Private equity (PE) acquisitions are complex financial strategies and are often shrouded in complexity. By leveraging staged acquisition structures and strategic levers, PE investors can unlock value while protecting their investments. This article explores the nuances of these frameworks, from the role of acquisition vehicle to jurisdictional complexity and the rise of offshore registrations. This is the first of a three-part series.
When PE investors acquire a company through a buyout, they typically use a newly formed acquisition vehicle rather than directly acquiring the operating company. These vehicles (also known as holding companies or special purpose vehicles (SPVs)) are established for buyout purposes and do not trade until the transaction is completed.
The number of acquisition vehicles created can vary and will depend on the complexity of the acquisition structure and the jurisdictions involved. Figure 1 shows what a typical three-tier acquisition structure looks like.
Figure 1: Phased acquisition structure
In this example, Topco, Midco, and Bidco are vehicles created to facilitate acquisitions of operating companies. PE funds often work with the target company's management team to invest in newly formed Topco acquisition vehicles. This vehicle lends funds to the Midco vehicle, which borrows some amount of debt (typically shareholder debt from PE funds or junior debt from external providers), which in turn lends funds from the Topco vehicle to the Bidco vehicle. Masu. Finally, the Bidco vehicle borrows some senior external debt and uses the entire amount to buy out all the debtors and shareholders of the operating company.[1]
Through this hierarchical structure, the senior lender lends to the Bidco vehicle rather than the Topco vehicle, so the senior lender has direct rights to the assets of the entity that owns the operating company, i.e. the target group. This structure ensures that senior lenders' obligations are not structurally subordinated to junior debtors or equity holders. This gives the senior lender a first claim on the underlying assets of the target company. External senior debt providers in buyouts, such as banks, often prefer this structural subordination.
The number of different securities issued to finance the transaction and the complexity of the buyout are both important factors in forming the buyout structure. For example, these acquisition structures can be more complex in buy-and-build deals, where PE investors acquire one platform company and then bolt on other targets to the platform.
Jurisdictional differences also play an important role in determining deal structures. For example, in the United States, Chapter 11 bankruptcy protection provides strong protections for junior lenders, so intercreditor agreements and contractual provisions may be sufficient. Strong protection also means there is less need to create step-by-step acquisition measures, as in the UK and European jurisdictions.
In fact, there may only be two avenues for a U.S. acquisition structure. One for equity holders and one for all debt holders. All debt instruments used to finance the transaction may be financed by a single entity. In that case, contractual provisions and creditor arrangements exist to achieve the necessary structural subordination, in the same way that UK and European buyouts layer various acquisition vehicles on top of each other. . Nevertheless, more complex U.S. acquisitions and multijurisdictional transactions may involve more complex structures.
It is also worth understanding the registration of acquired vehicles in offshore jurisdictions. This has become common practice in the UK in recent years, primarily to avoid withholding tax.[2] Many PE investors acquiring UK companies create acquisition vehicles registered in offshore jurisdictions, whether based in the UK, US or elsewhere. Popular offshore jurisdictions include the Channel Islands, Luxembourg, and the Cayman Islands. Apart from tax-related reasons, registering these entities offshore may give PE acquirers more flexibility in receiving dividends from their portfolio companies. For example, distributions under Jersey or Guernsey law (Channel Islands) can be made without the need to have a distributable profit.
A recent research paper documents a significant increase in the use of offshore vehicles in acquisition transactions in the UK. In 2000, offshore ultimate holding companies were involved in just 5% of buyouts, but in 2022 they accounted for more than 25% of deals (see Figure 2). This appears to be particularly common in large acquisition transactions and acquisitions involving PE firms headquartered overseas. Given that when the ultimate holding company is registered offshore, its financial accounts are not publicly accessible (unlike when it is registered in the UK), this represents the lowest level of transparency in PE buyouts in the UK over the past 20 years. highlights an important decline in gender. .
Figure 2.
Important points:
- Acquisition vehicles as essential tools: Private equity acquisitions generally rely on a staged acquisition structure, with vehicles such as Topco, Midco, and Bidco playing a key role in managing investments and debt.
- Structural Subordination Interest: A hierarchical structure allows senior debt providers to hold priority rights over junior creditors and equity holders, protecting their claims to the assets of an operating company.
- Jurisdictional differences matter: Differences in laws, such as Chapter 11 in the United States, impact the complexity of acquisition structures. Stronger bankruptcy laws could reduce the need for multiple vehicles.
- Offshore flexibility: Registering an acquisition vehicle in an offshore jurisdiction such as the Channel Islands or Luxembourg offers tax advantages and operational flexibility, particularly with respect to dividend distributions. This is a practice that has become increasingly common in the UK in recent years.
- Complexity grows with strategy: Buy-and-build transactions and cross-jurisdictional transactions add complexity, making structuring important for effective management and risk mitigation.
Understanding these factors will enable parties to confidently and accurately navigate the complex world of private equity buyouts.
In our next post, we will cover portfolio account consolidation for PE firms.
[1] These acquisition methods can be called arbitrarily. Topco, Midco and Bidco are traditionally common in the UK and are used here for descriptive purposes.
[2] This does not apply to transactions within the United States.
