new HSR competitive overlaps with the target (or their ultimate parent entities), if they Instructions also modify the reporting business, but also overlaps between the contain content of the type responsive with respect to revenues derived from target business and control or minority to Item 4(c) and specifically relate to the manufactured products that the reporting investments of any fund under common sale of the acquired business. This person both manufactures and sells at management with the acquiring fund. provision makes clear that even wholesale or retail, to eliminate potential documents generated by advisors or “Item 4(d)” Documents double counting and ensure uniform potential advisors at the earliest stages of Private equity firms are generally very treatment. A filing party must use only a transaction are required. 3 familiar with Item 4(c) of the HSR Form, the more granular 10-digit NAICS codes which requires submission of documents to report U.S. revenues from products 3 The FTC limited the final version of Items prepared by or for officers or directors of that it manufactures and sells (even if sold 4(d)(i) and (ii) to materials prepared by or for either party for the purpose of evaluating or officers and directors and clarified that the language through a separate wholesaling or retail analyzing the proposed transaction with “specifically related to the sale of the acquired establishment). The 6-digit NAICS respect to markets, market shares, [business]” means the current transaction that is the wholesaling or retailing codes are to be subject of the HSR filing, from its earliest consideration by either party, but not other used only to report revenues of non- 2 If the filing party is unable to identify which of contemplated transactions involving the same target. manufacturing U.S. operations and U.S. its associates’ minority holdings have sales in These changes were intended to address concerns revenues from foreign operations of overlapping NAICS codes with the target, it may expressed in the public comments about risks to deal products that are manufactured by a third instead provide a list of such holdings in entities confidentiality if parties were required, as having operations in the same industry as the target. apparently contemplated by the initial proposal, to party under contract for the filing party. The party also may simply list all its associates’ search the files of a broad group of individuals, In addition, as noted above, Item 5 has minority holdings, although the FTC has warned including some who might have no prior knowledge been simplified by eliminating the that this approach may result in follow-up requests of the current transaction. that could delay the review of a filing. CONTINUED ON PAGE 19 page 18 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 UPDATE New Proposal to Tax Carried Interest as Ordinary Income

As many of our readers likely know, on of any gain from the sale of an interest in partnership. In contrast, the bill would September 12, President Obama released a carried interest partnership would be only apply to a partnership if substantially the text of the proposed American Jobs treated as ordinary income. This all of the partnership’s assets (other than Act of 2011, which includes provisions provision is particularly controversial goodwill and other intangible assets) that would tax carried interest as ordinary because it would subject individuals to a consist of securities or any of the other income. The proposed carried interest higher rate of taxation on gain from the specified assets described above and provisions generally would become sale of a carried interest partnership than certain other conditions are met. effective on January 1, 2013. The Jobs on gain from the sale of other businesses. Limiting the application of the carried Act’s carried interest provisions are based A prior proposal generally would have interest rules in this manner may help largely on prior Congressional proposals taxed only 75% of such gain (50% in the protect, for example, the sale of to tax carried interest as ordinary income case of a five-year holding period) at management companies that hold and would fix a number of technical issues ordinary income rates. specified assets from inadvertent taxation with the prior proposals (although certain Narrower definition of carried under the enterprise value regime. other issues remain unresolved). Below is interest. The bill limits the scope of Adele M. Karig a summary of the key differences: partnerships to which the new carried [email protected] Taxation of carried interest. The bill interest regime would apply. Previous would tax 100% of carried interest at proposals potentially applied to Vadim Mahmoudov ordinary income rates. Previous proposals partnerships that held (directly or [email protected] generally would have treated only 75% of indirectly) any securities, real estate, David H. Schnabel the carried interest as ordinary income interests in other partnerships or [email protected] and would have preserved the favorable commodities, or options or derivative treatment under current law for 25% of contracts with respect to the foregoing, or Peter F. G. Schuur the carried interest. other specified assets, without regard to [email protected] Taxation of enterprise value. 100% the materiality of these assets to the

