Debevoise & Plimpton Private Equity Report

Fall 2010 Volume 11 Number 1

Is Dual Track the New Normal? WHAT’S INSIDE Learning to Live with Simultaneously pursuing an IPO and a Journal article headlined “IPOs, it seems, 3 Regulatory Uncertainty: private auction process is an increasingly are key to M&A success” followed on the Recent Foreign Public popular option for PE sponsors and other heels of the study, joining the chorus of Exits from PRC Investments sellers wishing to preserve flexibility while news articles heralding the return of the maximizing competitive pressure. dual track deal. According to Reuters, GUEST COLUMN Recent examples of deals that started out about two-thirds of companies preparing 5 Active Private Equity on a “dual track” include: the IPO of AIG’s for an IPO in the third-quarter of 2010 Fund Management in the Asian life insurance business, AIA Group were simultaneously pursuing a sale. Context of Asset Limited; the sale of the Logan’s Roadhouse Of course, the dual track phenomenon restaurant group to Kelso; Clayton, runs both ways: sponsors are just as likely Allocation Dubilier & Rice’s investment in Univar’s these days to end up on the buy-side end of EU Directive on chemical distribution business; and the sale line as well as the sell-side terminal. Given 7 Alternative Investment of Pets at Home to KKR. Many hail the the increasing prevalence of dual track practice as a win-win proposition for the auctions, sponsors need to be attuned to the Fund Managers: seller. A study published in the July 2010 opportunities and pitfalls of these processes Good News at Last issue of the Journal of Business Venturing from the buyer’s perspective too. Monetizing the Shield: found that companies sold privately in the Why Dual Track? 9 course of a dual-track process realized a 22- Tax Receivable What are the advantages of running a dual 26% premium over companies acquired Agreements in Private track process from the seller’s point of view? without a concurrent IPO. A Wall Street Equity Deals First, and foremost, recent academic m

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© is there. And even if a private sale is ultimately Terra Firma v. Citibank: pursued, the additional 15 A Cautionary Tale? competitive pressure of a viable IPO process can drive ALERT bidders to put more money 17 Proposed Exemptions on the table. For instance, from SEC Registration Bridgepoint Capital’s dual Available to Non-U.S. CONTINUED ON PAGE 20 Advisers “I think you're going to need a bigger box” Letter from the Editor

The fact that our Fall issue is being disseminated electronically in institutional investors is being replaced by a more activist model. the very late Fall (and in the middle of the Holiday season) tells We also report on some lessons to be learned from the well- you a lot about the level of private equity activity. Deal rhythm publicized case brought by Terra Firma against Citibank alleging has accelerated, financing markets have revived, the regulatory fraud in connection with a 2007 auction in which Citibank acted scene has become more settled and there is more optimism about as a financing source as well as a sell-side advisor. future fundraising than there has been in many quarters. That Private equity firms and deals continue to be the focus of will explain why our issue is arriving with flurries and not foliage. regulatory attention in the European Union and the U.S. In this Traditionally, the simultaneous pursuit of an IPO and a issue, we examine proposed exemptions from SEC registration potential private sale to a private equity firm or strategic buyer available to non-U.S. advisers and report on the recent decision has been perceived as providing a seller with optionality in by the European Parliament to extend the "passport" allowing uncertain markets. On our cover, we examine the dual track fund managers to market alternative investment funds within the approach to exits and note that there may well be significant EU to fund managers based outside the European Union. advantages for buyers as well as sellers in the dual track process. We also report on possible changes to the HSR reporting Elsewhere in this issue, Jeff Rosen and Peter Furci analyze the regime which could create added filing burdens for private equity recent use of tax receivable agreements. These somewhat esoteric buyers, and update you on the status of proposals to reform the arrangements first developed as a way for pre-IPO shareholders UK Takeover Code which would, among other things, prohibit to retain the economic benefits of certain tax attributes post-IPO. break fees unless an auction process is commenced by the target. These arrangements can also be used to bridge valuation gaps in As always, we welcome your input on topics you would like to valuing tax benefits attributable to, among other things, NOLs see addressed in future issues of The Private Equity Report and we and options. wish you a happy, healthy and prosperous New Year. In our Guest Column, Daniel Feder, formerly with the Franci J. Blassberg Princeton Endowment and currently a private equity advisor, Editor-in-Chief examines whether the endowment model of investing for

Private Equity Partner /Counsel Practice Group Members The Debevoise & Plimpton Franci J. Blassberg The Private Equity Hedge Funds Guy Lewin-Smith – London Private Equity Report is a Editor-in-Chief Practice Group Byungkwon Lim Li Li – Shanghai publication of All lawyers based in New Gary E. Murphy Dmitri V. Nikiforov – Moscow Stephen R. Hertz York, except where noted. Robert F. Quaintance, Jr. Debevoise & Plimpton LLP Andrew L. Sommer Mergers & Acquisitions William D. Regner 919 Third Avenue Associate Editors Private Equity Funds Andrew L. Bab New York, New York 10022 Kevin A. Rinker Marwan Al-Turki – London E. Raman Bet-Mansour – Paris 1 212 909 6000 Ann Heilman Murphy Jeffrey J. Rosen Kenneth J. Berman – Washington, D.C. Paul S. Bird Managing Editor Kevin M. Schmidt www.debevoise.com Erica Berthou Franci J. Blassberg Thomas Schürrle – Frankfurt David H. Schnabel Jennifer J. Burleigh Richard D. Bohm Washington, D.C. Wendy A. Semel – London Cartoon Editor Woodrow W. Campbell, Jr. Thomas M. Britt III – Hong Kong 1 202 383 8000 Andrew L. Sommer Sherri G. Caplan Geoffrey P. Burgess – London London Please address inquiries Stefan P. Stauder Jane Engelhardt Marc Castagnède – Paris 44 20 7786 9000 regarding topics covered in this James C. Swank – Paris Michael P. Harrell Neil I. Chang – Hong Kong Paris publication to the authors or John M. Vasily Geoffrey Kittredge – London Margaret A. Davenport 33 1 40 73 12 12 any other member of the Peter Wand – Frankfurt Anthony McWhirter – London E. Drew Dutton – Hong Kong Practice Group. Frankfurt Marcia L. MacHarg – Frankfurt Michael J. Gillespie Leveraged Finance 49 69 2097 5000 All contents © 2010 Debevoise Jordan C. Murray Gregory V. Gooding Katherine Ashton – London Moscow & Plimpton LL P. All rights Andrew M. Ostrognai – Hong Kong Stephen R. Hertz William B. Beekman 7 495 956 3858 reserved. Gerard C. Saviola – London David F. Hickok – London David A. Brittenham Hong Kong David J. Schwartz James A. Kiernan III – London Paul D. Brusiloff 852 2160 9800 Rebecca F. Silberstein Antoine F. Kirry – Paris Pierre Clermontel – Paris Jonathan E. Levitsky Alan J. Davies – London Shanghai Peter Hockless – London 86 21 5047 1800 Learning to Live with Regulatory Uncertainty: Recent Foreign Public Exits from PRC Investments

Notwithstanding expectations that to be in the pipeline. have limited offshore listings since China’s regulatory hurdles imposed in 2006 would In comparison, it has been a relatively cross-border M&A rules came into effect make offshore listings of China-based difficult year for domestic Chinese IPOs. on September 8, 2006. In order to better companies rare, offerings of Chinese The value of stocks listed on Chinese stock understand these trends and the relevant companies on U.S. and Hong Kong stock markets dropped approximately 26% in the regulatory uncertainty, it helps to briefly exchanges have been the stars of 2010. By first six months of 2010 and remained review the regulatory environment for the end of the third quarter, China volatile throughout the rest of the year. As offshore listings before and after September surpassed Israel as NASDAQ’s No. 1 U.S. listings of Chinese IPOs were 2006. foreign market, with 156 companies listed, responding to the enthusiasm of U.S. and Until 2006, the preferred exit from including a number of private equity- global investors for China-based companies, China-based private equity investments was sponsored companies. Perhaps most a number of domestic Chinese listings, a public offering in Hong Kong or the importantly, IPOs of China-based including companies such as Ningpo, one United States of a special purpose vehicle companies have been amongst the top of China’s largest port operators, were (“SPV”) that acted as a holding company performing IPOs in the United States. For slashing their offering size and pricing at for the issuer’s China-based operations. example, the shares of Soufun Holdings, the low end of the range. In mid-October, Many of China’s leading public companies, the operator of China’s largest property China announced the first increase in including Baidu and Alibaba, have been website, soared 73% in its September interest rates in three years and the structured in this way. This type of exit was trading debut, and the shares of JinkoSolar, Shanghai Composite Index fell more than typically structured as a so-called “round- a Chinese solar company, have recently 10%. In recent weeks, a number of large trip investment” in which investors would been trading at more than 250% of their cities in China have introduced pricing establish an offshore SPV, typically in the IPO price. It has also been a banner year controls, and in early November, the Cayman Islands or the British Virgin for IPOs in Hong Kong, the leading market People’s Bank of China increased reserve Islands, to acquire the assets or equity of for offshore IPOs of China-based requirements twice within two weeks in an the Chinese company. Generally the companies. By the end of October, there effort to suck excess liquidity out of the founders would acquire a significant equity had been 78 new listings on the Main domestic market. stake in the SPV in exchange for their Board of the Hong Kong Stock Exchange These trends are particularly striking equity in the Chinese business. (HKSE), raising a jaw-dropping total of because they are contrary to widespread In August 2006, China’s Ministry of US$44 billion, with another 72 listings said expectations that offshore offerings of Commerce (“MOFCOM”), together with China-based companies would five other regulatory authorities, promulgated wind down as a result of significant the Provisions for Foreign Investors to Guy Lewin-Smith – London Alan V. Kartashkin – Moscow Trust & Estate Planning regulatory hurdles to listing a Merge and Acquire Domestic Enterprises Li Li – Shanghai Pierre Maugüé Jonathan J. Rikoon China-based business offshore. (关于外国投资者并购境内企业的规定 ), Dmitri V. Nikiforov – Moscow Margaret M. O’Neill Cristine M. Sapers Robert F. Quaintance, Jr. Nathan Parker – London Not long ago, most pundits were commonly referred to as Circular 10. Employee Compensation William D. Regner A. David Reynolds & Benefits predicting that offshore IPOs of Circular 10 not only provides for Kevin A. Rinker Jeffrey E. Ross Lawrence K. Cagney mainland Chinese businesses procedures for foreign investors to acquire Jeffrey J. Rosen Philipp von Holst – Frankfurt Jonathan F. Lewis Kevin M. Schmidt would be completely supplanted by Chinese companies but also gives Tax Alicia C. McCarthy Thomas Schürrle – Frankfurt John Forbes Anderson – London Elizabeth Pagel Serebransky domestic IPOs as companies took MOFCOM and other Chinese regulators Wendy A. Semel – London Eric Bérengier – Paris Charles E. Wachsstock Andrew L. Sommer advantage of the higher valuations comprehensive control over the offshore Andrew N. Berg Stefan P. Stauder The articles appearing in this Pierre-Pascal Bruneau – Paris and captive liquidity of mainland listing process of the Chinese companies. James C. Swank – Paris publication provide summary Gary M. Friedman John M. Vasily information only and are not China’s maturing domestic An SPV established in the “round-trip Peter A. Furci Peter Wand – Frankfurt intended as legal advice. Readers exchanges. In reality, 2010 appears investment” described above generally falls Friedrich Hey – Frankfurt should seek specific legal advice Leveraged Finance Adele M. Karig before taking any action with to be the year in which a critical within the scope of Circular 10 and Katherine Ashton – London Rafael Kariyev respect to the matters discussed mass of China-based companies therefore an offshore listing using the William B. Beekman Vadim Mahmoudov herein. Any discussion of U.S. David A. Brittenham Matthew D. Saronson – London Federal tax law contained in these learned to live with, and work “round-trip investment” is subject to Paul D. Brusiloff David H. Schnabel articles was not intended or around, the regulatory hurdles that Pierre Clermontel – Paris Peter F. G. Schuur written to be used, and it cannot CONTINUED ON PAGE 4 Alan J. Davies – London Richard Ward – London be used by any taxpayer, for the purpose of avoiding penalties that Peter Hockless – London Fall 2010 Debevoise & Plimpton Private Equity Repor t page 3 may be imposed on the taxpayer l l under U.S. Federal tax law. Learning to Live with Regulatory Uncertainty (cont. from page 3)

