LINPAC is Britain’s 26th largest private company. It is a £1.2 billion turnover manufacturer of packaging and provider of materials handling solutions, present in the UK, North and South America, Australasia and throughout the EU. LINPAC was the subject of an £860m leveraged buyout led by Montagu Private Equity in August 2003.
Andrew Foulkes
Group Treasurer
Andrew Foulkes is Group Treasurer of LINPAC. In addition to a detailed understanding of treasury operations in a leveraged environment, Andrew has 20 years’ experience as a treasury manager and adviser. Before joining LINPAC he headed KPMG’s treasury practice in London and has led major treasury projects in Europe, Africa and the Middle East. Andrew is co-author of the Association of Corporate Treasurers’ book, Introduction to Treasury.
John Rundle
Group Taxation Manager
John Rundle is Group Taxation Manager of LINPAC and joined the group at the time of the buyout. He has 18 years’ experience advising on, and managing, corporate taxation matters. Prior to joining LINPAC, he was a senior tax manager in PwC advising multinational corporate groups and venture capital backed companies, including leading the tax advice on management buyouts and large corporate merger and acquisition transactions.
Before we start, could you clarify exactly what a leveraged buyout is?
Andrew: A leveraged buyout is the purchase of all or part of a private or public company where most of the purchase price is funded with bank debt, secured on the assets of the target company – hence the term leveraged – and the purchasers include the company’s management – hence the term buyout.
Buyouts are usually backed by private equity houses and, in the case of larger buyouts, the private equity house (together with its funds) may take a majority stake with management owning a minority. In LINPAC’s case the backer was Montagu Private Equity, together with the company’s existing management team.
John: In the past, UK tax laws have encouraged leveraged buyouts but recently changes have been announced which might lead to slightly different structures in future. It is likely, however, that those structures will have the same basic ingredients that Andrew has outlined.
How does life in a leveraged buyout differ from a public company environment?
Andrew: Perhaps the most striking differences concern the company’s objectives and the rulebook. In a public company a great deal of activity revolves around share price and compliance with stock exchange rules. In a buyout the focus is different. Putting it simply: instead of share price the key driver is exit value; and instead of stock exchange rules the key sources of restriction are obligations and constraints in the loan and buyout documentation.
Of course there is also a potential difference in shareholder involvement. Some private equity houses can be very involved in decision making at Board level, others are very ‘hands-off’, but whatever role they adopt there will always be a list of decisions and actions which need their approval, because they could affect the value of the business.
John: A key difference on the tax side is a very strong emphasis on optimising the effect of tax on the group’s cash position, rather than focusing on the tax rate shown in the profit and loss account. So the tax manager will often be asked to estimate the future tax cash flows expected to arise from the underlying business forecasts. It can be very difficult to predict the timing of some flows. While VAT flows are generally frequent and consistent, corporation tax flows tend to be lumpy and, for refunds, the company has little control over when they actually happen. The tax cash flow implications of large capital transactions can also be significant.
Another key area in a buyout is obtaining cash tax relief on the financing costs of the main bank funding and owners’ investment. Unfortunately, because an international business tends to be managed on a pan-national basis, this does not sit easily with the way tax works, which is on a country by country basis. For tax purposes, the generally preferred position is for the funding costs to be borne in the countries where the group’s operating profits are generated so the two can be offset against one another. This offset can be achieved either by the lenders lending into those countries direct or by the initial borrowers lending down to subsidiaries in those countries. Any resulting inter-company loans must be set up and managed on arm’s length terms.
So how does the leveraged buyout structure directly affect tax and treasury?
Andrew: A traditional area that does receive a great deal of attention in a buyout is cash management. Cash really is king when commitment fees and interest rates for leveraged debt are so high. Holding cash while borrowing at the same time can be very expensive. Therefore treasury needs to broadcast this message and persuade the operating units and head office to take the forecasting and control of cash very seriously.
There is also a big focus on managing communications with the owners and the banking syndicate. Treasury is most heavily involved in communications with the banking syndicate, particularly in making sure that the detailed rules concerning obligations, restrictions and limits (covenants) in the banking documentation are followed. Where these covenants may prevent the company from taking sensible commercial decisions, permission has to be obtained from the syndicate to amend the covenants. This can happen surprisingly often. The quality of the team at the agent bank, which acts as a conduit for most communication with syndicate members, is vital to the success of such requests. We have been fortunate that our agent bank has been very good.
John: The impact of the buyout structure on tax management is quite fundamental. New legal entities are set up specifically to facilitate the buyout. These entities carry the acquisition investments that may include equity, preference shares, loan notes, mezzanine finance and senior debt. In order to obtain offset of the acquisition debt costs against operating profits, these companies often need to be in the corporate tax groups of the appropriate territory. Creating and maintaining such groups may require specific steps to ensure that one is not tripped up by any relevant tax grouping anti-avoidance rules. Assuming a tax deduction is obtained for debt financing costs, the corporation tax liabilities for companies in those countries are likely to be significantly reduced. For example, in the case of a UK based buyout, in some circumstances the debt financing costs in the UK may even exceed UK operating profits, such that tax losses are created each year. Unfortunately, they may be trapped in a form that makes them difficult to use against future profits, so planning may be required to mitigate the problem.