Alert: FTC Implements Revisions to the HSR Form (cont. from page 18) requirement to report “base year” * * * be made as promptly and as painlessly as revenues, so that only revenues for the In sum, these amendments mean that possible. most recent fiscal year need be included. private equity firms and their portfolio Kyra K. Bromley companies should be prepared for a Other Changes [email protected] potentially more time-consuming and The FTC’s amendments also include intrusive data collection process in Gary W. Kubek numerous other minor changes to the connection with future transactions (in [email protected] HSR Form, some of which address particular where acquiring a target omissions from a prior FTC rulemaking business in the same industry as an (e.g. , inclusion of unincorporated entities existing portfolio company), and should in Items 6(b) and 6(c)), and many of a reach out to their antitrust advisors as ministerial or organizational nature ( e.g. , early in the process as possible so that any requesting the filing party’s website issues can be spotted early and filings can address).

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 19 “Recent” Market Trends in IPOs of Sponsor Portfolio Companies (cont. from page 1) market—at least prior to the summer Board Control and of the Exchange Act) which own more volatility. This assembled information and Composition: The Controlled than 50% of the voting stock of a public analysis should serve as a useful starting Company Exemption company, invoking the “controlled place when the market returns. The chart You may recall that observers have company” exemption under either the below provides specific information with wondered, particularly in a post-SOX and Nasdaq or NYSE rules. This exemption respect to the deals we analyzed in our Dodd-Frank world, whether the public allows such a sponsor or group to have the survey. markets would be receptive to sponsors or right to designate a majority of the board

groups (as defined under Section 13(d)(3) CONTINUED ON PAGE 21

IPOs of Selected Private Equity Portfolio Companies

*Note: Each company has the requisite authorized and unissued capital stock to implement a poison pill as, and when, desired. page 20 l Debevoise & Plimpton Private Equity Report l SUMMER 2011 “Recent” Market Trends in IPOs of Sponsor Portfolio Companies (cont. from page 20) of any public portfolio company without the company’s nine directors. “non-controlled company” situations, regard to any “independence” requirements Note, though, that sponsor practices are sponsors or groups of sponsors are provided (other than with respect to the audit not uniform in this regard. Two of the with board designation rights in proportion committee) so long as such individual or newly public portfolio companies that to their respective equity interests in the group’s decision to treat such company as a otherwise qualified for the “controlled newly public company, and these board “controlled company” is disclosed in the company” exemption at the time of their designation rights typically decrease as the company’s prospectus. IPO disclosed in their prospectuses that equity stake of the sponsor or group While the ability to appoint a majority their sponsors would not treat the portfolio diminishes over time until they terminate of such directors to the newly public company as a “controlled company” post- entirely. Some sponsors retain nomination company’s board is obviously significant to IPO and would instead abide by all of the rights until they hold as little as a 3% sponsors, it is important to keep in mind in corporate governance standards of the ownership interest, whereas others provide this context that any director designated to applicable exchange, including having a for nomination rights to expire at higher the board of any public company by any Board comprised of a majority of ownership percentages, but provide sponsor or group, whether or not such independent directors. sponsors with non-voting board observer company is a “controlled company” or such Board Designation Rights. rights once their board designation rights director is “independent,” will have fiduciary have terminated. A successful IPO cannot be a “controlled duties to all stockholders, not just such company” for the long term since the Veto Rights sponsor or group, and therefore will not be sponsors liquidate their ownership stake In four of the 11 deals we surveyed, able to make decisions solely on the basis of over time. Moreover, in other cases, sponsors continued to enjoy certain veto the interests of such sponsor or group. sponsors or groups of sponsors never hold rights in their capacities as shareholders Our market survey suggests, perhaps in part 50% of the voting power of the post-IPO with respect to certain corporate actions of for this reason, that the market is generally company to begin with or choose not to the newly public company. Unsurprisingly, comfortable with sponsors electing to treat take advantage of the “controlled company” sponsors have generally received these rights the portfolio company it is taking public as exemption. in circumstances where the company a “controlled company.” Six of the eight In eight of the 11 deals we surveyed, qualifies as a “controlled company.” But companies in our survey that qualified as sponsors or groups of sponsors entered into somewhat surprisingly, unlike the right of a “controlled companies” at the time of their an agreement at the time of the IPO giving sponsor or group of sponsors owning more IPO chose to take advantage of the them the right to designate directors to the than 50% of the voting power to appoint a exemption. In some instances, such as board of the company, even when it no majority of the board of that company, these APAX’s IPO of Bankrate, Inc., a sponsor longer qualifies as a “controlled company” veto rights do not sunset once a company took advantage of the exemption due to its or if it never qualified as one. In Vanguard ceases to be a “controlled company.” ownership of more than 50% of the voting Health Systems, Inc., where Blackstone In the precedents we identified, these stock of the portfolio company following held the vast majority of the stock held by veto rights varied in scope but have the IPO. In many other instances, such as all sponsors post-IPO, Blackstone retains included veto rights with respect to (1) the the recently completed IPO of Dunkin’ the right to designate five of the 11 hiring and firing of the CEO, (2) certain Brands Group, Inc., sponsors in a club deal, directors until such time as it owns less than major strategic corporate transactions, sometimes with the inclusion of 10% of the outstanding common stock of including mergers, consolidations or sales of management, qualified as a “controlled Vanguard. Similarly, in certain club deals, assets and (3) bankruptcy filings. Sponsor company” by virtue of a voting agreement such as Dunkin’ Brands and HCA veto rights of this kind typically terminate with respect to the election of directors Holdings, Inc., each sponsor has the right, once the sponsor’s percentage ownership designated by members of the club, thereby after these companies cease to be falls below a specified level (generally constituting a “group” holding more than between 25% and 40%). Notably, in “controlled companies,” to appoint a 50% of the voting power of the portfolio Vanguard, Blackstone enjoys veto rights significant portion of the company’s board company. In the case of Dunkin’ Brands, over certain significant company until such sponsor ceases to own a specified for instance, this voting arrangement allows transactions for so long as it holds more percentage of the voting power, often 10%. each of the three sponsors to appoint two of More frequently however, including, in CONTINUED ON PAGE 22

