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DECEMBER 2020 LW.com The Rise of Growth Equity — Connecting PE and VC

Emerging companies have historically been PE Investor Led VC Deals by Industry Sector backed by venture capital funds, but as 180 Europe’s startup scene matures, involvement 160 by more traditional private equity investors is growing, particularly in the tech, consumer, 140 and digital health sectors. The number of PE 120 investments in emerging companies has 100 increased year on year, with investments in 80 companies such as Wolt, Moonbug 60 Entertainment, Zwift, Klarna, Epic Games, and Oatly demonstrating the range of 40 opportunities available to PE sponsors in this 20 space. While PE investors are increasingly 0 familiar with VC deal dynamics, they are also 2016 2017 2018 2019 2020 YTD pushing to align growth-deal terms more Financial Services Materials & Resources Energy Consumer Products & Services closely with traditional concepts. Business Products & Services Healthcare Information Technology Source: PitchBook While PE investors are an exit through majority voting (at both requesting a participating preference (i.e. increasingly familiar with shareholder and board level), and ultimately their money back in priority, as well as pro rata VC deal dynamics, they are through drag rights and unilateral IPO trigger participation in the ordinary share return) or also pushing to align growth- rights. Minority investors in emerging coupon accruing on the preference return. PE companies, on the other hand, will typically sponsors are also exploring a right to have deal terms more closely with need the support of other investors to their shares redeemed if an exit has not traditional buyout concepts exercise a drag and typically lack an IPO occurred by a certain date, to provide the exit trigger. Recent deals have shown that certainty that they are lacking in the VC Relinquishing Control founders frequently control the exit, with construct. Investors typically invest in a growth minority investors granted at most a blocking company as a minority investor at the top of right if anticipated returns fall below a There is also a push to introduce more a stack of existing institutional investors, certain threshold. robust governance rights and structures. meaning they are unable to exert the level of For example, PE investors have sought the right to remove founders from the board if control usually seen in buyout deals. One Alignment with fellow investors board seat and a limited set of reserved their conduct brings the company into matters are likely to be the limits of their is important, and something disrepute. In light of recent high-profile influence. Alignment with fellow investors is that we are seeing deal teams controversies, sponsors are keen to mitigate therefore an important dynamic, and reputational risks associated with bad something that we are seeing deal teams consider at the outset of the founder behavior, though this type of consider at the outset of the transaction. transaction protection continues to be hard-fought.

Investors also need to potentially get Meeting in the Middle PE sponsors require more robust compliance comfortable with founder management As PE investors seek growth equity to fulfil their internal requirements and holding the balance of power and influence. investments, we are now seeing increased prepare the business for an IPO. Though Unlike a traditional buyout, where the convergence between typical PE buyout and founders can be reticent to spend the time sponsor has control, founders will not want, emerging company deal terms. While venture and cost, ultimately they often welcome the or expect, to relinquish control to financial capital investors typically expect a non- assistance of a PE sponsor in this regard. investors. In most cases, one or two founders participating liquidation preference (i.e. the will be responsible for all of the key decisions, option to have their money back in priority to Our view is that venture and more traditional subject to a set of reserved matters. the ordinary share return, or to participate pro PE industry terms will continue to converge, rata in the ordinary share return), PE sponsors but PE sponsors will still need to be very A lack of control over exit is another concern. are going one step further to protect sensitive to the expectations of founders PE investors are used to being able to control themselves in a downside scenario by when investing in growth targets.

