Fat cats

Private equity funding might be a risky business, but it is certainly profitable and is fuelling the growth in the M&A market. One of the latest deals was the purchase of clothing retailer Fat Face.

Fat catsFat Face founders Jules Leaver and Tim Slade started selling sweatshirts and T-shirts on the ski slopes in 1987. They opened their first store in London in 1993 and now have more than 100 outlets in addition to their catalogue business. Their `lifestyleorientated’ outdoor clothing and accessories epitomise the Fat Face philosophy: “Life is out there.”

Following a lot of press speculation about a potential sale or initial public offering (IPO), Fat Face was bought by Advent International in April 2005 from ISIS Equity Partners, the founders Leaver and Slade, and other employee shareholders. Advent International is a global private equity house which has to date invested in approximately 500 companies in different industries, and one of the sectors it particularly focuses on is retail.


One of the most dramatic developments in the European mergers and acquisitions (M&A) market over recent years has been the emergence of private equity funds as acquirers of businesses. They have the financial ability and the experience to match, and in many cases outbid, trade buyers. This has helped to fuel the exponential growth in private equity transactions, both in terms of value and number, at a time when much of the mainstream M&A market has been relatively quiet.

A private equity buyout – rather than a venture capital transaction, which focuses on start-ups or developing businesses – is the acquisition of an established target company or business. The deal is driven by the private equity investors, and management are offered a small percentage interest in the company as an incentive to drive the business forward. Private equity investors choose companies with the potential for growth and increase in value, and with a strong cash flow. They use the cash generated by the business to pay down the debt borrowed to finance the acquisition. Their aim is to sell the target, or to list it on a stock exchange, within three to five years, realising profit both for themselves and the individual members of the management team who held shares. On a successful deal, a private equity house will hope to make a return of at least 25 per cent and to get back double the money it originally invested, which compares very favourably with average returns on the stock market. The challenge is, of course, that not every deal is successful.

There are various types of buyout (see Jargon Buster), but the majority of issues and structures discussed below apply equally to each type.


Fat Face was a relatively standard management buyout, with a couple of distinguishing features. First, the process was being run consecutively with an IPO and therefore the sellers and management team had to divide their time and efforts between two potential exit strategies.

Second, and connected to the fact that the IPO process was being run, the deal was negotiated, signed and completed in a very short period – about one month.

Finally, it was a secondary buyout, which means that a management buyout had already taken place a few years before and the private equity house involved in the buyout at that time was now the major selling shareholder. On a secondary buyout, members of the management team will usually be selling to the new private equity house as well as participating in the new deal as members of the management team.


A leveraged buyout can be seen as three separate transactions that have to happen at the same time: there is the acquisition of the target; the equity financing and the arrangements with the management team; and the bank financing. The special purpose vehicle set up by the private equity investor, and ultimately owned by the private equity investor and management, is always known as `newco’.

The equity documents govern the relationship between the private equity house and the management team. They will set out the mechanics of the investment and the rules for the ongoing governance of the group. The main document is a shareholders agreement, which will grant certain control rights to the private equity investor and set out the framework on which the management team will run the business on a day-to-day basis.

The shareholders agreement will be supported by the articles of association of newco. The articles will set out the share rights for the shares held by management and the private equity investor in detail. Additionally, the private equity investor is likely to impose further restrictions on the management team through their employment agreement. The private equity house and the management team will have separate legal advisers.

The main acquisition document is the sale and purchase agreement (SPA), which sets out the terms upon which newco will purchase the shares in the target company. An SPA in a buyout is likely to be similar to one in any other acquisition. But there are certain features that are common to secondary buyouts, for example the reluctance of private equity sellers to give warranties other than relating to ownership of the shares. This means that on secondary buyouts it is usually the management team who give warranties relating to the business of the target and so the buyer needs to pay particular attention to its due diligence as there will be less cover available to pay out if there is a breach of any of the warranties. In addition to the SPA there are various ancillary sale and purchase documents, such as the disclosure letter.

The terms of the debt finance provided by the senior and mezzanine banks are set out in a facilities agreement, or potentially in two separate agreements – one for the senior debt and one for the mezzanine debt. Additionally, there will be security documentation under which the banks take security for the loans, for example over the shares of the target.

The other main agreement is the intercreditor agreement which governs the order of priority of the payment of any money by the newco group and the control of any insolvency process. The parties to the intercreditor will include the members of the newco group, the senior and mezzanine banks, the private equity investors – as they are likely to have provided shareholder debt to the newco group by way of loan notes – and often management.


Lawyers advising private equity houses on buyouts typically get involved in four to six deals a year that complete, and many more that fall by the wayside. For the corporate lawyers, each completed deal is hopefully the start of a relationship with the target company, which may well see one or more `bolt-on’ acquisitions take place, followed by work on a disposal or a float. It is no wonder then that so many law firms and lawyers want to be private equity specialists.

Samantha McGonigle is an assistant in Lovells’ private equity team. She qualified in 2003 and has worked on a number of private equity deals, including the acquisitions of The Telegraph and Fat Face


BIMBO: Buy-in management buyout. A transaction where both incoming and existing management are involved in acquiring the target.

Bolt-on: An acquisition by newco of an additional business to add to the target.

IBO: institutional buyout. A transaction structured and driven by an institutional investor/private equity house.

IPO: Initial public offering. The process by which a company obtains a first listing for its securities on an investment exchange and offers securities to the public for the first time.

LBO: Leveraged buyout. Any buyout where the equity investment is leveraged up by debt.

Leverage: The ratio of debt to the amount of equity investment in the company. A highly leveraged transaction will involve a proportionately large amount of debt.

Loan notes: A form of debt, usually where the shareholder is the lender and the company is the borrower. The lender is issued loan note certificates that are effectively an `I owe you’.

MBO: Management buyout. A transaction where the existing management team of a business joins up with a private equity investor to acquire the business or company they already manage.

MBI: Management buy-in. This is a transaction where a new management team, usually selected by the private equity investor, are involved in acquiring the group.

Mezzanine debt: The mezzanine bank provides debt that is subordinated to senior debt and is therefore more risky. Mezzanine debt is likely to have a higher rate of interest.

Secondary buyout: A buyout by a private equity buyer where the majority seller is also a private equity investor.

Senior debt: The senior bank provides debt to the newco group that is not subordinated to any debt and is intended to rank ahead of other debt on the insolvency of the borrower.

Sweet equity: Equity that is taken by a management team where they have not had to take loan notes at the same time.

Trade buyer: A buyer that is a business rather than a financial institution and usually a buyer that is involved in the same or similar business as the target.