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 21 “Recent” Market Trends in IPOs of Sponsor Portfolio Companies (cont. from page 21) than 25% of the common stock. In many shareholders’ ability to act by written did not adopt a pill, whereas 13 companies club deals, shareholders’ agreements have consent and call special meetings, adoption (or 62%) did not opt out of 203 (some of recently been structured to either (1) of a poison pill and whether or not to opt which also adopted pills). provide each sponsor with certain veto out of the anti-takeover provisions of Our survey of the current market reveals rights so long as the club holds in the Section 203 of the DGCL (“203”)), can be a trend towards fewer anti-takeover aggregate more than a specified percentage a nuanced one given that the utility of such defenses, but the retention, in most cases, ownership or (2) provide the club with one defenses to a sponsor is subject to change of meaningful anti-takeover defenses veto right, therefore requiring a meeting of based on a variety of factors. nonetheless. As an overview of this trend, the minds of the club members prior to the Immediately following an IPO, such (1) none of the 11 companies we surveyed exercise of such right. anti-takeover defenses are, at best, of adopted a poison pill at the time of their Veto rights of this kind are particularly limited usefulness for most sponsors IPO, but all of them had sufficient valuable for sponsors by permitting them to because the most effective defense against authorized preferred stock to put one in retain some absolute negative control over an unwanted takeover attempt is the place quickly, as needed, (2) eight of the 11 certain major decisions affecting their significant ownership percentage held by companies implemented a staggered board, public portfolio companies, since, unlike the sponsor or group of sponsors. However, and (3) most companies have adopted sponsor-appointed directors who, as noted as a sponsor’s or group of sponsors’ other significant anti-takeover devices, such above, have fiduciary duties to all ownership stake in a public portfolio as limitations on their shareholders’ ability stockholders, sponsors do not have as company gradually declines over time, its to act by written consent and to call special significant fiduciary duties in their ownership stake will cease to constitute, by meetings. capacities as shareholders and can, itself, a de facto deterrent to unwanted bids. As you may know, 203 imposes a three- therefore, generally focus solely on their Consequently, sponsors need to consider year moratorium on business combinations own interests in electing whether or not to whether, at various points along this between a public Delaware company and invoke any particular veto right. continuum, they would prefer to retain, as any 15% or greater shareholder unless the Anti-Takeover Defenses shareholders, the flexibility to decide whether business combination or the crossing of the or not to cause the sale of the company, 15% threshold receives prior board The decision to include one or more anti- and, under the right circumstances, perhaps approval, the bidder reaches the 85% takeover defenses in the constituent obtain a control premium for their shares, threshold in the same transaction as it documents of a portfolio company a or have in place anti-takeover defenses, reaches the 15% threshold, or the sponsor is about to take public ( e.g. , a such as 203 or a poison pill, that effectively combination is approved by the board and staggered board, the elimination of shift the right to make such decision to the by holders of two-thirds of the shares not board, which, of course, is no longer owned by the bidder. While 203 does not controlled by the sponsors. apply to a private equity sponsor who As a practical matter, As a practical matter, sponsors must continuously holds 15% of the company’s sponsors must design the design the anti-takeover profile of a shares following the IPO, it does restrict the portfolio company at the time it goes sponsor’s ability to control or at least anti-takeover profile of a public without retaining a realistic ability to facilitate an exit by selling its shares to, or modify these defenses as their ownership entering into lock-up agreements with, portfolio company at the stake in the public company evolves. potential bidders, even bidders constituting As a point of reference, in our Winter affiliates of such sponsor, without the time it goes public 2003 edition of the Debevoise & Plimpton approval of the company’s board, which without retaining a Private Equity Report , we published an will have fiduciary duties to all article entitled, “Shark Repellents That Can stockholders. A sponsor of a Delaware realistic ability to modify Bite,” noting similar considerations with company can avoid these restrictions on respect to shark repellents, but also noting exit by “opting out” of 203 at the time it these defenses as their that out of a selected group of 21 IPOs by goes public. U.S. portfolio companies over the period Our survey of the current market reveals ownership stake in the from May 1996 to January 2003 only 8 CONTINUED ON PAGE 23 companies (or 38%) opted out of 203 and public company evolves.