MOFCOM’s approval and registrations For example, a widely used alternative material adverse effect on our business, with other Chinese regulatory authorities. structure (often coupled with other operating results and trading price of our Because of the stringent requirements structures) involves the use of a variable ADSs.” of Circular 10, it has been practically interest entity (“VIE”). Interestingly, the In Hong Kong, where the regulator is impossible for China-based businesses to VIE structure was not specifically less likely to rely on disclosure of obtain the relevant approvals, and there is developed in response to Circular 10; regulatory risk and seeks comfort that the no publicly known case of any successful rather, it was initially used for IPOs of corporate structure is fully compliant with offshore listing with the required Chinese Internet companies, in which local law, the exchange has been approvals. From the moment these rules foreign investors were not allowed to hold considerably less enthusiastic about VIE were announced in 2006, foreign private a direct equity interest in the business. offerings. So far, the HKSE seems to be equity firms scrambled to reorganize their Sina.com utilized this structure for its comfortable with companies using the Chinese investments so that they could be successful IPO on NASDAQ in 2000, VIE structure only if they are in the IT grandfathered prior to the rules’ effective and the VIE structure is now widely industry or other industries which do not date of September 8, 2006. Until referred to as the Sina model. allow direct foreign ownership. relatively recently, it was widely believed The VIE structure typically establishes Anecdotally, this appears to be driving that once the pipeline of grandfathered a wholly-foreign-owned enterprise some small- and medium-size China- portfolio companies ran dry, most Chinese (“WFOE”) in China through an offshore based companies that would otherwise portfolio companies would forego the SPV. However, rather than acquiring an have listed in Hong Kong to list in the offshore model in favor of an IPO on one equity stake in the Chinese business, the United States. However, this does not of China’s domestic exchanges. Not SPV acquires control of the Chinese mean that China-based companies have surprisingly, the expectation that domestic operating company and is entitled to all of sworn off listings in Hong Kong. Rather, IPOs are likely to become an increasingly the economics via a series of contractual it appears that the uncertain regulatory likely option for successful China-based arrangements between the Chinese environment has only inspired issuers and companies has also been one of the key operating company and its original their investors to devise even more factors fueling the increasing popularity of owners, on the one hand, and the SPV innovative structures. funds denominated in local currency or and the WFOE, on the other hand. The work-around structures developed renminbi for foreign private equity Accounting standards generally require since the enactment of Circular 10 more investors. that the WFOE and the Chinese than four years ago have made it possible The diverging performance of offshore operating company be treated as for a number of China-based companies and onshore offerings, as well as other consolidated subsidiaries of the SPV, formed in the new regulatory factors such as the longer lock-up periods which is desirable for the IPO of the SPV. environment to successfully list in the common in onshore offerings, however, The VIE structure has been particularly United States or in Hong Kong with the appear to have inspired a number of popular with China-based companies VIE structure and other innovative issuers that were reorganized post-Circular listing on the NYSE or NASDAQ. Both structures. Neither the VIE structure nor 10 (and not grandfathered thereunder) to exchanges have recently permitted China- any other work-around structure has been go to significant lengths to work around based companies to list such structures blessed by MOFCOM or other Chinese the regulatory hurdles. Post-Circular 10, with relatively unattractive disclosure authorities, and accordingly, these many Chinese companies and their about whether the issuer has complied structures are not risk-free. However, the advisors have been innovative in devising fully with Chinese law. For example, use of these structures is no secret and as alternative structures that some Chinese JinkoSolar’s offering documents contained long as MOFCOM and other Chinese law firms have blessed by opining that the following risk factor: “If we were authorities do not expressly prohibit these they do not trigger Circular 10 approval required to obtain the prior approval of alternative structures, one can expect the requirements. As a result, offshore IPOs the PRC Ministry of Commerce, or work-around trend to continue. have been undertaken on the basis that MOFCOM, for or in connection with In any event, the desire of Chinese these alternative structures are not subject our corporate restructuring in 2007 and businesses to seek access to offshore to MOFCOM approvals. 2008, our failure to do so could have a CONTINUED ON PAGE 12 page 4 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 GUEST COLUMN Active Private Equity Fund Management in the Context of Asset Allocation

The relationship between institutional investors and private out managers whose investment strategies are defined more by equity fund managers is evolving to allow for more active creativity than a predictable formula. Because this type of engagement by investors. Endowments, foundations, pension selection is based primarily on bottom-up analysis, portfolios of funds, and other multi-asset class investors have traditionally the best investors are idiosyncratic in nature. Imbalances with allocated capital to private equity (including venture capital) to regard to macro factors are generally accommodated through enhance portfolio returns and improve diversification. While more liquid investments in which a top-down orientation is these investors have generally treated private equity as an asset more appropriate. class that can be passively managed through carefully selected Limitations of the Asset Allocation Approach fund managers, some institutions (including sovereign wealth The general approach of allocating capital to private equity as an funds) have taken a more active role in the development and asset class does not present a one size fits all solution. Smaller management of their private equity portfolios. pools of capital cannot support the internal resources necessary to excel in the selection and oversight of private equity fund

Selection focused relationships — this is especially true in the context of global Asset Allocation to on access to best- Passive engagement Private Equity performing, with fund managers markets. This dynamic is evident in the realm of endowment established firms management, where large endowments have tended to be more aggressive with their allocations to private equity — the ability to create investment relationships with best-in-class fund managers Active Investing Within has perhaps been the primary factor in explaining high an Asset Allocation Approach allocations to private equity funds (as well as other alternative A small number of endowments and foundations have a track asset classes) by large endowments. record of active engagement with regard to selection and At the other end of the continuum, very large institutions relationship management. These investors have been successful cannot reasonably expect to rely on superior selection to in creating distinctive and high-performing private equity outperform a market in which the best fund managers tend to programs, but have tended to avoid direct investments and have come in small packages. Moreover, the traditional (asset mostly invested using customary fund structures. allocation) approach to private equity investing contains several inconsistencies and shortcomings that are more acute with larger Creation pools of capital. Selection of new Ongoing focused on Asset Allocation investment engagement with access to best- Approach with vehicles, fund managers, l Private equity is not an “asset class” — it has some unique performing Active Selection including first- including leveraged established time funds – information features and can reach corners of the market not otherwise firms active networks easily accessed. Private equity is more appropriately described involvement as an “investment class” and used as a mode of implementation. The wide dispersion of returns among private equity firms clearly establishes the importance of selection. While effective l The private equity industry, as a whole, requires investors to selection involves identification of the best groups, active pay fund managers for the value of the liquidity they bring to investors have essentially created their own deal flow by backing the table — this is most easily seen in the obvious disconnect first-time or newly developed investment vehicles through a between actual fund operating expenses and management fees process that optimizes alignment of interests within the charged, as well as carry/profit-sharing schemes that operate constraints of the typical fund structure. The best investors have independently of the amount of capital employed. also been willing to exercise independent judgment in rooting CONTINUED ON PAGE 6

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 5 Guest Column (cont. from page 5)

l Typical fund structures are blunt instruments – it is puzzling relationship between investor and fund manager should take that that “sophisticated” investors are willing to accept essentially into account. By providing capital when liquidity is constrained standardized terms ( e.g ., two & twenty fees, five-year (“flexible capital”) active investors can counteract the tendency of investment periods, holding periods of less than ten years, funds to be pro-cyclical in their deployment of committed capital etc.) to access a wide range of investment types and strategies. (i.e ., increasing their investment pace when liquidity is expensive and pulling back when premiums for illiquidity are high). By These factors have led some investors to take a more active acting as a principal investor with regard to the use of flexible and direct role in their private equity portfolios. The most recent capital, investors can evolve from passive investors to strategic iteration of this desire to be more active goes beyond a simple partners with fund managers. goal of reducing fees (which has long been the typical rationale It would be natural for fund managers to consider active for direct and co-investment programs). Instead, the newer form investors (particularly those with substantial direct investment of active engagement is aimed at improving the underlying programs) as potential competitors. While increased active quality of investment programs. Sovereign wealth funds and engagement by investors will necessarily result in some some pension funds have garnered the most press for taking this disintermediation, there may be substantial opportunities for type of active role in developing their private equity portfolios. strategic alliances that could expand the universe of potential Active Investing Outside transactions and create unique pathways for generating the Asset Allocation Approach investment returns. For instance, sovereign wealth funds have The current trend among some large institutional investors regional expertise and information networks that can toward active involvement embodies a rejection of certain meaningfully improve a fund manager’s capabilities in deal elements of the asset allocation-based approach to private equity sourcing and due diligence. investing. With this type of active approach, private equity funds Is There a “Right” Answer? are not viewed as comprising an asset class, but instead are Unfortunately, the answer to the question, “Is there a right treated as one of perhaps several ways to access specific types of answer?” is an unfulfilling one: it depends. With each evolution investments in an operationally efficient manner. of the private equity market, there is inevitable debate about whether prior strategies have become invalid. The current set of Creation Intense Private Selection of new engagement evolutionary change (from passive asset allocation, to selection- Active / equity focused on investment with fund principal- viewed as access to vehicles, managers, driven asset allocation, to active principal-oriented investing) oriented mode of best- including including approach implementation performing funds and leveraged reflects a natural and healthy progression in which discreet versus asset established strategic information segments of the market strive to create investment programs that class firms relationships networks are best-suited to the nature of their capital.

