Dealmaker Insights

When issues arise at a portfolio company, private equity (PE) sponsors face a complex web of legal, reputational, and regulatory risks. In this episode of Dealmaker Insights, Reed Smith partners Siddesh Bale and Rizzy Qureshi discuss how PE sponsors and their portfolio companies can navigate legal privilege, manage risk, and structure effective internal investigations.

This episode features a panel discussion on how evolving regulations, shifting market dynamics, and operational challenges are reshaping the health care private equity landscape. Panelists express cautious optimism for increased deal activity in the latter half of 2025, while acknowledging ongoing regulatory and market uncertainties.

The discussion was moderated by Chris Sheaffer, global vice-chair of Reed Smith’s Private Equity Group. Panelists included Charles Simon, director at Stifel; Brandon Cohen, principal at H.I.G. Capital; Adam Boorstein, vice president at InTandem Capital Partners; and Nicole Aiken-Shaban, partner with Reed Smith’s Health Care and Life Sciences Groups.

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Transcript:

Intro: Hello and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers. 

Chris: Just to kick things off, my name is Chris Sheaffer. I’m vice chair of Reed Smith’s private equity globally. We’re going to do a quick 30-minute panel talking about, you know, the changes that have happened over the last six months in particular has definitely been an interesting year. We've had new regulation, deregulation, up markets, down markets, tariffs, changing policies seemingly, if not every other week, kind of daily. So we wanted to pull together, you know, some of the team to just talk about what they're seeing, how those changes have impacted valuation, how things have impacted deal flow more broadly. So with that, maybe I'll just ask each of the panelists to do a short introduction of themselves, and then we'll go forward. 

Nicole: I can start. Nicole Aiken-Shaban, I'm a partner with Reed Smith in our Philadelphia office. I'm a healthcare regulatory and transactional lawyer in our LSHI group doing a lot of private equity work. 

Charles: Hi, Charles Simon. I'm a director at Stifel's New York office, focused on healthcare, services, and technology M&A across providers, pharma services, health tech, and then also have a focus area in dental and vet. 

Adam: I am Adam Boorstein. I'm a vice president at InTandem Capital. And InTandem is a healthcare-only sponsor, 5 to 30 million of EBITDA, frequently first institutional capital in. And we invest pretty evenly across provider, payer and tech, and outsourced pharma services.

Brandon: And then Brandon Cohen, I'm a principal in Miami at HIG Capital, and we're LBO fund. 

Chris: So I know when we did this last year, and obviously we stay in touch with the markets pretty closely, you know, last year we talked about, you know, new administration, less regulation around banking, more stable private credit markets, best deal year ever, 2025. 25. I know I am quoted in quite a few periodicals that have not aged well for me in terms of my predictions of the market. But maybe, Charles, let's start with you. How's the year been for you guys so far? 

Charles: With that good setup. Not what was expected. Our saving grace, just in our particular team, is that we always have a mixture of founders and private equity. We had a lot of deals in a private equity pipeline that all just sort of said like for obvious reasons like now is not the time so we just keep the dialogue open. On the founder side, those are still active and I would say the general theme if you were to ask why would somebody come to market now? It's generally people who need capital so founders who are retiring, somebody who has built a business, bootstrapped it from the ground up and don't have additional capital to continue growing they're looking for either majority or minority partner, somebody who needs to do a cap table cleanup, somebody who's in a minority position needs to exit or someone who is previously in a growth mode and has now cleaned up their company but really just needs to find somebody who will be a long-term partner. 

Adam: I would agree with much of what you said. For us, you can really split the world into two pieces. Within our existing portfolio companies, we do continue to see a large volume of add-on work. And most of that is founder-owned, relatively small. And coming to market for each of the reasons you just described, mostly either retirement or trying to continue to grow within a larger platform. So we've been active across the portfolio in adding on business. On the new deal front, it has been, I think, slower than expected. We were very busy at the end of last year, and there was the promise of a whole series of new potential sponsor trades coming in the early part of this year. Some have materialized, others have been pushed. But I think broadly, we still see very competitive processes for a handful of really good assets and many assets below the really good range that come out to a process and may not transact and are still sitting on the sidelines to look for a relaunch at some point, either later this year or into next year. 

Chris: Brandon, how are you guys looking at stuff? 

Brandon: Yeah, I would echo that sentiment. I mean, we had a pretty busy Q4. I think there were, in my fund alone, three deals that closed in the last couple weeks in December. Not necessarily all healthcare, but just more broadly. I think, you know, to Charles's point, you have to be kind of a little bit more creative, a little bit more scrappy. You know, corporate carve-outs, two of those were corporate carve-outs. I think, you know, the founder-owned deals, and then exactly at Adam's point, feels like there's kind of the haves and have-nots, where you have the A-plus assets where the market still remains hot. We've seen that on both the buy side and sell side. And then there's kind of the long tail of everything else. And I'd say many of those deals don't seem to be getting done. 

Chris: I mean, Charles, just you talked about, obviously there's certain, especially founder businesses, there are certain factors that are going to drive exit as compared to a sponsor-to-sponsor deal. I mean, are you seeing the sponsors push timelines? Like maybe they were going to launch earlier this year back to the back end or, you know, looking to start to come to market sooner rather than later. 

Charles: I’d say a lot of folks didn't have a hard timeline that they're necessarily pushing back. They sort of had a soft timeline knowing that the market was going to be questionable and if it's good they'll go. So it's less of that you know we told everybody we told our LPs this is when we're going to exit and more around watching the market. What I think a lot of people are doing are add-ons that's a key component right now. Then a lot of folks are just doing internal repair work so, you know really I should be putting in a CEO is going to be able to take it to either through a deal or for the next owner. A lot of folks who, in a hot M&A market, will just focus on M&A. And integration is sort of, they hope to get paid on it on the exit. Now you're seeing a lot of folks spending time on internal work. Integration is a key one. Supplier integration, IT systems. 

Chris: Have you guys, I mean, last year, there was a lot of pressure from LPs to transact. This year, I feel like for at least a little while, LPs backed off a little bit because they weren't sure just literally day to day how the market was going to change. Is that a correct assumption that you guys haven't seen as much pressure to return capital or is that starting to ramp back up a little bit? 

Adam: I’ll speak for myself, but we do continue to see, I think, a broad trend across the LP base that returning capital continues to be very important. However, what Charles started with, longer prep time in order to come to market really prepared for your A assets is being understood by our LPs to make sure that our shot on goal is the right one, rather than having a stop and a start. But there is certainly, I think, still pressure amongst the LP bases, both our own and new LPs that we might talk to, to really begin to return capital at a faster clip than what has been over the last several years. 

Brandon: Yeah, I would just add, I mean, there's clearly pressure. I don't think it's insurmountable. I think one of the challenges from a deal flow standpoint is on the financing side. I don't think there's a pressure that people thought may come from lenders, just given how much dry powder there is out there. When you talk to lenders, it's kind of like, hey, new deal flow is slow. I'm working on a ton of restructurings where I can kind of buy out somebody who's a little bit tired. And so I don't think you have the lenders kind of holding the gun to folks and saying, hey, you're at year five, sell now. They're kind of, let's figure out how to be a little bit more creative, at least from what I've seen in the market. 

Adam: I would agree with that. We have looked at creative solutions and extended credit facilities that were coming up for maturity, I think primarily because those lenders also don't have a ton of new deal flow. So they're staying in otherwise relatively good credits at a slightly elongated timeframe. 

Chris: Yeah, I mean, I think nobody wants to get financed out at the moment, just given opportunities more broadly. So that's certainly fair. And I do agree. I mean, on the Reed Smith side, we're still seeing a bunch of LBOs, but I would say, and this isn't just healthcare, a lot of it is prepping the balance sheet. We're selling off non-core assets. We're selling off stuff that maybe wasn't integrated properly because they don't want to deal with that through a full exit process. So it sounds like it's pretty consistent across the board with what you guys are seeing. I mean, in terms of the different healthcare verticals, obviously, that's a healthcare life science is a very broad spectrum. I mean, there are there specific areas that you are seeing more attractive than others, whether for valuation, regulatory reasons, or otherwise? 

Adam: I can start that. 

Chris: Go for it. 

Adam: We've been far more active I think in the last six months outside of provider services focused on payer and tech and outsource pharma services but but I think that that's not unique just to us and it's been shown in the multiples and where those transactions have have ultimately ended at, that there is I think a lot of interest around really scalable businesses. Businesses with less regulatory risk generally, and I think still continued to a certain extent away from core physician practice roll-ups, which has been interesting to watch on the new platform side because I think we've had personal success within PPM, but it still, I think, is relatively out of favor for the next several months, if not the next year, and focused on other areas of health care services. 

Brandon: Yeah look I think that's not unique and you know pretty similar across the board we've we've tended to focus on kind of outsourced services within health care over the last year or so because an RCM deal and then a provider of services into the derm space in the last probably six months so like those trends i think you know both from a provider standpoint and some of the challenges there also from a reimbursement standpoint. Sure, we'll talk about this in a little bit, but just some of the uncertainty there, especially things that touch Medicare, Medicaid, and the outlook around funding, around enrollment, has just made it a bit of a tough environment to kind of figure out what the right underwritable levels are. 

Charles: And just to cap that off, basically echoing what you guys said, but I think specifically pharma services, less around CROs because with RK Jr., there's a lot of just stoppage of new phase trials, new funding, but things that are serving the industry, especially for post-commercialization companies, services into them, services into PPMs, a lot of pharma logistics, pharmacy logistics, a lot of cold chain has been hot for a couple of years and will continue to be hot. And then I think home health is continued to hum along and the demographics of the big boomers retiring just supports that as a good long-term play. 

Adam: Just one additional comment on that. I do think it's an interesting dynamic in provider services in that the provider services that are the most triple-aimed or quintuple-aimed aligned, even if not core physician services, still do see traction in the deals that we see, in what gets done. So I think there still is a market there. It just is being really focused on, is it outsourced services into something? Is it home health? Is it a site of care shifting thesis? I think lowering costs and improving access is becoming even more important now than it was in the last several years. 

Chris: I mean, Charles, you brought this up, but let's, maybe Nicole, I see this as well. I mean, the changes of the administration have been significant. How has that impacted, you know, Nicole, maybe I'll start with you, you know, regulations more broadly, or just kind of the approach that you're seeing people take to the market and how they address some of these changes? 

Nicole: So with respect to changes coming from this administration specifically, I think two may be worth mentioning. There are obviously a lot of them. There could be a very long discussion about it. But the DHS reorganization, which was announced back in March and has resulted in a reduction of about 20,000 full-time employees from DHS. So HHS at the federal level does a lot of involvement in change of ownership approvals and other deal-related processes for certain types of providers, as well as other oversight work that we've seen have an impact on some of the decisions about where transactions might be going from a provider perspective and what types of providers maybe investment in. There's the One Big Beautiful Bill Act that everyone is, I know, tracking in the press. That is a very large pending piece of legislation that could have significant impact in the healthcare space, particularly on traditional provider industry. So you've heard the panel talk about diversification into payer support services, other support services, pharmaceutical services, services outside of what we consider within healthcare to be a provider service that is reimbursed either by the federal government or a third party payer in a more traditional way for the delivery of health care services and items to patients. Because the latter category could be heavily impacted by that bill, depending upon what it looks like if it goes through, including potentially large changes to Medicaid that will impact certain types of providers that rely very heavily on Medicaid and just a number of other changes, obviously, that are involved in that. On the non-federal side, though, Chris, I just want to mention again, those healthcare state transaction loans. So we talked about those last year. I think everyone in this room is aware of them. They are becoming more impactful on the transactions that we are doing. So some of these target private equity specifically. Indiana is a great example of that 90-day pre-filing requirement. Any type of merger acquisition with a healthcare entity, even MSO structures can be pulled in. Connecticut has pending legislation, just as an example, there are more coming up, about prohibiting private equity and re-ownership of certain facilities, hospitals, skilled nursing facilities, and strengthening statutorily the corporate practice of medicine doctrine in Connecticut, which is interesting. And that would affect the PPMs that we've heard, you know, discussion about as well. But also just worth noting is some of these states where there are existing laws, we've all started to do transactions going through those processes and are learning from them, Oregon being one very painful example for probably most of us in this room. And what we're seeing clients do and we're helping them with is when we have the runway to think about an exit and we have time to prepare internally, it's not just preparing financially and operationally. It is, what if we have a really small operation in a problematic state like Oregon? We don't want that to hold up a much larger exit. Can we do something about that now to potentially avoid the pain when we get to the sale process? And so I think that strategy is really playing into some of those sales side processes that we're talking about. 

Charles: Yeah, I would echo that. I think that that's the big point. The state's component is that's where we're focused. So on the federal level, just to touch on it briefly, that will determine what assets are going to be interesting for new investors. So I think all the work requirements around Medicaid, that's going to really just kick out a lot of people who would otherwise be eligible. If you're in a business that has more than enough Medicaid volume, then you probably don't care, but it will impact around the margins and probably more so. Things like pediatric dental that's covered by it, you know, worry less. I don't think that there's going to be big changes to Medicare Advantage, But that's in the news a lot because United and some other players are going through basically a review of their practices. So I think there the industry will do internal cleanup to avoid regulators wrath. So the federal level, Medicare, Medicaid, is really a determination of what's going to be a strong asset or a less strong asset. But where we really spend a lot of our time thinking about day-to-day basis is the states. So we sold a business in Massachusetts. They had a big regulatory effort. There, the regulators wouldn't even start the review until they had every piece of paper in front of them. So that was pretty annoying. Once we sort of got through that, it was fine. The review was actually not bad. We just had to sort of get them to get moving. One of my colleagues sold a large Medicaid payer business in New York. They signed that on December 31st, 2023, and didn't close until December 31st, 2024. And that was all tied to the New York State regulator. And then right now, we're doing a deal that California will have a big presence. And even selling with a public company that's going to have to do a shareholder vote, register share for the SEC, our long pull and attempt from execution standpoint is the OCC regulators in California. 

Adam: I broadly agree with what's been said here. We do spend most of our time thinking about state-by-state regulation. And I think with the exception of a handful of states, Oregon in particular, where there is some really aggressive legislation. We have gone through a series of smaller transactions in some of the states that have mandatory either waiting or review periods. And it may be that it is still new in several of these states, but after a waiting period, it is very akin to an HSR filing where there was no enforcement, no questions, all the paperwork was done, and we were able to close. And so as we think about our sale processes and buying new assets, we're just building longer closing timelines in, following signing, but are watching a handful of states very closely to see if legislation that's passed in those states is picked up in some form or fashion across new states to add to the areas that we need to be looking out for, either acquiring or building new business in certain states. On the Medicaid side, I would agree. I think there are certain protected populations, waiver populations, pediatrics, that I don't expect to have material movement, but certainly work requirements and adult Medicaid recipients will be something to watch in the next year or broadly as more comes out about what ultimately will become of state-by-state Medicaid programs and of federal matching beyond those. 

Brandon: The only other thing I would add, you know, I think from a investment committee standpoint, it's just a lot of uncertainty, right? I mean, you go back two months ago, and it was kind of, hey, the base case should be the recession case that's changed and gone back and forth probably several times over the last couple months. But, you know, I agree with everything that everyone said. And I just think that uncertainty just makes it a little bit harder to kind of get through investment committee, you're running more cases. And, you know, things just seem to change from day to day. So it makes it tougher to underwrite some of these deals, especially if there's any element of that complexity. Again, on the one hand, that creates opportunity. On the other hand, it just makes it challenging for a seller and buyer to find common ground. 

Chris: I mean, I assume your IC reviews are just taking more time, you know, in general with a lot more questions. And I'll maybe use HIG, which is obviously multi-strategy. I mean, how are you getting some of your team comfortable with these changes that are literally daily, weekly? We were taking a business to market, wouldn't have thought that it would have directly been hit by some revenue issues because of some changes more broadly. It was, and it was like three levels down where we realized we were probably going to get hit through the supply chain. I mean, how are you getting kind of the broader IC comfortable that, you know, especially on the state level, that there's not going to be a, you know, an imminent change coming between signing and closing that's really going to hit you? 

Brandon: Yeah, look, I think it's on a case by case basis, right? I mean, we've seen multiple processes get pulled, all right, you know, kind of post-LLI or in some cases, pre-LLI, especially things, DME space with tariffs, and same thing on the Medicaid side, right, where it's just really challenging to underwrite. I know what the volume is today. I can look back at the last 100 years and it grows by 1%. I can't do that math anymore. And so we've seen a number of processes get pulled. And I think there have been probably a handful where we've said, I can't think of an IC instance, but where we've said, hey, let's press pause on this and do some more work. So I think it's on a case-by-case basis. But yeah, it becomes pretty challenging to kind of underwrite what's going to happen tomorrow. 

Chris: I mean, Charles, how are you giving guidance to your clients, right? I mean, you know, I feel like for the last, well, my entire career, it's get the deal done, get the deal done, get the deal done. Right now, it's, especially for the buyers, well, let's see, let's see, let's see what happens, you know, unsure. I mean, how are you counseling kind of the balance between the risk versus, you know, the pressure to get deals closed? 

Charles: I mean, I think it's sort of what was said. I think really it's just a longer timeline to close. So instead of just the expectation that you're going to have simultaneous signing close, now you just know you're going to have, or shortened between signing close, you just know now that you're going to have longer timelines. So what we're actually seeing is a lot more discussions as we're entering the LOI phase around And a lot of board members are saying, hey, can you give me an updated timeline? How long to close? Whereas previously you just said, okay, well, you know, it'll take them, you know, 60 days. And then we've got two 15-day periods where, you know, exclusivity can get extended. And then now you're really having to map out all of the different state regulators. I can't talk to them. So there you go. 

Chris: Nicole, I don't know if you want to add anything in terms of what you're seeing on the legal side. 

Nicole: I think that's right. I mean, it is, and we talked about this a little bit earlier, but it is trying to plan for the timelines in those circumstances. I, you know, we have seen if you're selling, you want to try to get signed up as quickly as possible. I think, you know, I was on a team where we got from, it was about a five day turnaround from a markup to getting to signing and it was all hands on deck, you know, but it's just trying to, you know, move as quickly as you can to get the buyer locked in because of the uncertainty. And then I think on sort of the buyer side, it has been more of a little bit of, well, can we draw it out a little bit longer and see where things are? And some of that is planning on these timelines and trying to build that in on the back end. And some of it is just slowing down the getting till signing, depending upon the market that they're in and whether, you know, the Q of E's are coming back consistent with what you thought it would be. And some of those other challenges that I think seem I'm noticing are coming up more frequently than they have in the past. 

Chris: I know we're wrapping up here on time, this one very quickly, but recognizing all of the uncertainty that we've discussed here. I mean, how are you guys looking at the rest of the year? Maybe I'll just ask each panelist to give their perspective. Do you think we're going to see an uptick in activity? Do you think it's going to be a slog for the rest of the year? Maybe we're looking at 2026, but whoever wants to kick things off, go for it. 

