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Analysis of Transaction Documents for Private Equity Transactions

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Private equity investment is an important phase in the growth of any company and it enables a company to unleash its business offering on a larger scale and to a wider customer base. However, while there are tremendous benefits of a private equity fund infusion, there also needs to be a sense of caution exercised while negotiating such deals and the transaction documents as there are, hidden under the terms of the transaction documents, some clauses which may have consequences not well understood by the promoters. Further, the non-exposure of a growth-stage promoter in dealing with such situations makes them vulnerable without adequate legal advice and support.

While advising on private equity related transactions and drafting down the understanding in writing we usually come across negotiation sessions between the promoters of the company and the investor, in which we invariably have situations wherein one side comes up with a point of view that “this is a fairly standard clause” and the other side which is generally the promoters are unsure whether such a proposition is an industry standard practice or is the position negotiable and both the parties can negotiate the same based on their relative bargaining powers.

Information of market standard practice is a fundamental premise in any negotiation. An understanding of what is ‘market’ or ‘standard’ in such peculiar situations enables a healthy discussion and fruitful negotiation between the contracting parties.

• PROCEDURE ADOPTED IN THIS RESEARCH PAPER

We have considered 10 private equity transactions (“Sample Size”) which have taken place since 2012 and have reviewed the publicly available (on www.mca.gov.in) Articles of Association (“AOA”) of these Investee Companies (“Companies”). Material clauses of a Transaction Document between Private equity Investors (“Investor”) and Investee Company (“Company”) are generally also captured in the Articles of Association of the Company so as to be binding on the Company as well.

Based on our experience we have listed down all standard clauses which are generally present in a transaction document for private equity deals and focused our efforts on these clauses in the AOA and summarized the differences and uniformities in these clauses.

The result of such a process is being placed before you for your reading and interpretation. The sample size being only a representative small number may not necessarily be conclusive of the entire PE deal market but nevertheless an attempt is made to make some sense out by organizing the unorganized data available in public domain.
We have endeavoured to avoid use of legal jargons and kept it for plain reading for a larger audience.

• OBJECTIVE

The objective of this research paper is to assist Promoters, Investors, legal and accounting practitioners, students of law and accountancy, professors to understand the general trend in private equity transaction documents, so that it gives a flavour as what can be considered as common industry practice and which is a standard clause and which clauses can be negotiated upon.

• ASSUMPTION

The AOA properly and completely reflects the agreement between the Investors and the Promoters and the Company on the clauses under consideration. Also, it is assumed that there have been no changes in the understanding between the parties in these private equity deals subsequent to the versions of AoA’s we have used.

• THE RESEARCH: OBSERVATIONS ON MAJOR CLAUSES

• 1. AFFILIATES

About the Clause:
In the corporate world an affiliate is understood to mean a Company which is related to another Company in some way, either by way of being under the same control or by one Company controlling the other. Affiliate in a private equity transaction document is defined in order to serve a variety of purposes including restricting the Company in entering transactions with Affiliates etc.

Observations:

♦ All the Companies have included ‘Affiliate’ or ‘Affiliates’ in the defined terms.
♦ 30% of the Companies have provided separate definitions for the Affiliates of an Investor.
♦ ‘Affiliate’ or ‘Affiliates’ has been defined so as to refer to an entity/person which is under the same management or control as the Company or is being controlled by the Company or is controlling the Company. Such entity/person can include any individual, partnership, corporation, company, unincorporated organization or association, trust or other entity, whether incorporated or not.
♦ If an Affiliate is a natural person, his relatives shall be considered as Affiliates.
• 30% of the Companies have defined ‘Relatives’ to include children, spouse and parents of the person concerned.30% have provided that ‘Relatives’ shall be understood to be as provided under section 6 of the Companies Act, 1956 (which includes 26 relatives).
• 40% of the Companies have not defined relatives.

Points to Ponder:
♦ All AoA’s have provided for a definition of ‘Affiliates’.
♦ 40% of AoA’s have not provided for a definition of ‘Relatives’ within Affiliates.
♦ It is important to define the term ‘Affiliate’ because certain rights/liabilities under the transaction documents extend to affiliates and it is important to ascertain the entities which can avail of such rights and which are responsible for the liabilities.
♦ Promoters are restricted from having transactions with affiliates, hence from their point of view, a definition which limits ‘Relatives’ to children, spouse and parents is more compliable unlike a definition which would include 26 relatives.
♦ From an Investors perspective, a wider definition of ‘Relatives’ as per section 6 of the Companies Act, 1956, would better serve the purpose as it ensures that the Company and its Promoters do not indulge in any activity of impropriety.

