Understanding your buyers

Navigating different types of buyer

Your universe of potential buyers can have a significant impact on the shape, structure, and speed of a deal. This section explores some of the unique features and potential challenges of some of the different types of buyers: private equity, strategic, and US. Private equity buyers, in particular, have been showing an increased prevalence and interest in the broader life sciences sector over the recent years.

Private equity

Jargon busting, documents, and drivers

For many founders, private equity (PE) jargon can be bewildering. The good news is that none of this needs to be overly complicated.

‘Private equity investor’, 'fund', 'sponsor', and ‘institutional investor’ – while these are all different types of investors, these terms are pretty much interchangeable.
'Leveraged buyout' – shorthand for any transaction where existing management and/or new management, together with a PE investor, acquire a company using third-party debt.
'Senior debt' vs 'junior debt' – senior debt is usually advanced by commercial banks and so-called because they normally take first-ranking security over the assets of the business. ‘Junior debt’ or ‘mezzanine debt’ ranks behind senior debt but ahead of equity. This can include high-street lenders or other boutique debt providers who specialise in this type of transaction.

The jargon and documents of the private equity world may be unfamiliar at first, but understanding what drives an institutional investor to pursue a leveraged deal is simple. Essentially, it’s getting the right mix of equity and debt to leverage the equity returns.

This will be determined by confidence in the strength of the business plan and the amount of debt and interest it is believed the business can support through its free cash flow.

The function of PE houses is to make acquisitions, help to build and grow the business, then sell them. This means that PE buyers can often move faster than their trade counterparts due to their streamlined internal systems and external approach (including their familiarity with doing transactions).

The terms of the documents on a PE deal may seem quite lengthy. As a result, it may be tempting to think the buyer is looking to control the business, but that is almost never the case. Institutional investors prefer to leave the management team to run the business day to day. They use heavier duty documentation than may be common for strategic buyers to ensure that a sufficient level of protection for their investment is maintained.

In addition, perhaps unlike trade buyers, a PE investor will be considering their exit from the outset (which will typically occur within five years of their initial investment). This mindset is a defining feature of a PE buyout and will influence the structure of the deal and what protections you should expect.

Private equity deal structure

PE investors tend to favour a ‘triple newco’ structure where three new companies are incorporated to facilitate the acquisition. A ‘quadruple newco’ structure is also becoming increasingly common because senior debt lenders wish to ensure that any junior debt is structurally subordinated (ie held by a company below it in the structure) to senior debt.

How will you invest?

A PE buyer will most likely want you to invest in the newco structure (the percentage of your proceeds from the sale that they want you to invest will be a matter for negotiation). This will be in the form of an investment in the ‘institutional strip’ and/or ‘sweet equity’. You may also be asked to accept the issue of loan notes and/or preference shares as part of this process. What does this involve?

Institutional strip

PE investors will ask you to ‘rollover’ (via share for share exchange) or reinvest (via cash contribution, net of tax) some of your sale proceeds in the company. This is known as investing in the ‘institutional strip’. Managers are often asked to reinvest up to 50% of their proceeds after tax, but this may vary depending on the nature of your sale process and the commercial negotiations. The institutional strip may take the form of ordinary shares, loan notes, and/or preference shares (we cover these in more detail later in this guide).

It is important that your institutional strip is structured and priced in the same way as the PE investor’s investment to reflect the fact that you’re investing your own money in these securities and that they are not payment for your ongoing employment. For example, you should not be required to sell your securities if you leave the company before an exit (except, perhaps, in certain ‘bad leaver’ scenarios).

Sweet equity

Key managers of a company are typically allocated sweet equity to incentivise their future performance. You may be allocated some as a founder if you are staying on in the business. Sweet equity is typically structured to give managers an economic stake in the business for a low (often nominal) upfront cost compared to other forms of investment such as institutional strips. Sweet equity aligns the interests of key management with those of the PE investor by providing significant potential upside to the sweet equity holders on a future exit if the company performs well (ie it sweetens their deal with the company).

PE investors will set aside a pot or pool (a certain number of reserved shares) of sweet equity on completion of a transaction so that any existing and future managers can be allocated shares. Sweet equity shares generally have limited rights and protections. For example, you may not have any voting rights nor any rights to receive distributions, and you will likely be required to sell your sweet equity if you leave the company prior to an exit (and you will get different amounts for it depending on how you leave, for example, as a ‘good’, ‘bad’, or ‘intermediate’ leaver; for more information on these terms, see the table below).