Brandon: Happy to kick things off. Look, I think notwithstanding all the challenges we just spoke about, and I think we're all kind of set on this baseline of 2021-2022 deal activity, when you look across our healthcare deal activity, businesses with $10 million of EBITDA+, across all the HIG funds, I mean, volume is up, right? So it's up 70%, still call it 90% of peak levels. So, you know, there are deals coming to market, the close rates lower as we as we spoke about. And so, you know, you are you are seeing the volume increase. I think we've all been here for the last two years as you kind of started off and, you know, you're going to have that that great wave of deal activity. And, you know, I'm not sure what the impetus is for that to come. But, you know, we have seen 24 and then into 25 kind of a steady uptick. And I think that continues. 

Adam: Yes. I remain pretty bullish that the end of this year will be much stronger than where we started. I think for a couple reasons. First, you have diversified funds that might be indexing more heavily to certain areas of healthcare because they're not exposed to things like tariffs or other sort of cross-border considerations that U.S.-only services may have. So I think that starts to bring in potentially a new buyer set into certain areas. And I think second, there does continue to be ongoing pressure to a lesser extent than we expected from lenders, but yet still there, as well as LPs on the sponsor side to make sure that you're transacting in normal course and normal cadence. And I think third, there is always a push towards the end of the year. And so for those who may have prepped for a longer period of time to wait out a bit of uncertainty. Late summer, I think, is the time for many of those to come to market as some of the first several months here and reactions to policies that have been laid out or executive orders that have been laid out with more knowable now outcomes of either something has happened or something has not happened will influence, I think, a much stronger third and fourth quarter than we've seen early on in the year. So we continue to be pushing on and expecting that there is a bolus of platform activity between 10 and 20 million of EBITDA that might spill into the first quarter of 26, but is certainly in market this year. 

Charles: Yeah, I'd agree with that. I think volumes are definitely up, but they're on smaller deals. So you're working hard on live transactions, but the total deal volume at the end of the year will not be as high as the scars that you have at the end of the year. But if that's what needs to get done, that's what happens. I do agree that there will be, I think there will be continued to be wins on the small side, and then there will be sort of medium-sized companies that come to market, get decent exits. So I don't think that we're going to see a floodgate opening. But I think that, Adam, your point around people coming to market the back half of this year, maybe closing Q1 of 26, I think that's very likely. I think we'll see a lot of basically the green shoots, to use the old proverb, and then 26, I'd like to say it should be better, but I think it's just going to be a slow recovery back to what should be normal. 

Nicole: And at the risk of creating press that will haunt me later as well, Chris, I'll say, I think that I agree with everything that's been said, so I won't use up a lot of time repeating it. But I am also optimistic that the end of the year, you know, end of Q3 into Q4 will be picking up. And whether that's from pressure for the sale of certain assets that have been held for a long time that, you know, just need to be sold or, you know, a little more uptick because we have a little more certainty from the changes the administration has proposed and other considerations. I do think we'll see some more movement. 

Chris: Well, it's great to hear in terms of an ending note and doing it positively. So thank you to our panelists. We really appreciate the time. Very informative. Thanks. 

Outro: Dealmaker insights is a Reed Smith production. Our producers are Ali McCardell and Shannon Ryan. For more information about Reed Smith's corporate and financial industry practices please email [email protected]. You can find our podcast on Spotify, Apple Podcasts, Google Podcasts, reedsmith.com, and our social media accounts. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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Transcript is auto-generated.

In this episode of our Private Equity Spotlight series, Reed Smith partner Nik von Jacobs is joined by Thomas Weinmann, Managing Partner at REIA Capital, for an insightful conversation about his work and the intricacies of the fund of funds model.

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Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers.

Nik: Hello, everyone. I'm Nik Van Jacobs, private equity partner at the Munich office of Reed Smith. And today I'm welcoming to our Dealmaker Insights series, Thomas Weinmann from REIA Capital. Welcome, Thomas.

Thomas: Hi, Nik. Great to see you again or talk to you again on a podcast.

Nik: Once more, it's great to have you with us, Thomas. Tell me, who is REIA Capital?

Thomas: So we are basically a fund of fund advisors. We manage money from private individuals and small endowments, small pension funds, and ultimately we invest the money in private equity funds. And our speciality is basically we focus on small cap private equity funds, not on the big names, on the real small names, unknown names, but on the ones who have a better performance.

Nik: That's fantastic. And I know you're very active in Europe since a long time. And today, given that we're focusing on the U.S. I think it's worthwhile that you also have a reach out to the U.S. and I'm looking forward to hearing on that.

Thomas: Yes. Actually, we have been in Europe with our model for more than 10 years. I'm personally, I'm in the private equity space for more than 25 years. Now, we now move to the U.S. with a partner because we actually want to invest our own money plus the money of our investors in the U.S. to get more and better diversification into our portfolios.

Nik: Interesting. And I think you just teamed up with the U.S. likewise fund of fund. Tell me about what that is like, who it is, what's the background, and what your search was like.

Thomas: Yeah. Actually, their background is quite similar to ours. The people who are working there, they've been in private equity funds before, spent more than 10 years in PE funds, and then decided to basically start a fund-to-fund business. They initially did it through a multifamily approach, so a family office approach. So it was not that they started just as a classical fund-to-fund. And they, in a way, yeah, I think I would more call it we are a copy of them more, not knowing when we founded ourselves because they operate in the same manner, coming from PE, doing a very deep due diligence, only focus on small cap, and they only do it for their clients from the U.S. In the U.S. market. And we've done the same, but on the European side, so other side of the Atlantic. Now we join forces. They help us to get access to good U.S. funds. And yeah, let's wait and see what might even develop in the future.

Nik: That's interesting. And where do you see the comparisons and the overlaps in terms of, well, let's say the market, the investment approach, and the process of holding those portfolio companies?

Thomas: It's actually quite interesting. If you look at the small end of the spectrum, so in small cap in Europe and the US, you ultimately see that fund managers have the same approach, which sounds a little bit strange. They try to find smaller businesses. They often only buy, let's say, a small majority, and a large minority is still with the previous owners. They look into operational improvements. They do a lot of M&A or add-on acquisitions. And then they often sell the businesses to larger funds or strategic buyers. And that's something we see on both sides of the Atlantic. When you look into the return expectations, pretty similar. When you look into the real returns achieved in the past on these sort of models. Similar, where are really differences? The US market is slightly larger than the European market. I would say in the US, you have roughly 50% more fund managers. So we are more towards 18 to 19, perhaps even 100 or 2000. In Europe, we are more towards 1,200 fund managers in that size bracket. So you have to dig a little bit deeper because there's more to be digged through. And the other thing is, in Europe, often we see fund managers who are getting larger tend to become more management fee driven. In the U.S., you have that also sometimes, but the very good funds often also stay smaller on purpose. So it's much more difficult if they stay smaller to get access to them if they have a stable investor base. So you need more of an entry ticket into the funds, which is less the issue in Europe.

Nik: Interesting. And in terms of the market, in terms of the assets you see, would you say there's a huge difference?

Thomas: No. In reality, not really. It sounds strange. I think what you might have in some areas, you might have more assets in Europe than the U.S., for example, for manufacturing businesses. But that's also a regional thing. business services, you see a lot in the US. You might more regularly see financial service business models in the portfolio of private equity funds, less the case in Europe. But really, if you go to the bottom, it's pretty similar. It's a similar model and similar return expectations. So the good question is, why do you still go there? I think overall, on a long-term period, it's similar. But if you look in certain, let's say, timeframes, certain vintages, it might be that there's the U.S. A little bit more positive on the optics and then other times when European fund managers showing better returns for a short period of time. And if you want to have a good diversification, you should not leave out the one or the other.

Nik: That's interesting. And does the market, sort of the size of the local home market, play a big difference? Does it make a difference? I mean, if you look at Europe with those various jurisdictions, various regulations, etc., are there more sort of operational costs attached to that or does that level out?

Thomas: No, I think on a smaller spectrum, businesses are often very local. So in Europe, you have, of course, the borders and the languages and legal systems which are different which creates some let's say a separation of fund managers and their approaches in the US I would say often the small cap funds focus on a local area as well so they do not go all over the US to buy assets because it's just too expensive from a logistic point of view so if you're based in Chicago you regularly focus on the area in Illinois, and you just don't often go to California just to buy assets. It's just easier to do it locally, and you have sufficient number of investment possibilities also. So in this respect, I would even say it's pretty similar, but in the U.S., you have a bigger market in respect of you have not these language barriers. So you have English and Spanish, I would say. In Europe, you have many more languages. And then I think on the legal barriers, they are lower in the U.S. than in Europe.

Nik: Interesting. And tell me, do you also sort of have specific sector focuses in terms of where you invest or are you very open and let it play out?

Thomas: We operate a fund-to-fund model. And as we don't have the crystal ball in front of us, and we're investing over the next 10, 11 years when we do a commitment, we ultimately need to diversify. So, I think it would not be a wise decision just to go into healthcare only or in tech or business services. But what we do is we try to pick fund managers, and that's irrespective if you're talking about the U.S. or Europe. We try to pick fund managers with a sector specialization. Because very often that sector specialization is a USP. We try to find people who do something much better than, let's say, journalists. And that's where we see basically an upside, better returns, but it also helps us to diversify within our portfolio. So we want to have business services, we want to have healthcare, we want to have tech. And what helps us, if the fund managers have a clear-cut view on their industries they want to invest in and have a USP, how they basically, for example, source businesses, how they help the businesses to grow faster. If you have such a situation, then we can actively build a portfolio, which helps us to get a diversified investment for our investors and ourselves.

Nik: Great. Looking at such funds, in how many funds does one of your funds then basically, or together with your partner, do you invest? And what sort of might be roughly ticket size, which you invest? And finally, what assets, in terms of the bracket, what is sort of the asset class or the range of sweet part, if you like, of those funds investing into individual assets?

Thomas: There we have a slight difference. In Europe, we target to invest in 10 private equity funds out of a single product. And it ranges, the investments ranges between seven and a half to even going up to 15 million euros. And that's based on the 100 million target size we have for our fund. In the US, the target size is slightly smaller. We only want to achieve $75 million dollars for our fund there we're gonna have 20 percent of our investments in co-investments because we get the co-investments alongside our partner and therefore it's it's reasonable to do that we want to do five two to ten co-investments so basically two to four percent of the fund of each fund from our end goes into co-investments and the remaining remainder so the 80 percent goes into seven, perhaps max 10 funds there. So the diversification is a little bit smaller, but in reality, we end up somewhere between 80 and 100, 110 companies, realistically.

Nik: That's a great diversification for your investors then.

Thomas: Yes, yes. And it's not too diversified, but also not too, let's say, too small and too few companies.

Nik: Great. And maybe turning to the investors, what are your typical investors, right? I mean, what do they do? Are they institutions, individuals?

Thomas: Mm-hmm. It's predominantly, it's private individuals, but it's not retail, which is very important. So they ultimately invest with us between 200,000 euros in the European product or a quarter of a million in US product, a quarter of a million dollars. On the low end, going up to, yeah, even 10 million. So it's very broad number and brackets. And if you look at the private individuals, it's a lot of people coming from the industry, i.e. Investment bankers, M&A lawyers, people who have worked in funds or are active in a private equity fund, managers from portfolio companies of private equity funds. So people who know the industry, who want to invest in a diversified manner into their asset class. That's our core clientele with whom we started our business. We now have a lot of managers from big companies, big corporates. We also have entrepreneurs who want to invest their private money either directly or through their family offices or through multifamily offices. And we also have the one or the other endowment, even church money is investing with us. So they are also coming in, but these institutional investors are actually more the smaller institutional investors. For us, they are the larger ones. So they invest between a million and 10 million. So a lot of people and smaller institutions.

Nik: That's interesting. And does it also say roughly how many investors such a fund up here might have? I mean, having in mind, obviously, that the investment amount is different.

Thomas: Yeah. Yeah, I think for the European fund, it's very likely that we're going to end up with 250 to 300 investors. For the U.S. Fund, it should be at least 200. So we're talking about a well-diversified investor base, which is also helpful for them and for us, because it means we're not too much dependent on a single investor. And that's also very helpful for our funds in which we want to invest because we are a stable investor. We're not coming like tourists coming in and out, but we have a lot of people who are backing us and therefore it's much more stable and more predictable.

Nik: That's great. Thomas, maybe one thing we started easily by mentioning you're doing, basically, obviously investing into small cap. What's the rationale? Explain the rational small cap versus, well, large cap to take the other end of the pole. So maybe you want to give some differentiation and some explanation of the different mechanics and economics.

Thomas: Yeah. Perhaps I need to add something I didn't say at the very beginning. Before I started our fund-to-fund approach, I was actually working in large cap. So I've been in that part of the business spectrum for more than 10 years. So I've done public to private. I've done high yield bond issues. I've done IPOs I wouldn't say I've seen it all but most of it and on purpose I decided to move out of large cap into small cap because I see higher higher returns in the small cap space and that has a couple of reasons it's not a single reason so it basically already starts when the businesses are quiet very often the purchase price multiples are much much lower for a couple of reasons. So the vendor wants to stay in with some shares. He wants to have a partner for the next five years before he or she sells all the shares in the business. And therefore, the purchase price is not everything. It's very important, but it's not the main driver. And that's irrespective if you're talking about the US or Europe. And then the other thing is the smaller businesses, of course, they have higher inheritance and risk. So if you have a higher risk, let's say an investor pays a low price, has a higher return expectation. And that also shows up in the price you normally pay. And when you buy these businesses, the good thing is you can develop them. So if you have a global company with, let's say, 10,000 people. Ultimately, you cannot improve that much any longer because it might be already very good. So what we have is a lot of optimization in these small companies where they benefit from. We have a lot of add-on acquisitions where they benefit from. And there we have something we call the base effect. So when you acquire a small business and you buy another one or two at the same size, you double or triple the size of the businesses. Whereas when you buy a very large business and you even when you acquire a higher number of companies, if you have the market leader and you only acquire very small ones, you might have a small additional growth from the add-ons. So that base effect helps a lot. And then when you sell the businesses, you have two big advantages. First of all, you're not dependent too much on the capital markets because often the businesses are still too small so a buyer can digest them. Or you're not dependent to IPO the businesses because if you sell a business for a quarter of a billion euros or dollars, it's too small to put it on the stock exchange. So, for example, in today's markets, it would be difficult to IPO a company. Therefore, an exit doesn't happen. And the last point on the exit side is other than when you acquire often businesses in, let's say, as the only sole potential buyer, when you sell the businesses, you use an auction. And through auctions, you can actually increase prices dramatically. And that basically also helps the house when you want to earn more money.

Nik: That's great. You have a lot to exit market there. That's fascinating. Thomas, we started with the U.S., went to asset class as such, small cap. And now also for the benefit of the U.S. Audience, I'd like to turn to Europe because obviously that's something people might be interested in if they know the U.S. market. So maybe let's focus a bit on Europe. And maybe you want to give a bit of an outside explanation of what the landscape looks like with the various regions, how they are perceived in terms of economic strength. Maybe also sector-wise and what your approach in Europe is?

Thomas: Yeah. Actually, our approach from the investment side is a little bit driven by our investors. We have a lot of, basically, almost only German investors, and that means that we under-allocate money into Germany because our investors are already invested there. I wouldn't say we would not allocate money because we don't like Germany. I think if I would come from the U.S. As an investor, I would have a higher allocation to the German market than what we do. On our end, it's only driven by our investor base. I think in general what you see, if you look, I wouldn't go into, let's say, economic cycles with the next answer. I would more look where do you see better performing funds. And what we see is above average returns we see in the in the UK basically see it in the nordics and we say see very good returns in the bandlocks so on average in these three regions we tend to invest a little bit more than in the others in france we see very stable businesses. So a smaller dispersion. For us as a fund-of-fund manager, it also means we don't see that much alpha. And therefore, we are actually more reluctant to invest too much in France because we are alpha hunters. In Italy and Spain, we see a couple of funds who generate huge alpha returns. And there you actually need to know them, you need to find them, you need to get access to them. You might even have a language barrier. And in Germany, I would say it's a good mix. You have a sufficient number of very good funds. So if you're coming from outside, that's actually also an area where you want to invest. That's one thing. So you have a little bit of a regional mixture. The other thing is, if you look into the various markets, you have different industries. So just to take Germany and Italy, you often also have funds who invest in manufacturing companies because the businesses are there. So you have a higher share in these two countries, whereas when you go to Banalux, to the UK, to the Nordics, you often have a higher share of business services, tech companies, and also, let's say, consumer-driven concepts. So you have a little bit of a different industry mix. And if you want to invest in basically in healthcare, it's all over Europe. So there's no speciality on a local level. So you still have a little bit also of an industry flavor.

Nik: Right. And does that mean that overall you sort of mix geographies within Europe into every fund? or does it sometimes sort of more concentrate on the northern part?

Thomas: No, given we only bundle funds from a year and a half vintage, so 18 months roughly, we want to see everything. So we want to have a country mix, we want to have an industry mix, and we bring basically every 18 months a new product and bundle 18 months. So our investors who invest regularly do it in each and every product And through that, they get basically a portfolio of roughly 30 funds in, let's say, in a full-blown investment cycle of four to five vintages. But we also want to have a product which is digestible for our small investors. So they might only invest once in our fund-to-fund, then skip two programs and go after the first investment just in the fourth fund-to-fund again. And by doing so, they also need to have a good diversification on their fewer number of fund-to-fund products. Therefore, it's always a mix on purpose. And what we try to do is to find the best funds in Europe. In these 18 months, but in a mixed way and in a blended way.

Nik: And talking about Europe, do you also look at Central Eastern Europe? Has that developed to a level where you say that's interesting? Or is it investors generally still shying away from the border?

Thomas: Yeah, actually, we look into Poland, into Hungary. We look into Czech and Slovak Republic, Slovenia. So these are mainly the countries we're looking into. The number of funds is very small. The returns have not always been very great. We have seen funds which showed great returns, but where we have question marks on future returns. So we're looking into it, but realistically we would say there might be one GP coming into our program every, I wouldn't say every time, but every second time because the number is just very small. And we are very selective. In reality, we only want to invest in 2% to 3% of the markets.

Nik: And to give a bit of a feeling, how many, when you do sort of, you set up a fund, you look at your investments, how many funds do you screen in order to come down to those 10 to 15 funds, as you mentioned?

Thomas: Yeah. So over a year and a half, we can screen in the market technically, no, let's call it theoretically, we can screen 400 to 500 funds. That's, in theory, the market size. Realistically, half of them are not good. And we apply a rating to funds. So basically already half of the funds which we have in our whole database are rated at a level where we say, let's talk to them every two years. And there might be a surprise and there might be better than expected. The other half we actually look at. So we screen them on a constant basis. We go to all the big private equity fairs. We talk to them directly, call out to them, talk to the placement agent. So in reality, over a year and a half, we have at least 100, if not even 150 internal papers on funds where we have an initial screening. And then ultimately, we visit 15 to 20 fund managers in a final stage of due diligence to ultimately invest in 10. So it's a lot of funneling, let's call it this way.