page 22 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 “Recent” Market Trends in IPOs of Sponsor Portfolio Companies (cont. from page 22) that two of the 11 companies opted out of and Dunkin’ and Targa as not “opting out,” potential of impacting the success of the 203 completely, five companies elected not approximately 64% of the newly public offering, any such post-IPO fee payments to opt out and the remaining four companies in our survey did not opt out of and/or arrangements may affect the companies took more bespoke approaches 203 (similar to the 62% number noted in independence of the sponsor’s board to 203 designed, in most cases, to retain our 2003 article). Alternatively, if one nominees under the applicable stock most of the defensive benefits of 203, but views each of Vanguard, Bankrate, Dunkin’ exchange rules. also to modify it so as to confer greater and Targa as effectively “opting out” of 203, * * * flexibility for the sponsors to orchestrate then approximately 55% of the newly The gist of our survey of current market exit transactions to their liking. public companies in our survey did not opt terms for sponsor-backed IPOs suggests For instance, in the case of Vanguard out of 203. While unlike the case in our that (1) most sponsors, whether acting and Bankrate, this was achieved by having 2003 survey, none of the 11 companies we individually or as a member of a group, the companies opt out of 203, while surveyed had any poison pills in place, as seek to nominate as many members of the simultaneously adopting a charter provision noted above, all of them have the capital newly public company’s board as the law virtually identical to 203, except that, structure to implement a poison pill very allows, (2) sponsors of companies unlike 203, the charter provision allows the quickly, as and when needed. constituting “controlled companies” at the sponsors to sell any or all of their shares to, Management Fees time of the IPO often enjoy some form of or enter into lock-up agreements with, any veto rights in their capacities as Private equity sponsors usually enter into bidder without such bidder being subject to shareholders, even after the company ceases management or consulting agreements with any of the provisions of the new charter to be a “controlled company,” and (3) most their portfolio companies at the time of the which otherwise mirror 203. In effect, sponsors are arming their newly public initial acquisition that provide for the these provisions allow a private equity portfolio companies with significant shark payment of periodic administrative, sponsor to confer a blanket exception to the repellants but are doing so in a way that management or professional service fees to 203-like provisions in the company’s charter gives them more flexibility to disarm or the sponsors. These agreements generally to any third party of its choosing, thereby elect not to use those shark repellants for terminate upon the portfolio company’s retaining the benefits of 203 for deals it deals they support. Two examples of this IPO and result in some instances in does not support but eliminating them for are not adopting a pill but retaining the payments to the sponsors structured either deals it does support. Somewhat similarly, mechanics to do so quickly, if needed, and as a one-time fee payment at the time of albeit less sponsor friendly, in Dunkin’ technically opting out of 203 but at the the IPO or periodic fee payments for a Brands, a “club” deal where each of Bain same time adopting 203-like charter specified period of time following the IPO. Capital, Carlyle and Thomas H. Lee provisions that allow such sponsors to Our survey suggests that the current trend Partners held approximately 25% of the utilize a modified form of 203 as a tool to seems to favor a termination of post-IPO shares, Dunkin’ adopted the same influence their control over their ultimate management agreements for a lump sum approach as Vanguard and Bankrate but exit, as well as to enjoy the general defensive fee payment at the time of the IPO. More limited the blanket exception to the 203- mechanisms associated with 203. specifically, of the five deals which specifically like provisions in the company’s charter to mentioned sponsor management Franci J. Blassberg the sponsors’ affiliates only and did not agreements, in one case the management [email protected] extend it to unaffiliated bidders. A third agreement was terminated in the IPO for approach was adopted in Targa Resources Stephen R. Hertz no fee, and in the other four cases, the Corp., where the company elected to opt [email protected] management agreements were terminated out of 203 until such time as the sponsors, in consideration for payments to the David P. Iozzi their affiliates and transferees own less than sponsors structured, in three instances, as a [email protected] 15% of the company’s common stock, at one-time fee payment at the time of the which point the company automatically Salim Sader IPO and, in one instance, as periodic fee opts back into 203 for all purposes. payments for a specified period of time [email protected] While susceptible of different following the IPO. It is important to note interpretations, if one counts Vanguard and that, in addition to being negatively Bankrate as effectively “opting-out” of 203 perceived by the market and having the

Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 23 Is Russia Ready for Serious Attention from Private Equity Investors? (cont. from page 8)

there is a lot of red tape in originating large buy-out shops and sovereign wealth instead of having just a stand-alone co- and operating businesses in Russia. But funds. When an international (or local) investment vehicle, we need a broader by way of comparison, there are so many investor sees an interesting investment government-sponsored private equity international PE firms actively investing proposition, but the deal size is very large, platform with a fund-of-funds structure in India, despite the very bureaucratic or the investor is more comfortable supporting local funds. More generally, we environment there, just because of having a government affiliate co-investing, believe the government should act as a different context and different they can apply for capital from this fund regulator or a passive investor rather than connotations. So the major challenge is to be invested in direct deals. We believe really a direct private equity player or perception. it could be a good opportunity to develop stakeholder in the traditional sense. The working relationships with a number of government should create the framework In an effort to boost foreign investment, leading institutional players in this space and give a boost to industry, but by no the Russian government recently who historically have never invested in means should it dominate the private announced that it was establishing a Russia. David Bonderman of TPG has equity market by its own investment. U.S.$10 billion fund (Russian Direct joined the international advisory board; Regarding our role, we plan to Investment Fund) to invest alongside Stephen Schwartzman from Blackstone, continue our talks with the government foreign private equity players. Could people from CIC and the Kuwait and VEB (the Russian Development you tell us more about the fund’s Investment Authority also showed some Bank) in order to add other missing mandate, what kind of investors will be interest. elements to the program announced by targeted and what role RPEI will have We still believe capital should flow first the government. It remains to be seen in connection with the fund? to Russia-focused local funds. The how the arrangement will develop, but, of The idea is to create a private equity fundraising environment is very difficult, course, if this is a success, it will be a vehicle to match the investments of and these funds, apart from Baring Vostok major boost for the Russian private leading international firms in certain and probably Russia Partners, have equity industry. sectors of the Russian economy. It is not a limited opportunities to raise capital fund-of-funds structure, but more a co- abroad. Our view, then, which we have investment vehicle that can partner with communicated to the government, is that