Loan notes vs preference shares

As part of your investment in the institutional strip, you may also be allocated loan notes and/or preference shares alongside the PE investor that will accrue a yield at a specified interest/coupon rate. In short, loan notes are an IOU and, like preference shares, will be paid out ahead of any ordinary shares on an exit.

The tax implications to the company and the shareholder of any post-sale holdings in the new structure (and the valuation of those holdings) should be carefully considered, and Section 431 elections should be signed where appropriate. Please see our section on Tax considerations and wealth planning for further details.

Protecting your investment

As an investor in the company after the sale, you will want to consider how best to protect yourself and your investment. The table below sets out a list of the key equity terms and how you might want to position yourself against a PE investor.

These are designed to be indicative of a typical situation and not to provide legal advice. You should always obtain legal and personal tax advice to understand exactly how the proposed structure will impact you.

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Key equity terms

Key terms	Institutional investor position	Manager/founder position
Board composition	PE investors will insist on a contractual right to appoint a certain number of their representatives (perhaps a majority of the board) as directors. Their directors (or their alternates) will usually have to be in attendance at all board meetings for them to be valid.	As the founder or the management group together, you may want the right to appoint a director. Also, beware of any directors’ fees charged by the institutions; they should be reasonable and capped at an annual amount.
Consent matters	PE investors will usually specify some shareholder and operational matters that need their approval before the company can undertake them, such as varying the rights attaching to their shares, issuing new shares and unbudgeted spending.	You should consider any consent matters carefully; they should not impact or restrict the day-to-day running of the business unnecessarily. Managers should also request certain consent rights, such as any amendments to the equity documents that could disproportionately affect their terms, or the economic rights attached to their shares. Founders may want consent rights similar to those given to the investor (this will usually depend on the size of their investment stake).
Swamping rights	Institutional investors will require additional voting rights in certain default situations (swamping rights), such as a material failure to perform against budget. These rights are intended to allow the PE investor to control board and/or shareholder matters (if they do not already have control) and, if necessary, implement an emergency issue of shares to inject capital or to remove or appoint directors.	You should ensure that the trigger situations to implement swamping rights are sufficiently material (eg financial default events), and if an emergency issue is made, you are able to subscribe for additional shares to maintain your pro rata shareholding (a ‘catch-up right’).
Permitted transfers	Institutional investors will likely want a veto over certain share transfers to prevent them from taking place without their consent, so that they have control over who they are investing alongside.	You should ensure the equity documents allow certain transfers to be ‘permitted transfers’ that do not require investor consent. Such transfers may include transfers to a family member or trust for tax planning purposes or transfers to a warehousing entity or employee benefit trust to be held for new members of the management team. You should also consider restricting permitted transfers by PE investors to related funds or investors to the extent that they constitute an exit for limited partners of the original fund or providing for any such transaction to entitle you to 'tag' along – see below.
Drag-along right	If an institutional investor wants to sell all of its shares to a third party, it will want the ability to require minority shareholders to also sell their shares (known as a ‘drag-along’ right) so that the new third-party buyer can acquire 100% of the business.	You should aim to agree on a threshold to exercise the drag (eg 50% or more of the ordinary share capital), and/or the drag-along rights could be suspended for a period of time or until certain returns are achieved to give the managers the opportunity to follow through on the business plan. Consider if there are circumstances where you would like to force a sale.
Tag-along right	PE investors will usually want this right only to apply if the sale would result in a new investor taking control of the company.	You should ensure that if a material level of shareholders receive an acceptable offer from a third party, they are obliged to provide that the third party makes an offer to purchase at least the same proportion of the other shareholders’ shares on the same terms (a ‘tag’ right).
Leaver provisions	If you leave the business before an exit, a PE investor will typically want you to sell some or all of your sweet equity back to the company. This allows it to reallocate your sweet equity to any new managers to encourage them to grow the business. The amount of money you will get for your sweet equity will depend on the circumstances in which you leave. Typically, there are ‘good’, ‘intermediate’, and ‘bad’ leavers. It is possible that a PE investor may also require you to sell your ordinary shares that comprise your institutional strip and/or look to reduce the interest or coupon on your loan notes/preference shares in 'bad' or 'very bad' circumstances.	The investment documents should clearly define what constitutes a ‘good’, ‘intermediate’, or ‘bad’ leaver as this will determine what price you will receive for your shares. Good leavers typically leave employment due to death, disability, or illness; intermediate leavers have often been terminated with notice, whereas bad leavers have voluntarily resigned, been dismissed for cause, or breached their restrictive covenants. Good leavers usually receive ‘market value’ for their shares; bad leavers receive the lower of the price they paid and market value; and intermediate leavers receive market value for an increasing percentage of their shares the longer it is until they become a leaver (this is called ‘vesting’).
Restrictive covenants	A PE investor will seek to limit your ability to damage the business of the company if you leave and will require managers to agree to certain restrictions (‘restrictive covenants’), including agreements not to compete with the business and not to solicit customers or staff.	Restrictive covenants in the investment documents may cut across any restrictive covenants you already have in your employment agreement. You should always make sure the restrictions are reasonable and don’t unduly prevent you from earning a living after you leave the business. Navigating the covenants is a balancing act; you will be keen to ensure that your fellow managers are themselves appropriately restricted if they leave.
Warranties	You and the management team will be asked to give investment-related warranties, such as to the accuracy of your forecasts, projections, and business plan, and to confirm certain information contained in the various vendor due diligence reports and/or those reports commissioned by the institutional investor. If you fail to disclose anything that makes a warranty untrue, you will be in breach of warranty and may be liable to pay the institution’s damages.	You should expect to be able to limit the scope of the warranties through negotiation, be able to cap your liability under the warranties by negotiating a financial limit on your liability (usually a multiple of your annual salary) and should ensure that the warranties expire after a certain period of time. Don’t be put off by this process. Proper preparation and disclosure mitigate the risks of any claim arising.
Information rights	You and the management team will be asked to provide various information to the PE investor, including monthly/quarterly/annual accounts, cap tables, an annual business plan and budget (that the investor will likely want to approve), and a management pack (often measuring performance against KPIs).	You should ensure that the information obligations are achievable for you and your team and will not unduly distract management from running the business. You should also consider what information you would want as a shareholder if you were no longer a director or employee of the business.