Nik: Yeah, interesting. And I believe that at the end of the day, when it comes to due diligence, that's probably as natural, sort of the key of your investment activity, obviously. But I understand, despite your size, if you compare yourself with other investors into private equity funds, my feeling is you're very well esteemed given the quality of your developments also. And some lighthearted diligence in front of management teams.

Thomas: Yeah, actually, that's very true. So what we basically have, we initially only do quantitative analysis. So we look, for example, at value creation of the fund managers on a deal-by-deal level. So if you have a lot of numbers, numbers tell you a lot of things. You can ask the right questions. But where we also need to connect the numbers is with the team. Are the right people still there? Are the right people at the fund management team on a GP level highly incentivized? And is a team basically a team which wants to stay and move forward? And that's not always the case. So even if you have a huge GP commitment, it might even be that there's a disincentive coming out of that huge GP commitment and people get too cautious. They don't want to sell at the right time and they might hold on to assets too long. And to do this sort of analysis, you also need to have a lot of judgment and you need to apply... Basically your knowledge from history. And the good thing is we as a team, we have been working, and not just me, but also colleagues have worked in private equity in the funds. They have seen the development of fund managers over time. They've seen when there was a generation change in a fund management team. And they've also seen that some people might be motivated, let's say at one time, and that might change over time. And I think there we're coming in a part of our due diligence, which is not numbers-driven. It's really qualitative due diligence. And I think there it's very helpful. And that's one of our USP that we have worked ourselves in product equity funds.

Nik: That's helpful. That's helpful. Thomas, I could go on for a long time. I mean, just to come to the end. And finally, sort of linking your insights, your experience with the actual market in the U.S. And if opposed to or similar, Europe. In five sentences, what are your thoughts and is your perspective basically on the current market and the nearby developments in the U.S. And in Europe as regards the small cap space and private equity active in that space?

Thomas: We are currently going through a very volatile market and that is the best time for PE funds to earn money. It has always been because high volatility means that people who are forced to sell, sell at a low price. The other thing which is important, one of the main reasons why we invest in small cap is that we don't want to have a high dependency on capital markets. We're not dependent on an exit through an IPO, for example, or to get a high bond financing done. And in times like today, high volatility, higher uncertainty, it also means you can much easier buy assets. And sell assets because you're not too dependent and then the last thing is what people should not not leave out in there basically in the investment assumptions and return expectations the world has changed over the last couple of years so until beginning to mid 2022 we were in a low risk and also low interest environment that's not the case in the longer but that also means that return expectations have to go up. So nowadays, a couple of years after this change, we, in our assumptions, want to see 5% higher IRs from the fund managers because we have high interest rates and we have high risks. That's something you also should remember.

Nik: That's fantastic. I think that's a great outlook, higher IRs, right? Thomas, we had a great tour de raison Through your activities in the U.S., the basics and philosophy of your investment, and also looking closely at Europe. Thank you so much for those insights. Thanks a lot for listening to DealMaker Insights. And I would invite everybody to join our next series. Many thanks.

Thomas: Thank you.

Outro: Dealmaker Insights is a Reed Smith production. Our producer is Ali McCardell. For more information about Reed Smith's corporate and financial industry practices, Please email [email protected]. You can find our podcast on Spotify, Apple, Google, Stitcher, reedsmith.com, and on our social media accounts at Reed Smith LLP on LinkedIn, Facebook, and Twitter. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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Transcript is auto-generated.

In this episode of our Private Equity Spotlight series, we explore what the UK Economic Crime and Corporate Transparency Act means for those in the private equity industry. We focus in particular on the “failure to prevent fraud” offense introduced by this Act. Our speakers will talk you through which companies will be liable and explore how they can defend themselves against regulatory action.

Private equity partner Tom Whelan is joined by Reed Smith regulatory and investigations partners Rosanne Kay and Ali Ishaq, as well as former Reed Smith partner Patrick Rappo, to share practical insights and tips in this edition of our series.

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Transcript: 

Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers.

Tom: Hi, everyone, and welcome back to Dealmaker Insights. I'm Tom Whelan, a partner in Reed Smith's private equity group in London. I'm joined today by Roseanne Kay, Patrick Rappo and Ali Ishaq. Before we dive in, I'll let them briefly introduce themselves. Roseanne.

Rosanne: Hi everyone, I'm Roseanne Kay. I am a partner in Reed Smith's London office, specialising in white-collar crime. I focus on financial services litigation also.

Tom: Patrick.

Patrick: I'm Patrick Rappo, formerly headed up the Bribery and Corruption Divisions at the UK Serious fraud office and advise some members of the House of Lords in relation to the legislation that we're going to be talking about today.

Tom: Excellent. Ali.

Ali: Hi, Tom. I'm a partner in the firm's London office, and my practice focuses on regulatory investigations and enforcement proceedings, profane claims, and also general commercial litigation and arbitration.

Tom: Great. Thank you all. Well, today we'll be discussing what the Economic Crime and Corporate Transparency Act means for the private equity industry, with a special focus on the failure to prevent fraud offence. There's a lot to cover, so let's jump right in. Ali, why are the two new corporate criminal offences relevant to private equity and their portfolio companies? Namely liability for failing to prevent fraud by associated persons and liability for senior managers who commit economic crimes.

Ali: Thanks, Tom. So this is a new UK offence, which is the failure to prevent fraud offence, which is coming into force in September 2025. It was brought into the UK statute books together with a new senior manager offence, which came into force in December 2023, and which I'm going to touch on very briefly and to begin with. Now, both of these new corporate offenses are part of the UK government's plan to make it easier to find corporates criminally liable. Starting very briefly then with the senior manager offense. This new offense makes corporates criminally liable for the actions of their senior managers acting within the actual or apparent scope of their authority who commit economic crimes. It is also going to apply to private equity companies, and like the failure to prevent fraud offense, has a wide extraterritorial effect. Now, a senior manager is defined as someone who plays a significant role in making decisions about how all or a substantial part of the organization's activities are to be managed or organized, or in actually managing or organizing a whole or substantial part of those activities. Now, the applicable economic crimes which a senior manager can commit and therefore make the company liable for are broad in range and include offenses such as cheating the public revenue, false accounting, money laundering, bribery or fraud, and even sanctions violations. So that very briefly was the senior manager offense. Moving on then to the failure to prevent fraud offense. Now, this offense is important to private equity firms and their portfolio companies for two key reasons. The first reason being, in very simple terms, that the failure to prevent fraud offense can hold a private equity company liable for fraudulent actions committed by associated persons if it can be shown that the private equity company or its clients benefited from that fraudulent act. These associated persons whose actions can create liability include employees and most notably both portfolio companies and even the GP. And adding to this concern is the fact that the failure to prevent fraud offenses is broad in nature. It covers a range of fraud offenses from abuse of position and failing to disclose information to fraudulent trading and false accounting. So under this new offense, there are a range of fraudulent acts that can be commissioned by a portfolio company or the GP that results in liability ultimately for the private equity company. Now, the second reason why this offense is of relevance to PE firms is that the offense is a strict liability offense, which means that to be found guilty of this offense, the authorities do not need to establish criminal intent or even show that the entity had knowledge of the offense being committed. So once the offense has been committed, private equity company cannot come out and say that they were not aware of the portfolio company's action to avoid liability. In fact, the only defense would be for the firm to show that it had reasonable procedures in place to prevent the fraud. So to summarize all of that in a few sentences, the failure to prevent fraud offense has meant that PE firms now face increased risk of liability from the daily operations of their portfolio companies, and this risk of liability is quite significant. However, not all entities will fall under the purview of this offense. It's only going to apply to an entity within a PE structure that meets two out of the three qualifying criteria. So firstly, if the entity employs more than 250 employees. Secondly, if the entity has total assets worth more than £18 million pounds and/or the entity has a turnover of 36 million pounds. Now, these criteria apply to the whole organization, including subsidiaries, regardless of where the organization is headquartered or where the subsidiaries are located. So that Tom is a very quick summary as to why these two offenses are something PE firms need to consider very seriously.

Tom: Thank you, Ali. And we go on now to Roseanne. So Roseanne, what sort of conduct is going to create a problem under the failure to prevent fraud offence for private equity and their portfolio companies?

Rosanne: So the way it works, Tom, under this failure to prevent fraud offence is that there are some specific base fraud offences which are referred to in the act that brought this new offence into force or is going to bring it into force, which must have been committed in order for a corporate to then have the criminal liability of failing to prevent that fraud offence. And what I'm going to do is refer to some practical examples. But before that, I just wanted to mention a few points, which are that we're not dealing with new kinds of misconduct. So the sort of practical examples that I will mention will be recognisable types of fraud. But what's new is that that misconduct will now more easily create criminal liability for the corporates under the new offence. The second point to mention is that the fraudulent conduct can be looked at from different perspectives, from the perspectives of the different entities and individuals who might be involved in the typical private equity structure. So although we're focusing on the failure to prevent offence, the same misconduct may give rise to liability for different individuals and different entities under different offences at the same time so for example the specific employee who may have done the the wrong act will be themselves liable personally for a fraud offence there may be liable liability for a corporate under the failure to prevent offence, in addition to liability for entities under this new senior manager offence, which Ali mentioned, if there were senior managers involved in the commission of the offence. So turning now to some of the practical examples, there were sort of four headings that I wanted to mention. The first is fraudulent financial misrepresentation. And here we're talking about some form of misrepresentation, for example, of the fund's performance. For example, if an individual within the general partner provides inflated valuations or misrepresents the performance of portfolio companies to attract investors or false statements to the limited partners or misleading disclosures, those kinds of fraudulent financial misrepresentations are the type of base fraud offence which could then create liability for failing to prevent fraud. Another area, misrepresentation to lenders or regulators. So, for example, some misleading information in a loan application to banks or private credit lenders to secure financing. Similarly, could amount to one of these fraud base offences, which could give rise to a failure to prevent fraud offence on the part of the entity. As I mentioned, these are sort of misconduct that won't be new to you and the listeners of this podcast. Other examples I'll mention briefly would be market manipulation, insider dealing. Obviously, we know that those are offences in any event, but they will now give rise to additional liability under this new offence, as could some fraudulent conduct in the portfolio companies, for example, accounting fraud or some tax evasion or false expense claims, all of which could be appropriate fraud that could give rise to liability.

Tom: Thank you very much, Rosanne, for that level of detail and some of the examples where such fraud is caught by this legislation. So I'm going to turn now to Patrick. From a practical point of view, Patrick, what do private equity managers and their portfolio companies need to do to protect themselves from prosecution under the failure to prevent fraud offence?

Patrick: Thanks, Tom. Important to note that these are fairly seismic changes in UK law. I've been actively involved in the prosecutorial side of UK law enforcement for many years and have been defending and acting with various investigations and with litigation. And this really is a huge change of focus, making companies liable for a much broader range of offences than ever before. Very similar to the US system, where the company is effectively liable for all acts of its employees that benefit the company. Not quite as broad, but it's getting there. So that's the first point. In terms of practical steps, I think the first one is, are you caught within the crosshairs of either of these bits of legislation? In most cases, actually, you don't need to spend a huge amount of time looking into that. Because ultimately, if you've got some kind of UK nexus, some kind of activities taking place in the UK, or senior managers or associated persons who are UK based, you're likely to be caught by it. But that's question number one, you know, are you caught by it? Number two is really, assuming that you are, is looking at your risks and what your risks are underneath both of these bits of legislation. And really, your risks are who are your associated persons and who are your senior managers. So first off, you need to start identifying who those individuals and entities are within the sort of PE group structure and then also within your and also the PE group's organization just to see who could in effect make you liable. Part of that risk assessment will be what are the risks that they could make you liable for, which are the various misrepresentations that Roseanne outlined in some detail there. So looking again at what your risks are in relation to the various products and funds that you are likely to be involved with. Next is really getting your policies and procedures in shape. And by in shape, I mean you have a legal defense, which is a full defense in law, if you're able to show the authorities, should they ever come knocking, that you have reasonable prevention procedures in place. Now, what are reasonable prevention procedures? Well, they will be based on what procedures are needed to counter the risks that you identify within your risk assessment. There's a bit of a wishy-washy legal answer, which ultimately means you need to assess your risks. Then you need to make an analysis of what you should be introducing to counter those risks and having policies which effectively put that into effect. And then on top of that, I think you need to train. You need to train your senior managers. You need to train your associated persons. You need to train, essentially, your employees and those within the group to ensure that everybody is aware of what could make the respective companies liable and the code of conduct, the culture, which is expected in all of the circumstances. Also, it's useful to be monitoring the effectiveness of those policies and procedures, doing biannual or annual audits of your processes and procedures to see if they are, in fact, fit for purpose. The deadline for having policies and procedures in place in relation to the failure to prevent fraud offence is the 1st of September this year. So essentially, there's six months left. Many within the PE space will already have been looking at this for some period of time. They, as Roseanne have mentioned, are likely to have policies and procedures in relation to fraud, money laundering, and other things already in place. So that's a good starting point. On its own, not necessarily enough. And that's why you need to conduct minimum a gap analysis, maximum a full-on risk assessment. But this needs to be ready to roll by 1st of September this year. Next, there are some other issues which are useful to take a look at to make sure that those are in place as well, which is your whistleblowing procedures, because you need to know what is happening within the group, within the entities involved. Before effectively it goes outside to an external regulator. And as recently as a number of days ago, HMRC introduced that there would be a new government scheme set out in the near future, which effectively rewards whistleblowers for coming forward with information that leads to the recovery of unlawfully withheld taxes. As a result, there's going to be a huge incentive out there for whistleblowers to skirt outside of the organisation and go direct to government, you want to make sure that you've got whistleblowing policies and procedures in place as well in order to be able to check if there is a problem long in advance of it ever going to the regulators. So again, that's a sort of whistle-stop tour of the types of things that can be done. That sounds, obviously, as if it's going to take a huge amount of time, cost a huge amount of money. But in the grand scheme of things, many firms out there, such as Reed Smith and others, can offer quick turnaround assessments, gap analysis in relation to these things. But ultimately, it's a matter which can and should be done. And the advantage of it is that it will provide you a full defense. Along with training your employees, it'll put you in the best position to be able to show you are a reasonable company that is looking at all of the risks that it has, is mitigating them as well as they can, and as a result, should not be prosecuted for any of these matters. So back to you, Tom.

Tom: Thank you very much, Patrick. And also thanks, Roseanne and Ali as well for your earlier insights. If I may sum up what we've heard briefly today, the failure to prevent fraud offence is relevant to private equity managers and their portfolio companies who have a UK nexus and the senior managers within them. The failure to prevent fraud offence will impact such private equity managers and their portfolio companies and ultimately their investors and senior managers of such portfolio companies if steps are not taken to prevent fraud and a fraud comes to light, with such impact being primarily felt through reputational damage and the potential for unlimited fines. This clearly reduces returns not just to investors but also to the underlying private equity managers and executive management, both of which may impact the ability then of a private equity manager to raise a new fund. So the failure to prevent fraud offence should encourage such private equity managers and portfolio companies to start taking steps now to protect themselves by identifying affected senior managers and associated persons, risks assessing their geographies, sectors, clients and suppliers in light of the new offence, updating their policies and procedures, providing training, monitoring, and incentives compliance, and extending the use of whistleblowing hotlines to include fraud to the extent they don't cover fraud already. I think that's all we have time for today. If you'd like more information about the offense and practical next steps, please do feel free to reach out to Roseanne, Patrick, or Ali. Thank you for listening and have a great day.

Outro: Dealmaker Insights is a Reed Smith production. Our producer is Ali McCardell. For more information about Reed Smith's corporate and financial industry practices, Please email [email protected]. You can find our podcast on Spotify, Apple, Google, Stitcher, reedsmith.com, and on our social media accounts at Reed Smith LLP on LinkedIn, Facebook, and Twitter. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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Against the backdrop of a new administration, the introduction of new HSR rules in early 2025 will impose significant additional burdens and risks on deals subject to premerger notification in the United States. How will new DOJ and FTC leadership impact antitrust enforcement, can we expect the private equity industry to remain a key target under the new administration, and what can private equity firms do to prepare?

In this episode of our Private Equity Spotlight series, private equity M&A partner Nick Gibson is joined by antitrust partners Michelle Mantine, Ed Schwartz and Chris Brennan.

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Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers.

Nick: Welcome back to Dealmaker Insights, the Reed Smith podcast series spotlighting the private equity industry. I'm Nick Gibson, a private equity M&A partner in the Chicago office of Reed Smith, and I'm excited to have antitrust partners Michelle Mantine, Ed Schwartz, and Chris Brennan here today to discuss the antitrust outlook for 2025 and what changes the industry can expect and start preparing for. We have a lot to cover today, so let's jump right in. So the U.S. presidential election was a few weeks ago, and a second Trump administration is quickly approaching in January. Let's level set for the audience. What is the current antitrust environment for private equity, and were there any major developments over the last four years that specifically affected M&A activity by private equity firms?

Ed: Yeah, Nick, good question. This is Ed Schwartz, and I'll jump in, and I know Michelle and Chris are going to have thoughts as well. So, I mean, the short answer is there's been a sea change. Historically, the antitrust agencies, both the DOJ and the FTC. Really only focused on private equity and the nature of ownership to the extent that it related to adequacy of the divestiture buyer in a deal where divestitures were required. And that's an issue and a concern that goes back with the agencies for some time. Will a private equity firm be an adequate divestiture buyer and compete effectively and aggressively? The world has changed in that regard. Pretty early on, certainly by 2022, both the DOJ and the FTC were making very aggressive statements about their intent on focusing on private equity and whether private equity were going to be adequate or an acquisition by private equity would be adequate in order to preserve competition in a particular industry. And both Lina Kahn and Jonathan Kanter were making statements along the lines that we're going to take a muscular approach and expressing concerns about whether PE firms were in fact well-suited to compete as effectively and aggressively as other potential buyers. And it didn't take long for the agencies to begin taking action. And so we saw the first sent decree between the FTC and a private equity firm, and this was involved JAB and its subsidiaries, which owned a bunch of veterinary care clinics in Texas. And the Kitsets Decree. Was negotiated and effectuated and required significant divestitures. And we saw also a case a lot of folks are going to be familiar with, and that's the FTC's Law of Citizens, Welsh Carson, a private equity firm, and its portfolio company, which owned a bunch of anesthesia companies. And the complaint that was filed focused on roll-ups in that industry for the last, you know, the prior roughly 10 years. And this is the first case that we've seen that was like this in a number of ways. One, it focused on roll-ups by a PE portfolio company. Two, it sued to block the deal under Sherman Act Section 1, so it hasn't seen in a long time. Ultimately, the case was dismissed by the district court judge, importantly, because Welsh only owned a minority share. But, I mean, this was really a watershed moment that one of the agencies sued on this basis. So the short answer is there has been a sea change. I mean, it's effectively a complete turnaround in thinking about how the antitrust agencies think about ownership, the nature of ownership, and how effectively they may compete. And I think it's worth adding that since their loss in the Welsh Carson case, the agencies haven't let up. They've continued to issue a number of statements, sometimes along with other agencies, you know, really pounding on the fact that they're going to be looking very, very closely at private equity firms and just how effectively and aggressively they will compete following their acquisition. So the heat is very much still on with PE firms, at least in this administration.

