There can be a broad array of matters to consider when structuring and executing a transaction involving a funds management business, writes Henry Davis York’s Jon Ireland.
Buying into and selling out of these businesses involves many of the characteristics inherent to mergers and acquisitions in different industries.
However, additional complexities arise from the fact that funds management is a regulated activity and can involve a range of specific separation and operational/back-office considerations.
The transitional arrangements necessary to fully complete on a funds transaction will often be deal-specific and can create significant impediments if adequate planning and pre-transaction legal due diligence is not undertaken.
This article looks at how a funds management deal (involving companies which are not market-listed) can be organised to address the relevant transitional arrangements.
While the issues are mainly considered from a purchaser's perspective, many of the points will be relevant to the vendor in that they will need to be dealt with to manage a successful outcome for all parties.
When to start planning?
Appropriate due diligence and transaction planning is critical and does not necessarily need to be kept on hold until the target entity or entities have been confirmed.
Depending on the timeframes involved, it may be that a broad-based review is necessary to determine the optimal transaction structure.
The objectives in the planning exercise will be to ensure the key risks and procedural mechanics are identified and that appropriate processes are followed to achieve the targeted commercial objectives.
Appropriate risk sharing measures will need to be considered based on issues that come out of the legal due diligence, including representations, warranties and indemnities in the share or asset sale agreement.
In addition, a broader framework or implementation document may need to be developed to address the separation or transitional requirements.
What are the threshold issues to consider?
A threshold issue in any unlisted M&A deal is to identify the specific target entities.
In the case of funds management, where the entire business is operated through a single company, this will be an easier exercise on the basis that the essential functions, licensing and operations are centralised and more likely to be transferred simply through acquisition of shares in that company.
However, identifying the target can be more complex where the business operations are not centralised, for example, where a fund manager relies on services provided by a broader group or outsourced third-party service provider(s).
In the group or third-party service provider context, it is not unusual for decentralised/outsourced services to include provision of trustee or responsible entity services and other back-office operational and compliance funds services.
Investment management may, itself, be partly or wholly sub-delegated to another entity, for example, where the manager relies on offshore investment management expertise.
In addition, it is not uncommon for groups to house their employment arrangements within a single service company.
Accordingly, acquisition of the fund manager company may not in this instance bring across the employment arrangements for the funds management staff.
In all these group or outsourced third-party cases, a transitional or separation plan will be critical.
Faced with the option of acquiring a funds management business, it may also be relevant to consider whether the transaction should proceed by way of a share or asset purchase.
Often, the choice of approach can be a trade-off between convenience and risk.
A share purchase can be executed more simply than an asset purchase but carries with it the risk of the purchaser acquiring historical issues relating to the company concerned such as any tax issues, liabilities and claims.
A business purchase on the other hand allows the purchaser to ‘cherry-pick’ the assets but can be more time-consuming owing to specific transfer arrangements which need to be addressed for each asset.
In the case of a funds management business, key assets will comprise the management rights which the business holds in relation to the investment funds it manages or segregated institutional mandates.
These arrangements are likely to be documented in investment management or advisory agreements which would need to be novated to the purchaser in the event of an asset sale because the fund manager counterparty would not be transferring with the business.
Novation by definition would require the consent of the client under the agreement and the parties will need to factor in the necessary time and relationship management involved in obtaining that consent.
Assurances may be sought by the client around continuity of the portfolio management team in that situation.
It is though worth noting that even with a share sale where the manager counterparty is not changing, client consent or waivers will still be required if the investment management agreement contains a change of control clause which is triggered by the sale.
The key areas at the legal due diligence stage that are particularly important for a funds management business are as follows.
Contract transferability and compliance
The key material contracts will need to be reviewed.
Change of control and consent clauses will be critical to identify, as well as other terms which are relevant to pricing the business.
For example, if a material investment mandate is set to expire shortly after the due completion date, the purchaser may require, as a completion precedent, that the vendor arrange for the agreement to be extended.
In addition, material contracts may need to be reviewed for compliance with applicable law and regulation.
Financial services licensing arrangements
Where the business operates under its own Australian financial services licence, that licence should be reviewed to ensure that any changes under the transaction do not adversely impact on the licensee's ability to meet its continuing obligations under the Corporations Act and the licence conditions.
If the business does not hold its own licence, the nature of the existing arrangement ought to be considered (eg. the business may be operating as an authorised representative under another licence) in case it needs to be unwound or replaced post-completion of the transaction.
In a group arrangement, the target fund manager company may not own the intellectual property rights to the business name under which it operates.
In this case, the vendor and purchaser will need to put in place arrangements to ensure that there is no inadvertent breach of those rights as part of the transition.
A short-term licence from the vendor group entity which owns the rights may be an interim solution, pending the transition being completed.
Even in that scenario, it will be important to map out the areas where the branding is relied on, which could include letterhead, fund names, disclosure documents and other marketing materials.
Back-office and third-party support
The target business may rely on either a group entity or a third-party service provider for key support functions.
Where those are required to continue, transitional support arrangements will be needed unless there are already formal agreements in place with the target entity that can continue in their current form.
However, it is not unusual for group service supply arrangements to be undertaken on the basis of a generic intra-group supply arrangement, which would need to be formalised under a standalone transition support agreement.
For third-party service suppliers, the vendor and purchaser may need to address separation issues under the existing contracts.
For example, where the manager is one of a number of entities supported under a single agreement, that agreement may need to be modified and set up on a standalone basis with the third-party supplier.
There can be critical timing and commercial implications involved with transitioning these arrangements.
Wholesale and retail funds transition
Where the business is a wholesale investment manager, in addition to running segregated institutional mandates, it may be acting as a trustee for wholesale funds.
In this case, the planning and review will need to take into account the manager's operational and compliance arrangements as trustee as well as the governing and offering documentation for those wholesale funds.
This review will be heightened where retail investor moneys are being managed through registered schemes and the manager is acting as a responsible entity.
In the retail context, the manager will be subject to the additional compliance requirements of the registered scheme provisions of the Corporations Act.
These requirements include the need to obtain unitholder approval if the responsible entity is to retire and be replaced as part of the transaction.
Coordinating the project
Other areas of legal due diligence and planning will also be important for a funds management business, just as for businesses operating in other industries.
These areas include tax and accounting, property, employment contracts, superannuation entitlements, liabilities and commitments, IT requirements, insurance, financial accommodation, litigation, claims and solvency.
The key is to allocate appropriate resources and expertise to the relevant areas.
It is also important to have a coordinated approach to the assessment and reporting of findings coming out of the broader due diligence process, given that this is likely to involve bringing together inputs from various sources – internal and external – to the purchaser.
Coordination drives not only efficiencies but also a greater likelihood of ensuring that the commercial objectives are fully realised at the end of the project.
Jon Ireland is a partner at commercial law firm Henry Davis York.
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