Boosting EBITDA: The Cost Savings Add-Back (cont. from page 12)

changed as a result of that transaction. 2 this position in a credit agreement have been taken (or the relevant cost In the context of cost savings, the would largely, if not completely, exclude savings plan needs to have been Division of Corporation Finance has most adjustments based on expected or implemented) during the test period, specifically stated that pro forma planned cost savings of the type or whether the add-back is also adjustments that give effect to actions discussed herein. available with respect to actions taken by management or are expected to “committed to be taken,” “to be Key Issues for Negotiation occur after a business combination, taken” or “expected to be taken” after Credit agreements that permit cost including termination of employees, the test period. Any timing flexibility savings-based pro forma adjustments closure of facilities and other restructuring of this sort differs from the add-back typically refer to cost savings resulting charges, are not appropriate. 3 Adopting based on the acquisition or from “actions,” or “specified actions” or disposition of a line of business, “a costs savings plan.” Given the 2 Division of Corporation Finance's Financial which typically requires the relevant somewhat open-ended nature of the Reporting Manual, Section 3210.2. acquisition or disposition to have trigger, key questions for negotiations are: been completed during the period or 3 Division of Corporation Finance's Financial Reporting Manual, Section 3310.3. l Whether the relevant action needs to CONTINUED ON PAGE 25 page 24 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 Boosting EBITDA: The Cost Savings Add-Back (cont. from page 24) at least before the date of the relevant an expected new contract already be triggering the add-back is required to financial calculation. in place, or (in the context of be taken within a certain period of redundancies) that the borrower have time following the date of the credit l Whether the cost savings are subject identified the personnel to be agreement. to a qualitative control. For instance, terminated. certain credit agreements limit the The Market Today add-back to savings “actually realized” l Whether management is required to Of course, borrowers and lenders during the test period. Other credit prepare a certification with respect to sometimes have different views as to agreements, in permitting add backs the savings. The range of items to be whether or not specific add-backs are with respect to actions not yet taken, certified can be very broad. Some appropriate, especially in the case of cost may require that the savings be credit agreements require no savings plans that have not yet been “projected in good faith to be certification at all. Other credit implemented. As a result, even before realized” and sometimes may require agreements require a certification the recent poor performance of the that the relevant action be expected describing in reasonable detail the financial markets, some lenders have or projected to be taken within a relevant savings or confirming that pushed to limit the add-back to savings certain period of time following the the relevant cost savings plan has actually realized, arguing that savings EBITDA calculation date or the end been implemented or, in the case of based on actions not yet taken are too of the relevant test period. savings based on actions not yet speculative. However, the cost savings taken, confirming the reasonableness add-back, a popular feature in financing l Do the savings need to be “reasonably of the expectation that the cost documents in the robust markets of identifiable” and/or “factually savings will be realized during the several years ago, particularly large supportable?” “Factually relevant time frame. transactions involving major sponsors, supportable” is a term that is used in was making a reappearance in financings the provisions of Regulation S-X l Whether the Administrative Agent during the first seven months of this discussed above. In general, to be can request that the savings be year. It will be interesting to see if this factually supportable, an adjustment verified by an independent third trend continues when the markets regain must be the quantifiable outcome of party. stability. identified actions. The level of l Whether the add-back with respect to factual support for an adjustment Pierre Maugüé any test period is subject to an overall would be a case-by-case analysis but [email protected] cap and whether the relevant action it may well require that, for example,