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CMA Clamps Down on Deals — Navigating the UK’s Increasingly Securing a Successful SPAC Sale — What PE Firms Need to Know

Interventionist Merger Control Regime Special purpose acquisition companies US SPAC Activity (SPACs) have emerged, somewhat $80 240 Dealmakers must be alert to the increasingly CMA's Increasing Phase 2 Referral Rate — Number of Deals unexpectedly, as the hottest market trend in 220 the US this year, allowing SPAC sponsors to $70 interventionist approach of the UK’s 200 Competition and Markets Authority (CMA), launch shell companies with the goal of taking private companies public via merger. 180 including on transactions with a limited nexus 14 $60 SPACs are rare in Europe due to regulatory to the UK. Until now, the European Commission 160 has acted as a “one-stop shop” for large-cap 12 constraints — a SPAC acquisition is a deemed $50 140 transactions. But the end of the Brexit transition reverse , likely to result in the SPAC’s 10 period means that from the start of 2021, shares being suspended and/or cancelled, with $40 120 the enlarged group only readmitted following acquirers may face parallel EU and UK 100 8 publication of a prospectus. investigations — with the effect that the CMA $30 80 will play a more prominent role in reviewing 6 global deals. With nearly 200 US SPACs $20 60 4 seeking a business partner, PE 40 $10 The end of the Brexit transition 2 sellers are taking note 20 0 period means that from the 0 $0 However, US SPACs offer a direct pathway 2016 2017 2018 2019 2020 start of 2021, acquirers may 2016-2017 2017-2018 2018-2019 2019-2020 to the equities markets. With nearly 200 US Aggregate Gross Proceeds (mm) IPO Count Source: SPACInsider, YTD 13 December 2020 face parallel EU and UK SPACs seeking a business partner, PE Source: CMA Merger Inquiry Outcomes investigations — with the sellers are taking note. We believe these SPAC sales can be particularly multiple SPACs, or distributing a letter of intent to which SPACs respond — although effect that the CMA will play dynamic, forward-looking assessments of the newco stack, the investing fund, affiliate vehicles can offer an attractive exit route for advantageous by allowing European PE portfolio assets. sellers should be mindful that the ultimate a more prominent role in parties’ overlaps, even in cases in which the funds, and advisory entities. An IEO freezes portfolio companies to raise value of the listed company is frequently target had no revenues directly attributable any further integration of a completed SPAC as Monetization Alternative determined through the PIPE process, as reviewing global deals to the UK. Further, the CMA can and often transaction, and may even require that any funds via a private investment For PE sellers, taking a portfolio company institutional investors indicate the value at does investigate acquisitions of “material integration that has already taken place be in public equity public by merging it with a SPAC can be a which they are willing to participate. Deal This is likely to increase the regulatory influence”, such as E.ON/RWE and Amazon/ reversed. The order also places significant faster, cheaper process compared to a teams should expect a thorough diligence burden on acquirers, including for non- Deliveroo, both of which involved influence restrictions on the acquirer to “preserve the Key Attributes for Success traditional IPO, and can allow the sponsor to and process, with both the problematic cases, since the CMA has no being conferred by a circa 16% shareholding. competitive structure of the market”. Many traditional investment document preserve upside by retaining shares in the SPAC counterparty and the PIPE investors. equivalent to the EU’s “short form” procedure concepts such as “Qualified IPO” and , like an IPO. Because the allowing for a more truncated and less Use of Initial Enforcement Orders Poses “Liquidation Event” do not contemplate the SPAC has already gone through an IPO prior Deal structure and ongoing governance burdensome notification in simple cases. Challenges for PE The UK’s “voluntary” merger unique structure and considerations to seeking a merger counterparty, SPAC expectations also require consideration. Further, for potentially problematic cases In the UK there is no requirement to obtain regime operates increasingly associated with going public by combining mergers help avoid market timing issues and SPAC sponsors expect some level of requiring remedies, differences in process clearance prior to closing. However, the with a SPAC. It is therefore important that the like a mandatory regime, not the risk of a deal falling down due to volatile board representation, and PE firms should be and the need for regulatory buy-in are likely CMA’s powers give it considerable leverage portfolio company’s financing