Strategic buyers

Also commonly referred to as ‘trade buyers’. In the life sciences sector, this type of acquirer is likely to be operating in the same or an adjacent space as your company, which makes the acquisition for strategic rather than purely financial reasons. Large pharma, medical device and other life sciences companies are active acquirers particularly with the looming patent cliff that many will experience in the next few years. Strategic goals can vary, but they will typically include a desire to bring in new IP, technology and assets.

Sometimes, because they are buying for their own strategic reasons, trade buyers are prepared to make higher offers for businesses than financial institutional buyers, who may be looking for a purely financial return from the existing business. This is particularly the case now, with many trade buyers able and willing to fund acquisitions exclusively from existing cash resources rather than having to rely on debt finance, which has become materially more expensive in the sustained higher interest rate environment.

Being part of a larger group may also offer new and enhanced opportunities to:

develop at scale
fund clinical studies
obtain regulatory approvals
access new markets, sectors, and/or sales and distribution channels.

Against this backdrop, we consider some of the key features of an acquisition by a strategic buyer.

Deal structure

Trade buyers tend to want to acquire 100% control when they undertake an acquisition and then integrate the business into their wider group. This may mean that ongoing management is given relatively less autonomy and can find itself operating in or absorbed by a different business culture, or it may no longer be required for the ongoing business. Management teams that do stay on are likely to need to make a transition from being decision makers to decision takers.

If you’re going to stay on in management at the business, you should give careful thought to the cultural fit and your ongoing employment rights. It’s understandable for your main focus to be on getting the deal over the line, but asking the right questions about what integration means for you and your team and what support and investment the business will receive following completion of the sale is important. Doing this before you hand over the keys to your business and relinquish negotiating power is key.

In terms of process and documentation, strategic buyers sometimes have less flexibility on terms, sometimes have an internal ‘playbook’ they need to follow, and can be slower and more cautious, particularly if it’s a first-time or transformational deal for them. They also commonly want to receive a great deal of information about the strategic and technical elements of the business (beware of the business and legal hazards in doing that), with an emphasis on longer-term potential.

Unlike private equity buyers, strategic buyers do not tend to ask management to ‘rollover’ or reinvest a portion of their sale proceeds into the company. They often instead offer more money upfront, use milestone consideration structures, and might, less commonly, offer shares or options in the ultimate, controlling company of their group.