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Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 25 A Primer for Due Diligence in Each BRIC Country (cont. from page 14)

and regulations are quite dated and are not computerized and can be in the many foreign investors are opting for very protective of employees. The local languages of the states, the tax insurance policies to safeguard their Industrial Disputes Act, 1947, for process can be very time consuming tax structures and exit options. example, makes it difficult for and expensive, and there is no title l Intellectual property: As a signatory to companies employing more than 100 insurance currently available. It is also the Agreement on Trade-Related workers to conduct layoffs. It is also important to point out that although Aspects of Intellectual Property Rights common to find workers organized there is a statutory requirement to (TRIPS), India has enacted all into unions that prove to be very register all sales of land, the reality in mandated intellectual property laws. successful in negotiating pay increases India is that due to the high cost of However, even though sufficient laws and securing benefits for their registration (in the form of stamp duty are in place, intellectual property members. Foreign investors ought to that varies from state to state), a large enforcement remains problematic, a get a clear understanding of these number of realty transactions are never big issue in this country, especially in issues, especially if they plan on registered. There is no mandatory the area of copyright. It is also restructuring the target’s business in registration of land acquisitions, court important to note that there is no any way. decrees, land orders, partitions, separate data protection law in India so mortgages, agreements to sell, etc., l Land title issues: Land registration in all confidential information has to be under state legislation. Foreign India does not involve a registration of protected by contract. investors used to deriving comfort title, but a registration of deed, i.e. , it from clear records of title are, Financial Due Diligence is simply an acknowledgment that a therefore, often surprised at the transaction has taken place between the l Accounting records: The accounting complexity of, and lack of assurances parties. Additionally, there is no system books and records of Indian companies provided by, a title search in India. of issuing title certificates for land, are sometimes less transparent and which makes it necessary for a buyer to l Tax-related issues: The fiscal regime in reliable than those of U.S. companies. establish a “chain of title” that involves India is extremely complex and poses In fact, some Indian companies searching relevant land records for the numerous additional challenges. Each deliberately keep two sets of preceding 30 years. Since land records year’s budget session brings with it new accounting records, one for the levies and taxes. Business entities in statutory reporting purpose and the India are frequently involved in other for internal use. The latter Beyond governance and extensive litigation and administrative reflects a company’s actual financial condition and results, whereas the transparency, Western proceedings that challenge the interpretation and application of the former set of records tends to book less sponsors will also need tax framework. Anyone planning to revenue and/or more expenditures with establish or invest in a business in a view to reducing the company’s tax to become accustomed to India should conduct a thorough liability. review of the transaction by local Indian bureaucracy.... l Financial auditing terms: India does consultants so the potential tax impact not permit FDI in accounting and Murky litigation risks, is clear. India also has Double Taxation auditing services businesses. However, Avoidance Agreements with various the “big four” accounting firms have licensing and permitting countries and most foreign investors established offices in India and offer prefer entering India through these uncertainties and consultancy services through tie-ups jurisdictions. Adding to the confusion and other arrangements with local vagaries surrounding real and complexity are recent court partners. It should be noted that many decisions and the introduction of the local accounting firms in India may be estate matters are new Direct Tax Code, which purports less credible and impartial in to override certain aspects of existing significant problems in treaties. It is no wonder then that CONTINUED ON PAGE 27 India. page 26 l Debevoise & Plimpton Private Equity Repor t l Summer 2011 A Primer for Due Diligence in Each BRIC Country (cont. from page 26) performing audits, as they are more Conclusion bureaucracy and its by-products. Murky susceptible to pressures from the In sum, the diligence process is much litigation risks, licensing issues and company as a result of an eagerness to different in Bangalore than in Bangor. vagaries surrounding real estate matters win engagements or maintain existing Indian companies, particularly those on are significant problems in India. In relationships. the smaller side, may need to be addition, this backdrop tends to create fertile ground for corruption issues. In l Accounting standards: Indian convinced that transparency and good fact, India placed 87th out of 178 companies are required to prepare governance are part of the growth process countries ranked in Transparency audited financial statements in for an emerging company to begin International’s “Corruption Perception accordance with Indian GAAP. The operating at the next level. Their owners Index,” behind China and Brazil, Government of India has proposals may also need to be convinced that although well ahead of Russia. pending that would require certain foreign investors, including private equity Notwithstanding these challenges, the entities including listed companies, investors, can be more than just sources of role played by private equity in India is banks, insurance companies and other capital, and, perhaps more importantly, growing, and many new funds have large entities to comply with IFRS. can assist in the growth of institutional made successful investments in the However, these proposals have yet to structures and governance. Many private country in the last few years. So, while be enacted. equity firms have been successful in fostering a spirit of openness by prudent investment in India is possible, l Related party transactions: Since many developing relationships with founders thoughtful and thorough due diligence businesses in India are still structured based on professionalism and trust. will remain crucial to success. as family-owned conglomerates with a Strong personal relationships are clearly Geoffrey P. Burgess great deal of interdependence, there key in almost all successful business [email protected] can be extensive related-party settings in India. transactions that must be identified Beyond governance and transparency, Maurizio Levi-Minzi and examined. Western sponsors will also need to [email protected] become accustomed to Indian