documents conditions — a commonly encountered issue, prepared to consider dual-class shares, to create challenges in ensuring that remedy to investigate deals that are of interest to it. least because of the CMA’s and management equity documents are particularly this year. shareholder consent rights, and other structures, offers can successfully straddle the EU and Indeed, the UK’s “voluntary” merger regime use of hold separate orders carefully reviewed to determine how they will for the PE firm's benefit as a majority (or near UK systems effectively. operates increasingly like a mandatory or IEOs operate on an exit via a SPAC IPO. majority) owner of the public company. regime, not least because of the CMA’s use Taking a portfolio company of hold separate orders or Initial PE sellers must also ready their portfolio The CMA’s increasingly Derogations can be agreed and accepted in Enforcement Orders (IEOs). The “quasi- public by merging it with a asset for the public markets. While a SPAC Recent successful auction advance to ensure that the operative interventionist approach has mandatory” nature of the UK regime means SPAC can be a faster, cheaper may offer a strong , target portfolio provisions of the IEO only extend to the processes have involved that acquirers will have to make difficult companies should take steps to prepare to resulted in an increase in overlapping portfolio company(ies) and process compared to a judgment calls in relation to filing strategy in operate as a listed business. This means soliciting term sheets and the actual acquiring fund. However, this the number of cases being the UK. The CMA will invariably impose an traditional IPO ensuring that the right administrative and indications of valuation from process can take time, is subject to referred for an in-depth IEO on any completed transaction that governance structures are in place (i.e. negotiation, and the CMA does not always multiple SPACs — although it investigates. A SPAC transaction is generally not a financial reporting, internal audit, and a investigation accept requested derogations. complete exit. In most cases, deals are not general counsel’s office). sellers should be mindful that structured as full cash-out sales and PE firms the ultimate value of the listed Brexit and an Expansive Approach to The CMA is making dynamic, While the new environment is challenging for are frequently locked up, unable to sell shares Jurisdiction Brings More Deals In-Scope acquirers, deal teams can mitigate the risks, for a period post-closing. Even once that Target portfolio companies company is frequently determined The CMA’s increasingly interventionist forward-looking assessments and early engagement with the CMA is vital. period expires, sell downs will be made in should take steps to prepare to through the PIPE process approach has resulted in an increase in the of parties’ overlaps, even accordance with a registration rights number of cases being referred for an operate as a listed business. This in cases in which the target An IEO freezes any further agreement, aspects of which are heavily Keeping Up With Innovation in-depth investigation. negotiated. Accordingly, PE firms should plan means ensuring that the right had no revenues directly integration of a completed As PE sponsors consider options for for a structured and longer-term sell down. administrative and governance monetizing portfolio company investments, The CMA believes that it may need to review attributable to the UK transaction, and may even up to 50 additional notifications each year as going public through a business combination However, for portfolio companies seeking structures are in place with a SPAC has rapidly become a viable a result of Brexit. The increase in workload is From a PE perspective, the key takeaway is require that any integration growth capital, SPAC sales can be alternative to a traditional IPO, direct listing, or also the result of the CMA taking an that the starting point is for an IEO to apply to As with any exit, PE firms should consider that has already taken place particularly advantageous by allowing them outright sale. As deal terms evolve in this expansive approach to jurisdiction. Cases all global operations of the entire organisation. maximising their options by running an be reversed to raise funds via a private investment in growing sector, sponsors must remain such as Sabre/Farelogix and Roche/Spark In the case of a typical private equity auction process. Recent successful auction public equity (PIPE), in addition to the cash apprised of current market terms and remain demonstrate that the CMA is making acquisition structure, that would now include processes have involved soliciting term available from the SPAC’s trust account. nimble to maximise the opportunities available. sheets and indications of valuation from