Included in this more active approach is an understanding Daniel Feder, CFA that investors in private equity funds are bringing value to the Advisor, Heritage Fund at Sequoia Capital table in the form of liquidity and that the terms of the

A complete article index, along with Looking all past issues of the Debevoise & Plimpton for a past Private Equity Report , is available in the “publications” section of the firm’s website, article? www.debevoise.com.

page 6 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 EU Directive on Alternative Investment Fund Managers: Good News at Last

Private equity firms based outside of Europe impact on the management and marketing (wherever established) in the EU. breathed a sigh of relief when the European of private equity funds in the EU and There is a limited exemption for EU Parliament finally decided that even fund impose significant increases on the managers with combined assets under managers based outside the European compliance costs of funds and their management of less than €100 million Union may well be entitled to a “passport” managers. This article summarizes the (€500 million in the case of funds that are entitling them to market alternative Directive’s principal features. ( For the not leveraged and have no redemption investment funds within the EU. In quickest overview of the Directive, see the rights exercisable for a period of 5 years November, the European Parliament voted tables entitled ‘AIFM Directive at a glance,’ from initial investment). However, these to adopt the text of the directive on on page 8, and ‘AIFM Directive — managers will still need to be registered in alternative investment fund managers (the Anticipated Timeline,’ below. ) their home Member States and will not be “Directive”) that was agreed in October Scope of the Directive able to benefit from any of the rights under following months upon months of the Directive (including passport rights), The Directive will apply to all (1) EU negotiation among the European unless they elect to comply with the managers (managers with a registered office Parliament, the EU Council and the Directive. in the EU) that manage 2 one or more European Commission (the funds, and (2) non-EU managers that Authorization “Commission”). manage one or more funds established in and the Fund Passport Much of the negotiation centered the EU or that market 3 one or more funds Once the Directive is implemented around whether or not fund managers sometime in 2013, an EU manager will based outside the European Union (“non- 2 “Manage” for the purposes of the Directive means need to be authorized by its home State EU managers”) should be allowed to benefit discretionary investment management rather than regulator in order to be able to manage and from a European fund “passport” that merely providing investment advice or market funds. Authorization will involve grants managers the ability to market recommendations. significant compliance and reporting alternative investment funds (“funds”) 1 to 3 “Marketing” is defined in the Directive as any obligations. However, once authorized, an investors in EU Member States using a direct or indirect offering or placement at the EU manager will be able to market the EU single notification procedure. The initiative of the manager (or on behalf of the manager negotiated compromise extends the of units or shares in a fund it manages) to or with CONTINUED ON PAGE 8 investors domiciled in the EU. passport to non-EU managers, but only after a two-year waiting period, and only if the new European Securities and Markets AIFM Directive — Anticipated Timeline Authority (“ESMA”) based in Paris advises the Commission that extending the passport April 2011 Entry into force of the Directive. to non-EU managers is appropriate. April 2013 Time limit for transposition of the Directive into national law by The Directive is likely to enter into force EU Member States. by mid-2011 and will then have to be April 2015 ESMA to report to the Commission on possible extension of the implemented ( i.e. , transposed into national passport to non-EU managers and funds. law) by Member States within two years — by mid-2013. It will have a profound July 2015 Commission to decide, subject to ESMA’s advice, whether the passport should be extended to non-EU managers and funds.

1 “Alternative investment funds” are defined in the April 2017 Commission to begin a review of the application and scope of the Directive as collective investment undertakings which Directive. raise capital from a number of investors with a view to investing it in accordance with a defined July 2018 ESMA to report to the Commission on the possible termination of investment policy for the benefit of those investors (but national private placement regimes. excluding retail open-ended funds complying with the October 2018 Commission to decide, subject to ESMA’s advice, when national EU UCITS Directive). Most private equity funds are “alternative investment funds.” private placement regimes are to end.

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 7 EU Directive on Alternative Investment Fund Managers (cont. from page 7)

funds 4 that it manages to professional l non-EU managers will have to comply National private placement regimes are investors 5 in the manager’s home State, with the Directive’s disclosure unlikely to last indefinitely. Approximately and in other Member States, using a requirements and (if relevant) portfolio three years after the Commission extends passport. This means that, instead of company requirements; the passport to non-EU managers and having to comply with multiple EU funds (2018, assuming it does so in l appropriate cooperation arrangements private placement regimes, an EU 2015), the Commission will decide when will have to be in place between the manager will be able to market its funds national private placement regimes are to regulator of the Member State where to professional investors throughout the end, after which the fund passport will be the fund is to be marketed and each of EU following a single notification to its the only means of marketing EU and non- the non-EU manager’s regulators and home State regulator. EU funds to EU investors. the regulator of the non-EU fund; and A non-EU manager proposing to Authorization the country where the non-EU manager manage EU funds or market funds in the l of non-EU managers EU will not be able to apply for or the fund is established must not be Non-EU managers who wish to become authorization (or market funds using a listed as non-cooperative by the passport) until the Commission extends Financial Action Task Force (FATF). CONTINUED ON PAGE 22 the passport to non-EU managers. The earliest will be in 2015, two years after the AIFM Directive at a Glance Directive is implemented, provided that the Commission receives a favorable Scope Applies to all EU managers of alternative investment funds (hedge funds, private equity funds and real estate funds) and non-EU opinion from ESMA recommending the managers who manage or market such funds in the EU. passport’s extension to non-EU managers. Until the passport is extended, non-EU Authorization EU managers will need to be authorized to manage and market managers will be able to continue funds from 2013. Non-EU managers may need to be authorized to manage (EU Funds from 2015) and market funds in the EU marketing their funds to investors in the from 2018. EU under national private placement regimes. However, once the Directive is Fund passport Fund passport (allowing funds to be marketed throughout the implemented in 2013, certain minimum EU) to be introduced for EU managers and funds from 2013. European Commission to decide whether to extend the fund conditions 6 will apply: passport to non-EU managers and funds in 2015.

4 EU managers will not be able to market non-EU National private National private placement regimes to continue (subject to funds in the EU using a passport until the placement regimes some additional conditions for non-EU managers from 2013), Commission extends the passport to such funds. but European Commission may decide to end them in 2018. Until then (probably in 2015), EU managers will only be able to market non-EU funds to investors in Compliance Significant compliance and reporting obligations are imposed Member States under national private placement obligations on authorized managers, including requirement to appoint a regimes, and only if the country where the fund is depositary (custodian) for each fund they manage. established satisfies certain conditions. Leverage Managers of funds using leverage must disclose information on 5 “Professional investors” include entities required disclosure use of leverage to their regulator. Member States can impose to be regulated or authorized to operate in the leverage limits on managers. financial markets, such as banks, investment managers, insurance companies, pension funds and Portfolio Managers of funds acquiring interests in unlisted companies institutional investors, and large undertakings company must disclose information to their regulator and, in the case of (businesses) meeting at least two of the following disclosure acquisition of control, to the company and its shareholders. three size requirements: (1) balance sheet totals of €20 million or more, (2) net turnover of €40 Asset stripping Managers of funds acquiring control of unlisted companies will million or more, and (3) own funds of €2 million be subject to restrictions on asset stripping for two years or more. following acquisition.

6 Individual Member States may impose stricter ESMA Enhanced supervisory role for the new European Securities and requirements. Markets Authority (“ESMA”).

page 8 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 EU Directive on Alternative Investment Fund Managers (cont. from page 7) Monetizing the Shield: Tax Receivable Agreements in Private Equity Deals

There has long been a pervasive view that one or more lower-tier partnerships, was a Endo Pharmaceuticals public markets systematically undervalue variation of the “UPREIT” structure (in A broadly similar form of symmetry was tax assets of various sorts — perhaps which a publicly traded corporation or present in the 2000 IPO involving Endo because they are inherently arcane, or REIT owns interests in a lower-tier Pharmaceuticals. There, the terms of perhaps because the ability to realize upon operating partnership along with other Endo’s existing options were modified so them depends upon so many partners.) that they would be exercisable only into imponderables. Whatever the reason, in a In these offerings, the individual equity shares held by existing shareholders rather number of public offerings in recent years owners of the sponsor would typically sell a than newly-issued shares. As a result, the the pre-IPO shareholders have devised ways portion of their partnership interests to the dilution associated with the exercise of these of retaining for themselves the economic public entity, while receiving the right to options would be borne entirely by the benefits of identified tax attributes. Called exchange their retained interests for equity existing shareholders. However, under the “tax receivable agreements” or “TRAs,” of the public entity at a fixed exchange rate. tax rules, Endo would still receive the these arrangements generally provide that Future exchanges of the interests of the compensation deduction associated with the existing shareholders will be individual sponsors in the fee-earning future option exercises. The parties entered compensated as the pertinent tax attributes partnership entities would be structured as into a TRA under which Endo would pay are utilized, with the result that the taxable sales. Both the initial acquisition of to the existing shareholders the amount of company is effectively taken public ex those interests at the time of the offering and the any realized tax benefit from such attributes. TRAs may well have a role to future exchanges would result in a “step-up” compensation deductions. play in other types of transactions where in the basis of the interest of the subsidiary CONTINUED ON PAGE 10 the valuation of tax assets may be valued corporation in the assets of the underlying differently by various consituencies. fee-earning partnerships, creating an TRAs intangible asset that would be amortizable [I]n a number of public over 15 years for income tax purposes. TRAs made their first appearance in the Under the TRAs, the sponsors would be public offerings of private equity and hedge offerings in recent years compensated in an amount equal to 85% of fund management companies such as the tax savings realized by the subsidiary the pre-IPO shareholders Fortress, Blackstone, Och Ziff and others. corporation from such amortization Those offerings were structured so that the have devised ways of deductions. Payments would be made as public entity was treated as a partnership the deductions reduced the actual tax for tax purposes. In order to avoid retaining for themselves liability of the corporation (determined on treatment as a corporation for tax purposes, a cumulative basis comparing the the economic benefits of those entities are required to derive 90% of corporation’s actual tax liability to its their gross income from passive sources notional tax liability if such amortization identified tax such as investment gains and dividends. deductions did not exist.) Fee income would not have qualified, so attributes....TRAs may The structure described above reserves to the public vehicle set up a subsidiary the existing owners the tax benefits (or 85% corporation to own the interests in the fee- well have a role to play in of the tax benefits) associated with a basis earning operating entities that were step-up that results from a taxable exchange other types of allocable to the public ownership. The on which the existing owners were taxable balance of the interests in those operating transactions where the — in short it has a certain symmetry entities were owned by the pre-IPO because existing owners receive tax benefits shareholders. The resulting structure, with valuation of tax assets associated with a tax liability they have a public partnership owning a corporation borne. may be valued differently that in turn owned some of the interests in by various consituencies.