Milestone payments

Milestone payments are very common in life sciences, particularly biotech transactions, and typically provide that the sellers will be paid further consideration if the business achieves certain milestones in the years after the sale (commonly the one- to three-year period after the sale). The milestones in this context are typically financially driven, such as revenue targets, but might be developmental or regulatory milestones (ie related to successful progress through clinical phases and product approval) or a mixture.

Milestone payments are used to allocate risk for the successful progression of a promising drug candidate, bridge valuation gaps between buyers and sellers and to incentivise the selling management team to stay on in the business, help with integration, and drive future performance.

Having less control over the business could also mean that achieving the milestones is not entirely in the hands of management (eg does the business require investment or operational input from its owners, could business be diverted away from it, or could employee numbers be cut?). This means you should pay close attention to the contractual restrictions on the buyer and its obligations to assist management in achieving the milestones.

Remember that the people you’re dealing with at the buyer and/or their priorities may change during the period covered by the contingent value rights, so you could be caught out if you haven’t built the appropriate guardrails into your documents.

It’s worth considering the culture of the buyer in helping previous sellers achieve their own milestones, and you should also consider what happens if you leave the business before the contingent value rights are realised. In some circumstances, if you are a ‘good leaver’ (eg if you are unwell, retire, or die), you or your estate may be permitted to keep a greater share of the proceeds than if you are a ‘bad leaver’ (eg if you are dismissed or resign), though any disparity in treatment between different types of leavers (or shareholders) may have tax implications.

It is crucial to structure contingent value rights correctly to minimise the effective tax rate and, to the extent possible, any upfront tax charges on future payments. See our Tax considerations and wealth planning section for further details.

Share consideration

Selling your shares in return for shares in the buyer adds a new dimension to a deal, particularly where it’s a pure share-for-share deal or where the share component of a mixed cash/share deal is significant. In those circumstances, sellers will need to grapple with many of the same issues as buyers. These include:

Valuation of consideration shares

If consideration shares are being offered, you’ll need to agree on a value for them. This can be a thorny issue when it comes to unlisted companies, particularly if a buyer is seeking to rely on a valuation of more than a year old. Valuations, particularly from before 2022, have significantly pared back in recent times. It will also be important to understand what class of share you’re being offered and where it sits in the return waterfall, noting that the consideration shares are being acquired for value and should be treated accordingly.

Reverse due diligence

Most sellers aren’t expecting to have to carry out due diligence when they launch a sale process, but where a significant portion of the overall consideration is in the form of shares, it would be worth carrying out some level of reverse/confirmatory due diligence on the buyer to ensure there are no material flags that impact your willingness to do the deal.

If the buyer has completed a funding round recently or has itself been acquired (eg by a PE fund), it might be possible to get access to the investors’ due diligence reports on a non-reliance basis to short circuit some or all of that exercise and bridge the gap between the date of those reports and your deal with appropriate warranty cover.

Contractual protections

As a future shareholder in the buyer, you should expect some level of contractual protection in relation to your ‘investment’, both in terms of warranty cover in the share purchase agreement (ie beyond the typical fundamental buy-side capacity warranties) and appropriate minority shareholder protections in the shareholders’ agreement and/or articles of association. The extent of those protections will depend on relative bargaining positions and the size of your stake in the buyer; the stronger your hand and the larger your stake, the more you can expect here.

The tax implications of any share consideration mechanics should be carefully considered (including whether you want it to trigger a disposal for capital gains tax purposes or ‘rollover’ any gain). Please see our Tax considerations and wealth planning section for further details.

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US buyers

It is increasingly common to find UK companies are the subject of interest from US acquirers, particularly given the relative strength of the US dollar and the perceived discount at which UK targets trade relative to their US peers.

US buyers, especially those less familiar with the UK market, tend to have a different approach to deal terms. They may look to implement these even where the target is based in the UK (and English law is chosen as the law governing the transaction documents), so it’s important to understand these differences in approach to help bridge the expectation gap on transatlantic deals.

It is worth noting that English law governed documents are generally viewed as being more favourable to sellers.

Below we set out some of the key differences between UK and US buyers in their approach to legal terms.

Pricing mechanisms

Conditions of the deal

Liability and recourse

Restrictive covenants

Transfer tax

Private equity-related differences

Pricing mechanisms

Conditions of the deal

Liability and recourse

Restrictive covenants

Employees

Transfer tax

Private equity-related differences

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