5 things management teams need to know about preparing for exit by their private equity owners

Starting preparations early is crucial for a smooth and successful exit by a private equity sponsor. By initiating the process well in advance, in-house management teams can streamline document gathering, minimize disruptions to daily operations, and proactively address potential issues that could impact deal deliverability and value.

Whether an exit is sought via a bilaterial sale, an auction process or another method, there are a number of key considerations that play a crucial role in exit preparedness and which can be addressed prior to launch of the exit process in order to maximize efficiency and success.

Alongside early-stage considerations such as deal structure and preparation of preliminary marketing materials, regard can and should be given to the following items in the lead up to any exit:

1. Setting up the virtual data room (VDR)

A well-organized VDR not only saves time, but also instills confidence in buyers, demonstrating that the portfolio company is well-managed and ready for a seamless transition. It allows for easy access to critical information, reduces the risk of errors, and ensures that all parties have the necessary data to make informed decisions.

Aside from selecting an appropriate VDR platform and taking into consideration user functionality and experience, it will be necessary to determine the structure and scope of the VDR. A clear understanding of the key areas that will need to be diligence, as well as setting a materiality threshold, will enable in-house legal and management teams to collate documentation to populate the VDR in a focused manner. Historical VDR structures from the initial investment can also be leveraged to assist with locating documents.

When setting a materiality threshold, consideration should be given to the likely threshold to be agreed with the lawyer in the context of business warranties. This will prevent there having to be a further round of document collation for the purposes of disclosure against the warranties.

Access to sensitive data (such as personal information in employment and pension agreements, pricing in commercial contracts, particularly where a trade sale is contemplated, or material contracts that are subject to confidentiality clauses) should be limited, either by providing access only to professional advisers or "clean teams" of certain purchaser representatives, sharing information later in the process with a selection of preferred bidders and / or redacting or anonymizing data where possible.

2. Preparing the business

In order to place the company in the best position for a sale, management teams should ensure that any issues flagged in the due diligence conducted as part of the current sponsor's initial investment (or any 100-day plan) are addressed. In most cases, unrectified issues from the sponsor's initial investment will continue to exist and inevitably, will be identified in due diligence conducted as part of the exit process. Attending to such issues ahead of time will allow the business to be presented as a clean and organized business and also remove complications that may otherwise need to be addressed as part of the exit transaction leading to additional delays and costs.

Resources should also be dedicated to ensuring that corporate information and records (such as the corporate structure chart, records of ownership, company books and records, company filings, board minutes and governing documents) are accurate and up-to-date, and that robust internal policies that could be requested as part of due diligence are in place. Dealing proactively with items that bidders would otherwise need to address during their diligence processes will not only increase the appeal to bidders, and consequently increase competitive tension, but also – hopefully – make the diligence process less burdensome for management.

3. Shareholder alignment

Many portfolio companies will have management incentive plans (MIP) in place that offer shares or securities in the company to individuals working in the business as employee incentivization. Assuming that the exit is structured as a sale of all of the shares in the company, it will be crucial to ensure that all shareholders are willing and available to execute sale documents.

To avoid delay at a later stage in the process, consider the scope of the wider seller-base and whether that includes any managers who have left the business but continue to hold shares in the structure or managers who are uncontactable or misaligned with the sponsor-led sale. While a sponsor may exercise its drag rights to require minority shareholders to participate in an exit, disgruntled (or even just unavailable) shareholders can nonetheless significantly delay or hinder the process.

Even where the shareholder base is willing to participate, proper communication and organization will be required on a practical level. All shareholders will be impacted by the proceeds of their sale (including tax treatment of such proceeds), be required to agree to the terms of the exit and be available to sign documentation on short notice. Where a company has a large shareholder base, it may be necessary to implement powers of attorney in order to enable the transaction to move at pace. Alternatively, if there is an employee benefits trust holding MIP shares on behalf of managers, it will be necessary to bring them on board with negotiation of the transaction documents to ensure that they are able to obtain internal approvals to execute sale documents.

Where exiting management and employees are not shareholders in the business, sponsors may nonetheless find it helpful to devise a suitable strategy to keep them on board during the transaction as they may play an integral role in information provision and the disclosure process.

4. Change of control rights held by third-party stakeholders

As with internal shareholders, it is important to understand and plan ahead for the impact of third-party stakeholders on the exit process. If any material contracts of the business (such as customer and supplier contracts) contain change of control (CoC) provisions, forward thinking will be required to ensure that such provisions are not triggered or, if triggered, are addressed or complied with.

As a starting point, it is key to determine whether any CoC provisions are triggered by the proposed exit structure. Common triggers include a change in majority shareholding or a percentage of voting power and may apply only to a change of control of the group entity that is party to the contract or further upstream to capture indirect parent entities. How counterparty risks should be managed will depend on the consequences of triggering the CoC provisions – these can vary from requiring the group entity to notify or seek consent from the counterparty prior to proceeding with the transaction or giving the counterparty rights to terminate or seek additional payment.

Assuming that contracts with triggered CoC provisions are important to the business and should remain in force, a plan should be put into place for management teams to approach counterparties to comply with the relevant requirements. Practically, counterparties will often provide consent or confirmation that they will not terminate where they have long-standing relationships with the group and can be given comfort that the counterparty's relationship with the business and the business' credit risk will not change. Any material contracts reaching expiry in the near future should also be addressed with counterparties. Overall, ensuring that key counterparties are on board and material agreements can be transferred as part of the exit will minimize risks around the value of the business being impacted by changes arising from the transaction.

5. Managing existing known liabilities

Management teams, along with the sponsor, will be best placed to understand if there are any likely areas of concern in the business for potential bidders. These may include matters such as actual or threatened disputes, litigation or investigations involving the group, employees' terms of engagement, ongoing employee grievances, works council / trade union issues, pension arrangements, ownership of intellectual property rights, information technology incidents such as security breaches, interactions with regulatory authorities, and management of licenses and permits.

Should any known liabilities or risks be identified, it should be considered whether these can be addressed pre-launch of the exit process and if not, how they can be explained, managed or resolved. Marketing of the company as part of the preliminary exit process can also help to position these issues in addition to any asset or industry specific intricacies.

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

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