Michelle: And I couldn't agree more. I mean, really, since Biden's executive order back in 2020, the heat's been on and sort of been being turned up, right? With respect to almost every angle of antitrust enforcement, and PE has had sort of the share of the limelight, you know, often with industries like healthcare and tech, who sort of usually have that role from an antitrust perspective. Private equity has joined them. When you look at the revised merger guidelines at the end of last year and their focus on private equity, the final HSR rules, which will go into effect February 10th that were largely done under Lina Kahn and their focus on private equity and the ownership structures. The agency's public forum last March, really delving into private equity ownership issues and providing a forum for folks to sort of share their stories about private equity. In my view, it's been much of a one-sided story to date, unfortunately. The only real sharing of the other side, so to speak, the benefits of private equity has been shared with a public filing by an amicus brief in the USAP case where an interested party and association sort of laid out how private equity has also benefited from competition and market. So it's an interesting dynamic at the moment. The heat is very much on and definitely a challenging environment for private equity.

Chris: I think some of this too, the numbers bear out that this isn't necessarily just the Biden administration. It's also the market over time. In 2022, two out of five deals involve some private equity participant. That is up way, way beyond where it was in 2000. So over the last two decades, you've seen a massive increase in private equity participation. Nick, I'm sure you have seen that in your practice. And so I think a lot of what we've seen from the Biden administration is really a feeling that enforcers were asleep at the wheel. Right. And when we can think about that in terms of other ways in which this has been a very active administration, we know that private equity is here to stay and that those rates may actually increase. The question is really going to be what happens if a new Trump administration takes a different approach.

Ed: That's a really good point and an interesting perspective, Chris. And I think one that does bear emphasis is you could look at what's happened as the antitrust agencies finally capping up with the massive change in the nature of ownership in the United States that shifts from public equity ownership to private ownership. And, you know, and I agree with you. I think that perspective does bear upon, you know, or does help us think about what's going to happen in the future, you know, both in the Trump administration and administrations beyond. I mean, I think it may be too easy to chalk up what we've seen. Under the Biden administration, with private equity antitrust enforcement as well, it's more the same. We've seen very aggressive, some might say hyper-aggressive enforcement efforts to greatly, if not grossly, expand the scope of antitrust enforcement and chalk it up maybe too easily to that. And we do have to keep in mind that to some extent it arguably is attributable to the massive change in ownership and investment in the United States. It's probably worth just mentioning one more thing, and that is, you know, a lot of folks who listen to this know this, but the revised horizontal antitrust guidelines did include language, new language that expressly addressed private equity investment. And the language is where one or both of the merging parties has engaged in a pattern or strategy of pursuing consolidation through acquisition, the agencies will examine the impact of the cumulative strategy to determine if that strategy may substantially lessen competition or tend to create a monopoly. So this focus on roll-ups isn't, of course, limited just to a focus on private equity, but it does seem that that language was included in particular for the purpose of signaling that they're going to be looking hard at private equity. So one of the questions, and I don't want to jump ahead too far. So one of the questions that we're all thinking about is what changes are we going to see and what pullbacks are we going to see in enforcement policy under a Trump administration? Some of them are probably easy to predict. The FTC's policy statement about Section 5 enforcement issued in November 22, that's gone. I think we can all be pretty sure of that. Are the agencies going to revise yet again or even just withdraw? The revised horizontal merger guidelines and this new language with it. We'll see. If we take a step back and we look at what's happened in antitrust enforcement and merger enforcement in general with respect to private equity firms, I think you could look at it and, conclude that it's really a lot like we've seen with a lot of the merger enforcement efforts across the board under the Biden administration. I mean, put cynically, a lot of talk, not much action, and not much success. And I think to some extent, the agencies may be okay with that. Obviously, they don't like losing in court. They hate losing in court. But to some extent, it may be what they expected in that, at least under this administration, they've taken kind of a long view and their efforts are to you know not just win but to A) change policy and B) over time change the case law and change how the courts examine all kinds of antitrust challenges, including merger challenges. And so they may be okay with where they are. They've certainly shifted the narrative. They've shifted the way the antitrust community is thinking about antitrust. And I think to that extent, they maybe have succeeded to some degree. I think the big question, though, is under a Trump administration or any other administration going forward with a very different mindset about antitrust enforcement, how much difference will this all have made? Are we going to just revert to pre-Biden administration completely? Maybe. There's a good chance of that. How much impact has this administration actually had on the case law? Some, probably limited. We've seen some success in shifting how courts think about merger enforcement and antitrust enforcement. You know, I'll cite the loss by the FTC as one example where the court at least seemed to acknowledge the viability of new antitrust thinking. But, you know, we'll have to see how much of an impact over the long term this actually has.

Nick: Thanks for that, Ed. You really started hitting on the next question I had. Maybe we can dig a little deeper on, you know, the future here. Michelle and Chris, how do you see this environment changing at all under President Trump? How quickly might those changes come? And then maybe another question related to that, how much weight should we give to Trump's first term with respect to our expectations for the antitrust environment during his second term?

Michelle: Nick, I'm going to start backwards and Chris can obviously fill in. I think his prior term, you can only give limited or marginal weight. This is It's only the second time in history we've had a non-consecutive term president. And I just think so much of what we're going to see and what happens next. Depends upon the leadership that gets put into place. And, you know, while Trump, you know, President Trump, he is a disruptor by nature. That's just, you know, sort of his way. I think it really depends on who will be in charge of the FTC and the DOJ during his term and how they prioritize different aspects of what's going on in antitrust. When you look back at President Trump's first term, right? Antitrust was not a high priority, right? It kind of was let to do its thing. Antitrust was let to do its thing. You had more what I view as independence by the FTC, less politics involved. There wasn't really a focus on either the FTC or DOJ. I think there will be more of a focus coming into this administration. I think given sort of the focus on antitrust and the agency's aggressive approach the past four years, there will still be a focus come January. But sort of that what happens next question, that million dollar question, really depends on who's in charge. So for example, right, J.D. Vance, he supports going after tech companies, right? Will that continue? What influence will he have? It's just a tough prediction to make, I think, at this point in time. I really do think it's inevitable that Khan and Kanter do leave, and I think we'll see a lot of people leave the agencies. But, you know, whether everything goes out the window or not is a much bigger question. So as Ed mentioned earlier, right, the FTC statement on Section 5 of the FTC Act, I think that will change, right? The abandonment of the consumer welfare standard. I think that's likely to be reversed. I think that things like, you know, that came out with some discord, right, the revised merger guidelines, I think some of that perhaps will be pulled back or interpreted in a lighter way or a different way. Than what we've seen thus far from the agencies. Where other things like the revised HSR rules, I think that's a lot tougher of a call, given the way those rules were implemented, how they were walked back from the June 2023 draft by the Republican commissioners and the statements that supported their unanimous vote back in October. So there's really a lot to watch. I don't think any of it will be able to happen tremendously quickly because I think it's going to take time for people to get in place and prioritize their next steps and how to sort of, you know, take on antitrust enforcement going forward. So, you know, it's really going to be something that we're going to have to somewhat wait and see. Right. And while there's history there to say a little bit about what President Trump did under his last term, I don't think it's necessarily indicative of what we'll see in the future. But I'm sure Chris has some thoughts to add to that.

Chris: Yeah. You know, Michelle, look, I agree. Almost every client alert I've seen in the past couple weeks has suggested that, you know, well, what to expect? Well, let's look at what happened in term one for Trump. I just don't know how valuable that is, especially for strategic planning or thinking about the road ahead. I mean, one thing is Trump came into office and was not a career politician. And I think he has learned tremendously over the last eight years about what he would do differently, whether you agree or disagree with what he's done. I think he has learned a lot about his approach to, you know, we're recording this right in the midst of all these cabinet nominations. I mean, who had some of these picks on their bingo card? And so I don't think, you know, I think Trump 1.0, we saw a fairly traditional assortment of conservative appointees. We're not seeing that. I think that's going to continue. And I think these more unorthodox appointees are going to want to impress the boss and be able to say, look, here's what I'm doing for you. I think we're going to see a very, very different approach. But one thing I would point out is we are seeing a number of actors in Trump's circle that may or may not be part of the cabinet. And so who's going to have a bigger influence on policy? Is it going to be Elon Musk or J.D. Vance? Traditionally, the vice president gets a lot of attention. And then after the election, after inauguration, you don't hear from them. So he may not be as influential. A lot of people have looked at his track record to suggest, well, maybe there'll be more active enforcement. I don't know if he's going to have the president's ear, we certainly know, based on history, that you don't get to do anything for long in a Trump administration if you're disagreeing with the boss. And so to the extent there's daylight between what Trump thinks we should be doing from an antitrust perspective and what J.D. Vance thinks, I'm confident betting that Trump will have his way. I think in terms of any predictions I would feel comfortable making, I do think we're going to move away from these sort of categorical approaches. And this is particularly true to private equity, to bring it back to this spotlight. I think there was a feeling from critics of this administration, the outgoing administration, that private equity was viewed as some inherent problem that needed to be solved via aggressive antitrust enforcement. It didn't matter the industry, didn't matter the dynamics of the transaction. It's just we're going to be a little suspicious here because it's private equity. I think that's going away. I think the same is true for big tech. I think we're going to have to look deeper what aspect of big tech social media might be treated differently than AI might be treated differently than autonomous driving might be treated differently than search so I think we're going to get back to maybe some deal specific some market specific industry specific. Transaction evaluations and that can make a big change from the Biden administration that was very categorical in its enforcement.

Ed: Chris I agree with all that I think those are really helpful comments. I think... Well, we just take a step back. The crystal ball is really, really cloudy here. And, you know, as Michelle and Chris both said, you know, it really is going to depend on who is, you know, who's going to wind up chairing the FTC and who else is at the FTC and who's going to head the antitrust division. So I think this could go a lot of different ways. And there is a lot of chatter in the antitrust community about who's going to be filling these seats. A lot of wildly different perspectives on this. Here's what I'll say about it. I mean, at bottom, I think the chances of our seeing it under Joe Simons, who chaired the FTC under the first Trump administration, that is someone who came out of a big law firm who approached every issue that was put on his desk based on thoughtful consideration. Of antitrust policy, what it is and what it should be, and a careful application of the law. I think the chances of our seeing another Joe Simons is really low. And I'll get back to why. What are the chances we're going to see another Makan Delrahim heading the antitrust division? Pretty good chance of that. Maybe it even will be Delrahim. There's been some chatter on the internet that he's lobbying for the job again. Who knows? The one thing I think that will drive enforcement under the second Trump administration that will be very different from the Biden administration, well, one among many from the Biden administration, and even different from the prior Trump administration, particularly the FTC. Is that it is very likely that whoever he appoints is going to be very much open to taking calls from the White House and considering very seriously what the White House wants. Why do I say that? Well, I think we ought to take Trump at his word. That's what he has said he's going to do. And that's what we've seen him do largely, almost entirely with his proposed nomination to date. So what does that mean? I think that means, and this may sound cynical to some listeners, I think what that means is we are going to see politics play a bigger role at the FTC and a bigger role at the antitrust division. So what does that mean for private equity firms? I think it may mean that for private equity firms that have the ear of someone powerful on Capitol Hill or the White House, that they may get treated differently than others. And that may sound cynical and it may be too cynical, but I think. Again, if we take Trump at his word and we look at his proposed nominations to date, I think there's a reasonable to good chance that that's going to happen. I completely agree with Chris that private equity will not be vilified the way it's been under this administration. Again, I think what happens under Trump could really depend upon the administration's goals, and that's going to be very much a matter of policy and a matter of politics. We all have a pretty good idea where Trump's politics lie, the hostility towards some of the digital platforms that is going to continue, maybe very much like it has under the Biden administration. With respect to the rest of tech, I completely agree with you, Chris. It's going to depend on the industry and how the administration views that industry, both as a matter of policy and politics.

Nick: All right, let's step into the shoes of our clients. what should private equity firms be doing right now to best position themselves for deals in 2025, maybe breaking it into two parts, you know, deals that are in process now, but not closing until Q1 2025, and then perhaps for deals that will close later in the year.

Chris: So I think just starting with that early piece, I think it's important to remember that even though we're all talking about changes and where these agencies are likely to go, it's still very much business as usual on the short term. Leadership changes, it's all going to take time. And just you know, it sort of gets lost in the in the more interesting topics. But the staff at the P&O, the people who do this, you know, Monday through Friday, they're going to be around, they're not going to go anywhere. And their sort of approach to how they evaluate mergers and review these things is largely going to stay the same. It's there, you know, those are career positions in many respects. So while some headline deals might get a different treatment, I think if you're in the midst of a deal, I think you just keep plugging ahead, I don't think you really change course. I do think, and I'll let one of my colleagues pick this up, that I think the changes with the HSR form and some of those changes, I mean, I think you have to start to get ready for that because that's, you know, right on the horizon. And so that is a different issue. And you really need to start to get ready for that.

Michelle: Yeah, Chris, I couldn't agree more. I mean, right now it's business as usual, right? You keep moving forward and working through your transactions as you would have last month. But I do think with that February 10, 2025 effective date on the new HSR rules, that will be a game changer in terms of the time, burden, and cost it takes to actually make an HSR filing. And then we need to see what does it actually mean, right? Does that additional data or information lead to more questions, more investigations and the like, or is it just sort of out there, so to speak? I mean, it's interesting because under Khan, you know, there's no data to suggest that there was actually an increase in merger cases or an increase in conduct cases. You know, a lot of the merger cases that were out there, frankly, when Khan got in, were out there or started during the Trump administration. The prior Trump administration. So the merger statistics are down. There's no data showing really that agencies materially or significantly stopped more deals. But I think one thing's for sure is that the current administration materially increased the costs of trying to do the deals, right? And so now I think you have to look at it as not a free pass. You need to keep doing the hard antitrust work you've always done regarding your transactions, but focusing on how do I get this done and knowing that if there are issues, the new administration is likely to be more receptive to some sort of merger remedy, perhaps more open-minded to getting the deal through with a remedy as opposed to challenging it. But I think that's well down the road sort of in that after February time period to think about that. And there's going to be a lot of that depends again on who Trump puts into place at the agency's.

Ed: Yeah, I think that's all spot on, Michelle, and maybe just to drill down a little bit more. On what companies and PE firms should be doing right now, or if not now, very soon to prepare for the implementation of the new HSR guidelines, February 10th. And there's been a lot of talk about all this. I think maybe just hit the high points. I think obviously with respect to planning, which I know a lot of folks are starting to do now, planning for a much heavier lift to prepare HSRs and beginning some of that work before you're really ready to dive into a new transaction. And that includes working on the narratives, and I do think that preparing the narratives that are going to be required under the new HSR regime present unique challenges for PE firms, and that's going to require some significant thought in preparing them. It does require looking very closely at documents that are going to have to be filed and then weren't previously required to be filed with HSRs in order to identify the kinds of content that may set off. Alarms at the agencies in reviewing the filings. And that means taking a close look at, for example, ordinary course reports that are going to senior management at the PE firms and, of course, at the portfolio companies as well. There are a lot of things that are going to require a lot of serious thought and preparation that weren't required before. The other thing, of course, is to prepare for longer investigations. And that is something that may well change under a Trump administration. To Michelle's point, investigations are taking much longer now. We may revert back to the norm, which itself was very long, but still, I wouldn't count on that in the next administration. You know, I think going forward, another thing for companies to be taking a close look at is, of course, interlocking directorates. And most all of you know that the renewed focus on interlocking directorates, which may not change under a Trump administration, is something that places, you know, that raises particular challenges for PE firms. So I think that is something to be taking a look at now.

Nick: Great. Thanks, Ed. I think that's all the time we have for today. So thanks to Michelle, Ed, and Chris for today's episode, and thank you all for tuning in.

Outro: Dealmaker Insights is a Reed Smith production. Our producer is Ali McCardell. For more information about Reed Smith's corporate and financial industry practices, Please email [email protected]. You can find our podcast on Spotify, Apple, Google, Stitcher, reedsmith.com, and on our social media accounts at Reed Smith LLP on LinkedIn, Facebook, and Twitter. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

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In this episode of our Private Equity Spotlight series, Reed Smith partner Nick Gibson is joined by Patrick Floeck, a principal at Valesco Industries, to learn more about his work in the lower middle market, with a focus on private and family-owned businesses.

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Intro: Hello, welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content through this series, please contact our speakers. 

Nick: Welcome back to Dealmaker Insights, the Reed Smith podcast series spotlighting the private equity industry. I'm Nick Gibson, a private equity M&A partner in the Chicago office of Reed Smith, and I'm excited to have Patrick Floeck of Valesco Industries today as our guest. Patrick and his team focus on the lower and core middle market, particularly in private and family-owned businesses, which we'll dive into today. But first, I'll turn it over to Patrick and let him introduce himself and Valesco. Thanks for joining us today, Patrick.

Patrick: Hey, thank you, Nick, and appreciate you having me on. A little bit about myself and Valesco. We're, as you mentioned, a lower middle market private equity firm focused on primarily controlled buyouts and particularly like to be the first institutional capital. We pride ourselves with a long history of being a really good partner and helping family and founder-owned and operated businesses transition into that next stage and evolution of their business cycle. And what that has evolved into is utilizing our fund of capital to help employ things like process and procedure. Building out management teams and putting the right people in the right seats, putting in place the appropriate systems to help manage the business, to allow it to capitalize on the already strong demand that is in the market for products and services that the company provides and offers. And so we've developed a core strength of being a very operationally focused private equity firm that truly partners with the management team to help drive the critical agenda. Our focus is on businesses that are roughly $5 to $15 million of EBITDA, and primarily in the manufacturing, distribution, and some business services. We are industry and sector agnostic. It's easier to say what we don't focus on, which are specialty industries like oil and gas and other commodities, tech, software, healthcare services, et cetera. But if you can make it in a manufacturing plant and it has a strong demand and a unique value proposition, those are the types of companies that we really find attractive. I am a principal at the firm. I've been with the firm about 10 years. I run our origination and marketing strategy, as well as sit on a few of our portfolio company boards and help fundraising and other activities at the firm and sit on the investment committee.

Nick: Very interesting. And what about your and Valesco's approach distinguishes you from other shops that might also take pride in partnering with management and kind of sit in the lower middle market?