There are also a host of other ‘buyout specific’ tax issues too detailed to describe now. Examples include ensuring tax deductibility of interest, whether paid in cash or rolled up, dealing with withholding tax on payments to certain lenders and making sure that VAT on the buyout costs can be recovered.
How do tax and treasury have to work together?
Andrew: Good dialogue between tax and treasury is crucial in a buyout. In our case, this has come fairly easily, since we both joined LINPAC at the same time, each coming from a different Big 4 accounting firm background. We knew that poor communication between tax and treasury can lead to significant practical difficulties and were determined not to let it happen to us. In some companies tax and treasury responsibilities are held by one ‘combined’ manager. This must help to minimise communication problems but we have found it more effective to have the two sets of skills working in concert rather than to have one person trying to cover both aspects.
John: We certainly need to bring complementary skills to bear, particularly for international issues. For example, if the group is planning to expand abroad, the decision on what corporate legal structure we use is driven mainly by tax constraints here in the UK and in that foreign territory. However, this in turn can lead to cash flow and treasury administration issues for Andrew. It can also clash with the banking covenants so that amendments may need to be obtained. If I don’t discuss my plans in detail with Andrew there could be delays that, if they cut across a key date, could be fatal.
Similar issues arise in the other direction. If Andrew wants to change a cross border financing arrangement, I need to understand what taxable income and tax deductions this could generate, whether there are any transfer pricing or withholding tax implications and even if we need to obtain prior clearance from the tax authorities.
What were your biggest challenges on day one?
Andrew: For me the biggest challenges were getting to grips with the new loan agreement, setting in motion all the changes that would be needed after completion and trying to ensure that completion day itself went smoothly.
In the case of the loan agreement there were many proposed covenant restrictions that were too onerous or were impractical for one reason or another. There was still time to iron these out with lawyers and lenders. The changes that would be needed after completion involved creating new internal reporting and communicating to the managers of the operating divisions and head office (including John) the new rules under which we would be operating. As for completion day itself: the big challenge was ensuring the right funds flows between the right entities took place. Lawyers, accountants, tax advisers and the agent bank all worked together to make this happen.
John: I joined LINPAC a few weeks before the buyout itself, so most of the planning had already been done. But there was still plenty more to do. In a very short time I needed to understand the tax issues arising from the corporate structure created for the buyout and prioritise my next pieces of work. What I had not appreciated was the restrictions imposed by the banking covenants (which Andrew was trying to communicate so vigorously) and what that would mean for managing the timescales for my work going forward. Suffice to say that I went through a steep learning curve to get to grips with the transaction. Many of the loans that were planned still had to be put in place so I had a very busy six months completing the major changes which this required.
So once the dust has settled, do you have a fairly steady time until exit?
John: I would like to say ‘yes’ but a major international group like LINPAC just never sits still. Commercially, the focus is on increasing shareholder value, and this objective is pursued relentlessly. Since the buyout occurred, the group has acquired, disposed of and rationalised businesses and has sold surplus assets. It has also sought to streamline its financing. All these activities have had important tax implications, and the mitigation steps that I needed to take have all had a significant impact on Andrew. Such issues will not be new to anyone in a multinational company but for a private equity owned group, the timeframe within which such business transformation happens is compressed.
Andrew: In addition to the ‘normal’ activities that John has described, there were many knock-on effects of the buyout itself still echoing around the group a year after completion. For example, the banks wanted to see a high proportion of the group’s assets pledged as security for the debt. Granting debentures for the UK companies and giving pledges on US assets was fairly straightforward, and the cost acceptable, but the granting of security in other countries was far more complex, slow and expensive. As a result there was a fair amount of discussion in respect of some countries. In the end the banks made concessions in some jurisdictions and the company gave way in other areas but it all took a very long time.
What impact does the eventual exit have on the way you work?
John: An important issue that I have to bear in mind is that one day a prospective purchaser looking at the group will perform due diligence work. His objective will be to identify cash tax risks and exposures and to use those to drive down the price of the group. Consequently, I need to ensure that risks are identified and managed now so they never become due diligence issues in the future. For some of these matters I work closely with the treasury function, for example in ensuring that internal loans comply with the expectations of the tax authorities in the various jurisdictions in which we work.
Andrew: We certainly need to build any future exit into our planning but this does not generate the attitude of short-termism that you might expect. Yes, there is a real focus on payback. It would not make sense to embark on projects with uncertain outcomes and only long-term returns. However our aim is to enhance the value of the business whoever owns it, so we have many business improvement projects that not only win short-term gains but also look beyond that to long-term value creation. In that sense we are just like any other growing business.