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 9 Monetizing the Shield (cont. from page 9) TRAs for NOLs corporation controlled by Blackstone apportioned between the founders and the Both the basis step-up TRAs and the owning a majority interest in a lower-tier existing shareholders in proportion to the Endo arrangement have the effect of operating partnership in which the relative amounts that would have been giving the existing shareholder group the founders of the company retained an due under each TRA before giving effect benefit of tax attributes that flow from interest. The 1998 acquisition by the to the cap. transactions (pre- or post-IPO) with corporation of the majority interest in the Graham Packaging’s use of TRAs for respect to which they had borne or would partnership had created a stepped-up basis existing tax attributes gives further shape bear the cost. A similar logic arguably and amortization deductions that to a fairly nuanced landscape for such supports TRAs that are intended to give produced a large net operating loss arrangements — they can apply to pre-IPO shareholders the benefit of any (“NOL”) at the corporate level. In attributes that exist at the time of the pre-IPO net operating loss carryforwards, connection with the offering, the public IPO, to attributes that will be created and TRAs have begun to be utilized in entity entered into two TRAs: one with post-IPO as a result of gains realized by that context as well. A case in point is the the founders, to compensate them for the original owner group (the recent (February 2010) IPO of Graham 85% of the cash tax savings arising from UPREIT/basis step-up case) and to Packaging, a Blackstone portfolio amortization deductions created on future attributes that will be created post-IPO as company. Graham Packaging was also an exchanges of partnership interests for public a result of costs borne by the original UPREIT-type structure, with a stock; and another with the shareholders of owner group (the Endo Pharmaceuticals the corporation, to compensate them for options). The final possible case would be 85% of the cash tax savings arising from the tax attributes that will be created in the The market seems to have use of the NOL and any additional future where the costs of the transactions amortization deductions arising from the creating those attributes will be borne by become accustomed to 1998 acquisition. all shareholders — this would be the case As with other TRAs, the amount if the options in Endo Pharmaceuticals seeing [tax receivable payable under the Graham Packaging diluted all shareholders. Although the agreements] in the arrangement is calculated by comparing quid pro quo in such transactions is not as the corporation’s actual tax liability with readily apparent as in the others, there is UPREIT/exchange context; its notional tax liability excluding the tax no reason that they could not be attributes in question. However, due to structured and such structures may be in other situations, the dual TRA structure and the appropriate in cases where the market is entitlement of different parties to discounting the offering price for the sponsors may wish to payments for usage of different attributes, option dilution without adequately consider the relative it was necessary to determine some reflecting the tax benefits associated with allocation of payments between the the options. advantages of retaining founders and the existing shareholders of Tax Treatment of Holders the corporation. Each TRA first compares of TRAs such value through TRAs the cash tax savings that would arise from Two related tax questions arise for holders one set of attributes as if the corporation’s versus providing more of TRAs. The first concerns the tax actual tax liability excluded the effect of treatment of payments made under the tax attributes covered by the other TRA. detail on the expected arrangement and the second relates to the To the extent that the amounts otherwise tax treatment of the receipt of the right to utilization of such due under the TRAs exceeded a cap equal receive the payments (if any). In the to 85% of the overall realized tax benefits UPREIT/exchange transactions, the TRA benefits in an effort to (with the actual tax liability determined payments were treated as additional taking into account both sets of cause such benefits to be consideration for the exchanged equity, attributes), the aggregate TRA payments providing exchanging equityholders with properly valued in the would be limited to the cap and CONTINUED ON PAGE 23 offering price.

page 10 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Monetizing the Shield (cont. from page 9) Reform of the UK Takeover Code: The End of the Affair?

As we reported in the Spring 2010 edition that “hostile offerors have, in recent times, bidders. The Code has traditionally of the Private Equity Report , on 1 June, been able to obtain a tactical advantage over provided that financial information 2010 the UK’s Takeover Panel (the the offeree company to the detriment of the about the offeror was relevant only in “Panel”) published its consultation paper offeree company and its shareholders,” and respect of securities exchange offers. on the possibility of reforming the UK’s indicates that it intends to bring forward However, in light of a number of Takeover Code (the “Code”). The June certain proposals to amend the Code with consultation responses, the Panel has consultation was prompted by growing a view to redressing the balance in favour now concluded that, irrespective of the concerns that it has become too easy to of target companies. The changes being nature of the offer in question, financial achieve takeovers of UK companies subject proposed by the Panel include: information about the offeror is also of to the Code and that the outcome of such concern to shareholders in the offeror l Requiring potential offerors to quickly offers may be unduly influenced by the as well as creditors, customers and clarify their position. The Panel actions of hedge funds and other “short- employees of both parties. The Panel proposes to restrict the “put-up or shut- term” shareholders who become interested has, therefore, proposed that such up” period following the announcement in shares only during an offer period. information be incorporated into cash of a possible offer to 4 weeks, after Although such concerns were not offer documents as well. which time the potential offeror must necessarily new, the circumstances either make a binding offer or walk l Requiring further disclosure in relation to surrounding Kraft’s £11.6 billion hostile away (in which event it cannot usually the financing of an offer. With an eye, takeover of UK confectioner Cadbury plc, return with another offer for at least six no doubt, on the controversy suggested to many political and industry months). This time limit would not surrounding Kraft’s closure of the commentators (particularly in a General apply to auctions where the target Cadbury plant at Somerdale in the UK, Election year in the UK) that something board has established a formal sale the Panel has proposed amendments to needed to be done. process. the Code to make it clear that the As previously reported, the June target board is entitled to consider the consultation paper did not contain specific l Prohibiting deal protection measures. longer-term effects of a successful proposals for reform. Instead, reflecting Despite most consultation responses takeover on the merged business in all political and commentator suggestions, it suggesting the opposite, the Panel the circumstances. In fact, the Code rehearsed a number of possible changes to intends to prohibit inducement fees does not currently contain a restriction the Code, with a non-exhaustive list of and undertakings by the target board to on what factors the target board may arguments for and against each of them. support an offer (other than in certain consider, albeit price has traditionally Some of the possible changes — such as limited circumstances). This dominated. Bidders will now be disenfranchising shareholders who have prohibition will not apply to auctions required to include in the offer acquired shares during an offer period or where the target board has established a document a pro forma balance sheet for increasing the current minimum formal sale process. the combined group and greater acceptance threshold of 50% plus one of l Requiring disclosure of offer-related fees. disclosure of any bank facilities taken the voting rights in a target — go to the The Panel chose not to prohibit out to finance a bid. heart of UK company law and would advisory and other fees involving an l Improving disclosure relating to the therefore, if implemented, require incentive or success based component, offeror’s intentions regarding the target legislation by Parliament to change. but proposed that the minimum and and its employees. Again, with an eye on The Panel’s Response maximum amount of such fees should the Somerdale plant closure, the Panel On 21 October, 2010, the Panel published be disclosed along with the fees of other has proposed that an offeror’s plans for its much-awaited response to the June advisers. target employees, assets and places of consultation paper. In its response, the l Requiring disclosure of the same financial business should be the subject of greater Panel concedes, citing a range of reasons, information in relation to all types of CONTINUED ON PAGE 12

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 11 Reform of the UK Takeover Code (cont. from page 11)

disclosure and that if no time periods The End of the Affair? an offer without having first secured are indicated, such plans will be Few will be surprised that the Panel has financing. expected to hold true for at least one not proposed sweeping reform, even if it Does the Panel’s response mark the year after the offer becomes may purport to do so. Its response does end of the affair, at least for now? unconditional. The Panel also intends not fully address the vague concept of Comments made over the last few that it should be easier for employee “short termism” which has so dominated months by the UK’s Secretary of State for representatives to make their views the debate. Neither, of course, does it Business, Innovation and Skills, Vince known. address the issue of foreign ownership of Cable MP, in relation to “short termism” A Bridge Too Far UK public companies (up from 36% of and the takeover market in general suggest that he, at least, within Britain’s The Panel does not propose, however, to quoted company shares in 2000 to 41% Coalition Government, was looking for a take forward some of the more in 2008) which was arguably the real particular outcome from the consultation. controversial proposals in the June reason for the furor surrounding the Whether he feels that the Panel’s consultation. By reference to the views Cadbury-Kraft deal. response is adequate remains to be seen. of respondents, and not the views of the Still, sweeping or not, there are some Detailed rule changes are expected to be Panel per se , the response paper notes important changes proposed and it is published for consultation in the first that the acceptance threshold of “50% likely that private equity firms will be quarter of 2011, with implementation plus one” is inextricably linked with the affected by some of them. For example, following by early summer. We will keep passing of an ordinary resolution under buy-out firms which have traditionally you apprised of any developments UK company law, and that if such a used “break fees” as a means of deal change were to be made, it should be the protection (capped at 1% of deal value Guy Lewin Smith domain of Parliament and not the Panel. under the current regime) will no longer [email protected] Similarly, the suggestion that shares be able to use this as a method of Edwin James Northover acquired during an offer period should offsetting costs in the event of a failed [email protected] be disenfranchised, compromised the bid unless an auction process is instigated company law principle of “one share, one by the target. Additionally, the proposed vote” and accordingly, any introduction shortening of the “put-up or shut-up” of weighted voting rights or qualifying period will significantly restrict the periods before voting rights could be tactical ploy of putting the target exercised was rejected as also requiring management under pressure by legislation. announcing only an intention to make

Learning to Live with Regulatory Uncertainty (cont. from page 4)

markets, particularly U.S. capital markets, corporate structures to delicately navigate structures, it is hardly surprising that coupled with a spike in global interest in through China’s evolving regulatory investors have, in the words of the the region, has inspired many issuers and regimes. In China, the reopening of the American idiom, been quick to “make hay investors to take a new look at an exit IPO window and offshore exit while the sun shines.” option that many private equity investors opportunities in 2010 after the more Edward Drew Dutton had assumed was off the table. difficult period of 2008 and 2009 is [email protected] Increasingly, investors and capital markets causing some investors to cite the Chinese appear willing to accept a certain amount idiom “ 雨过天晴 ” (after rain comes Haifeng Peng of regulatory uncertainty in supporting sunshine). Although there is no certainty [email protected] IPOs of Chinese businesses that rely on that Chinese regulators will not move to relatively creative and complicated restrict the use of some of these alternative page 12 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Reform of the UK Takeover Code (cont. from page 11) ALERT RFeTcCen Ct aonnds iUdpecrosm Cinhga Snpgeeask intgo Ethngea gHeSmRe nFtos rm Impacting PE Sponsors