Patrick: It's a great question that I've been giving a lot of thought to because it's one that I think is always asked, whether it be by a management team or an LP. And I think, you know, Valesco has been around for 30 years and what we've been doing for the last 30 years, going all the way back to our founders that started out as independent sponsors through our first fund, which was very small, all the way now to our third fund. Which is $435 million. But our strategy and the way that we partner with business owners has never changed. We never wanted to be or set out to be an asset manager or a financial engineering private equity firm that looks to make a platform acquisition and do a bunch of lower multiple add-ons and cut costs in a way to producing a return. We really do focus on building the enterprise value via sales growth, better processes, better systems, capturing additional market share and wallet share, and really growing the enterprise value of the organization all while producing employment opportunities. Employment growth, etc. And so we really focus ourselves on investing in opportunities where we can invest in the growth of a business, as opposed to trying to cut costs and manufacture a return. We believe that returns should be the result of a better business and a better operation after we are finished with it.

Nick: That makes a lot of sense. Where is Valesco at in its fundraising cycle and what are you hearing from your LPs this year that might differ from previous years?

Patrick: We are fortunate in that we finished our most recent fundraise in the summer of 2023 and had raised the majority of that capital by the beginning of 2023. The last 12 to 18 months has been interesting. One of the things that we've been hearing is, number one, the pandemic has increased the hold period and life cycle for assets to the tune of about 18 to 24 months. And so a lot of funds that are looking to raise capital are being pressured to have to exit. However, it's not been the greatest exit environment given the increase in interest rates, the ups and downs of different headwinds in different sectors of the economy, the election coming up. And so what we've heard is a lot of allocators are looking to consolidate their commitments back to a handful of GPs that they know well, which is a little bit different from the last decade or so where we've heard that a lot of allocators had diversified their portfolios amongst a bunch of different GPs. And now it seems like they're starting to make bigger commitments to a more consolidated group of general partners.

Nick: Got it. And you touched on this a little bit in terms of kind of understanding the concerns of management and family owned businesses. What are you hearing from founders and targets this year, particularly with, as you just noted, election seasons in full gear now?

Patrick: Listen, I think I'm not an economist, but in my own opinion is that we've been in a recession for the last 12 to 18 months. It's been a bit of a slow burn. The indicators from history, I think, are different in that we are primarily a services-based economy in the new millennium relative to the past. And so the traditional indicators around what precipitates a recession, I think, are different. You also look at consumer spending and inflation. People don't save as much. There's not the incentive to save or invest as much across the economy. And so I think a lot of businesses are facing challenges and headwinds that have made them flat to down this year. Despite the consistent increase in consumer spending and inflation that we've had over the last few years, I think the recent Fed rate cut of 50 basis points is a really good indication that we've got inflation under control and maybe we were a little bit too aggressive and it's time to pull back a little bit. I certainly think that there is some uncertainty around what happens with the election. The two parties' policies and agendas are so different that I think it's creating a lot of uncertainty for business owners, for private equity firms, and it's manifesting in a way that everyone is just kind of putting deal-making on pause. Because if you have certainty, whether you like the outcome or not, you can plan for it and you can forecast and budget, but you can't plan and forecast for uncertainty. So, we're really not seeing a whole lot of activity right now in Q3 and likely into Q4 this year, but my hope is that by the first part of 2025, it will be a good environment for M&A transactions to pick back up.

Nick: What are some of the trends you've seen, particularly in your end of the market, maybe some that aren't the obvious that are talked about as much?

Patrick: Yeah, it's certainly kind of going back to, you know, non-cyclical and non-consumer facing manufacturing businesses. You've seen kind of a move away from, you know, the residential services, roll ups, the, you know, the med spas, all the things that are have been focused around consumer spending, as well as anything that has financing. Related to it, and really gone back to your old economy, manufacturers that are supporting industries like infrastructure, food and beverage, things like that. Even agricultural deals, we've seen quite a few of. I'd say anything that is large old economy type businesses, as opposed to anything that's service-based or consumer. We really haven't seen a whole lot of activity nor appetite.

Nick: Got it. All right, bonus round now. Patrick, you're a big golfer. We first met over a round of golf and had a lot of fun. What is your favorite golf club in your bag? And then second part is, if you were a golf club among a set of clubs making up your deal team, what club are you and why?

Patrick: Yeah, it's a fantastic question. And I appreciate the heads up on this one because it gave me some time to think about it. But I am definitely a wedge guy. I carry four wedges regularly. And the reason I like a wedge of any different degree is because it's such a utility club that you can utilize from multiple different distances, whether it's a full swing, a half swing a chip around the green you can go a high flop shot you can go a low bump and run a spinner that checks and the reason I like it is that if you can get good with that club you can typically get yourself out of a bad situation so if you hit an errant tee shot and you can put yourself back into the fairway with a wedge in your hand you still have an opportunity to get up and down for par. If you miss a green and you can utilize a wedge shot that's going to get you close to the hole and still have an opportunity to make a par putt. That's what I really like about it. That's where I've spent a lot of time trying to make my game strong. Honestly, it doesn't always work out the way that you want, but I at least think that if I can have a consistent wedge game for the most part, I can typically get myself out of trouble.

Nick: I like it. So are you the wedge guy on your deal team as well?

Patrick: Oh, that's an interesting question. I think we're all wedge players. That's what private equity is, right? Our goal is to come in and be a utility player to help augment a management team that they're hitting the big drives and they're making the big money putts. But along the way, they need some help with things like process and procedure and how do they implement KPIs. They're going to help them look at their business in a different way to make them more effective and more efficient. And to me, that's what a wedge is as a utility. And so I think that's what private equity is in general, or at least our firm, to try and help augment the big money clubs like a driver and a putter.

Nick: I think it's a fantastic answer. Patrick, that's all the questions I had for today. Really appreciate you joining Dealmaker Insights. You've shared quite a lot and found it extremely valuable and interesting. I'm looking forward to having you back on and we'll follow you in Valesco the rest of the year.

Patrick: Really appreciate it, Nick.

Outro: Dealmaker Insights is a Reed Smith production. Our producer is Ali McCardell. For more information about Reed Smith's corporate and financial industry practices, Please email [email protected]. You can find our podcast on Spotify, Apple, Google, Stitcher, reedsmith.com, and on our social media accounts at Reed Smith LLP on LinkedIn, Facebook, and Twitter. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

All rights reserved.

Transcript is auto-generated.

This episode features a panel discussion on the current state of the health care private equity market, comparing it to previous years and exploring how the industry has adapted, and continues to adapt, to remain competitive.

The panel was moderated by Chris Sheaffer, global vice-chair of Private Equity at Reed Smith, and Nicole Aiken-Shaban, Life Sciences & Health Care partner at Reed Smith. Panelists included Tony Crisman, managing director and head of Healthcare IB at Stout; Daniel Schultz, managing director of BD at Webster Equity; Kevin Reilly, managing director at Ally Bridge; Brandon Cohen, principal at H.I.G. Capital; and Brian Bewley, Life Sciences & Health Care partner at Reed Smith.

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Transcript:

Intro: Hello, welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content through this series, please contact our speakers. 

Chris: Welcome to the panel. Appreciate you guys taking part in this kind of state of the healthcare healthcare market panel as part of our private equity healthcare forum being hosted in the New York office today. We've got a great panel together. Maybe before we start, we'll kind of kick things off with introductions. My name is Chris Sheaffer. I'm vice chair of Reed Smith's private equity group. 

Nicole: Nicole Aiken-Shaban. I'm a partner in Reed Smith's Philadelphia office with a focus in healthcare regulatory and transactional work, and particularly in the private equity space. 

Tony: Tony Crisman, Managing Director, Head of Healthcare Investment Banking at Stout, 25-year healthcare investment banker. I was at Lincoln for 15 years before that and started out at an old name firm, Dain Rauscher Wessels. 

Brandon: Brandon Cohen, I'm a principal at HIG Capital based out of Miami. I spend all my time in healthcare. 

Daniel: My name is Dan Schultz. I'm a Managing Director at Webster and I manage all of our business development. 

Kevin: And I'm Kevin Riley. I'm Managing Director at Ally Bridge Group. We're a life sciences-focused healthcare investor, predominantly in biotech and medtech, mainly focused on growth stage transactions. 

Brian: Good afternoon. My name is Brian Bewley. I'm in our life sciences and health industry group like Nicole and heavily focused on private equity transactions. 

Chris: So let's just dig into it. I mean, private equity investing in healthcare has been a very hot topic over the last couple of years. You know, the market generally between interest rates, you know, macro events, obviously an upcoming election. There's been a lot of focus on the regulatory side recently. Look, Tony, you're sitting closest to me. I mean, look, on the investment banking side, you guys obviously see quite a lot. I mean, how has 2023 been? How's the first ’24 been? How's the first half of the year? 

Tony: It's been an interesting start to the year. I think that there was a lot of pent up demand, an interesting thing that I always think about. The beginning of my career, capital was the scarcity and assets were the commodity, and we're completely upside down. And we were trending that way over the last 20, 25 years. But I think a lot of people were really hoping for a tidal wave of transaction activity to start ’23, or start ’24. And I think for the most part, what we've seen coming to market are a lot of assets that bankers and private equity have been kind of holding on to maybe late ’22, ’23 might have been their initial timing. But just looking at the overall market dynamics and things of that nature, they were kind of held. So it really started to perk up in late March. And I do think that the regulatory dynamics, they always drive deal activity within healthcare, which is why it's technically attractive. And so you do see a lot of portfolio adjustments through COVID and into the current day in terms of where healthcare investors are looking to deploy capital, not just recession resistant, but pandemic resistance. 

Chris: Brandon, what are you guys seeing on the sponsor side? I mean, have you guys been hearing from your LPs a little bit more? I mean, how are things going with HIG? 

Brandon: Yeah, I'd echo some of the comments. It felt like the first month or two of the year were a little bit slower than expected. I was actually looking back at some data. Our healthcare deal volume is probably up 30%, 40% in 24 year-to-date versus the same period in ’22, ’23, still off of the 2021 peak. The interesting thing that we've seen is just the quality of the assets. You mentioned in, people holding things back. And we've seen, it feels like the number of deals getting done are far fewer than that 2021 level, despite the volume being fairly close. And it feels like buyers are still pretty cautious, right? We've seen a lot of instances where a banker tells me, hey, got a dozen IOIs or multiple turns higher than you. And weeks later, that deal kind of falls apart. And on the sell side, we've seen several processes where buyers kind of complete most of their work and don't show up at the end. And, you know, I don't know that that's healthcare specific, but it just feels like buyers are fairly cautious and, you know, sellers don't necessarily want to take a discount to 2021 levels. 

Chris: Yeah. I mean, I think that extends well beyond healthcare. We're seeing the same thing regardless of market and sector. It just seems like the valuation still needs to be bridged a little bit, both healthcare and otherwise, but hopefully, you know, we're optimistic for the back end of the year here. 

Nicole: Brian, this one's for you. Chris did mention some of the recent changes in the healthcare industry that have been happening recently. Could you give a brief overview of those to the participants here today and thoughts on what investors should be thinking about on the horizon when they're looking to invest in the healthcare space? 

Brian: Thanks, Nicole. I actually printed off something because this is a year where there's quite a bit of activity, so it's unusual. There's been a lot of developments on both the state and federal level. I'm sure most of you have been following it. At the state level, several laws have been passed. There's some laws that are pending. Really around, I think approximately 13 states now have promulgated or adopted essentially many HSR laws requiring notice and at times approval by the state governments for private equity transactions. There are some states that are, for lack of a better way of saying it, worse than others, more restrictive. California, Illinois, Minnesota, and New York are the four that I wrote down that are incredibly restrictive because they require pre-merger notification requirements and then also approval of the transaction. At the federal level, similarly, there's been quite a bit of activity from the antitrust side. And I'm not an antitrust attorney, but because I do a lot of of work in this space. It's obviously on the top of minds of us as counsel, but also our clients. The first thing, FTC, DOJ, and HHS issued a joint request for information in March of this year to examine private equity's role in healthcare consolidation. They actually extended the deadline for responses to June 5th, which has already passed. Obviously, we don't know the outcome of that RFI and what they're ultimately going to do with it. But I assume that probably by the end of the year, we'll see some activity resulting from that RFI that the government issued. And as you all probably know, because you've gone through deals that require these HSR filings, but FTC has proposed changing to the filing requirements that would increase the disclosure obligations for healthcare deals. Usually I'm generally reluctant to talk about proposed legislation because it's just proposed and you don't know for sure if it's going to come to fruition, if it will ultimately result in some sort of law that's promulgated. But I think it was about four weeks ago, Senators Warren and Markey proposed, and this is the exact title of it, Health Over Wealth Act. There's a lot of different things that it requires. If it's successful, it will require private equity firms to obtain licenses from the Department of of Health and Human Services to invest in health care entities. And if you fail to qualify or obtain a license, you would be restricted from doing deals in the health care space and potentially would have to divest portfolio companies. This would also allow HHS to block deals pending their review, and then it would also require that the PE firms disclose financial and operational data, including debt levels, political spending, what wages are going to be, and what facilities are going to be utilized and not utilized. And then the last thing that would be required, again, if this is successful, is that there would have to be an escrow account. You'd have to establish an escrow account to cover all health services costs for five years should there be facility closures. Now, again, this is their proposal. I think there's quite a bit. I don't know if it will be successful. And frankly, even if it is, I think it's going to be challenged because of how restrictive this law would be. And frankly, it's anti-capitalistic. And so I'm not sure how much legs or how if it will actually get legs but it is certainly something that we should all be paying attention to and then I guess the last thing and this is more of a general theme and some of you are probably members with like the American investment council but a lot of the activity that we're seeing at the state and federal level you know is the result of really one-sided narratives that are being pushed about private equities role and and health care transactions and obviously at the FTC level even at the congressional level and I would even say the Department of Health and Human Services, some of you may know, I was a former government attorney well over a decade ago, both with the Department of Justice and with the Office of Counsel to the Inspector General for HHS. And private equity was a thing back then, and there was some talk about it, but it's taken well over a decade to see what we're now seeing both at the state and federal level. And I think, unfortunately that is part of that is the result of private equity not having the same same type of representation from a lobbying perspective within the gov you know within the government and I think that's now changing and so I what I do expect and what I do anticipate I know many of you the private equity firms are part of this you know whether it's AIC or other industry associations I do expect that counter narratives are going to start being popping up and being presented because there's obviously a really good story and narrative that private equity needs to put out there. Namely, if private equity is not funding technological advances or advances in patient care, where's the money going to come from? Because we know the government is not going to fund these things. So I do think that we're going to see changes in how this narrative is being presented, But it largely is going to be driven by private equity firms and cooperation with industry associations and law firms. 

Chris: Yeah. And just picking up on those last points, if anybody's listened to the webinars that have been put out there as part of the FAQs of the government, they are very anti-private equity, to the point they're completely one-sided. Maybe I'll throw this to Dan and Kevin. What has been, I guess, your respective firm's reaction to some of this regulation? Are you looking at it both in terms of investment and PR? I mean, how are you guys kind of thinking about it more broadly? Because there's just such a spotlight on the sector right now. 

Daniel: Yeah, I mean, for us, it's not necessarily outward PR, but more with our LPs and trying to position to them sort of where patient care meets what we're doing to give them their returns. And so for us, it's internally thinking about within ESG, within some of these other initiatives that we have is how do we message that to LPs and other groups that we work with that what we're doing is actually a benefit to the community. 

Chris: Kevin? 

Kevin: Yeah, I mean, I think the increased scrutiny in this entire space just coming from a place of regulators trying to understand everything that's going on, right? Trying to digest the effects of consolidation within the healthcare industry and how does a traditional private equity flip and strip transaction affect jobs? How do physician roll-ups affect the space? How do these new value-based care platforms and startups affect the market? So honestly, I get the focus on it. It's something as healthcare investors need to be constantly thinking about. I've spent my whole entire career in healthcare and I don't understand the intricacies between all these different subsectors within healthcare. So why do we expect the regulators to, right? So I think the intent might be well warranted. I think the problem is, in reality, I think consolidation that's causing a lot of issues in the healthcare world is less so by private equity-backed businesses and more so by corporate giants amongst the payers and PBMs, et cetera. So it keeps me up at night. It's top of mind for us on all the HSR issues that was just touched on. And I think the problem is, is we're investing in companies, particularly in biotech and medtech, oftentimes this increased scrutiny is preventing additional innovation in the category, right? So again, it's top of mind for us and very similar to what was just described over here. It's something we need to constantly be educating our LPs on too. 

Nicole: Yeah and I think it's a good point to make that the scrutiny at the government level is not just on private equity, although that's obviously one of the big talking points that we see in the press and in the proposed legislation that Brian was talking about as well. But we also see it with sort of that consolidation more broadly with vertical integration with some of these payer organizations. So I think there's going to continue to be that government activity as we move forward into 2024 and 2025. A question for you, Brandon, on your end, when you're thinking about the government's role in healthcare investing going forward, let's say in the next six to 12 months, what do you think that role is going to look like and its impact on the investments that you're looking at doing? 

Brandon: Yeah, obviously don't have a crystal ball. And Brian, one more quick answer to that question. Look, I think we're obviously focused on the areas that you brought up from a regulatory or approval standpoint from an FTC perspective, corporate practice of medicine at the state level is something we're very focused on. Obviously, it depends on who wins the election and what that does to regulation. But as I think a lot of folks have touched on, we've always been focused on, compliance and quality on outcomes, as I'm sure most investors are. And demonstrating that value proposition has become a bigger topic to us, getting involved in those lobbyist groups and showing that, hey, we are creating jobs, we are driving, you know, better quality, better outcomes, and, you know, kind of setting that up, regardless of what the government decides to do with some of their proposed and pending regulation. 

Nicole: And Kevin, feel free to weigh in more broadly on what you think the government's role would be, but maybe more specifically, thinking ahead to the election, which is, you know, coming up in a few months, you know, what do you think the outcome of that election one way or the other might have on the healthcare investing sort of in that period of time right after the election finally, the dust settles, let's say, and we know who the next president's going to be. 

Kevin: Yeah, I mean, on the first part, I think the cardinal rule in healthcare is things always take more time, more money, just because everything is incredibly regulated, right? I think on the product side that we're investing in, again, drugs, medical technologies, et cetera, FDA has done a great job of pushing drugs and technologies to approvals. I think they're at all-time highs, which is great. Reimbursement has become more and more of a slog for investing in commercial stage opportunity, just getting an approval means nothing nowadays. Now you have to go out and get reimbursement coverage. And we're seeing that across our portfolio. It's getting more and more difficult, even though we're picking companies that have an incredibly robust amount of clinical evidence that shows good clinical outcomes. And also, you're actually saving the healthcare system money. I think back to the HSR side, it's cloudy our investment thesis if we think it's going to be a difficult ultimate exit down the road, if a strategic is thinking about how this affects you know antitrust issues right we were we we led this series seeing a company called GRAIL if you guys probably know that was sold to Illumina that just had to be forced to divest that business actually yesterday and spun it out so it's just it's all very top of mind to us on the question around election I i'm not going to pretend to be a political analyst here obviously there's always critical matters at stake I looking back at the data over the last four or five election cycles, so-called the last 20 years, I think we've seen Republicans sweep, Dems sweep, split government and if you look at all the data, there's always volatility in and around the time of the election, but the healthcare market generally performs well right after the election. And I think this year specifically, I actually think healthcare is a little bit less in the limelight than just other broader geopolitical issues and things that we're all well aware of. So versus elections in years past, I'm actually less concerned about who wins the house and how that affects our investment philosophy. 

