Corporate law update: 18 - 24 February 2023

In this week's update:

• PERG publishes its 15^th annual report on compliance with the Walker Guideline
• EY publishes its annual report on the performance of private equity portfolio companies
• The BVCA publishes a revised suite of its early-stage investment model documents
• The UK Jurisdiction Taskforce publishes a legal statement on the viability of digital securities
• The FRC publishes a "myth buster" on corporate governance and stewardship
• The FCA clarifies that issuers may prepare financial statements using Chinese GAAP

PERG publishes annual report on Walker Guidelines compliance

The Private Equity Reporting Group (PERG) has published its 15th annual report on compliance with the Guidelines for Disclosure and Transparency in Private Equity (the Walker Guidelines).

The Guidelines are designed to assist private equity firms and their portfolio companies with improving transparency in financial and narrative reporting. They require portfolio companies to make certain disclosures in their annual report, publish their report and a mid-year update in a timely manner, and share certain data to gauge the contribution of UK private equity to the economy.

They also require private equity firms to make certain website disclosures.

The report assesses compliance with the Walker Guidelines during 2022. This year's report covered 73 portfolio companies and 64 firms that backed them.

We have set out below the key points arising from the annual report in our separate in-depth piece.

Alongside PERG's annual report, EY has also published its own annual report on the performance of portfolio companies in 2022 (see below).

EY publishes annual report on portfolio company performance

EY has published its annual report on the performance of private equity (PE) portfolio companies in 2021. The report accompanies the review by the Private Equity Reporting Group (PERG) on compliance with the Walker Guidelines in 2022 (see above).

The key findings from EY's report are set out below.

• The average timeframe of PE investment in portfolio companies (from acquisition to exit) in 2021 was 5.9 years (the same as in 2020).
• Portfolio companies increased reported revenue to 7.8% compound annual growth rate (CAGR) since acquisition (up from 4.9% in 2020) and EBITDA to 6.0% CAGR (up from 4.1% in 2020).
• These figures outperformed the equivalents for public company benchmarks (which were 2.3% for revenue increase and 5.6% for EBITDA increase).
• Reported employment under PE ownership increased by 1.5% in 2021 (up from 0.9% in 2020).
• Of portfolio companies at the time of review, 57% had made net bolt-on acquisitions, whereas only 10% had made net partial disposals.
• Portfolio companies had an average gross debt-to-EBITDA financial leverage of 6.6 at acquisition and 6.9 at latest date or exit (similar to 2020 levels).
• Female representation at board level stood at 26% (up from 24% in 2020 but still lower than FTSE 250 board representation in 2021, which stood at 37%).
• The equity return from portfolio companies stood at 3x the public company benchmark (the same as in 2020), with around 40% of the return attributable to strategic/operational improvement.

BVCA publishes updated model early-stage investment documents

The British Private Equity and Venture Capital Association (BVCA) has published updated versions of its model documents for early-stage investments.

The model documents are designed to promote standard legal documentation for early-stage venture capital investments. They are commonly used as a starting point for early-stage fundraising and occasionally follow-on investments.

The BVCA has split its combined model subscription and shareholders' agreement into separate model subscription and shareholders' agreements. It has also published revised model articles of association and promised a revised model term sheet and ancillary documents in due course.

Many of the changes are technical in nature. We have summarised the key changes below.

• The subscription agreement now contemplates completion of the investment in stages.
• Founders no longer provide warranties to the investors on subscription. Instead, warranties are provided solely by the company itself. However, the company will be deemed to have knowledge of anything of which the founders are aware.
• Limitations for warranty claims have been changed, including a blanket 18-month time limit for bringing claims and removing the small and aggregate claims hurdles.
• The liquidation preference for series A shareholders has been modified so that each series A shareholder will now receive the greater of a fixed preference per series A share and the amount they would have received if they had converted their series A shares into ordinary shares.
• The full and narrow-based weighted average anti-dilution ratchets have been shifted to a schedule, with the broad-based weighted average ratchet now serving as the default position.
• The threshold for varying the rights attaching to a class of shares has been lowered from more than 75% to more than 50%. Different classes of share are also treated as a single class if a proposed change would affect all those classes in the same way.
• Pre-emption rights on the issue of new shares are now drafted for the benefit of investors only (and not ordinary shareholders). There is also the option to further limit the benefit of pre-emption rights to "major investors" holding a stake above a minimum size.
• Pre-emption rights on transfers of shares have been reworked, although in substance they remain similar. But the ability to impose a "minimum transfer condition" has been removed, and there is now an option to expand the board's power to block the transfer of any unallocated rump.
• An employee (now termed a "service provider") will now be a bad leaver if they materially breach their non-compete covenants. This aligns with market practice on PE investments, where a breach of restrictive covenants will often result in "very bad leaver" status.
• The drag-along provisions now contemplate that a sale agreement between a dragged shareholder and a buyer may contain more extensive terms than merely confirming title, including placing part of the purchase price in escrow to meet any warranty claims.
• The articles now contain a 180-day lock-up on share transfers following an IPO and specific provisions to facilitate the interposition of a new holding company.
• Finally, the articles now contain optional drafting for EIS/VCT investors, including a modified liquidation preference and a 50% cap on corporate shareholders.

UKJT publishes legal statement on digital securities

The UK Jurisdiction Taskforce (UKJT) has published a legal statement on the feasibility of UK companies issuing "digital securities".

The UKJT was established in 2019 to support the digital transformation of the UK legal sector. Its new legal statement follows a consultation it launched in August 2022 on the validity and viability of digital securities under English law.

The statement examines whether English private law can support the issue and transfer of equity, debt or other contractual securities using blockchain or distributed ledger technology (DLT).

The UKJT notes that certain aspects of the issue and transfer of shares in UK companies can already be accommodated by a DLT-based system. However, in other respects, formalities under the Companies Act 2006 may prove to be impediments to a fully "on-chain" system.

You can read more about the UKJT's comments on equity securities, as well as our own thoughts, in our separate in-depth piece. You can also read more on the policy drivers behind the legal statement in this separate piece by our colleagues in our Lawtech practice.

FRC publishes "myth buster" on corporate governance and stewardship

The Financial Reporting Council (FRC) has published what it has termed a "myth buster" to "dispel common misconceptions about corporate governance and stewardship".

The three-page document contains 12 questions and answers, addressing (among other things) the scope of the FRC's UK Corporate Governance Code and its Stewardship Code, the concepts "stewardship" and "comply or explain", and the FRC's powers in relation to poor reporting.

FCA clarifies equivalence status of Chinese GAAP

The Financial Conduct Authority (FCA) has published Primary Market Bulletin 43, in which it has confirmed that (among other things) it considers general accepted accounting principles of the People's Republic of China (Chinese GAAP) to be equivalent to UK-adopted international accounting standards.

As a result, companies that are subject to the FCA's Disclosure Guidance and Transparency Rules (DTR) and are based outside the United Kingdom are permitted to prepare consolidated annual and half-yearly financial statements in accordance with Chinese GAAP, rather than UK-adopted IFRS.