There can be a broad array of matters to consider when structuring and executing a transaction involving a funds management business. 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 which need to be addressed. 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.
In this article we identify how, with an appropriate pre-acquisition plan, a funds management deal can be organised to address the relevant transitional arrangements. While we mainly look at the issues from a purchaser’s perspective, many of the points will be relevant to the vendor in the sense that they will need to be dealt with in order to manage a successful outcome for all parties.
When should we start the planning exercise?
Appropriate legal 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 we buying?
A threshold issue in any 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.
Asset or share purchase?
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.
What are the key legal due diligence issues?
Key areas for the legal due diligence stage which are particularly important for a funds management business include:
- Contract transferability and compliance: The key material contracts will need to be reviewed. As noted above for investment management agreements, 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. In the case of custody agreements, from 1 November 2015 all agreements will be subject to the new content requirements under ASIC’s updated Regulatory Guide 133. As part of the planning stage, appropriate provision would need to be factored in for engaging with any custodians and updating those agreements.
- 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. For example, if the licence contains key person conditions and one of the key persons will not be transferring with the business along with the acquisition, a licence variation will be required. If the business does not hold its own licence, the nature of the existing arrangement ought to be considered. It could be that the target company was acting under an authorised representative appointment arrangement with a third party. It would then need to be considered how that arrangement may need to be unwound or replaced post completion of the transaction. The purchaser would need to ensure that it had appropriate licensing arrangements in place from completion.
- ASIC notification: It is a general licence condition under the Corporations Regulations that any change in control of a licensee must be notified to the Australian Securities and Investments Commission within 10 business days. Importantly, this is a notification requirement rather than a pre-approval. However, ASIC retains the discretion to scrutinise changes of ownership in the event that there are any concerns regarding the ongoing ability of the licensee to meet its licensing obligations. The need for a change in control notification will be clear where the company being acquired holds its own licence and there is a 100% change in ownership of its shares. However, the change in control test is benched in general terms and so there is the potential for changes in ownership upstream at an indirect parent level to also trigger the requirement.
- Branding: 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. These can include letterhead, fund names, disclosure documents and other marketing materials. The brand mapping exercise will give the parties better clarity about the amount of time which will be required to effect the necessary updates.
- 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 which 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 this process, particularly where the existing agreements have been in place for some time or are established on the basis of group rates or discounts which may not apply after the target entity has exited the group.
- 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.
A key separation issue arises where the responsible entity function is provided by a group entity or third party and needs to be changed. In that scenario, the transition planning will need to address meeting the Corporations Act requirements for changing the responsible entity either after the acquisition has completed or as a pre-completion condition. Under the Corporations Act, a responsible entity for an unlisted registered scheme can only retire and be replaced by a new responsible entity if the change is approved by extraordinary resolution of the scheme unitholders i.e. at least 50% of the total votes that may be cast by members entitled to vote at the unitholder meeting. Given this high threshold for passing the approval, it has in practice presented procedural challenges when either the scheme is widely held or where it is distributed through platforms which are often reluctant to act on corporate actions. In addition, restrictions on voting applying to a responsible entity and its associates under the Corporations Act may apply to prevent them from voting in connection with any units held by them in the scheme.
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 tax and accounting, property, employment contracts, superannuation entitlements, liabilities and commitments, IT requirements, insurance, financial accommodation, litigation, claims and solvency. The key will be to allocate appropriate resources and expertise to the relevant areas. It will also be 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. In our experience, significant benefits can be obtained from ensuring that the designers of the initial due diligence and
transaction planning remain involved through the due diligence, transaction execution and the following transition period. This continuity drives not only efficiencies but also accountability for ensuring that appropriate and thorough planning is undertaken to ensure that the commercial objectives are fully realised at the end of the project.