Chris: Maybe I'll throw this to you, Tony. We've started this panel about everybody expecting to be this massive waves of assets, of quality assets that have been building up and building up. We heard from Brandon, obviously, though, that sale processes are taking longer, people are being a lot more deliberate. I commented about valuations maybe not yet being there. We've also talked about the increased regulation. How is all of this coming together? Where are we heading for the next six months? Where are we heading next year? Are people less inclined because of some of this regulatory focus to be in the market? What's your view in terms of what things look like going forward? 

Tony: Yeah. No, there's going to be activity. I think post-Labor Day, we're going to see, as I mentioned, I think a lot of what's been coming out are things that I'll say bankers have been holding back, rightfully bankers and their owners saying, hey, it's not the right time until we got some normalization of the debt markets. We're just accepting what the debt markets are, I guess is what it really is. But the thing now, I think we're going to start seeing that pitch velocity for the assets that are going to be coming out. What's interesting, I do still think there's been a quality of asset. I said, I mean, I'm a banker, so every B and C asset's an A, don't worry about it. But I think we have seen more of the Bs and Cs where we are getting the canaries in the coal mine, like those A assets in certain segments that everybody else is watching to see if it transacts and happens. And that gives people the confidence that, hey, the values are out there, right? I mean, hey, we can put five and a half times leverage on this. Great. At that interest rate, we've got handcuffs with those. So how do we manage through that and things of that nature? One of the things, and I think, Brandon, you said a couple of things that are very important, and it's something I'm talking to everybody within our team, but also across the bank, about is process design matters. I'm hearing a lot of frustration from private equity players that bankers are still trying to run processes like it's 2021. Now, we know banking is a young person's game. We haven't had a down market for 15 years. So a lot of folks who've only really seen an up market and how you market in an up market. My reality is I think some bankers are still over pitching valuations because in a down market, you got to get what you can get. Problem is if you go out and try and mark that in the market, you end up with issues of, and we give a lot of advice to buyers looking at assets. We're like, look, this is a 10 to 12 times business all day long. We think you got bid 14 to get in. And there are groups bidding the book. And what's happening is you're ending up with attrition immediately post-MP and losing parties, losing competitive tension, and ending up with hung transactions. The secondary thing is if you're running your process too fast. Private equity is in the conundrum right now. They have to do twice as much diligence. It's half because of lenders, but it's half because, hey, I'm willing to get to your premium value. I've got the capital. I've got to put it to work. I need it to diligence out clean. So stop telling me it's speed, certainty, terms, and value all day long. You're going to have to start giving people exclusivity. It was the anomaly was 2020, late 2020 to late 22. too. That was the anomaly, not the norm. And I think people are still trying to run processes through that. And it's creating a lot of challenge for buyers and you're seeing attrition. So I'm telling our team, we're running processes proper. We're not telling clients we can get you everything all the time. And it says, by the way, I don't like hung deals. And then finally, bring in some of your hard bidders. If you've got bidders at 14X, bring in your hard 12, because I guarantee you that 14 is going to turn into an 11 and the hard 12s are going to say, you're an idiot. And by the way, that's good for your fee overall, but bring in some of those players that are cuspy. You can go ahead and keep your message to the market that, hey, it's 14X to get in and just tell the player that's a hard 12. Hey, I know you can play up, you know, play into that. And that's why we're seeing far more transaction activity than we're seeing transaction closings. 

Chris: I mean, Dan, you're on the other side of that. You're getting the books, you're looking at everything, you're acting with Stout and the banks. I mean, what's your reaction to what Tony did? 

Daniel: I think first, you still have a very, very wide range of expectations, right? Buyers have one expectation that we're in the credit market. Sellers have the other expectation that we're two years back and we're still trying to look back in the 2021, 2022 timeframe. From where I sit in sourcing deals as my primary job, deals between zero and 15 million to be able to have still been in the market in healthcare services. We're seeing those deals. There's good quality deals. The ones that are larger than that, bankers are really having to have tough conversations. We've been sitting on this deal for the last six months, nine months, 12 months, is now the right time to pull the trigger. Good assets still get premiums and are still getting valuations that we expect. We're still buying deals that we're getting on good multiples. I'll say where the add-ons come into play is a little different. They're not getting the same multiples today that they were getting two years ago, which were consistent with what we were playing for platforms. So you're seeing the change as we do our buy and build strategy within healthcare services. The add-ons are not as rich of a multiple as we had been. Going forward, I think that you're probably gonna see deal flow kind of stay the same within that lower middle market, you're going to have some of those larger deals come to market. But really, I think 2025 is going to be when more of the floodgates open and people get a little more comfortable with the market. 

Nicole: We've heard a little bit about the changes on the horizon from a regulatory perspective, the financial outlook, and the markets generally. This is going to be the lightning round for the entire panel. And I'll start with Tony, since you're right on my right. I know you get to go first. Just a one-minute view on what you expect the outlook for healthcare investing to be for the rest of 2024. 

Tony: Yeah, I think for the remainder of 2024, we are going to continue to see increased activity month over month. I do also think you're going to start to have those conversations happening in Q4 for Q1 launches, because I do think 2025 is setting up to be a year of necessity of going to market in transaction velocity. You know, hopefully we can get to a point where we're seeing transaction closings matching what's in market. But I do think that's getting to that alignment that Dan was talking about. So I would anticipate seeing increasing deal flow, increasing direct discussions with some of those assets, maybe you've been knocking on doors of where they're getting serious and saying, all right, now's the time to go make it happen. So through the remainder of the year, I think I'm optimistic. I've never been a great wave person. Like, hey, there's going to be a wave of deals. I do think ’25 is going to be better, but I think each month is going to tick up. And I think investors are finding the right seams where they want to go target. We have seen increased interest in life sciences and diversifying some of those healthcare services plays. But we saw that starting kind of back in ’21 having to do with that pandemic resistance dynamic overall. So I would anticipate seeing more in med tech, seeing more in outsourced pharma services, areas like that where there's a little bit more insular budgets and better regulatory dynamics where, hey, we're actually getting FDA approval. So that's great, as opposed to, hey, everything's a problem and a little bit murky and opaque. 

Nicole: Yeah, go ahead, Brandon. We'll go down the line. 

Brandon: Yeah, I'd echo a lot of that. I think we've still seen those A-plus, A-deals getting done, not just the ones that Tony are telling us are A-deals. To Dan's point, I do think you see more activity in 2025. But I think, and you asked the question earlier, I didn't answer it. Look, we're fortunate to be a big firm and not have a ton of LP pressure, but you're going to see more and more LP pressure. I'm not sure you talked to our investor relations teams and they're telling you, you know, LPs are very focused on return of capital. I think on top of that, you're going to see lender pressure as well, right? Those companies that should have sold in 2022, it's now 24, you know, they gave you kind of a year or two. At some point, they're like, look, guys, we want to get out of this. And I think you'll start to see sponsors where, you know, hey, you were hoping this was a two, three times return. turn. But if you have a path to getting an acceptable outcome, whether it's your LPs or your lenders, you're going to be pushed. So I think from a deal activity standpoint, I think we'll expect to see volume increase. And I think you'll start to see that close rate increase as well. 

Daniel: Yeah. So I think the activity is still going to happen. I mean, right now we have in healthcare services, two deals under LOI. So in the summer months, hopefully those two will close, but I think you'll start to see some of those middle market deals actually get closed. One thing that we didn't mention is that I see approval too, is becoming harder to get with a lot of these companies. So I think that, you know, there are certain markets within healthcare services that are favorable and some that are unfavorable. So some of those favorable markets, deals are continuing to get done. The unfavorable ones, it's going to be cyclical. And once kind of the market knows and the perception changes, I think you'll start to see more activity there. But I think it's, as I mentioned earlier, I don't think it's going to be until 2025 that we really see the market come back to where we had seen it before. 

Kevin: First of all, I feel very good now that I know the playbook on how to sell a company, from Tony. But yeah, I think a little bit of what Brandon said too, I think just across the board for private equity firms, regardless of the subsector in healthcare, DPI is low in funds that were raised in 2018 through 2022. So I think you're just going to see more and more deal volume have to pick up from that perspective. On the product side and in biotech and medtech, we're seeing a lot more activity now. I think we did in medtech, for example, we did two investments in 2022, 2022 and 2023, we're doing four, about to be five over the next month and a half. So I think that's an effect of finally post the COVID kind of bubble era companies or high quality companies are finally willing to kind of take their medicine a little bit on valuation. So I think every single one of the deals we're doing right now are at significant down rounds or with heavy structure, which I think is just, you know, taking the dose of reality where the public markets are. In biotech, we've seen very high-quality companies be able to get public, and the highest-quality ones trade well. I think medtech and other areas like Digital Health will lag the biotech market, but I do expect IPO activity to pick up later this year and early next. And that's a little bit of a lag as well because M&A volume has picked up from strategics as they've sorted through their own balance sheet issues and on portfolio construction issues. So overall, I think activity will continue to pick up and I'm actually pretty bullish on 2025. 

Brandon: It's one thing that you touched on an interesting point, just like the need for creativity, whether it's through structure, or getting a little bit more scrappy on how to get a deal across the finish line. We've seen the founder led deals where they're not focused on last dollar, people feel are willing to maybe roll a little bit more and increasing corporate carve outs. So I think part of it to your point too, is not running the same playbook from the private equity guys and being a little bit more relaxed, I roll up your sleeves, do a little bit more work, incorporate structure. 

Brian: Yeah so notwithstanding what I said at the beginning at my talking points uh i'm incredibly optimistic uh I've been doing this for 20 years, eight years at a high level in the federal government and I've seen cycles where the rhetoric is really aggressive you know it was for several years it was targeted in the life sciences space with drug manufacturers med device manufacturers. You know and then it moved into the not-for-profit space with hospitals and health health systems being non-compliant, especially when it comes to the Stark law, a lot of types of, you know, lots of regulatory activity. And now we're seeing it in the private equity space. And usually what happens is, you know, the rhetoric starts very aggressive. There's a lot of hyperbolic comments and statements at both the federal and the state government levels, but then it ultimately balances out. It always comes back down to a more even keeled, manageable perspective and view. So unfortunately, I think that's what we're seeing right now. But like I said, if you go back 10 years, you will see that there were the similar types of rhetoric and hyperbole was being pushed by government regulators, but focusing on different companies in the industry. So I'm optimistic because of that. And I know Carol, I've been doing this for 20 years. Carol's been doing this for longer. I'm sure she would agree. It does go in cycles. We just happen to be in one of those cycles, but it will certainly balance itself out. 

Chris: Well I’m glad we're ending on a high note in terms of optimism going forward. Obviously, that's better for everybody at this table. So thank you, everybody, for participating in the panel. Really appreciate the time. Definitely some valuable insights. Thanks, everybody. 

Outro: Dealmaker Insights is a Reed Smith production. Our producer is Ali McCardell. For more information about Reed Smith's corporate and financial industry practices, Please email [email protected]. You can find our podcast on Spotify, Apple, Google, Stitcher, reedsmith.com, and on our social media accounts at Reed Smith LLP on LinkedIn, Facebook, and Twitter. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

All rights reserved.

Transcript is auto-generated.

Reed Smith partners Mark Goldstein, Cindy Minniti, and Michelle Mantine come together to break down the Federal Trade Commission's final rule on non-compete agreements and how it may affect U.S. businesses.

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Transcript:

Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers. 

Mark: Welcome back, everyone, to Dealmaker Insights. My name is Mark Goldstein. I'm a partner in Reed Smith and Labor and Employment Group, and I'm joined by my colleagues, Cindy Minniti and Michelle Mantine, both partners as well at the firm. Today's topic is non-compete agreements. Been all over the news lately. Non-compete agreements have long been used by businesses to bar key employees from leaving their business and going and setting up shop across the street the next day. There are a whole host of reasons why businesses may want to impose a non-compete agreement on an employee. However, over the past several years, state legislators have worked increasingly scrutinized the use of non-compete agreements that passed a whole host of legislation. And finally, the U.S. Federal Trade Commission in April 2024 issued a final rule that if it takes effect, would prohibit virtually all pre-existing and future non-compete agreements across the U.S. So I'd like to turn it over to my colleagues today, Cindy and Michelle, and together we'll break down what the Federal Trade Commission's final rule says and how it may impact U.S. businesses. So, Cindy, let me start with you. Can you tell us a little bit about the background to the rule? 

Cindy: Sure. Thanks, Mark. Like you said, there have been a lot of state legislation recently over the last couple of years, really trying to limit the use of non-compete agreements. And President Biden in July of 2021 directed the Federal Trade Commission to come up with some federal legislation really limiting the use of non-compete agreements. In an effort to really be wide sweeping in January of 2023, the FTC put out a proposed rule, which got a lot of attention from businesses and a lot of people commented on the proposed rule during the comment period. There were about 26,000 comments to the proposed legislation. And then ultimately, the proposed rule is now out as of May of this year, it was published in the Federal Register. And like you said, if it does go into It will go into effect in September. But it really is an absolute ban to non-compete agreements. There are very, very limited exceptions, but this is really an absolute ban on current and future non-compete agreements for virtually everyone. There's a small exclusion for senior executives and some other minor exclusions, but really this is an effort to really stop people from really enforcing non-competes on their workforce, really open up people and to be able to go to competitors. It's also interesting that it's not just for employees. The proposed rule is for anyone that's really doing work. So So employees, contractors, anybody that's got any kind of a relationship. So independent contractors, interns, it's really very broad sweeping. 

Mark: That's a great point, Cindy. And the definitions within the final rule are really key and are extremely broad. The definition of worker, as you said, the definition of non-compete clause is quite broad. Michelle, let me ask you, because I know that this is a question a lot of our clients have asked. We understand that future non-compete agreements after the rule takes effect, if it takes effect in September as the currently scheduled effective date, those would not be above board. But what about pre-existing non-compete agreements? I know Cindy alluded to it, but how does the final rule adjust pre-existing non-competes? 

Michelle: No, it's a great question, Mark. And as Cindy said, it's pretty broad sweeping. Yes, the final rule absolutely applies to pre-existing non-compete agreements. There is sort of or are limited exceptions. The exception that I would note here in particular is for pre-existing non-compete agreements entered into with senior executives. And that term, like so many of the other definitions that accompany this rule, is defined very carefully and specifically in terms of what it means to be a senior executive. And if you fall outside of that category, the ban does apply. With respect to those other pre-existing non-compete agreements, those not with senior executives, I mean, the ban is saying, as Cindy pointed out, that the agreements will not be enforced. First, they are illegal, and that would be after the final rule's effective date, which currently absent any changes from it based on litigation is September 4th. The FTC is also saying as part of this guidance that the employer must provide clear and conspicuous notice to the worker of these sort of factors to make it very clear to the worker that if they have this pre-existing non-compete agreement, it's going away very soon. So the exceptions are extremely narrow. And again, something that if you're looking on relying on an exception for the senior employees, the senior executive employees, or in another context, you really need to look closely at the definitions to make sure you're in a safe spot. 

Cindy: Michelle, that's a great point about the definitions. Another question we get a lot is when you talk about non-compete, what about competitive activity during employment? And I think it's important to note that this is a broad sweeping regulation for post-employment restrictions. So we still are able to have employers banning current employees from having any sort of competitive activity during their employment, that this is really post-employment competitive activity that we're talking about. And I think it's just important to note. 

Michelle: Great point, Cindy. Let me ask, are there any exceptions? I know, obviously, we have the carve out for pre-existing agreements with senior executives, which from a high-level perspective, the rule essentially defines as someone making at least $151,000 a year and in a policymaking position. Besides that, are there any, Cindy, let me ask you, are there any exceptions to the rule? Some state legislatures, like in California and Minnesota, who have adopted all-out bans on restrictive covenants, do still include a carve-out, for instance, in the sale of business context. 

Cindy: Yeah. So I think that's probably one of the most talked about things right here is it's a bona fide sale of business is an exception. And there was a lot of discussion about what is a bona fide sale of business and are there percentages or a threshold that should be considered. Considered, and that was a lot of the comments and a lot of the consideration, but this final rule does have a carve-out for bona fide sale of the business so that you could have a restriction there because there are other interests at stake. And there are two other sort of litigation exceptions as well. So if there was litigation or if there was some interest in enforcing the non-compete before the rule goes into effect, or if there's a good faith belief that the rule is inapplicable. So, you know, I guess if you're arguing, is someone really a senior executive, or if you believe that they are a senior executive, something like that. But so those are the two sort of litigation exceptions. But I think really, the sale of the business is probably the one that we're going to see the most. Mark, did you have any thoughts on the sale of business and all of the discussion and back and forth, you know, before the final rule was proposed? 

Mark: Yeah. So I think that the sale of business exception probably is the biggest change between the proposed rule and the final rule. Generally speaking, the proposed rule that came out in January 23 is conceptually the same as the final rule that came out in April, May of 2024. Some of the language was tweaked, but the underlying concepts are the same. But the sale of business exception changed substantially. And the reason for that is because in the proposed rule, the FTC said that this carve out for the sale of business would only apply if the person that you're trying to bound by a non-compete is purchasing or owns 25% or more of an ownership interest in the entity at issue. So if somebody had a 12.5% ownership interest, the sale of business exception would not apply and they could not be bound by a non-compete. So in the final rule, the FTC dropped that 25% requirement, really conceding that there was no specific underpinning or justification for that metric. However, the FTC has said that despite this, they do anticipate rigorously looking at transaction to make sure that folks aren't entering into what they call sham deals. So essentially make sure there's a genuine bona fide sale at issue, not some sort of attempt to evade the FTC's non-compete ban. 

Cindy: I’m going to jump in on that. I think that's really important because we were hearing a lot of questions when we saw the proposed rule about what really is a sale and what if there are some corporate maneuvers that can happen, would we still have the enforceability of these restrictions? And I think that the comments and the commentary took a long, hard look at that and tried to make this as broad as possible. 

Mark: Yeah, that's exactly right. And the FTC even calls out things like repurchase rights or mandatory stock redemption programs and makes clear that those are not bona fide sales transactions, so they would not be subject to the exception. Obviously, particularly in the private equity space, businesses will be looking to capitalize and see if there are transactions that can be deemed bona fide that perhaps are broader than the scope initially contemplated by the FTC based on the language in the final rule. And that's obviously something you'd want to consult with counsel about to see if you're able to exercise and invoke the sale of business exception. Michelle, let me ask you, because I know that I've gotten this question a whole lot. But if you put a non-compete into a document other than an employment agreement or restrictive covenant agreement, some other sort of agreement could be an equity incentive, equity agreement, does that matter at all to the FTC? 

