Private Equity Acquisitions - Asset Stripping Rules
It is almost a year since the Alternative Investment Fund Managers Directive (AIFMD) became fully effective in the UK.
In this blog we look at one particular aspect of the regime, namely measures restricting "asset-stripping" by private equity buyers.
The insurance industry is highly regulated, and it is well known that a variety of regulations/ other rules require that leveraged buyouts of insurance companies be financed with substantially less debt than those in other industries. In the case of a private-equity acquisition, AIFMD adds an additional layer of regulation, and regardless of the business of the target in question.
The AIFMD came into full force in the UK in July 2014, and as such applies to all EEA (and in some circumstances non-EEA) managers of alternative investment funds, which in turn captures most UK private equity fund managers. Amongst its many provisions, the AIFMD contains a prohibition on asset-stripping. Under these rules, the manager of an alternative investment fund (or AIFM) is heavily restricted in the first two years of control (whether acting individually or jointly) of most listed or non-listed companies in its ability to extract assets from that company by way of distributions, capital reductions, share redemptions and buy backs. This includes targets that are insurers or brokers.
This has impacted a number of common private equity structures in particular where the company needs to pays dividends (or otherwise return capital) to the holding company to enable it to service its debt.
There are a number of factors which may allow a buyer to mitigate the effect of the AIFMD asset-stripping rules:
- Control is defined to mean, broadly speaking over 50% of voting rights in the case of a private company and 30% of voting in the case of a listed company (a different figure may apply elsewhere in the EEA). It may be possible to structure an acquisition that does not trigger this requirement, e.g. by an acquisition of economic rights.
- The asset stripping restrictions relate to shares and distributions thereon. They do not relate to debt. Hence it may be possible to establish intra-group debt arrangements that have the equivalent effect of a dividend stream.
- The asset stripping restrictions do not appear to capture intra-group reinsurance, services and other arrangements, and the flexibility that these may offer for premia fees or commissions to be paid by the insurer to other entities in the group. Similarly, cash pooling arrangements and profit or loss sharing arrangements around the group may be means to enable debt service at holdco level. Note however that AIFMD will require an AIFM to have in place arrangements to ensure that any such agreement is on arm's length terms.
- The parties may agree that certain arrangements are put in place after signing but before closing, e.g. to maximise shareholder debt or to declare dividends which in many cases will, once declared, constitute a debt to the incumbent shareholder at the time of payment. Once in place, it may possible to re-configure such arrangements post-closing.
- The restrictions do not apply to acquisitions of SMEs, defined as a business with fewer than 250 employees and turnover not exceeding EUR50m or a balance sheet not exceeding EUR43m.
- The restriction does not apply to distribution of profits that have arisen and are available for distribution in the ordinary course. Hence a high quality business that produces a good dividend steam will continue to be able to pay them. Also the rules would not seem to prevent a portfolio company from making disposals and retaining any gain for future distribution.
We are aware of similar developments in the US where, for example, the New York Department of Financial now requires, in the case of insurers owned by private equity firms, increased capital at target level, a trust account to be triggered where this capital falls below certain levels, prior regulatory approval of changes to the target's business plan and more extensive reporting requirements.
These requirements certainly add challenge to private-equity activity in this area, particularly in the case of weaker targets that require re-organisation. However with care there remains scope for inventive deal structuring in a manner that is both compliant and workable from a business perspective.