Corporate Governance in Practice: Steps to Attract Private Equity Investment

Corporate governance is described as the system of rules, practices and processes that are used to control and manage a company. The Cadbury Committee produced the UK’s first code on corporate governance in 1992. This contained what is considered to be the best definition of corporate governance:

“Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship.”

In essence, corporate governance is a key element to running a business and is something that both the board of directors and the shareholders should keep at the forefront of their minds when making decisions. This is particularly true when it comes to selling the company and/or attracting private equity investment.

Companies receive investments from private equity firms in order to grow. Private equity firms often invest in companies in return for shares in the parent company and to exit after a number of years having made a profit. When preparing to sell shares to a private equity firm, business owners should be aware of what will be expected in the due diligence process, and what they can do to make this process quicker and smoother.

Company statutory registers / company books

Every limited company in the United Kingdom is required by law to maintain several registers and keep these up to date with any changes. These registers include:

• register of members;
• register of directors;
• register of people with significant control;
• register of directors’ residential addresses; and
• register of secretaries.

Companies must ensure that any changes to the information held on the registers are updated as soon as possible and that the information is accurate. The registers can be kept as physical copies or as digital copies, but they must be available for inspection by the Registrar of Companies at any time.

During due diligence, a buyer will request to see the company books, and if they are not up to date, or do not exist, this can cause delays and it is likely that the shareholders will be required to provide an indemnity against any issues which may come from the books not being accurate and up to date.

Material contracts

Buyers/investors will want to review the company’s material contracts. A material contract is one that is material to the business of the company. These may be contracts with suppliers or with customers. For those looking to sell or attract investment, it is recommended that directors ensure they hold up to date, fully executed copies of these contracts for review. For example, if there are any change of control clauses or if the transaction would amount to an event of default under any material contract, getting in front of these issues and obtaining any necessary permissions from the other party to the contract before completion.

Beyond this, a buyer or investor will scrutinise the terms of contracts, looking for, amongst other matters:

• lengthy, onerous obligations;
• any unlimited or very high limits of liability;
• indemnity provisions;
• ability to assign contracts; and
• ability to exit or terminate contracts.

It is therefore critical to enter contract negotiations with this in mind.  It is hugely important to review and negotiate contracts with the bigger picture in mind.  These are matters that can result in indemnities having to be provided and/or “price chip” in sale or investment.

Mortgages/charges

Similarly to material contracts, any mortgages or charges granted by the company are likely to include a change of control provision. Sellers will then be required to seek permission from the party the charge is in favour of prior to completion to ensure that there are no defaults. Furthermore, as charges are often given in favour of banks when the company is taking out a loan, any buyer/investor may want to be able to decide if the charge shall be discharged following completion or if it shall be kept in place.

Employment/employee details

A buyer/investor will also want to know the details of employees the company has (i.e. pay, contract terms, any employees on long term sickness etc). Maintaining an up to date record of the number of employees and their contract terms and salary will ensure that any employment due diligence carried out goes smoothly.

Bank accounts/loans

A company’s bank account(s) are probably an obvious point that a buyer/investor will review during due diligence. Matters under scrutiny will include:

• how many accounts the company maintains;
• details and terms of overdrafts; and
• details and terms of other loans.

Therefore, companies should ensure that they have copies of their most recent bank statements available for inspection and also copies of any loan/facility agreements and any amendment agreements that they are party to.

In conclusion, when shareholders are preparing to sell or attract investment, it is crucial to ensure that they statutory books/registers are maintained and up to date, as well as ensuring they have executed copies of all material contracts (which are on robust terms), any charges granted by the company, details of employees and their employment and any bank accounts held and loan agreements entered into. Having these ready for inspection during the due diligence process carried out by any potential buyers will help the process move along quickly and will make a good impression of the company.

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The information and opinions contained in this blog are for information only.  They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice.  Before acting on any information contained in this blog, please seek solicitor’s advice from Gilson Gray.