Unless the business community is able to for the filing party and its unconsolidated the HSR filing by “investment bankers, convince the Federal Trade Commission U.S. subsidiaries in Item 4(b), and “base consultants or other third-party (“FTC”) that its proposed new rules are year” (currently 2002) revenue data by advisors” for an officer or director of unduly burdensome, private equity firms NAICS code in Item 5. This Alert either party if they contain content of seeking to acquire businesses may have a discusses some of the less welcome the type responsive to Item 4(c) and significantly harder time making routine changes, particularly for private equity refer to the entity or assets to be filings for anti-trust clearance. The FTC firms. acquired, regardless of whether they is currently reviewing public comments on “Item 4(d)” Documents relate to the reported (or any) several substantial proposed amendments transaction. As many private equity managers know, to the Premerger Notification Rules and responding to Item 4(c) of the Form is 3. Item 4(d)(iii) would seek all the Notification and Report Form (the one of the most time-consuming parts of documents “evaluating or analyzing “Form”) that is used to report certain preparing the filing, and the associated synergies and/or efficiencies” that were mergers and acquisitions under the Hart- rules are some of the most complex. Item prepared by or for an officer or director Scott-Rodino Act (“HSR”). While many 4(c) seeks documents prepared by or for of either party for the purpose of of the FTC’s proposed modifications officers or directors of either party for the evaluating or analyzing the proposed simplify preparation of the Form by purpose of evaluating or analyzing the transaction. Under existing practice, removing outdated data and documentary proposed transaction with respect to documents discussing revenue synergies requirements, others would significantly markets, market shares, competition, are considered responsive to Item 4(c), expand the burden of HSR compliance, competitors, potential for sales growth or but documents exclusively considering especially for private equity sponsors. expansion into product or geographic cost synergies are not. This proposed Recognizing this, the Private Equity markets. The proposed rule changes change would include the latter, but Growth Capital Council (“PEGCC”) and would add an “Item 4(d)” to the Form, would exclude financial models without other organizations have submitted which would require submission of three stated assumptions. comments, which are available on the additional categories of documents: FTC’s website at www.ftc.gov/os/ The Item 4(d) proposals have been the comments/hsrformrevisions/index.shtm. 1. Item 4(d)(i) would ask for any offering subject of much controversy because many The FTC’s Notice of Proposed memorandum that refers to the entity HSR practitioners believe they would Rulemaking (see www.ftc.gov/os/2010/08/ or assets to be acquired and was greatly expand the scope of a filing party’s 100812hsrfrn.pdf), issued August 13, prepared in the two years preceding the search for responsive documents, even in Learning to Live with Regulatory Uncertainty (cont. from page 4) 2010, states that the purpose of the HSR filing. This item goes well transactions raising no competitive issues changes is to streamline the Form and to beyond codifying the FTC’s existing and where the parties report no product capture new information that will help the interpretation of Item 4(c), which or service overlaps on their HSR Forms. FTC and the Antitrust Division of the requires offering memoranda relating to The public comments have also Department of Justice (“DOJ”) conduct the transaction being reported, by highlighted the risk to deal confidentiality their initial review of a proposed requiring firms to collect and submit arising from the apparent need to search transaction’s competitive impact. offering memoranda “or documents the files of individuals having no prior Welcome changes to the Form and its that serve that function” that have no knowledge of the transaction (including associated Instructions include elimination relation to the reported transaction and officers and directors of other portfolio of the requirements to provide copies of, were not prepared by or for officers or companies) but who might have or internet links to, certain SEC filings by directors. documents responsive to Items 4(d)(i) or the filing party and its controlled (ii). Comments have also expressed 2. Item 4(d)(ii) would require documents subsidiaries in Item 4(a), balance sheets prepared within two years preceding CONTINUED ON PAGE 14

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 13 Alert: FTC Considers Changes to the HSR Form (cont. from page 13)

concern about potentially expansive knowledge or belief, its associates’ than 7-digit codes, which should not be a interpretation of new terms such as minority investments (defined as very burdensome exercise. However, the “consultants or other third-party advisors.” investments of at least 5% but less than new rules would also expand Item 5 to “Associates” 50%) in entities making U.S. sales in the include revenues of certain foreign same 6-digit NAICS industry codes as the operations. The current rules limit Item 5 Proposed changes involving the new term target entity or assets. Similarly, revised revenue reporting to operations conducted “associate” are specifically aimed at private Item 7 would extend the existing within the U.S. Thus, revenues from equity firms and other capital requirement that filing parties identify U.S. sales of foreign manufacturing management groups structured as NAICS code overlaps between the operations are reported only when the multiple limited partnership funds under acquiring party (including its controlled products are sold through a controlled common management but whose equity entities) and the target entity or assets to entity located in the U.S., but not when interests are widely held. Under the include overlaps with any associates of the sold directly from the foreign manufacturer current HSR rules, each such fund is its acquiring person. In the case of a private to a U.S. customer. The FTC’s proposal own “ultimate parent entity” because it is equity firm, these changes would mean would require that revenue from all U.S. not “controlled” (for HSR purposes) by that the HSR Form filed by an acquiring sales of foreign manufacturing operations any limited partner, general partner or fund would have to disclose any such be reported at the 10-digit NAICS code manager. This means that a HSR Form overlaps between the target entity or level regardless of how the sales are made reporting an acquisition by one such fund assets, on the one hand, and any control to the U.S. (or its controlled portfolio company) does and applicable minority investments of not include any information relating to Other Changes any fund under common management other funds under common management The FTC’s proposed revisions also include with the acquiring fund, on the other nor to those funds’ investments. Such numerous minor changes to the HSR hand. information might be of great interest to Form, many of ministerial or organizational As the PEGCC noted in its comments, the antitrust agencies where, for example, nature ( e.g. , requesting the filing party’s it may be difficult for private equity firms a portfolio company of a related fund is a website address), and some of which to know about overlaps or collect NAICS competitor of the target in the reported reflect prior changes to the HSR Rules or code data from portfolio companies in transaction, or where a related fund their interpretation ( e.g. , the change in which the firm has only a small minority already holds a minority interest in the civil penalties to $16,000 per day that interest. This difficulty would be target company. became effective in early 2009). multiplied if the “associate” in question The proposed rules would alter this was a third-party investment adviser, as * * * reporting requirement by creating the that individual or entity would not likely Given the controversial nature of some of term “associate” and defining it as any be willing to provide information about the proposed rule changes, and the entity (a “managing entity”) that has the its minority holdings or about other substantial objections and suggestions “right to manage, direct or oversee the clients it advises. In addition, the public provided by HSR practitioners and the affairs and/or the investments” of an comments have focused on the excessive business community, it is likely that the acquiring entity, as well as any entity that breadth and vagueness of the definition of FTC will modify some of the proposed has its “affairs and/or investments, directly “associate,” especially because the term rules before they are implemented. The or indirectly managed, directed or “oversee” could be interpreted to include timing of the FTC’s issuance of the final overseen” by the acquiring person or by a entities and individuals having no rules is uncertain, but it is not likely that managing entity. decision-making authority. the rule changes will take effect before The proposed rules also impose early 2011. additional information requirements Item 5 Revenue Reporting under Items 6 and 7 of the HSR Form The proposed modifications to Item 5 of Gary W. Kubek with respect to an acquiring person’s the HSR Form would require a filing [email protected] associates. The proposed change to Item party to report its manufacturing revenues Kyra K. Bromley 6(c) of the Form would require an from U.S. operations for the most recent [email protected] acquiring party to disclose, based on its fiscal year by 10-digit NAICS code rather page 14 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Terra Firma v. Citibank: A Cautionary Tale?

Five years ago few in the New York clear that EMI’s financial condition would those ethical walls operate. Indeed, the financial community would have imagined continue to deteriorate and that Terra evidence at trial suggested that Mr. Hands, that a preeminent London-based private Firma’s price might not have been justified. who was well aware of Citibank’s role and equity firm would sue a global bank in New Citibank received £92.5 million in fees on relationships with parties on both sides of York federal court and argue before a jury the deal. the transaction, viewed Citibank’s dual role that the bank had defrauded the private In December 2009, Terra Firma filed a as a plus to the extent that his close equity firm in connection with an auction. complaint against Citibank in New York relationship with Mr. Wormsley might be Nor would many have suspected that the state court, and Citibank removed the case helpful in providing Terra Firma with access global bank would have let the case go to a to federal district court in New York City. to information about the auction that it jury. Terra Firma’s recent case against Terra Firma’s central allegation was that might not otherwise have had. Citibank provided plenty of intrigue in a David Wormsley lied to Guy Hands and What was, in fact, more unusual about headline-grabbing trial conducted by two induced Terra Firma to bid £2.65 a share by the case was Terra Firma’s decision to sue high-profile trial lawyers and covered daily telling Mr. Hands, falsely, that Cerberus Citibank and Citibank’s willingness to let in the business press. The case was resolved Capital Management was a competing the case go all the way to the jury. As the when the jury quickly rejected all of Terra bidder at £2.62 a share. The complaint Wall Street Journal put it, the case Firma’s claims, determining that Terra further asserted that Wormsley’s motives to represented an “unprecedented attack by a Firma had not sustained its burden of proof deceive Hands, for whom Wormsley had private equity firm on a bank it depends on that there was a misrepresentation that acted as a close advisor for over 20 years, to help originate and fund its takeovers,” Terra Firma relied on. The case provided included (1) receiving a substantial advisory and was essentially a referendum on an intimate look at the auction process and fee from EMI, (2) avoiding the Citibank’s trustworthiness. Trial at how highly leveraged private equity embarrassment of a busted auction, commenced on October 18, 2010, with transactions are negotiated and structured. (3) protecting Citibank from an EMI default Terra Firma arguing that Citibank’s loyalties At the end of the day, however, the biggest on Citibank debt, and (4) creating an were divided, and that Wormsley had, in a surprise was that the case was brought and opportunity for Citibank to provide Terra moment of desperation, blatantly lied about that it was tried in front of a jury. Firma with financing for the acquisition. CONTINUED ON PAGE 16 A quick review of the facts can also serve Although much of the media coverage of as a reminder of several things worth the trial seemed to suggest that Citibank’s keeping in mind during “deal heat.” relationships on the sell side and in The case provided an The saga began in 2007, when EMI, a providing financing to bidders put it in a British music company in deteriorating conflicted, and thus, unusual position, it is, intimate look at the financial health, commenced an auction to in fact, not particularly unusual, as those in sell itself, with Citibank acting as its the deal community know only too well, auction process and at secondary advisor on the deal. After three for a bank serving as a financial advisor on how highly leveraged private equity firms submitted indicative the sell side of a transaction to have a bids, David Wormsley — then head of UK financial interest ( e.g. , as a lender) on the private equity transactions Investment Banking for Citibank — buy side of the same transaction. And contacted his friend and frequent client, because private equity transactions routinely are negotiated and Guy Hands, chairman of Terra Firma, rely on leveraged financing, virtually all about EMI. Terra Firma expressed interest major private equity firms have well- structured. At the end of and, as it prepared to submit a bid, the established and long-standing relationships the day, however, the other bidders, unbeknownst to Terra Firma, with the banks capable of acting as both dropped out of the process. On May 21, lenders and financial advisors. And, perhaps biggest surprise was that 2007, Terra Firma, by then the sole bidder most importantly, private equity firms in the auction, bid £2.65 a share and understand the ethical walls that financial the case was brought and succeeded in acquiring EMI. Almost institutions have put in place to deal with that it was tried in front immediately after the closing, it became these potential issues and the way in which of a jury.

