The importance of separate representation for management in PE-backed M&A transactions

Thursday 20th June, 2024

When a private equity house backs a management team to buy-out the existing owners, the three parties inevitably have different interests. A management team, in many ways, is caught betwixt and between – having worked for the sellers, but set to be more aligned with the private equity firm supporting the buy-out once it completes. This divergence is a misalignment that necessitates distinct legal representation for management to ensure their unique needs and objectives are adequately protected.  

There are a handful of reasons why this is the case. Here are six of the most common factors to consider in order to ensure the smooth running of the transaction and why it won’t be an unnecessary cost or complication in the long-run. 

Conflict of Interest 

In any M&A transaction, management’s interests can conflict with those of the sellers and the PE buyer. Management teams have distinct needs — such as leaver provisions and employment agreements — that must be addressed independently. Separate legal representation allows management to receive unbiased legal advice, helping them make informed decisions about their role and investment in the new structure. This protection minimises legal and regulatory risks and ensures that management’s interests are safeguarded. 

Negotiating Power 

Management plays a pivotal role in the success of both the transaction and the ongoing business. With separate representation, management can negotiate critical terms — warranties, leaver provisions, employment contracts, equity incentives, and transition plans — that are tailored to their interests. This independent negotiating power ensures that management is not overshadowed by the interests of the sellers or the PE buyer, leading to a more balanced and equitable transaction. 

Better Buyer-Management Relationship 

PE buyers invest in the management team’s ability to operate the business successfully. When management has separate representation, especially when the cost is covered by the buyer or newco, it fosters trust and collaboration. Management feels their interests are recognised and protected, reducing the likelihood of future disputes or dissatisfaction arising from overlooked issues. 

Protection of Confidential Information 

During a transaction, sensitive information about the target company is frequently exchanged. Separate representation for management ensures that their confidential information is protected and not compromised, maintaining the integrity of the transaction process. 

Fiduciary Duties 

Management has fiduciary duties to act in the best interests of the target company and its stakeholders. Independent legal representation supports management in fulfilling these duties by ensuring that their specific interests are adequately represented and aligned with their fiduciary responsibilities within the broader context of the transaction. 

Code of Conduct for Solicitors 

Solicitors are bound by a duty to act in the best interests of each client, which includes advising clients on whether separate representation is necessary. The differing interests of sellers and management mean that solicitors often cannot act for both parties without conflict. When sellers and management do not share substantially common interests, separate legal representation for management becomes imperative. If management cannot afford separate representation, it is reasonable for the buyer or newco to underwrite these costs to ensure fair and comprehensive legal support. 

Conclusion 

To ensure fair and balanced M&A transactions in the PE sector separate legal representation for management should become a recognised standard. PE and corporate finance firms are encouraged to adopt a voluntary code of conduct that mandates recognition and provision for separate representation for management. This approach will protect management’s interests, foster better relationships, and ultimately contribute to the success of the transactions and the future stability of the business.