Michelle: It does not. And I have gotten that question a lot as well, Mark. People are trying to think of ways in which perhaps the non-compete has legs. And I don't say that in a nefarious way. I think people are thinking about ways in which to protect their trade secrets, their technology, things that they have concerns about sort of walking out the door. What will happen to it if that employee leaves? Are they adequately protected? And the FTC has said that, you know, this non-compete ban covers all terms of employment that meet the definition of a non-compete clause, regardless of whether that terms in something characterized as an employment agreement, an incentive equity award agreement, or some sort of separate restrictive covenant agreement, separation agreement, employee handbook, whatever document it is, you have to, again, go back to those definitions and say, is this a non-compete clause? And then is there any narrowly tailored or limited exemption that might apply here, right? So they really are saying they want these gone. Interestingly, the FTC had sort of a follow-up to the final rule release in April that they did on May 14th of 2024, sort of talking about how do you comply with the new rule. Interestingly, they didn't provide, at least from my perspective, they didn't provide a whole lot of concrete, specific guidance. But they certainly hammered home this point that if it's a non-compete, it doesn't matter what kind of document it sits in. We're saying this rule is saying get rid of them. And they even said, if you're an organization that's perhaps not under the purview of being regulated by the FTC, that the FTC would encourage you to get rid of non-competes because of the damages that, in its view, non-competes have had on the working environment. So definitely broad sweeping, to say the least. 

Mark: And I want to ask you something, Michelle, and it relates to something Cindy said earlier. Cindy mentioned this covers post-employment non-compete agreements. So non-competes during employment are still permissible. I want to ask you about what we call garden leave agreements. And these are very common in the UK and in the US are fairly common in the financial sector. And essentially, a garden leave agreement is an agreement where for a certain period of time, often somewhere between 90 and 180 days, when individuals still remain employed by a business, they'll still be getting paid their salary, but they won't perform any active duties. They often won't come into the office. But again, they'll still technically remain an active employee. Does the FTC weighed in on garden leave agreements? 

Michelle: They have, and the final rule does not apply to these agreements. I mean, as you pointed out, sort of the structure of them, they're also common in different sectors like financial services, for example. I think that the idea that garden leave agreements are sort of outside the scope is consistent with what Cindy mentioned before about this being a post-employment rule. The final rule commentary actually specifies that an agreement whereby the worker is still employed and receiving the same total annual compensation and benefits on a pro rata basis would not be a non-compete clause under the definition because such an agreement is not a post-employment restriction. So they're looking at it in that circumstance as the worker continues to be employed, even though the worker's job duties, their access to colleagues or the workplace has been significantly changed or perhaps it's gone away entirely. You know, so it's a really interesting sort of take on things and makes you think that perhaps we'll be seeing more employers use these garden leave agreements as it seems like one of the only, if not the only, option for a business that has concerns about, you know, sort of how workers may compete post-employment with them. Can this garden leave provision provide them with any protection or benefit? 

Cindy: Michelle, I think that's a great point on garden leave and looking at garden leave and is that an opportunity for employers to protect interests that they want to protect while employees are They're still getting compensation, so they're not being penalized in some way. And I do think that we might see garden leave becoming a little bit more commonplace moving forward. The one thing that I would encourage everyone to do is just really take a look at garden leave and make sure that it's not having unintended consequences. Make sure that your benefit plans are protecting people that we think it's going to protect and make sure that there's no other agreements or anything else that we need to look at. So we want to make sure we're not solving for one issue, but creating others. So look at that closely. Great point. Mark, I think we were just going to turn and I think it would be interesting if you want to talk about non-exempt status and what does that do with this rule? 

Mark: Yeah. So a lot of chatter has been around what types of organizations are exempt from the purview of the FTC's rule, because Section 5 of the FTC Act does not apply to every single entity in the US. For one thing, certain banks are exempted from Section 5 of the FTC Act. Another type of business that has traditionally been thought of as being exempt are nonprofits. And the FTC acknowledges, therefore, in the commentary on the final rule, that on its face, a true nonprofit is not subject to the final rule and therefore is not banned from having non-compete agreements with its employees. Though, you know, I think it's probably fair to say that non-compete agreements are less common in the nonprofit sector than they are in the for-profit sector. But the FTC then goes on and cautions entities that are claiming tax exempt status as nonprofits and says, you know, just merely claiming tax exempt status does not mean that you are truly outside of the purview of the FTC Act. The agency says, you know, what we look to is really that there be an adequate nexus between an organization's activities and its public purposes, and also that its net proceeds be properly devoted to recognize public as opposed to private interests. So the FTC uses a two-part test to determine whether or not an entity truly meets the test for being a nonprofit, regardless of what's claimed on a tax form. So an entity theoretically could be claiming tax-exempt status, but for purposes of final rule, the FTC might not consider that to be a nonprofit. And thereby the entity would be subject to the final rule. So if you're a business that is claiming tactical gun status as a nonprofit and still want to be able to use non-competes going forward, it would certainly make sense to review with counsel, you know, whether or not, you know, you definitely squarely fit within, you know, the law's definition of a nonprofit. 

Michelle: Mark, just two points on that. At the May 14th discussion by the FTC on how to comply with the non-compete ban, they actually mentioned this scenario in particular. And the FTC encouraged entities that are truly nonprofits to also get rid of their non-competes. It was quite an interesting take, in my view, that they were sort of acknowledging, yes, some of you might be outside of the span and outside of our purview of Section 5, but that we're strongly encouraging you to get rid of these provisions that we think are just not good. The other point on that, I just want to flag for everyone, if you haven't read it, if you're thinking about relying on nonprofit status or anything else to say to keep yourselves out of the purview of Section 5, take a minute to read the FTC's statement from November of 2022 on sort of the scope as the current administrators, the current agencies who see the scope of Section 5 of the FTC Act. They are interpreting it more broadly than ever. Specifically, they've said in that statement and in other public forum that the FTC Act really is designed to go after conduct that doesn't otherwise violate the antitrust law. So it might not be a violation of the antitrust laws, but they still think it sort of looks and smells like it could be a violation. It is extremely broad right now in the territory that sort of is being caught within Section 5. So you want to be really careful about sort of what you're doing and whether or not you could get caught up in a Section 5 investigation. 

Mark: That makes sense. Thanks, Michelle. Before we turn to what the future holds, Cindy, I just want to confirm with you, outside of non-compete agreements, that's just one type of restriction or contractual clause that businesses may use to make sure that employees don't improperly compete with them. They may use things like employee or customer non-falsific clauses, confidentiality clauses. Are those referenced by the final rule? 

Cindy: So that's a great point. So yes, employers can still use non-disclosure agreements. We can still have non-solicitation agreements. We can still have confidentiality clauses, again, subject to other restrictions and other guidance that's already out there and in place. But that's all permissible. Here, we're really talking about non-compete, so stopping somebody from competing with the employer. So, as long as you're complying with applicable state law and other federal laws, these other agreements are permissible. 

Michelle: Probably a good time to take a look at those NDAs that you're using and those confidentiality agreements to make sure that they have the protections that you really need here. Because I think in the past, right, we've relied or some businesses may have relied on the non-compete and they're going to have to rely more heavily on the NDA and that confidentiality agreement. 

Cindy: So that's a great point, because not only do we want to make sure that the other agreements are in place and that they're drafted appropriately, but in practice, employers should be really making sure that they're doing what they need to do to really protect things that they're saying are protectable. So, you know, if you've got confidentiality agreements in place, you want to really make sure that you are treating that information as confidential and that if there's a challenge, that you can really show why you don't want that information getting out. So really looking not only at your documents, but your practices. 

Michelle: That's a great point. 

Mark: So I want to ask you both in closing, what you think employers should do in the near term and potentially in the long term. And just to give everyone a status update, the U.S. Chamber of Commerce has filed a lawsuit that has been consolidated effectively with another lawsuit in Texas federal court challenging the final rule on a host of grounds, including that the FTC doesn't have the authority to issue a rule like this. The Chamber of Commerce has made a motion to essentially ask the court to nullify or validate the rule. There's been no ruling on that yet, but since we have until at least September 4th before the final rule will take effect, there's plenty of time for the court to rule and for there potentially to be appeals. I think it's fair to say a lot of people from the business community think that there's at least a reasonable likelihood that the final rule will not take effect, at least as planned, understand either in whole or in part, and that some of the arguments put forth against the rule do hold water. So let me ask each of you, Michelle, I'll start with you. What would you say for the business community in the US right now, who's kind of bit of a limbo period, how they should proceed? 

Michelle: Mark, it's a great question because we're really in sort of this limbo period, right? I think the biggest thing I would recommend right now is not to panic, to use this time, as we were just discussing, to take a look at, sort of take inventory of your agreements, your NDAs, your confidentiality agreements, how many workers you have that have a non-compete, how many of those might fall into the senior executive category, sort of looking at, okay, what's our exposure if this rule goes into effect, if this ban goes into effect? And then you need to sort of take, I think, a measured approach and sort of evaluating, okay, if it goes into effect, when we get rid of these, how do we protect ourselves from what we otherwise saw that nothing could protect us? Protecting our business interests post-employment and thinking of practical ways to do that with other agreements. I wouldn't suggest doing anything rash at this point, Mark, because of the good points you made with this pending litigation. I would expect the court to move rather quickly here and within the next couple of months, knowing that this proposed ban goes into effect on September 4th. And I do think there are some excellent, excellent legal arguments as to how the rule is just outside of the FTC's domain here and is really stepping on what is otherwise within our state law purview. you. That being said, again, with the state laws, those have also been developing quite often and they're changing. So keeping an eye on those, if you do have non-competes, making sure that the ones you have, that you are okay from a state law perspective as well. I think it's a really good time to look at that as well. So that's just a few tidbits. I'm sure Cindy can add to that. 

Cindy: No, Michelle, that was a great answer. I think that's right. I think you should be taking stock right now of what agreements you have in place and what do you actually need, looking at what you want to protect and is there another better way to do that? And even making sure that the agreements, you know, whether this goes forward or is changed in some way or, you know, we really have to be mindful that there are state laws out there and there are other restrictions. So really want to make sure that we're looking at that. So I think take the summer, let's enjoy ourselves and look at all of our non-compete agreements and policies and practices and make sure that we're We're really protecting what we need to and so that you're ready if this does go into effect, but you're ready nonetheless for the state laws or other changes that may come along the way if it's not this one. 

Mark: Awesome. Thank you, Cindy. Thank you, Michelle. And thank you, everybody, to listening to the Dealmaker Insights podcast brought to you by Reed Smith. And we thank you very much. 

Outro: Dealmaker Insights is a Reed Smith production. Our producers are Ali McCardell and Shannon Ryan. For more information about Reed Smith's corporate and financial industry practices, please email [email protected]. You can find our podcast on Spotify, Apple Podcasts, Google Podcasts, reedsmith.com, and our social media accounts. 

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers. 

All rights reserved.

Transcript is auto-generated.

In our latest episode of our Private Equity Spotlight series, Reed Smith partner Nick Gibson is joined by Matthew Carlos, a principal at New Water Capital, for a deep dive into the unique aspects of Lower Middle Market Private Equity.

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Transcript: 

Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers.

Nick: Welcome back to Dealmaker Insights, the Reed Smith podcast series spotlighting the private equity industry. I'm Nick Gibson, a private equity M&A partner in the Chicago office of Reed Smith, and I'm excited to welcome Matt Carlos of New Water Capital as our guest today. I've really enjoyed getting to know Matt and his team who have focused and thrived in the lower middle market. Matt wears a lot of hats at New Water Capital, and that's one of the topics we'll dig into a bit today. But first, I'll turn it over to Matt and let him introduce himself and New Water Capital. Great to have you here, Matt.

Matt: Thanks, Nick. Appreciate you having me and happy to chat through the latest and greatest of New Water here. So I can dive right into a quick background on myself and on New Water. So I'm a principal here at New Water Capital. Been with the guys now for over seven years. Joined back in January of 2017. The fund officially started in 2016 and was originally a spin out of Sun Capital Partners. So Jason and Brian spent around a decade together at Sun. Saw Sun grow from a few hundred million under management, multiples of billions. I'm sure as as you know. And the rationale or the reason to spin out and do their own thing, create New Water, was to refocus on the lower middle market. And we've incrementally refined that for us to be really focused on what we call blue-collar industries. So manufacturing, industrial services, packaging, distribution. That really covers the majority of what we're focused on. From an end market perspective, we're a bit more agnostic. So if you look at in our portfolio. It's food and beverage, it's industrial technology, auto, packaging, you name it. And so we do tend to be more operationally focused and much more opportunistic. So we've got an in-house ops team, ex-CEO, CFO, COO type folks who work exclusively for New Water, so not consultants on hired guns. And so they are invaluable in dropping into our portfolio companies and help them think through next steps. So there's just creating KPIs, budgeting, walking the shop floor, look at efficiencies, and or just being a shoulder to cry on, quite frankly, as we go through growing pains or integration. And so really a valuable part of the team, but it helps kind of differentiate what New Water does in the market, which is really focused on where we can help portcos grow, improve, and. Get to the next level.

Nick: That's great. Can you talk about the various hats that you wear in your role particularly, and maybe how that differs in approach from other private equity firms?

Matt: Sure. Yeah, we are a lean team. And so because of that, like you mentioned earlier, we do wear a lot of hats. First and foremost, I think other private equity funds that are our size and focus in our industries, I think it's very typical for those firms or a lot of our brethren these days to have a designated business development arm. We at New Water do not at the moment. I think at some point in the future, hopefully we will be large enough to where it's needed. But at the moment, we don't. And so what that means is that myself and the other folks on the deal team here, we will kind of pass the hat or pull straws to just do the best we can to attend as many events and conferences, to be doing city visits visits, and meeting with intermediaries and bankers and lenders as much as we can. And of course, that takes away from, I guess, what you can say is our day job or what we are focused on most actively, which is portfolio management and getting deals done. The flip side is that I think if you were to poll the audience here in the deal team, we really do like being out in the market. I think it gives us a flavor, some firsthand experience of what people are saying, what other private equity funds are experiencing in real time, what bankers are seeing in real. And another angle to that is that a lot of our investment banker and intermediary friends, they feel like they have access directly into the deal team when they see us out on the road as well. So I think it works both ways. But additionally, what really makes us different and what we really focus on is on that ops part of the business. And so not just the operations team, do they focus a ton on portfolio management and portfolio improvement. Really, the deal team does as well. We oftentimes are just an extra set of hands for our leadership teams that are portfolio companies. And so when you get down with diligence and the ink dries on the purchase agreement, the folks who know that investment best right out of the gate is the deal team. And so we're really helping to help them think through forecasting and building out weekly flash reports and budgeting and all that good stuff. And then skew rationalization analysis, ad hoc analysis, we're oftentimes just extra arms and legs for the DLT or for the leadership team at our portfolio companies, just get stuff done out of the gate. And then over time, our ops team plays a much more active role with those portfolio companies, but it transitions that way over time.

Nick: Where is New Water at in its fundraising cycle? And what are you hearing from LPs this year that may differ from previous years?

Matt: Yeah, great question. Fundraising, obviously, a hot topic across the private equity universe. So for New Water, we are winding down fund one. We've got three assets left in fund one. Two of those three are pretty mature. And so hopefully in the next handful of months here, those will be officially in market via sell side. And fund two is ramping up we probably got enough room and fun too to do a couple more investments platform investments and so I put two and two together we're we're kind of knocking the door for for raising funds that's that's super exciting for us. The market so what what we're hearing is that the current state of the fundraising market is not too different this year from where it was last year. So I'm sure you're well-tuned to just general deal flow. It has been slow for the past couple of years. That means capital is not being recycled very quickly, which means LPs don't have a lot of room for allocations. And so the dam kind of has to break at some point. I think everyone knows it's going to happen. It's a matter of when. And so if you are listening to what LPs are saying, it feels like 2025 is the year in which more allocations are expected. And so we certainly hope that that's the case. We know that the fundraising environment has been tough over the past couple of years. And so once the wheels start turning in a more normal fashion in the market, assets are trading hands, there's more deal activity, we think that that domino effect will lead to more fundraising opportunities for the property equity universe.

Nick: Reflecting back on 2023, what were some of the market observations you had, maybe challenges you face, and then opportunities within 2023 that you found?

Matt: So 2023, I just mentioned it a little bit. It definitely was slower deal activity. I think 2022 was slow. And the numbers will tell you that 2023 is even slower than 2022. So definitely not a flurry of deal activity. The deals that we did get done were interesting. A lot of assets had what we were calling noisy EBITDA. So in this kind of post-COVID world we're living in, a lot has happened. Think about labor shortages, shipping crises, semiconductor shortages, commodity prices ripping. And so you add all that together and that just creates, again, kind of a noisy environment to look at an asset super clean and to really understand what's a normal margin profile or a normal growth rate you can expect out of the business. Again, given all those noisy dynamics over the past couple of years. And so it just took a lot more work and a lot more negotiating with sellers to come to a compromise on what's practical, what's transactable, what can two sides agree upon. So noisiness on what did get done was definitely an overarching theme for us. That's tighter leverage, of course. I think everyone's been well aware of what the debt markets have done over the past couple of years. Obviously, higher spreads, higher rates on that debt leads to just lower valuations and tighter leverage overall. Not a lot of platform opportunities for us. Specifically, we were being much more stringent, maybe a bit of a tighter filter on what we wanted to transact on from a platform perspective. But we got a ton of that on top. So I think eight transactions we completed over the past 15 months or so, all strategic add-ons for our current portfolio. So definitely active, definitely a lot of work getting done. You know, quite frankly, not a ton on the new platform front.

Nick: Got it. And now that we're into Q2, what are some of the trends you're seeing in 2024? Has anything carried over, at least in what you're seeing in your end of the market? Has anything surprised you yet?

Matt: So if you would have asked me a month ago, I would have said no real change in 2023. But really over the past month, we've seen deal activity pick up a pretty good bit. Definitely not this watershed moment where all of a sudden, it's blow your doors off busy, but it's definitely busier. Pipeline's a little fuller. There's more opportunities out there. We're actually seeing a lot of carve-out opportunities. The reason for that, not quite sure, but a lot of larger public and private businesses are trying to shed assets, maybe to raise some capital, maybe just being opportunistic in the market. But we're seeing a lot of carve-out opportunities, which is great for new water. Like I mentioned before, we're very operationally focused. So the extent there's some value there to carve something out of a larger business and get standing up on its own, clean it up. Obviously, all great opportunity for us. Valuation expectations, there does seem to be still a little bit of a gap from what sellers expect their assets to clear for versus what the market is speaking for at the moment. I think that's going to work itself off, but we definitely still see a bit of spread there. And the other thing that we've seen in 2024 that's a little bit of a mystery for us in 2023 is there is this kind of destocking phenomenon that folks kept talking about in 2023. Volumes were down pretty consistently across the board in industrial and markets. And a lot of folks pointed their fingers to this destocking event that was a byproduct of COVID. So, supply chain issues and COVID in many different facets led to buyers of raw material or commodities or finished goods to buy as much as they could because they weren't too sure of the certainty for product to be available when they needed it. And so, they opted to be more safe and just to buy as much as they could when they could. And what that led to is kind of rampant growth in 2021 and in 2022. And as you look back in 2023 and part ‘24 now, you can see that those inventory levels are coming back down, folks are buying less, and they're telling people that we bought too much and we have to clear out what we purchased too much of in prior years. And so in 2023, that felt like an anecdote. We were hearing that a lot, but couldn't be really sure of it as the dust settled. And in ‘24, we get to evaluate across our portfolio companies and talk to other experts in the the field, we can kind of validate that that was indeed a phenomenon that we saw. We see things kind of being more normal now and a little bit closer to business as usual.