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 15 Terra Firma v. Citibank: Cautionary Tale? (cont. from page 15) the Cerberus bid. Citibank, on the other and records containing both key and bid seemed to be undermined by evidence hand, depicted the case as Mr. Hands’ trivial information exchanged between the showing that Mr. Hands received an email attempt to shift responsibility for a bad parties — including dinner menus and from the Financial Times on the morning business decision to Citibank and to gain receipts — there was not a single email, of May 21, the day Cerberus allegedly was leverage in negotiations with Citibank note or other document in which going to bid £2.60, bearing the headline regarding EMI’s debt. Both sides agreed Mr. Hands had written down, “Cerberus is out.” Similarly, on at the trial that there were essentially two contemporaneously or otherwise, the all September 24, 2007, Mr. Hands received issues for the jury to decide: (1) whether important representation he claimed to an email from Stephen Alexander, a top Mr. Wormsley lied to Mr. Hands by have received from Mr. Wormsley, and Terra Firma executive, stating that telling him that Cerberus was planning to relied on. And no witness other than “Cerberus never actually submitted a bid £2.62, and (2) whether Mr. Hands Mr. Hands could testify to having first- formal offer.” The existence of these relied on that lie in formulating Terra hand knowledge of Mr. Hands’ emails, and the fact that Mr. Hands did Firma’s bid. After a three-week trial, the conversations with Mr. Wormsley. not try to walk away after the FT email jury returned a verdict for Citibank on Additionally, Terra Firma’s assertion of was sent or complain about being misled both counts after relatively short reliance on the Wormsley conversations in September, provided a substantial deliberations. The press coverage of the was undermined at trial by evidence that counter to Mr. Hands’ crucial assertion case didn’t provide much in the way of Terra Firma’s internal financial modeling that he had not learned, until 2009, that insight into how the jury reached its of the transaction reflected a Cerberus had not submitted a bid. verdict. But a review of the closing determination that £2.65 was a “good Of course, as is always the case, arguments and some of the evidence deal” that would allow for a 22% return particularly in a fraud trial, credibility and relied on by the parties suggests the bases rate. Even more strikingly, Citibank’s reputation played a critical role. Citibank on which the jury decided the case. lawyer made reference in his closing to presented extensive evidence of First and foremost, there was no evidence indicating that Terra Firma had Mr. Hands’ reputation as an aggressive documentation or other independent considered offering as much as £2.85 a businessman who relished challenges, corroboration of Mr. Hands’ claim that share on the basis of its belief that it could quoting him as having touted his ability Mr. Wormsley in fact represented to him “still make a lot of money at 2.85.” to “find potential where other people saw that Cerberus was going to bid £2.62 on Moreover, while Terra Firma depicted problems,” and having stated weeks before May 21. In a case involving a $4 billion Mr. Wormsley as being the sole source of the conversations with Wormsley, that transaction in which the parties information driving the final bid price, Terra Firma “intend[ed] to win” the introduced hundreds of communications witnesses on both sides apparently auction. testified that Terra Firma representatives Are there lessons to be learned from had spoken to EMI representatives other this drama? Nothing profound, but the [F]inancial institutions than Wormsley about price: EMI’s CFO case reminds us of a few fundamental testified that EMI’s board “had set 2.65 as points. should carefully being our aim” independent of any First of all, financial institutions should discussion with Wormsley, and an internal carefully consider whether to require their consider whether to Terra Firma memo dated weeks before the clients to waive jury trials in any disputes, require their clients to Wormsley discussions suggested a bidding regardless of whether they originate from price of £2.60 “[b]ased on the operating a formal engagement or not. While juries waive jury trials in any and financing assumptions that have often get it right, particularly in criminal emerged through conversations between cases, handing a complex financial case to disputes, regardless of Eric Nicoli, CEO of [EMI], and Guy a jury generally creates greater risk than whether they originate Hands.” requiring that any dispute be resolved by a Finally, the notion that Mr. Hands had judge or an arbitrator. from an a formal relied on information about the Cerberus Secondly, email and other documents engagement or not. CONTINUED ON PAGE 23

page 16 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 ALERT Proposed Exemptions from SEC Registration Available to Non-U.S. Advisers

Unlike most advisers to private equity VC Advisers Exemption l Acquired at least 80% of the securities funds, non-U.S. private equity advisers Proposed Section 203(l) of the Advisers of each qualifying portfolio company and advisers to venture capital funds may Act exempts from SEC registration directly from the company and not be able to avoid registration with the U.S. advisers solely to “venture capital funds.” from its securities holders. Securities and Exchange Commission (the Of relevance to private equity fund l Provides, or offers to provide, “SEC”). By now, virtually everyone in the advisers, the SEC takes pains in its release “significant managerial assistance” to, or industry knows that Title IV of the Dodd- to point out that Congress wanted to controls, the qualifying portfolio Frank Act repealed the current exemption distinguish between advisers to private company. from registration in the Investment equity funds, for which there is no specific Advisers Act of 1940 (the “Advisers Act”) exemption, and advisers to venture capital l Does not incur leverage other than for private fund advisers with fewer than funds which are eligible for this exemption short term borrowings. 15 clients and replaced it with three new from registration. l Does not offer investors redemption exemptions. What they may not realize is Proposed new rule 203(l)-1 would rights except in extraordinary the scope of the new exemptions, which define a “venture capital fund” as a private circumstances. A fund that permits apply to (1) advisers solely to “venture fund 2 that has all the following withdrawals periodically would be capital funds” (“VC Advisers”), (2) characteristics: considered to be granting redemption advisers solely to private funds with less l Invests in “equity securities,” as that rights even if the withdrawals are than $150 million in assets under term is defined in the Securities subject to gating or similar restrictions. management in the United States without Exchange Act of 1934, of “qualifying regard to the number and type of private l Represents itself as a venture capital portfolio companies.” A qualifying funds advised (“PF Advisers”), and (3) fund to investors. portfolio company means any company non-U.S. advisers with less than $25 that is not publicly traded, does not Of particular relevance for non-U.S. million in aggregate assets under incur leverage in connection with the advisers, the proposed definition of management from U.S. clients and private private fund investment, and is an venture capital fund does not currently fund investors and fewer than 15 such operating company. Thus, a fund of require that the fund needs to be managed clients and investors (“Foreign Private venture capital funds would not fall by an investment adviser based in the U.S. Advisers”) (emphasis added). 1 The Dodd- within this definition. The proposal Indeed, the SEC acknowledges in its Frank Act will take effect on July 21, 2011. would permit non-U.S. companies to release that venture capital funds with The SEC was directed under the be qualifying portfolio companies, but advisers operating principally outside the Dodd-Frank Act to promulgate rules to the SEC seeks comments on this U.S. may seek access to U.S. portfolio implement these new exemptions. On approach. companies or U.S. investors, and that U.S. November 19, 2010, the SEC issued a investors may wish to invest with non- 135-page release proposing three new 2 For purposes of all of the SEC’s proposed rules, a U.S. venture capital advisers. rules. This article focuses on how the “private fund” (as previously defined in Section Still, a key issue for non-U.S. advisers is SEC’s proposed rules would apply to non- 202(a)(29) of the Advisers Act) is any issuer that whether or not the VC Adviser exemption U.S. advisers to private funds. would be an investment company under the will be available at all once the final rules Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) under the Investment Company are adopted by the SEC. The fact that the 1 See also “Investment Advisor Registration: Act. In general, a section 3(c)(1) fund has fewer SEC is seeking comment on a number of Preparing for the New Environment” in Vol. 10, than 100 beneficial owners and a section 3(c)(7) issues makes it difficult for advisers based Number 4 of the Debevoise & Plimpton Private fund can be offered only to qualified purchasers outside the U.S. to make plans based on Equity Report, which discusses some additional which already own a specified dollar amount of exemptions not relevant for the discussion here. investments. CONTINUED ON PAGE 18

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 17 Alert: Proposed Exemptions from SEC Registration (cont. from page 17)

