Philip Millward, head of the private equity group in Walkers’ Hong Kong office, outlines the various options available to private equity investors
Philip Millward, head of the private equity group in Walkers’ Hong Kong office, outlines the various options available to private equity investors examining the possible restructuring of portfolio companies that have been affected by turmoil in the credit markets or seeking to invest in distressed companies without using any borrowed money.
Today’s private equity investment marketplace is considerably different from the one that drove the growth of the PE model in the boom years. As we sift through the debris of the latest bear market cycle – and watch with interest as the markets creep upwards on the thinnest of positive economic data – distressed investment and restructuring opportunities abound. Walkers is actively involved in advising general partners on the tools available to them when assessing a distressed portfolio investment and the exit and/or restructuring imperatives that need to be addressed.
As new investment activity declines and GPs focus on extracting maximum value from existing investments, Walkers continues to field an increasing number of enquiries from clients seeking to restructure existing investments that are often held via entities formed in the Cayman Islands and the BVI.
The key features of any restructuring proposal will, to a large extent, be governed by the level of financial distress that the relevant portfolio company is suffering, and the willingness and/or ability of equity and debt holders to reach agreement on how the company will be structured and governed post-restructuring.
Trends that we are seeing in the current environment include equity buyouts. The absence of freely available credit and the impact that this has had on portfolio companies’ working capital reserves as well as ‘buy and flip’ opportunities under the classic leveraged buyout model has, according to some industry commentators, made equity buyouts attractive to private equity firms as the latest investment strategy to purchase companies through 100 per cent equity structures without using any borrowed money.
With a relatively large pool of untapped capital commitments waiting on the sidelines – USD42.7bn was raised in Asia during 2008, according to preliminary research by AVCJ Research – the equity buyout, when combined with other capital-raising initiatives, may find favour in that region in the months ahead.
Before finalising the terms of any such arrangement, the portfolio company should make sure that it has considered and followed restrictions and/or other provisions governing the transfer of its securities, procedures relating to the issue of new securities and raising of new capital, and change of control covenants in any finance documents governing any existing debt.
Another approach coming to the fore is equity top-ups. The existing debt arrangements of many portfolio companies prohibit further drawdowns in circumstances that would mean prescribed debt to equity ratios are no longer met. In these circumstances, many portfolio companies are approaching existing investors for additional equity injections to meet working capital requirements.
Any such injections may result in the creation and allocation of new shares on preferential terms, the issuance of which is governed by the portfolio company’s M&A and shareholders’ agreements. Each should be considered carefully before finalising any top-up arrangements.
We are also seeing the acquisition of distressed debt. Private equity firms have started to buy up company debt trading at deep discounts as the conventional buyout market has dried up. PE buyers can either hold the debt to maturity in the hope of achieving private equity-like net returns, or try and take control of companies in the event of default.
Offshore counsel should be consulted where the finance documents contain provisions permitting change of control, with a view to establishing how such change of control procedures can be implemented under Cayman Islands or BVI law.
Insolvency and subsequent asset fire sales are often considered a solution of last resort. Investors may consider whether to call a shareholders’ meeting to propose a winding up of the portfolio company. They should carefully scrutinise the memorandum and articles of association of the portfolio company to establish how the assets of a portfolio company will be distributed on a winding-up.
Offshore counsel’s involvement will be critical to ensure that the appropriate procedures are followed, including meeting quorum requirements and voting thresholds. Walkers has experience of the types of strategies that have been deployed in similar circumstances throughout our network of global offices.
An important element of any restructuring involving a portfolio company established in the Cayman Islands or BVI will be the terms of the underlying constitutional documents, shareholder agreements and financing documents governing the operation of the portfolio company. These terms must be carefully considered by all parties, as some of the proposed solutions may require approval of both the directors and shareholders or trigger change of control covenants that will need to be properly thought through prior to such restructuring.