City law lowdown
9 June 2010
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If you are new to the ’square mile’, the first time you step inside a City law firm proper, whether as a vacation-scheme student or to start your training contract, can be an intimidating experience.
Everyone around you glides sleekly about their business, knowing their way around and seemingly knowing what they are doing. You do not.
But then salvation comes. A kindly soul puts you on your first deal. Great! You too can now glide about with a purpose. Only you have no idea what the deal is about. And you have to take the meeting notes. And there are an awful lot of parties involved - especially banks - and you have no idea how it all fits together.
Relax - we’ve all been there
Here is my foolproof guide to understanding your first deal. There are really only a handful of key points you need to know.
The first is what happens when a private company decides to list on the Stock Exchange. This is known variously - and confusingly - as ’going public’, ’floating’, ’doing a flotation’, ’listing’ and ’doing an IPO’. This last is the US term and stands for Initial Public Offering.
The Stock Exchange is simply a market where companies can list their shares to be bought and sold. In an IPO, a company issues fresh shares to raise additional money and expand its shareholder base. These new shareholders are institutional investors (pension funds, insurance companies and money managers who run investment funds). The Stock Exchange does not promise that the companies listed on it are good investments, simply that they will provide timely financial information on an ongoing basis so investors can make up their own minds. If they do not, the Stock Exchange suspends trading in their shares.
The money that the share issue raises is called equity. It is risk capital. If the company goes bust, the investors lose their stake. It is like people talking about the ’equity’ in a house: it is the bit they own, the balance being debt borrowed on a mortgage. Once a company is listed on the Stock Exchange, it can come back and raise more equity. This is called a rights issue (because existing shareholders have the right to be offered the new shares in proportion to their existing shareholding). The US term for this, which is catching on here, is seasoned equity offering. Usually a company will get its share issue underwritten by a bank, which means that, on the day of issue, the bank will buy any shares not taken up to ensure the company raises the money it expected to.
So far, what we have learnt is what an IPO and a rights issue are; that institutional investors buy these shares; that issues are underwritten by banks; and that this type of money is called equity.
Where lawyers get involved is in advising and assisting the company, for instance, by doing due diligence (making sure the statements it makes about itself in the sales document, called a prospectus, are true), or in advising the bank on the various underwriting agreements (the bank will pass on part of the risk to a syndicate of other banks). Lawyers specialising in this are often called corporate finance lawyers.
When money’s too tight to mention
The other type of money you will hear reference to is one you will be familiar with: debt. You and I get this from a bank by way of a loan on which we pay interest. Companies do the same. They get a bilateral loan from the bank (’bi’ because only two parties are involved: the bank and the company). If they want more money than one bank is prepared to lend, it will put together a syndicate of other banks (does that sound familiar?).
A word of warning: banks that underwrite share issues are called investment banks (bizarrely, they themselves do not actually invest) and banks that lend money are called commercial banks (equally bizarre - have you ever heard of an ’uncommercial’ bank?). But the biggest banks these days, such as Barclays and HSBC, do both. Goldman Sachs is a famous investment bank. Lawyers who specialise in advising on loans are called banking lawyers.
Companies are not the only users of debt finance. Governments (called sovereigns) are too. They cannot raise equity finance, since countries cannot issue shares; instead they have two sources of funding: taxing their citizenry and borrowing. If a government taxes too much it will eventually be voted out of office - hence the need to borrow. Sovereigns borrow in what are called the international capital markets (that is, the debt and equity markets), which are centred in financial capitals such as New York, Tokyo and London. They do this by way of the syndicated loans mentioned earlier.
However, like companies, they also do it by issuing bonds. This is the other type of debt instrument. A bond is like an IOU. A bond might be for, say, £1bn, repayable in 10 years’ time and paying interest of 5 per cent a year in the meantime. Such a bond will be broken down into much smaller tradable amounts so that institutional investors (remember them?), which are the biggest buyers of bonds, can trade them (that is, buy and sell them) just as they buy and sell shares. The lawyers who advise issuers and banks are capital markets lawyers.
You are also likely to hear your colleagues referring to financial instruments called derivatives (of which there are swaps, options and futures). These are so called because they are ’derived from’ (linked to) underlying equity and debt. So, you get traded options (shares) and bond futures (debt). The lawyers who advise on these are the aforementioned capital markets lawyers, who are also often called - you guessed it - derivatives lawyers.
Spare some change, Gov?