the assumption that the VC Advisers managed, even if some day-to-day U.S. exceeds $150 million, the Offshore exemption will ultimately be available for management of assets takes place Adviser would no longer be able to rely on them. Fortunately, they may be able to elsewhere. Thus, an Offshore Adviser with the exemption. If any assets are managed rely on the more flexible PF Advisers its principal office and place of business in from a U.S. place of business for any client exemption discussed below. London would be deemed to have all that is a U.S. person other than a private PF Advisers Exemption private fund assets under management in fund, the exemption is unavailable. This London. For Offshore Advisers with also holds true for any Offshore Adviser Section 203(m) of the Dodd-Frank Act personnel in different offices providing attempting to rely on the private fund directs the SEC to exempt from advice or research for private funds, the adviser exemption. registration any investment adviser s olely to proposed definition attempts to deal with private funds with less than $150 million of Foreign Private Adviser the difficult issue of determining where assets under management in the United Exemption the important advisory activities take States . We and many private fund advisers The Dodd-Frank Act replaced the current place. Nonetheless, there remain some anxiously awaited how the SEC would private adviser exemption with the Foreign important interpretive issues, as discussed interpret the phrase “assets under Private Advisers exemption, which we below. management in the United States.” believe will be of limited, if any, utility for An Offshore Adviser will need to Happily, the SEC in proposed rule most non-U.S. private fund advisers in examine whether, in fact, it has a place of 203(m)-1 provides a holiday gift for light of the way “foreign private adviser” is business in the U.S. and whether it investment advisers that have their defined. The Dodd-Frank Act defines the manages assets of private funds from that principal office and place of business outside term to mean any investment adviser that location in order to calculate its assets of the U.S. (“Offshore Advisers”). The has all of the following characteristics: under management in the U.S. toward the proposed exemption would be available to $150 million cap. A “place of business” in l No place of business in the United an Offshore Adviser as long as all of the the U.S. would be defined in the proposed States. adviser’s funds that are U.S. persons are rule as “an office where the investment “qualifying private funds” — i.e. Section l Fewer than a total of 15 clients in the adviser regularly provides investment 3(c)(1) or 3(c)(7) funds. And even better, United States and (fatally) investors in advisory services, solicits, meets with or for Offshore Advisers that do not have any the United States in private funds otherwise communicates with clients ….” place of business in the U.S., it does not advised by the investment adviser. If the adviser provides “continuous and matter how many private funds are advised regular supervisory or management l Aggregate assets under management in the U.S., where the funds are organized, services” from its U.S. place of business attributable to clients in the U.S. and the amount of assets under management, with respect to U.S. private funds, then it investors in the United States in private or how many U.S. investors the funds would be deemed to have “assets under funds of less than $25 million. have. Moreover, the Offshore Adviser is management” in the U.S. An Offshore free to conduct any type of business l Does not hold itself out to the U.S. Adviser with a place of business in the outside the U.S. public as an investment adviser. U.S. would need only count private fund An adviser’s “principal office and place As proposed to be implemented in rule assets it manages from the U.S. place of of business” is defined in the proposed rule 202(a)(30)-1, this Foreign Private Advisers business toward the $150 million limit as “the executive office of the investment exemption is of little to no use for most under the exemption and can disregard adviser from which the officers, partners, non-U.S. private fund advisers or other non-fund clients that are not U.S. persons or managers of the investment adviser financial institutions that relied on the old and whose assets are managed from non- direct, control and coordinate the activities exemption, even leaving aside the small U.S. offices. Such an adviser would have of the investment adviser.” The SEC $25 million cap. Specifically, unlike the to calculate the amount of assets it explains that this is the location where the broader language in the PF Advisers manages quarterly based on the fair value adviser controls, or “has ultimate exemption (which refers to “assets under of the private fund assets, including responsibility for” the management of the management in the United States”), the undrawn commitments. If the value of private fund assets and is thus considered the assets from a place of business in the CONTINUED ON PAGE 19 the place where the adviser’s assets are page 18 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Alert: Proposed Exemptions from SEC Registration (cont. from page 18) clear direction from the Congress was to proposed exemptions if it can satisfy the anticipate that it will take the SEC a few repeal the old “fewer than 15 clients” terms and conditions of the rules weeks to digest what are expected to be a interpretation that treated each fund as implementing them. flood of comments. The betting is that one client and to instead take into account The SEC attempts to clarify how a the SEC intends to issue the final rules in U.S. investors in the funds as well. subadviser, for example, might be able to early Spring of 2011. The SEC makes it clear that setting up rely on the PF Advisers exemption. For As noted above, we believe the most intermediate accounts to avoid counting example, if the subadviser’s services to the promising exemption for non-U.S. U.S. clients or investors is not possible primary adviser relate solely to private advisers under the SEC’s proposed rules is under its proposed rule. It specifically funds and the other conditions of the for PF Advisors. The SEC could, however, deals with master-feeder fund structures; exemption are met (such as if the make the VC Adviser exemption much the adviser to the master fund would have subadviser has its principal office and place more useful and practical for non-U.S. to look all the way through to the holders of business outside the U.S.), then the advisers if it determines to permit such of the feeder funds formed for the purpose subadviser would also be eligible to rely on advisers with a principal office and place of investing in the master fund. The the PF Advisers exemption. of business outside of the U.S. to provide holder of a total return swap would also be More interesting interpretive issues will advice to any client or fund outside the counted as an investor. be presented in the case of non-U.S. U.S. — in fact, taking the same approach The proposed rule also eliminates the advisers with advisory affiliates. proposed for PF Advisers. ability of non-U.S. private fund advisers to Specifically, will the non-U.S. adviser be In any case, we note that in the offer interests in private funds to their able to rely on the proposed exemptions companion release to the proposed rules U.S.-based knowledgeable employees without the need to integrate the activities described in this article, the SEC proposed without having to count them as investors. of its affiliates? Integration could be an other related rules, including amendments The proposed rule specifically states that issue if the non-U.S. adviser has affiliates to Form ADV, the Advisers Act knowledgeable employees will count as that are registered with the SEC or cannot registration form. Among other things, investors in a private fund. rely on the new exemptions (because they these proposals impose reporting The Foreign Private Advisers exemption advise registered investment companies or requirements on advisers relying on the refers to the term “in the United States” in separate accounts) even though the non- VC Advisers and PF Advisers exemptions. several contexts. As is the case with the PF U.S. adviser standing alone could rely, for Significantly, the proposing release Advisers exemption, the proposed rule example, on the PF Advisers exemption. specifically states that the SEC has the incorporates the definitions of “in the The proposed rules are silent on how this authority to require VC Advisers and PF United States,” “U.S. person” and “United will play out. The SEC is well aware that Advisers to provide the SEC with reports States” as those terms are defined in numerous interpretive issues will arise, and to maintain books and records and Regulation S, with a few tweaks to make it particularly, for advisers with multi- that the SEC has authority to examine clear that a discretionary account held for national operations that include operations such books and records. So, while VC the benefit of a U.S. person outside the in the U.S. We would encourage our non- Advisers and PF Advisers may be exempt U.S. will count if the account is held by a U.S. clients, in particular, to consider how from SEC registration, the regulatory related person of the investment adviser. their specific advisory activities are burdens associated with being exempt may How Do These Proposed organized and how those activities are nonetheless be significant. viewed under the proposed exemptions Exemptions Apply to Marcia L. MacHarg from registration. It will be much easier to Subadvisory Relationships [email protected] or to Affiliates of the Adviser? address interpretive issues during the comment period and before the rules are As a general matter, a subadviser to a finally adopted. private fund is deemed to be an adviser for purposes of the proposed PF Advisers and Conclusion VC Advisers exemptive rules. That means The comment period on the proposed that the subadviser can avail itself of the rules ends January 24, 2011 and we

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 19 Is Dual Track the New Normal? (cont. from page 1) track approach to selling Pets at Home contract terms generally parallel the schedules for a private sale agreement. culminated in KKR’s January 2010 situation a buyer would be in if it were The familiarity that outside counsel in an acquisition of the British retailer for $1.4 purchasing a public company. (A buyer, IPO will achieve with the business being billion, a price that was $300 million of course, will counter that a private sale sold will allow them better to anticipate more than early reports of the proposed does not expose the seller to the securities potential issues in a private sale and ensure IPO valuation. litigation risk present in an IPO exit, and that these issues are addressed efficiently Second, a dual track process can give a that underwriting agreements typically and flushed out early in the private sale seller significant negotiating leverage over contain both representations and process. deal terms in a private sale. Sellers will warranties and an indemnity against The Buyer’s Perspective argue that a “public M&A”-style contract, liability for material misstatements and Every advantage a seller can extract by with limited representations and omissions in the offering materials.) running a dual track process is to some warranties and no post-closing Third, a dual track approach allows a extent an equal and opposite disadvantage indemnification remedy, is appropriate — seller to keep its options open until it to the buyer. There can, however, be a given that the business being sold has becomes clear which route will yield the silver lining for bidders in a dual track made detailed SEC filings in connection highest value, thus preserving flexibility auction. An IPO process, particularly one with the proposed offering and that these and hedging against deal uncertainty. that has advanced to a point that SEC Particularly when market conditions are comments have been received on a Form volatile, a dual track approach can increase S-1, can provide a potential buyer of a the odds of being able to take advantage Every advantage a seller private company with significant insights of favorable conditions and therefore of a into the company’s business and the risks can extract by running a successful exit. it faces that may not otherwise be readily Fourth, while a dual track approach dual track process is to available. Particularly when faced with magnifies the cost, complexity and auction pressure to live with a contract management distraction inherent in any sale some extent an equal and that contains limited representations and process, it may also enjoy useful synergies. warranties, the Form S-1 can provide a opposite disadvantage to For instance, the electronic data room helpful supplement to the confirmation of prepared for private buyer diligence will buyer’s due diligence provided through the the buyer. There can, generally suffice for underwriter diligence as sale agreement, particularly if — as is well. A company’s preliminary securities however, be a silver lining often the case when the IPO process is filings in connection with an IPO (typically, sufficiently advanced — the seller gives a on Form S-1) can, if the company ends up for bidders in a dual track representation in the sale agreement as to being sold to a private buyer who requires the absence of material misstatements and auction. An IPO financing, offer a significant head start on a omissions in the preliminary Form S-1. debt offering memorandum. Disclosure in process...can provide a Bidders may also be able to take some a preliminary Form S-1 can be made an practical comfort from the knowledge that exception to representations and warranties potential buyer of a the company’s outside counsel have done in a private sale agreement , permitting the the diligence work necessary to be ready if private company with seller to prepare shorter disclosure called upon to give legal opinions and a schedules. Diligence by the company’s negative assurance letter to the significant insights into outside counsel in preparation for giving a underwriters. Finally, in a dual track customary legal opinion and negative the company’s business process a buyer is better assured of assurance letter to underwriters in an IPO receiving SEC-compliant audited financial can also be converted into vendor due and the risks it faces that statements and current unaudited diligence reports (common in Europe) financial statements, the creation (and may not otherwise be and facilitate the preparation of disclosure CONTINUED ON PAGE 21 readily available.

page 20 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Is Dual Track the New Normal? (cont. from page 1) Is Dual Track the New Normal? (cont. from page 20) cost) of which can be hotly contested that valued the company at to minimize these potential conflicts, between a buyer and seller in a carve-out approximately €5.5 billion, opting although this is not always feasible. divestiture not done on a dual track. instead to take the company public and The recent buzz generated by dual sell only part of its stake in March 2010. Weighing the options track deals obscures an important fact: Although the IPO priced at the low end Despite the potentially significant dual track deals have been in and out of of the expected range, the decision to advantages to sellers of running a dual- fashion since the mid-1990s, rising and pursue an IPO rather than a sale suggests track process, one size does not fit all. falling in popularity with broader industry that Providence saw opportunities ahead Key considerations that sellers should take trends and the ups and downs of the for the company. These are complex into account include: public markets. While these deals can business judgments that vary with each have pluses or minuses for PE firms, l Credibility of an IPO vs. Private Sale. Is potential transaction. an IPO viable given the state of the depending on which side of the track they l Incentivizing Management. Sellers equity markets and the company’s are on, there is no question their should keep in mind that financial situation? Failure to generate continued popularity would auger well for management’s financial and other much interest as a company is being the general state of the global capital personal incentives may lead them to prepared for an IPO could potentially markets. prefer one alternative over another. For dampen its private sale prospects. Is an Paul S. Bird example, senior management at some IPO a credible alternative given interest [email protected] companies may prefer an IPO exit from potential strategic buyers? It may because of the potential for a liquid Jonathan E. Levitsky be hard to generate public market market for their equity and the [email protected] demand or auction leverage from a opportunity an IPO presents over time dual track process if there is a natural Sue Meng to run the business without oversight strategic buyer who would reap [email protected] (and risk of being replaced) by a significant synergies and is therefore private buyer. On the other hand, a able to offer a significantly higher private exit may result in accelerated valuation for the business than the vesting of management equity and [R]ecent academic public markets. equivalents and a quicker payday for research confirms the l Cash Now, or Upside Later? A private management. These incentives may sale typically allows the seller to dispose affect the energy and attitude with common sense view that of its entire interest at once for a lump which a management team approaches sum, whereas in an IPO the seller will the sale process. Care should be taken (in the right market be required to retain a significant stake to ensure that management’s incentives conditions) a dual-track that can only be sold off over time — are aligned with those of the seller to exposing the seller to future public achieve the best available valuation. approach can maximize market risk and potentially negatively l Advisors. Sellers need to be attentive to affecting a private equity seller’s the price obtained by the the fact that M&A financial advisors internal rate of return. At the same and securities underwriters in a dual time, an IPO may be an attractive way seller....[Yet,] despite the track process will have differing to create a path to exit and achieve financial incentives, and these may potentially significant some initial liquidity while continuing cause each of them to seek to push the to participate in the upside of the process in one direction or another. advantages to sellers of business. For instance, according to One solution for the seller is to have a press reports, Providence Equity running a dual-track single firm as both M&A financial Partners rejected bids for its portfolio advisor and lead underwriter in order company Kabel Deutschland GmbH process, one size does not fit all.