Nick: And maybe it's among the themes you just touched on, but what excites you the most about the rest of 2024 ahead of us?

Matt: Yeah. Deal activity picking back up. I mean, you said it. So I think we are excited to have more to do, more to look at. That's every deal guy's dream, of course. So we're excited to see the wheels turning a little bit on the industry. We can definitely see it in our pipeline. I think investment bankers are reporting pretty robust pipelines of pitch activity. And so we know it's coming, kind of feeling it getting up a little bit. We hope it's something sustainable, not a head fake. And so we'll keep our ear to the ground there. And we know it has to happen, right? There's $2.6 trillion of dry powder on the sidelines, just in private equity capital. It's a record amount. Money has to be put to work. And so we know it's coming. It's just a matter of when, not if. We're still busy. A lot of space for smaller assets, founders, entrepreneurs in the lower middle market to where we play. They're still motivated to sell. That's where we find the most activity. So we continue to get a lot of looks. And like I mentioned before, hopefully more platform opportunities for us in 2024.

Nick: Well, you just touched on and perhaps gave a great segue into my next couple of questions, which are really focused on what you're hearing from founders, closely held businesses. I know from my experience in the lower middle market, there's some nuances there that maybe aren't as applicable or that are more important in the lower middle market. Maybe talk to us a little bit about what are you hearing specifically from founders and closely held businesses, particularly as now we're a few years past the pandemic, now we're heading into another election cycle. They've been through a lot, right? The last couple of years. So what is it in specific you're hearing maybe this year as you're talking to new opportunities or your existing platforms?

Matt: Yeah. I think you just said it, which is they've been through a lot. And I think that's why we're still finding motivated sellers in the lower minimum market. They've been through a lot. So between COVID and labor shortages, supply chain issues, commodity and raw material costs us swinging wildly up and down. And then just getting those materials was difficult for long periods of time. I think they've been through a lot. And to get through the other side of that. Pandemic and all the issues that came after, I think they're looking at is you've got a clean business now. You've got a good sellable asset at the moment. You're still going, okay, maybe I can't maximize my proceeds like I thought I could maybe a year or two ago or pre-pandemic even, but it's still sellable. It's still a life-changing event for me. And a lot of those founders and entrepreneurs are still pushing forward the transaction. And so... We know that to be true in our segment of the market. We've also seen a return. And this has been reported on a bunch. I don't think this is anything novel, but we've definitely seen a return of structure to the segment of the market as well. When the market was really hot, I think the ball was in the court of these founders and entrepreneurs, right? The sellers. And they were able to get better terms, not just in terms of valuation, but in terms of rollover and seller notes and structuring and performance notes, things of that sort that helped bridge the gap between expectations and market valuations. And as we sit here today, I think that pendulum has swung very much so back into the court of the buyers. So we've been able to execute transactions with more structure. So depending on the transaction, obviously what that looks like, but it's definitely opened up a little chest for us. A lot of uncertainty still with the economy. Like I mentioned before, you're still having to kind of wade through some noisy EBITDA. You know, 2023 was just a few months ago. And so you're still having to digest what actually happened in 2023, what's normal, what's not normal, and try to adjust for that. We know inflation has been sticky. It feels like rates are going to stay higher for longer. At least that's our expectation. We know that will have to come back at some point, but just given how sick inflation has been, it's not something we're betting on at the moment. And also, like you said, and I mentioned it just a few moments ago, but we can definitely tell a return to maybe more normalized volume activity in our portfolio has returned. Some of these destocking phenomenons that we were dealing with last year, I think that's been worked through. And so we've seen some volumes returning way too early to say if it's here to stay. Again, we hope it's not just a dead cat bounce or a head fake here. But at the moment, it feels like it's a more stable, normal operating environment.

Nick: Before we close, I wanted to go back to something you hit on in your intro, your blue collar industry's focus. What is your approach and how have you found success in building trust with founders in these blue collar industries, particularly from origination through exit? What does that partnership look like from your perspective? What do you hope it to look like from their perspective? And maybe then talk about the role that emotions play in these types of deals.

Matt: Yeah, such a good question. And honestly, it's something that we take a lot of pride in is this exact topic, which is gaining the trust of these founders, these entrepreneurs, these, multi-decade, multi-generational family-owned businesses, and getting them to trust that we will be good stewards or custodians of these legacies. And so it's something we focus on all the time. And... What I can say, what I think we do well is we are very transparent communicators. And so I think what these founders and entrepreneurs can tell is that we are being very honest in what our expectations are for the business, the relationship, the time, the energy it takes to transform business. And I think they feel that authenticity in our message. You know, we all sort of hyper communicative in our feelings around what we expect out of the business and them. And so I think they always feel like they're getting kind of an open book approach from us. And we combine that with the fact that thankfully, we have been very successful in our recent past and transforming these family owned businesses in the lower middle market. And so we're an open book when it comes to, please do call former sellers, executives, CEOs that we either work with now or worked with successfully in the past to ask them directly, how was it working at New Water? And so, again, we try to be an open book. We try to be transparent. We try to be authentic. And the last thing that I'll say, which I think is definitely more tactical in our approach that resonates with these sellers is we truly walk into these organizations without a playbook beforehand. And trust me, we've made mistakes before going and thinking that we already had a plan for business and we were just going to kind of expedite our way to success. And you can't move too fast without having everybody on board with you. And so the point of saying that is every opportunity is different. Every business is different. And you really have to go in there and listen to the people who have run that business every day for decades and solicit their feedback before making your own mind up on what does the business actually need, first and foremost, in terms of building out infrastructure and investing in people, investing in systems, investing in processes, before you have the platform ready to grow in the direction you want it to grow. And so no preconceived notions, no predetermined playbook, but just open communication and dialogue to figure out how to move business forward. I think that tactically has been helpful for us.

Nick: Well, Matt, that's all the questions I had for today. I really appreciate you joining Dealmaker Insights. You've shared quite a lot and I found it extremely valuable. Look forward to following New Water Capital the rest of the year and I look forward to you becoming a recurring guest on the program.

Matt: Perfect. Thanks, guys. Really appreciate it.

Nick: Thanks, Matt.

Outro: Dealmaker Insights is a Reed Smith production. Our producers are Ali McCardell and Shannon Ryan. For more information about Reed Smith's corporate and financial industry practices, please email [email protected]. You can find our podcast on Spotify, Apple Podcasts, Google Podcasts, reedsmith.com and our social media accounts.

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.

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In this episode of our Private Equity Spotlight series, life sciences and healthcare partners Carol Loepere and Nicole Aiken-Shaban discuss the new state laws requiring notices and consent from state regulatory authorities prior to completing healthcare transactions.

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Transcript: 

Intro: Hello and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content please contact our speakers.

Carol: Welcome back to Dealmaker Insights. I'm Carol Loepere, a partner in Reed Smith's Healthcare and Life Sciences Group and I'm joined today with my partner Nicole Aiken-Shaban. We both help companies navigate regulatory considerations for deals in the health care space. Today, we're discussing recent enactment of state laws requiring notice and in some cases approval from state regulatory authorities prior to completing a health care transaction. These are notable as they are separate from long-standing laws regarding changes of ownership or CHOWS as they're often referred to at the state level, governing state licensure and certificate of need. And also they're different from federal laws governing health care transactions such as Hart- Scott-Redo and Medicare, Nicole. Why are we seeing these laws? What are they designed to achieve?

Nicole: That's a great question, Carol. There are a number of different motivations and some states are focused on local concerns as a group. However, these laws broadly are meant to address a perceived gap in oversight for the majority of health care providers within a state that have not historically been subject to more intense certificate of need and or licensure processes. Uh think about hospitals and other hospices or entities like that. In that latter bucket, one question I have asked myself is why now as our listeners likely know, health care is a priority at the federal level right now with increased scrutiny on antitrust and anti competitive enforcement efforts, there's also a related effort to target private equity investment specifically in health care, both by federal agencies, Congress and also the press. Not surprisingly, that focus has trickled down to state legislative action when you take that focus and combine it with the proliferation of nontraditional providers that occurred during the pandemic. Just a couple of years ago, a number of states have started to look to exert more oversight over the provision of health care and who's providing it in their borders. Carol, what is a snapshot of the current landscape of these laws?

Carol: As of April 2024 there are 14 states with health care transaction notice and or approval requirements. Some of these have been on the books a long time while others are brand new and some are just taking effect later this year. One of them is Indiana and we'll talk a little bit about that later. Importantly, though there is legislation pending in several other states including California, for example. So it's very important to check state law as well as pending legislation and regulations that are implementing these laws as you consider health care transactions in various states. Before we discuss a couple of examples of these laws, Nicole, are there certain characteristics or themes that people should keep in mind in reviewing these laws?

Nicole: Yes, I know we are both a fan of lists and for our listeners, I've put together three key points to keep in mind when assessing these laws. First, they are very fact dependent. Many laws have threshold limits that define material transactions or the types of transactions and affiliations subject to the laws. They have varied effective dates, sometimes different effective dates within the same state based on the type of transaction. And there is specific language in those laws on their applicability to particular health care providers and entities in the space as well as obligations on those providers and their different types of notices. Second, definitions are key, not only are they fact dependent, but you have to understand what the definitions are for the law and to understand how it might apply to your facts. In a particular case, some state laws define health care entities subject to the law narrowly. Others are much broader. For example, in some states, the law is focused on health care providers, including even individual practitioners like physician groups and examples of those are Minnesota and Connecticut in other states, health care entities are even more broadly defined to include health insurers like in Indiana and California. And it's important to understand how they are defined in the particular state or states in which you are looking at doing a deal in order to know whether your deal may come within the purview of the particular law. Third on our list, some states have regulations or sub regulatory guidance that provides additional information on the application of the actual statutes and, and legislation such as Illinois is a good example. Washington has template notice forms that are available and the Attorney General's office is available to answer questions via email if you're not sure how to submit um a particular notice or have a question about applicability in other states regulations forms and FA Qs are or maybe forthcoming. A good example of that is New York where for now, um If you're doing a deal subject to the requirements in New York, you need to submit the notices based solely on what you the information provided in the legislation itself. Um but New York is planning to issue FAQs specific forms and additional information in the future. So it's important to really dig into that regulatory guidance and forms and FAQs where you have it, it's, it might add more color to what you need to provide in a particular notice how it should be submitted. And some of those logistics working through a deal. Let's take a deeper dive into a couple examples of some of these laws. Carol, why don't you get us started?

Carol: Thanks Nicole. Let's start with Indiana. I mentioned it earlier. It's one of the more recent laws that was just passed and it becomes effective July 1 2024. So here we are in April. If the parties are well on their way to doing a deal, they may be able to get a deal done even before the law becomes effective. Um So that's possible. And as we talked about, it's important to look at the effective dates if not. And if you're in a transaction that may take place later this year in, in Indiana, it's important to take a look at this law to see if it might apply. So the law adds a new title entitled Reporting of Health Care Entity, Mergers and Acquisitions to the laws and essentially parties must provide notice to the Indiana Attorney General 90 days prior to closing. So it's a 90 day notice requirement. It's important to keep in mind for this one that it's really a notice only requirement. Um The attorney general does have the authority to review the information that's submitted it. The attorney general can request additional information about the transaction and also can issue a civil investigative demand and issue a written opinion about the transaction, the parties to the transaction and whether it implicates any antitrust concerns. And under the law, the attorney general is supposed to do that within 45 days of submitting the notice. However, at least on its face, the attorney general does not appear to have the authority to block the deal from going forward. So what's covered under this law? So as I mentioned, it's, it's a discussion of transactions involving a merger or acquisition of a quote, health care entity, end quote. And that, that's a defined term as we talked about. Very key to look at that and I'll come back to that in a minute about what is a health care entity, but it's a merger or acquisition of a health care entity having assets of at least $10 million. If that's a transaction in which the parties are involved, the 90 day notice trigger may apply. Uh The term acquisition is also very broadly defined in the law. It's defined as any agreement, arrangement or activity, the consummation of which results in a person acquiring directly or indirectly the control of another person. So this would cover for example, asset acquisitions, equity deals and so forth. It's very broad. I mentioned that the law uh applies to a quote health care entity and, and in this law, it's is defined very broadly to include providers, payers, PBMs and private equity companies, which as we've discussed has been a focus of many of these laws. So the term of a health care entity is in an organization or business that provides diagnostic, medical surgical, dental treatment, or rehabilitative care. So that's gonna cover a lot of different kinds of providers. It applies to an insurer that issues a policy of accidental and sickness insurance, a health maintenance organization, a pharmacy benefit manager or, and here again, the focus on private equity, a quote, private equity partnership, regardless of where the private equity partnership is located seeking to enter into a merger or acquisition with any of these entities. Again, very broad. And we see that focus again here while the law does cover insurers, not surprisingly, the term does not include Medicare or Medicaid program. And also our listeners will note that there's no reference in this law to pharmaceutical or medical device manufacturers. Otherwise it's hitting a broad range of uh parties in the in the health care continuum. So again, uh an example of a very broad law, the law um does include specific information for parties to include in their notice. And importantly includes that the information submitted must be kept confidential. And of course, this is often a very key concern for parties doing a health care transaction. So stay tuned to see how Indiana law operates in practice. And again, whether there will be any sub regulatory or other guidance on how it will actually be implemented. But it is one of the ones that has been added to our list and should be on your list of states requiring prior notice of a healthcare transaction. Nicole let's take a look at another law. How about Connecticut?

Nicole: Thanks Carol. So Connecticut, while a smaller state has a health care review law that's been around for a few years actually, since 2018 and provides an interesting combination of considerations and applicability definitions that we've seen in a few different States rules. So I think it's a good test case to run through with our listeners today. Specifically, there are two types of transactions targeted by the law that are very different in scope. First, there are group practices in hospitals or other licensed health care providers and entities in the state that are parties to a transaction that involves a Hart-Scott\-Rodino or HSR filing with the FTC or DOJ. And then there's a separate group of transactions subject to the law for material changes to the business or corporate structure of a group practice. So that's a physician group practice regardless of whether there's an HSR filing. The first category of deals is a clear expression in the other state's interest in reviewing transactions within the state that would otherwise be subject to the federal antitrust review more broadly. Um And so there, I think it's more an aspect of Connecticut wanting a chance to review what's happening within its borders in tandem with the review happening at the federal level under those federal antitrust laws. The second on the other hand, seems aimed at those changes that by themselves will not trigger HSR thresholds and go through a traditional HSR review but could result in the consolidation of practices in a way that impacts the local market. And that's the state's attempt to start to look at some of these transactions that typically would not have been subject to that regulatory review. While the focus on group practices also could be viewed as aimed at private equity, given increased activity by private equity investment in the physician practice space. And it does require notices of mergers, consolidations or affiliations of group practices with other practices that results in more than eight physicians. So you know, potentially taking aim at some of those tuck ins where you grow from a number of smaller acquisitions into a much larger practice. Note that it's by its terms, affects by hospitals and health systems to form friendly PCs and or expand their group practice presence as well. So it's not targeted specifically at private equity, although you might have um some impact for those doing deals within the state and the physician practice space specifically with those tuck in practices with smaller acquisitions. adding on. From a timing perspective, it also matters what type of deal you have in Connecticut. So for those undergoing HSR review contemporaneously with the submission to the state notice is required to be submitted to the Connecticut Attorney General at that same time for the group practice changes. However, the notice is required to be submitted to the Attorney General at least 30 days before the effective date of the transaction. There are some detailed requirements for what goes into that written notice in the law itself. But in a nutshell, the goal is for the AG to better understand the party's proposed deal structure, location of affected service area and similar market related facts that are going to be impacted by whatever the particular transaction is. And as we see in many of these laws, Carol, the attorney general will review the notice and that gets submitted and then can institute any action it's otherwise permitted to do under Connecticut law if it needs to based on its review. So for example, you know, consumer protection rules that allow the AG to take certain action within Connecticut may be relied upon if the attorney general feels that that's necessary for a particular transaction. I think one final note on Connecticut for our listeners, that's interesting that there's a recent bill that was passed in committee late in March and is currently working its way through the legislative process in Connecticut, not fully approved and signed into law yet, but um has been progressing in a positive trend that may impact private equity investment within the state. The law itself does not implement restrictions on private equity investment or transactions within the state but instead instructs the Executive Director of the Office of Health Strategies to develop a plan to evaluate and address private equity investment in health care in the state. Um So more of a directive to that office of Health strategies to review the issue and then come back to the table to the legislature with a potential proposal, including any restrictions or additional notice and review requirements by early in 2025. So I think the final word on Connecticut is stay tuned. There might be more to see here, Carol. Do you have any closing thoughts for our audience as we work to wrap up our podcast today?

Carol: Yeah, Nicole, I think that you've really um made a great point in terms of talking about what's pending in Connecticut just to underscore that there is a lot of legislative activity in this area and the landscape is changing very rapidly. We are tracking a lot of different activities in various states, some proposed laws and you know, some additional guidance that we expect to see forthcoming in the coming months. So for all of our listeners, it's really important to keep on top of these and keep checking back as to where a particular state is in terms of potential notice or approval requirements, particularly for longer running deals. You might have a deal that, you know, you signed a letter of intent at the end of 2023 and are now just um dusting it off and getting going with the actual terms. It's a really good idea to check to see where, where these different states are or where your transaction may implicate various state laws and continue to monitor them as your transaction goes because we've seen some of these pop up pretty quickly. We here at Reed Smith, Nicole and I and our teams will continue to monitor these laws and publish onr updates. So please reach out if there are any questions on how they may apply to your deals. I know it is keeping a number of us very busy. Thank you so much for joining us today and please tune in to future episodes of Dealmaker Insights on more updates on these topics.

Outro: Dealmaker Insights is a Reed Smith production. Our producers are Ali McCardell and Shannon Ryan. For more information about Reed Smith's corporate and financial industry practices, please email [email protected]. You can find our podcast on Spotify, Apple Podcasts, Google Podcasts, reedsmith.com and our social media accounts.

Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.

All rights reserved.

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