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The new PSC register and its impact on private equity

The Small Business, Enterprise and Employment Act 2015 (the Act) aims to increase transparency in the ownership and control of companies incorporated in the UK. The government hopes that an increase in transparency will help tackle tax evasion, money laundering and terrorist activity.

Possibly one of the most controversial rules being introduced by the Act is the requirement for companies to keep a "persons with significant influence or control" (PSC) register. This means that all companies incorporated in the UK (other than publicly traded companies) and LLPs will have to maintain a register of those people who have significant control over them. This register must be available for public inspection and needs to identify the individuals who ultimately own or control the company or LLP.   

If a company fails to take reasonable steps to identify its "persons with significant influence or control" or a shareholder fails to provide the required information, then they risk being convicted of a criminal offence.

In this article we look at how the new register might impact the venture capital and private equity sectors and their portfolio companies.

Who is a person with significant influence or control?

A PSC is an individual who, either alone or as one of a number of joint holders, meets at least one of the following conditions:

  • directly or indirectly holds more than 25% of the nominal share capital of the company (or, where the company does not have a share capital, has a right to more than 25% of the entity's capital or profits);
  • directly or indirectly holds more than 25% of the voting rights of the company;
  • directly or indirectly holds the right to appoint or remove a majority of the board of directors;
  • actually exercises, or has the right to exercise, "significant influence or control" over the company; or
  • actually exercises, or has the right to exercise, "significant influence or control" over the activities of any trust or firm (who is not a legal person) which has significant control.

What does this actually mean?

The Act and The Register of People with Significant Control Regulations (in draft only at this stage) provide detailed guidance on the interpretation of the conditions. In addition, on 21 December 2015, an expert working panel produced specific guidance (Guidance) on the meaning of "significant influence or control".

It should be fairly straightforward for an investor to assess whether its interest in a portfolio company satisfies the first or second condition above. What may be less clear, however, is if the third, fourth and/or fifth conditions are met. This will only need to be considered if an investor’s nominal shareholding and voting rights are 25% or less.  

Institutional investments incorporate various checks and balances on the ongoing management of portfolio companies. It is these consent and veto rights which will then need to be collectively considered.  

The Guidance sets out a non-exhaustive list of situations where an investor may be deemed to have significant influence or control over a portfolio company. They distinguish between situations where a person has a right to exercise significant influence or control and where he actually exercises significant influence or control. Example situations include:

  • a person having veto or absolute rights over decisions relating to the running of the portfolio business (eg adopting or amending the company’s business plan, changing the nature of the company’s business, making additional borrowing from lenders, appointing the majority of the board of directors or establishing or amending any profit-sharing, share option, bonus or other incentive scheme for directors/employees); 
  • a person (who is not a director) having day to day management and direction of the portfolio company; and
  • a person (eg a founder who now holds a substantially reduced shareholding) whose recommendations are always or almost always followed by the portfolio company’s shareholders who hold the majority of the voting rights.

Slightly confusingly, the Guidance notes that a veto right for the purpose of protecting a minority interest is unlikely, on its own, to constitute significant influence or control. The examples given in this respect include veto rights over changing the portfolio company’s constitution, the dilution of shares or rights, the winding up of the company or making of additional borrowing from lenders above an agreed threshold.

On balance, assuming that an institutional investor has made an investment based on industry-standard investment terms (with associated consents and veto rights), it is likely in our opinion that they will be a PSC who must be noted on a portfolio company’s PSC register.  

Note that "swamping rights" (and other rights exercisable only in certain circumstances) need only be taken into account when:

  • the circumstances have arisen (for example, a defined underperformance) and for as long as they subsist; or
  • when the circumstances are within the control of the person having the rights.

What if I am an investor director?

Distinct from the above will be an assessment of whether an investor director appointed to the board of a portfolio company is a person with significant influence or control who should be included on the PSC register. The Guidance sets out various safe harbours for those people who will not, in the normal course, be considered to be a PSC. These safe harbours include: 

  • directors of the company, 
  • employees of the company acting in the course of their employment,
  • employees or directors of a third party who is a PSC, and
  • third party lenders who have a commercial/financial relationship with the portfolio company (even if they take security over some of the portfolio company's shares). 

So an investor director or third party funder will not automatically be deemed to be a PSC. The company will need to consider if such director's role or relationship differs materially from how the role or relationship is generally understood, or if it forms one of several opportunities which that person has to exercise significant influence or control.

What about our limited partners?

Where an institutional investor needs to be noted on the PSC register of a portfolio company, that portfolio company will need to identify the individuals who ultimately have ownership or control of the fund. This has raised particular concerns for the private equity sector which commonly uses two-tiered limited partnership structures for its investments.

The issue with such limited partnerships (distinct from LLPs) is that they are not legal entities which are capable of being noted on a company's PSC register. A portfolio company needs to look beyond the limited partnership to identify exactly who has significant influence or control over it. The initial draft legislation required that the individual limited partners (or individuals with interests in corporate limited partners) of such partnerships be noted on the portfolio company's register. The BVCA strongly lobbied against this on the basis that there can often be hundreds of individual limited partners. It argued that to note each of their names on a PSC register would suggest they have a greater level of control or ownership than they indeed have. The legislation has since been revised to make clear that individual limited partners (and individuals with interests in corporate limited partners) will not automatically need to be included on a PSC register merely because they hold that position. A company should consider, however, if a limited partner still needs to be noted as a PSC because he in some other way satisfies the fourth or fifth condition.

In contrast, general partners who have day-to-day management of a limited partnership's activities, or any investment manager they appoint to operate the limited partnership and manage its investments, will need to be captured in the PSC register.  

What next?

The obligation for relevant companies and LLPs to keep a PSC register comes into force on 6 April 2016. From 30 June 2016, PSC information will need to be included in a company's confirmation statement (currently known as an annual return) filed with Companies House.

As the BVCA has identified, guidance and illustrative examples are needed on:

  • how to determine who has a majority interest in a limited partnership in the context of the fifth condition (ie capital contributed, entitlement to profits and losses, or both); and
  • how individuals holding an interest in a portfolio company through general partners and through limited partners would fall within the conditions (including where management of the partnership is delegated to an investment manager).

For detailed advice on the Act and Guidance as they apply to your company or LLP, please get in touch with your usual contact at TLT or contact Jon Gill on +44 (0)333 006 0793 or jon.gill@TLTsolicitors.com or Jon Close on +44 (0)333 006 0481 or jon.close@TLTsolicitors.com.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at February 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions on www.TLTsolicitors.com

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