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 21 EU Directive on Alternative Investment Fund Managers (cont. from page 8)

authorized under the Directive once they l the laws, regulations and Implementation Measures are able to do so ( i.e. , from 2015) will administrative provisions of the Although the Directive runs to over 200 need to apply to their “Member State of manager’s home jurisdiction must not pages, it is only a “framework directive.” reference” — generally, the Member State prevent the effective exercise by More than 90 implementing measures where the manager intends to market its regulators of their supervisory need to be drafted and finalized by funds (that may include multiple functions under the Directive. ESMA and the Commission before the Member States, one of which will be Directive is fully implemented (the In addition, a non-EU manager will have designated as the Member State of Commission has already issued a detailed to appoint a “legal representative” in its reference under a “tie-breaker” procedure) provisional request for technical advice Member State of reference to act on its or, in the case of a manager proposing to on the implementing measures). The behalf in relation to its obligations under manage an EU fund, the Member State Commission has said that consultation the Directive. In order to market into where the fund is established. will be at the heart of the implementation the EU under the passport, similar Authorization will involve full process and that it has an open door conditions to those mentioned above in compliance with the provisions of the policy — there should be opportunity relation to marketing under national Directive, and: during the next 18 months for Member private placement regions will have to be States, managers, industry associations l appropriate cooperation arrangements satisfied. will have to be in place between the and other participants to comment on Transitional Provisions manager’s regulator and the regulator the final shape of the Directive. The Directive contains only limited of the Member State of reference; Managers should begin now to transitional provisions: consider whether any changes will be l the manager’s home jurisdiction must l Managers that are managing funds required to the management and not be listed as non-cooperative by before the Directive is implemented marketing of their funds in order to FATF, and must have signed an must apply for authorization within ensure that appropriate arrangements are OECD compliant tax treaty with the one year of the implementation date. in place in respect of the Directive. In Member State of reference; and (It is not clear what activities they may particular, non-EU managers that manage carry on prior to obtaining or propose to manage EU funds should Private equity firms authorization.) consider whether the transitional provisions will allow them to continue to based outside of Europe l Managers that manage closed-ended do so after the Directive is implemented funds before the Directive is in 2013. breathed a sigh of relief implemented that do not make any * * * additional investments after the We will provide regular updates on the when the European implementation date may continue to implementation process and other manage those funds without being Parliament finally developments in forthcoming issues of authorized. The Private Equity Report . decided that even fund l Managers that manage closed-ended Geoffrey Kittredge funds with subscription periods that [email protected] managers based outside close prior to the entry into force of Anthony McWhirter the European Union may the Directive (in 2011), and where the fund life is not intended to continue [email protected] well be entitled to a more than three years after the Philip Orange implementation date (beyond 2016), [email protected] “passport” entitling them may continue to manage those funds to market alternative without applying for authorization or complying with the Directive, except investment funds within for the disclosure and, if relevant, portfolio company requirements. the EU. page 22 l Debevoise & Plimpton Private Equity Repor t l Fall 2010 Terra Firma v. Citibank: Cautionary Tale? (cont. from page 16) can and will be used as both a sword and modeling might later be used to draw explicit that their pre-existing relationship a shield. Any time a party in a unintended conclusions. Models should in other contexts does not enhance their negotiation places substantial reliance on either be written over, or should include duties or obligations to, or reliance upon, information received from a counterparty, cautionary statements limiting the ability one another in connection with the the content of the information received, of third parties to draw such conclusions. current transaction. and the fact of the reliance on it, should In addition, while it is not unusual for Mark P. Goodman be quickly and carefully documented. If a financial advisor to have relationships [email protected] there had been a contemporaneous note with both the seller and a potential bidder that a reliable source had reported on in a transaction, it is prudent, under such Erica Weisgerber another bidder’s anticiapted price, this circumstances, for (1) the financial advisor [email protected] case might have gone differently. to fully disclose the scope and nature of Private equity firms should also think those relationships to the parties and carefully about how their internal (2) the advisor and the bidder to be

Monetizing the Shield (cont. from page 10) the ability to claim capital gains treatment TRA, the receipt of the TRA would either complicates the overall marketing of the on the payments (to the extent that a sale be taxable as a dividend or tax-deferred as offering. The market seems to have of the underlying partnership interest an installment redemption of shares. become accustomed to seeing TRAs in the would give rise to capital gains, and Even if taxable as a dividend, the receipt UPREIT/exchange context; in other subject to the rules imputing interest of the right to tax benefit payments would situations, sponsors may wish to consider income on installment payments). In occur in connection with a liquidity event the relative advantages of retaining such cases where the offering entity is an that should generate cash sufficient to pay value through TRAs versus providing existing corporation with tax attributes, the tax. more detail on the expected utilization of the tax treatment is more uncertain. To Conclusion such benefits in an effort to cause such the extent that existing shareholders benefits to be properly valued in the The question of whether a TRA is receive TRAs prior to the offering, the offering price. appropriate or beneficial in any particular distribution of the TRAs is likely to be offering is ultimately a question of pricing Jeffrey J. Rosen viewed as a taxable dividend in an amount and atmospherics. On the one hand, to [email protected] equal to the present value of the future the extent that the market is not fully TRA payments. One potential planning Peter A. Furci valuing existing or future tax attributes, opportunity would be to reclassify the [email protected] due to uncertainties about timing or stock held by the existing holders into a ability to fully realize them, it may make class that, in addition to normal dividend sense to compensate existing equity rights enjoyed by the stock issued to the holders through TRAs, so that the equity public, contained the entitlement to holders retain the associated value but are receive additional dividends calculated in a only paid if, and when, the tax benefits manner similar to TRA payments. This are realized. On the other hand, it may reclassification, instead of being treated as be difficult to ascertain in any particular a taxable dividend, could be treated as a case the degree to which the market has tax-free recapitalization, resulting in no improperly discounted tax attributes, and taxable event until TRA payments are the complexity of the TRA arrangements made. Upon an exchange of such class of may be viewed as creating “noise” that stock for the publicly-traded class and a

Fall 2010 l Debevoise & Plimpton Private Equity Repor t l page 23 Recent and Upcoming Speaking Engagements November 3, 2010 November 17, 2010 December 6-7, 2010 Geoffrey Kittredge Gregory J. Lyons, Moderator Gregory V. Gooding “Terms and Conditions – How Have They “Exit Strategies” Lawrence K. Cagney Changed in This New Financial Order?” “Corporate Governance, Clawbacks, and Michael J. Gillespie, Moderator Geoffrey Burgess Whistleblower Requirements” “Sourcing Investments and Adding Value” “Exits: How to Have a Successful Exit in the Linda Lerner Recovering Financial Climate” Peter A. Furci The Emerging Markets Private Equity “Impact on Other Financial Services: “Legal and Regulatory Aspects of Private Forum Investment Advisers, Broker Dealers, and Equity Investing and Fund Structures in EMPEA and PEI Media Derivatives” Brazil” London David A. Luigs “Expanded Regulation of ‘Systematically Erica Berthou November 4, 2010 Significant’ Financial Institutions” “Legal and Regulatory Aspects of Private Erica Berthou “The Bureau of Consumer Financial Protection” Equity Investing and Fund Structures in “Brazilian Regulatory Landscape and “Expanded Regulation of Banks” Brazil” Emerging Fund Structuring Trends and Byungkwon Lim The Private Equity Brazil Forum Opportunities” “Impact on Other Financial Services: Latin Markets Brazil Sao Paulo Gregory V. Gooding Investment Advisers, Broker Dealers, and “The Private Equity Landscape” Derivatives” Private Equity and Venture Capital in Brazil The Dodd-Frank Wall Street Reform and December 14, 2010 The British Private Equity and Venture Consumer Protection Act: Game Changer? Kenneth J. Berman Capital Association (BVCA) Pennsylvania Bar Institute “Spotlight on the SEC: Current Initiatives London Philadelphia and What’s on the Horizon” 2010 Securities Law Developments Conference November 8, 2010 November 18, 2010 Keith J. Slattery Investment Company Institute W. Neil Eggleston Washington, DC Colby A. Smith John M. Vasily “The Board’s Role in an Internal Doing Business Overseas: Investigation” What Directors Need to Know December 15, 2010 NACD Directorship Forum National Association of Corporate Directors Alyona N. Kucher New York Washington, DC “Warranties, Representations and Other Standard M &A Notions Used in M &A November 30, 2010 Agreements Structured Under Russian Law: November 12, 2010 Challenges and Opportunities” Sean Hecker Franci J. Blassberg, Moderator “US Market Discussion: General Counsels’ Seventh Annual National Forum Mergers “The Government Enforcement Agenda and and Acquisitions in Russia Practical Handling of Enforcement Issues” Forum” IBA International Private Equity Mergers & Acquisitions Magazine, Russo- Forty-Second Annual Institute on Securities British Chamber of Commerce and Regulation Transactions Symposium 2010: The Global Private Equity Market Corporate Lawyers Union of Russia Practising Law Institute Moscow New York, NY IBA London November 17, 2010 David H. Schnabel December 1, 2010 For more information David H. Schnabel “Tax Strategies for Financially Troubled about upcoming Businesses and Other Loss Companies” “Corporate Tax Strategies and Techniques Tax Strategies for Corporate Acquisitions, Using Partnerships, LLCs and Other Strategic events visit Dispositions, Spin-Offs, Joint Ventures, Alliances” Financings, Reorganizations and Tax Strategies for Corporate Acquisitions, www.debevoise.com Restructurings 2010 Dispositions, Spin-Offs, Joint Ventures, Practising Law Institute Financings, Reorganizations & Chicago Restructurings 2010 Practising Law Institute Beverly Hills, CA page 24 l Debevoise & Plimpton Private Equity Repor t l Fall 2010