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Summer 2011 l Debevoise & Plimpton Private Equity Repor t l page 27 Recent and Upcoming Speaking Engagements

July 11-12, 2011 August 1-2, 2011 October 26, 2011 David J. Schwartz Lord (Peter) Goldsmith QC Michael P. Harrell “Raising a Private Equity Fund: “The U.K. Bribery Act: What it Means for Jonathan J. Rikoon Current Trends” India and the Rest of Asia” Cristine M. Sapers Twelfth Annual Private Equity Forum Debevoise & Plimpton LLP and Deloitte “Estate Planning for Private Equity Practising Law Institute New Delhi Professionals and LGBT Families, with New York Mumbai UBS” Debevoise & Plimpton LLP and UBS July 12, 2011 August 4, 2011 New York Jordan C. Murray Lord (Peter) Goldsmith QC “LPAs and Other Material Agreements” “The U.K. Bribery Act: What it Means for October 27-28, 2011 Institutional Limited Partners Association Asia” Franci M. Blassberg , Program Chair New York Debevoise & Plimpton LLP and Deloitte “Special Problems When Acquiring Divisions Singapore and Subsidiaries” July 12, 2011 “Negotiating the Acquisition of the Private Jennifer J. Burleigh August 5, 2011 Company” “Raising a Private Equity Fund: Paul L. Lee 27th Annual Advanced ALI-ABA Course of Current Terms” “The Global Response to the Financial Crisis: Study on Corporate Mergers and Twelfth Annual Private Equity Forum The Canadian, U.K. and U.S. Perspective” Acquisitions Practising Law Institute ABA Annual Meeting Boston New York American Bar Association Toronto, Ontario October 30-November 4, 2011 July 16, 2011 Rebecca F. Silberstein Thomas M. Britt III September 9, 2011 “One Size Fits All? Recent Case Studies of “Private Equity in India—What Corporate Franci J. Blassberg Bespoke Structuring of Funds for Specific In-House Counsels Need to Know” W. Neil Eggleston Purposes” First Annual In-house Corporate Counsels' James E. Johnson 2011 Annual Conference Meeting Bruce E. Yannett International Bar Association Indian Corporate Counsel’s Association “Directors & Boards Roundtable: Global Dubai (ICCA) Governance Issues Facing Today’s Directors” New Delhi Debevoise & Plimpton LLP, Directors & Boards, Deloitte July 22, 2011 New York For more Maurizio Levi-Minzi “Introduction, Doing Due Diligence in October 18, 2011 information BRICs” (moderator) Erica Berthou “Negotiating Deals in and with BRIC: Jennifer J. Burleigh about upcoming Dealing with Local Market Practices, Legal Peter A. Furci Frameworks and Different Business Cultures” Jordan C. Murray events, visit “Doing Business with State-Owned Entities” “Structuring Brazilian Private Equity Funds: (moderator) Key Considerations” www.debevoise.com “How to Choose and Work with Local Law Debevoise & Plimpton LLP Firms” (moderator) Mattos Filho PLI’s Doing Deals in and with Emerging São Paulo Markets: BRIC and Beyond 2011 Practising Law Institute New York

page 28 l Debevoise & Plimpton Private Equity Repor t l Summer 2011