• 2. LOCK-IN PERIOD

About the Clause:
Lock-in indicates a restriction on transfer or a freeze on shares. Such a clause is inserted to ensure that the main stakeholders who have a say in the planning and management activities, continue to hold some minimum percentage of shareholding in the Company. Lock-in can be imposed on either the Promoter (which is generally the case) or the Investor or both. Also, the lock-in can either mandate the holding of a minimum percentage of shares or holding shares for a specific time period or both or it may require that one party cannot transfer shares beyond a certain percentage or before the lapse of an agreed period without the other party’s consent.

Observations:
(a) Promoter’s Lock-in:
♦ 30% of the Companies require the Promoters to hold a minimum percentage of shares till the Investors have a stake in the Company.
♦ 40% of the Companies require that the Promoters shall be allowed to transfer their shares before an agreed period of time or before an IPO only with the consent of the Investors.
♦ 20% of the Companies provide that the Promoters shall be subject to a lock-in provided the Investors have a minimum shareholding.
♦ 10% of the Companies have not provided for a lock-in on Promoters in their AoA.
(b) Investor’s Lock-in:
♦ 80% of the Companies impose no restrictions on the transfer of shares by the Investors provided the Investors provide a due notice to the Company and the Promoters and the transferee executes a deed of adherence wherein he shall agree to be bound by the definitive agreements as had been signed between the Investor and the Promoter and by the Articles of Association of the Company.
♦ 20% of the Companies have Investors lock-in which freeze the Investor shares for a specified period of time after the investment is complete or before the completion of an IPO.
Any transfer by the Investors should be duly notified and the transferee should agree to be bound by the same agreements as the Investor. Also, in the event the Investor wishes to transfer its shares to a competitor, consent of the board of directors of the Company is required.

Points to Ponder:
♦ The primary intention behind a Promoter lock-in is to ensure that the management of the Company continues to be the same which can be relied upon by the Investors to make profitable utilisation of the investment and hence, the returns on the investment can be guaranteed to a certain extent and also to ensure that the Investors are not left with the responsibility to manage and run a Company when their primary intention was to invest and reap the benefits out of it.
♦ 10% of the Companies do not have a lock-in on the Promoters, hence, it is not mandatory for Promoters to have a lock-in and depending on the negotiating power, the Promoters may avoid being locked-in.
20% of the Companies have Investors lock-in which freeze the Investor Shares for a specific period time after the investment is complete or before the completion of IPO. SEBI ICDR regulations also have lock-in requirements for investors.
♦ As can be inferred from the above data, Investor shares are mostly not subject to lock-in. 20% of the Investors have lock-in, hence, as mentioned above, if the Promoters have the bargaining power, even Investors can be subjected to lock-in.

• 3. INVESTOR DIRECTOR

About the Clause:
The Investor generally has the right to nominate a director(s) on the board of the Company. Such a person(s) serves to be the eyes and ears of the Investor and depending upon the agreement negotiated between the Investors and the Promoters holds significant rights. The Investor Director is a non-executive director and not responsible for the day-to-day functioning of the Company. As per Clause 49 of the Listing Agreement and also as per the Companies Act, 2013, a nominee of the Investor shall not be an Independent Director. His presence shall be required to constitute a quorum and his affirmative vote is essential for passing of a resolution on certain matters. He shall not be considered to be a person in default and shall not be held liable for non-compliances of the Company under any applicable laws. Moreover, the Company shall keep such director indemnified against any claims or damages for any liability incurred by him or imposed upon him on account of any non-compliance or negligence of the Company or Promoters or other directors.

Observations:
♦ 80% of the Companies have provisions for the appointment of Investor director.
♦ 12.5% of the Companies out of the above 80% provide that if required by the Investor, the Company shall obtain suitable Directors and Officers Liability insurance premiums for which shall be payable by the Company. This policy provides protection for claims brought against directors, officers and employees for actual or alleged breach of duty, neglect, misstatements or errors in their managerial capacity.
♦ 20% of the Companies considered under the survey have not made provisions for an Investor director in the AoA.

Points to Ponder:
♦ Generally, as seen above, Investors get the right to nominate a director to the board of directors of the Company, but Promoters can avoid such a clause provided they negotiate correctly based on the available bargaining power.
♦ Miniscule proportion of the Sample have provided for a Directors’ & Officers’ Insurance for the directors to be taken by the Company. Hence, one can say that this is generally not insisted upon by the Investors, given the existence of indemnity by the Company and Promoters in favour of the Investor.
♦ Such nominated directors keep a watch on functioning of the Company and give their decision over reserved matters (as covered hereunder), for the benefit of Investors.