While on the subject of debt, there are other types of loan-based financings with which you will need to be conversant. Project finance uses debt to fund big infrastructure projects in energy (power stations), transport (airports, motorways), health (hospitals) and education (schools). Lawyers specialising in these deals are known as project finance lawyers and the deals are often called PPP (public-private partnerships) or PFI (private finance initiatives) deals because they are public-sector projects funded in the private sector.
Asset finance is where a bank (the lessor) buys a big bit of kit such as an aircraft or a ship and leases it to an airline or shipping company (the lessee). It’s cheaper than borrowing by way of a loan because the bank owns the asset so it feels more secure, and there are usually tax advantages. Aviation finance and ship finance are industries in their own right with asset finance lawyers specialising in advising banks and lessees.
Trade finance is the funding by banks of exports through letters of credit, meaning that sellers can put their goods on board boats without worrying about getting paid by buyers on the other side of the world. This work is undertaken by banking lawyers and specialist trade finance lawyers.
Now, let’s flip back to equity and to our company that has just listed. It may decide it wants to grow by taking over another company. If so, it (the bidder) will make an offer for that company (the target). To win, it will have to persuade the target’s shareholders (our friends, the institutional shareholders) to sell their shares to it. Usually, a bidder will offer shares in itself so the target becomes its subsidiary and the target’s shareholders become shareholders in the bidder, alongside its existing ones. This is known as a share-for-share exchange and is often favoured, because the bidder doesn’t have to pay any actual money, but just print shares of its own.
However, the target may not want to be taken over, in which case the bid becomes hostile (aka contested) and is refereed by the City Takeover Panel, applying rules from the Takeover Code.
If the target’s shareholders want money instead, the bidder may need to raise the cash by doing a rights issue or raising debt by way of a loan or bond issue - these last two are called acquisition finance. Buying another company is called a takeover or M&A (short for merger and acquisition). Lawyers who advise on this may be corporate finance lawyers (because shares are involved) or may be even more specialist M&A lawyers, especially where a takeover turns hostile. They do due diligence (remember that?) on the target so the bidder knows what it is buying.
There is one final type of deal with which you should be familiar: private equity. A private equity deal is an M&A deal where the acquirer is not another company but a fund put together by an investment bank or specialist private equity house to raise money privately (not by way of a public issue, hence the term ’private’) from our old friends, institutional investors. This money is used to buy the shares (hence ’equity’) of a public company that, therefore, becomes a private company again and delists from the Stock Exchange, which is why these are also known as public-to-private deals. Lawyers who specialise in this area are called private equity lawyers.
So, let’s join up the dots
To recap then - there are two types of money: debt and equity. Companies and governments come to the City to raise debt finance (loans and bonds). Companies also raise equity finance (shares). Companies take each other over. They are also taken private by private equity funds. Commercial banks lend money. They do bilateral and syndicated loans. They also do asset finance, project finance and trade finance. Investment banks underwrite share and bond issues (issuance is called the primary market) and they trade those shares and bonds, once issued, in what is called the secondary (ie, second-hand) market. They place those shares and bonds with institutional investors and buy them back from them.
Institutional investors (pension funds, insurance companies and fund managers) buy shares and bonds. They also put money into private equity funds and are the ultimate arbiters of whether an M&A deal goes through or not as shareholders in the bidder and the target. They get their money from you and me - our insurance premiums, our pension contributions and any spare money we have that we invest in unit trusts and ISAs.
The lawyers who advise the parties involved, negotiate the terms and do the documentation, are basically corporate and finance lawyers.
Corporate lawyers encompass corporate finance lawyers (flotations, equity issues - if working internationally, they are often called equity capital markets lawyers), M&A lawyers and private equity lawyers. Finance lawyers comprise banking lawyers (including asset finance, aircraft finance, ship finance, project finance and trade finance lawyers) and capital markets lawyers (bond issues), as well as the derivatives lawyers who work on fancy instruments.
Of course, there are a whole lot of other lawyers - litigators (who take disputes to court), employment lawyers, intellectual property lawyers, tax lawyers, competition lawyers, real estate lawyers…. But the corporate and finance lawyers are the ones you’ll find at the heart of any City transaction. Armed with this guide, you now know enough to establish roughly the kind of deal you are working on and the parties involved. I hope that helps. Good luck.
Chris Stoakes is director of knowledge, research and learning at Hogan Lovells and author of various All You Need To Know guides, published by Longtail, on the City, commercial awareness and the global financial markets