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What shapes understanding of parties to a PE deal?

2018-06-30 06:57:30

By Paul Kibuuka

IN this week’s sixth part of our ten-part article series on private equity in Tanzania, we look into what shapes the understanding of parties to a private equity deal once the initial closing for a private equity (PE) fund is completed and the operations of the PE fund officially start.

For clarity purposes, the parties are the PE fund manager (one who manages the capital raised from investors in the PE fund); the company, including its owners and management and, in the case of a leveraged buy-out, the bank/financial institution that is offering to lend money.

The understanding of the parties is shaped by a Term Sheet. The process of negotiating and signing a term sheet is filled with tension and involves the action of a pull/push force. Good dealmaker lawyers can add business value to the deal by being able to smooth out things, and staying on top of the key documentation that makes private equity deals materialize.

It’s amazing how, for instance, Tanga Fresh converted the generally non-binding term sheet containing words and signatures into money in the bank from DOB Equity, a leading Dutch family run PE fund!

But, how exactly does that happen, and what does it mean?

A term sheet is the first step towards the definitive agreements that will reflect the terms of the private equity deal. Typically supplied by a PE fund manager, the term sheet is a pre-funding/acquisition “agreement to agree” the fundamentals of a deal. It can be furnished by the company, and occasionally is, however many PE fund managers will normally prefer to use their own version of the term sheet. Having looked at what a term sheet is, let us turn to what its purpose and implications are.

The purpose of a term sheet is to sketch the proposed terms and conditions of a private equity deal and to set out the amount of the investment that is to be made in the company. Even though customarily non-binding (except for the “No Shop”, Exclusivity, and Confidentiality clauses), it helps to facilitate the process from the initial negotiation to the definitive agreements (which are legally binding).

When a term sheet is agreed to and signed by the parties, it becomes a proxy and forms the rationale of the definitive agreements which are drafted by legal counsel. In short, a term sheet gives the parties a feel of whether the deal will eventuate. It also helps the parties to manage their expectations of each other.

While the confidentiality clause safeguards a company’s sensitive data from disclosure by the PE fund manager to third parties, the “No Shop” clause prohibits the company from considering other financing options for a definite time period. The implication of the confidentiality clause is that PE fund managers may hesitate to sign exceedingly restrictive NDAs as the essence of PE fund operations necessarily leads PE fund managers into contacts with multiple business entities.

Even so, the company’s owners should always anticipate a confidentiality clause in the term sheet. Additionally, company owners engaging with other funding sources should be cautious when entering into the “No Shop” clause, as negotiating on the side with another source would be a breach of the term sheet.

Because of space limitations, it is impossible to look at all the clauses that make up a standard term sheet. Nevertheless, we hope the foregoing discussion has given you a flavour of what to expect when engaging with a PE fund manager. Some of the clauses may sound like Greek to new company owners, but a good dealmaker lawyer should help to make the term sheet understandable.

Executing a term sheet is just a baby step in the process of getting equity capital from a PE fund. But taking the step is better than taking no step at all, especially in an environment of slow growth in bank credit to the private sector.

Moreover, although the process may appear to be combative, the PE fund manager wants to work with the company’s owners and management towards mutually satisfactory results, including growth in the company’s value and positive returns.

Paul Kibuuka is the managing partner of Isidora & Company Advocates, a corporate, commercial and financial law firm. This article was published in The Citizen on Saturday, 30 June 2018

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