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Scrutinising Supply Chains — New Tools for PE

Global supply chains have come under COVID-19 Pandemic's Consequences for Global Supply and Freight Chains in 2020 significant pressure in recent years, compounded by the effects of this year’s Volume Decline 71.4% pandemic and shifting global policy agendas. In our view, supply chain analysis and Transit Delays 60.9% management will remain critical for sponsors Delays From Port to Customer in the coming year as they seek to avoid risks 49% including reputational damage, loss of Lack of Capacity 39.1% revenue, and loss of . Performing diligence on a target is no longer enough — Other 23.5% rather, the target’s value chain and broader supply chain require careful analysis to Source: Statista Shipping & Freight Resource; Ocean Insights determine resilience and uncover risk areas, but such review can also identify opportunities. help identify supply chain risks on a termination-related clauses earlier in the year broadening spectrum of transactions. Tools (to determine provision for lockdown-related Recent Challenges such as RiskHorizon (which Latham has scenarios or sudden changes in contractual Prior to the pandemic, increased regulation helped develop) are being used to performance), as the economic crisis develops in China led to factory shutdowns across the benchmark a target’s operations against the spotlight is now shifting to include the risk of country, causing challenges for many wide-ranging ESG data, identify supply customer distress. Where a target is a supplier, international supply chains. Trade wars have chain risks, and obtain tailored due diligence the implications of recently enacted legislation also presented operational issues, with recommendations. Further, a growing restricting termination and other contractual many companies considering reshoring or number of companies are using other new rights if a customer enters one of several shortening their supply chains. technologies, such as smart devices and UK restructuring or insolvency processes, blockchain, to enable transparent and end- require review. In the UK and other jurisdictions, supply to-end tracking in many sectors, including chains have been under increased media minerals and cosmetics. Obtaining a Strategic Advantage and regulatory scrutiny. The recent We expect supply chain issues to be a government review of the UK’s Modern continuing area of regulatory, investor and Slavery Act found many companies were not Tools such as RiskHorizon consumer focus. Multiple jurisdictions, and compliant with the legislation, and suppliers (which Latham has helped the European Commission are seeking were brought into media focus this year develop) are being used to greater corporate accountability on a following the exposure of illegal labour growing range of supply chain topics, activities in the UK. benchmark a target’s operations including labour infringements, human rights and deforestation. Heightened investor and consumer focus on against wide-ranging ESG data, environmental, social and governance identify supply chain risks, and While many will focus on risk management, in (ESG) issues has also increased public obtain tailored due diligence our view, effective supply chain analysis of a scrutiny of portfolio company supply chains recommendations target can be viewed as an opportunity to and their oversight by PE firms. gain a strategic advantage. A strong understanding of value drivers, vulnerabilities, A New Approach Aside from these innovations, portfolio and areas of improvement at the center of a Supply chain diligence is becoming an companies should consider what legal business’ operations (and that of its integral part of the deal process, and deal protections are in place across their supply competitors) can enhance value and teams are embracing new technology to chain. Having focused on force majeure and performance in times of disruption.

CONTRIBUTORS CONNECTING PE AND VC CMA CLAMPS DOWN Shing Lo Robbie McLaren Farah O'Brien John Colahan David Little Jonathan Parker +44.20.7710.1817 +44.20.7710.1880 +44.20.7710.1188 +44.20.7710.1015 +32.2.788.6224 +44.20.7710.4513 [email protected] [email protected] farah.o'[email protected] [email protected] [email protected] [email protected]

Mike Turner Jon Fox Katie Peek Greg Bonné Anuj Ghai +44.20.7710.4642 +44.20.7710.1057 +44.20.7710.1820 +44.20.7710.4762 ++44.20.7710.1843 [email protected] [email protected] [email protected] [email protected] [email protected]

SECURING A SUCCESSFUL SPAC SALE SCRUTINISING SUPPLY CHAINS Neil Campbell Paul Kukish Ryan Maierson Paul Davies Michael Green Hannah Berdal +44.20.7710.4615 +1.212.906.1725 +1.713.546.7420 +44.20.7710.4664 +44.20.7710.4752 +44.20.7710.1824 [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

Suneel Basson-Bhatoa +44.20.7710.5853 [email protected] EDITORS David Walker, Tom Evans, and Catherine Campbell

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