• 4. ANTI-DILUTION CLAUSE:

About the Clause:
Dilution is a reduction in the percentage interest in the holding of the Investor in the Company by virtue of a subsequent issue of shares at a price per share less than that paid by the preceding Investor. Though any fresh issue of shares or securities will dilute the shareholding of the Investor to a certain degree but an issue in which the shares are priced higher will raise the value of shares, consequently increasing the overall valuation of the investment. Hence, issue of shares at a price lower than the one paid by the Investors is usually considered to be Dilution that affects the rights of the Investor.
In order to protect their rights Investors usually include an anti-dilution clause in the term-sheet. It protects an Investor from dilution resulting from later issues of stock at a lower price than the Investor originally paid. Anti-dilution can be effected through various formulas and methods.

Observations:
♦ 60% of the Companies have provided the Investors with an anti-dilution right.
♦ 40% of the Companies have not made a provision for anti-dilution clause in their AoA.
An anti-dilution clause generally binds the Company such that, it shall not issue any additional securities to any person, without the consent of the Investor, at a price less than a certain multiple of the post money valuation of the immediately preceding round or such other similar formula. If at all the Investor consents to such an issue, then the Company shall be obligated to issue such number of additional Securities to the Investor, at nominal price or the lowest price permissible by applicable law to the Investor such that the average consideration paid by the Investor per security held by it is equal to the weighted average price per security of all issuances of securities that are issued pursuant to these Articles.
40% of the Companies have not made any provision for anti-dilution in the AOA.

Points to Ponder:
♦ Since 40% of the Companies have not provided for an anti-dilution it is not a standard clause as far as investment agreements are concerned.
♦ Such a clause may have income tax implications for the Company, when the Company issues shares at lower than its fair value and hence, this should be understood clearly by the parties before entering into such a clause and it would be advisable to clarify as to who would bear the cost of tax implications on the same.
♦ Also, once the AoA incorporates a stringent anti-dilution clause, it becomes difficult for the Promoters to get new Investors at lower price for the shares.

• 5. RIGHT OF PRE-EMPTION

About the Clause:
The right of pre-emption enables the right holder to subscribe to the fresh issue of securities before the same are offered to any third party. When shareholders (usually a shareholder committing large amounts of capital to a Company) purchase shares, they want to ensure they have as much voting power in the future as they did when they initially invested in the Company. By getting pre-emptive rights in its shareholder’s agreement, the shareholder can ensure that any subsequent share issues will not dilute his/her ownership percentage. Right of pre-emption can lie with both the Investor and the Promoter.

Observations:
♦ 40% of the Companies have granted the Investors with right of pre-emption. In the event of a fresh issue of securities, the Investors shall have the right to subscribe to these securities in priority over third parties. The Investors shall subscribe to the shares on pro-rata basis depending upon their shareholding. 25% of these Companies provide that if the Investors do not subscribe to the issue completely then the Promoters shall have the right to subscribe to the residual securities and if still securities remain, the same shall be offered to third parties.
♦ 30% of the Companies have provided both the Promoter and the Investor with the right of pre-emption. In such cases all existing shareholders have the right to subscribe to the fresh issue of securities. 33.33% of these Companies provide that in the event the existing shareholders do not subscribe to the issue, the Company can offer the shares to the Promoters and Investors. In the event, they again refuse to subscribe, the shares shall be allotted to third party allotees.
♦ 30% of the Companies have not provided for right of pre-emption either to the Promoters or Investors in their AoA.

Points to Ponder:
♦ Since 30% of the Companies have not provided this right to either the Investors or Promoters, again it comes down to the negotiation to determine whether such pre-emptive right is to be incorporated into the transaction documents or not.
♦ It is advisable that the Promoters should insist upon having the right of pre-emption otherwise their holding will get diluted over a period of time.

• 6. RIGHT OF FIRST OFFER (ROFO)

About the Clause:
Right of first offer is defined as a contractual obligation, by the owner of shares to the rights holder, to negotiate the sale of the shares with the rights holder before offering them to third parties. If the rights holder is not interested in purchasing the shares or cannot reach an agreement with the seller, the seller has no further obligation to the rights holder and may sell the shares freely.

When a shareholder wishes to sell his shares, he shall provide notice of the same to the shareholders who have ROFO and the latter has to respond within the notice period. The notice may contain the price or the price maybe proposed by the offerees. If all right holders agree to purchase the shares, they shall purchase them in proportion to their existing shareholding. If the offer is not accepted, then the offeror shall be free to make the sale to a third party, provided the sale is not at a price lower or at different terms than the ones which were given to the ROFO right holders.

Depending on who has the right of first offer, the right can be categorised into Promoter’s ROFO and Investor’s ROFO. As the nomenclature suggests Promoter’s ROFO, provides the Promoter with the right to be offered shares by the Investor in the event the Investor is desirous of selling its shares and an Investors’ ROFO provides the Investor with the same right vis-a-vis a Promoter. A few variations of ‘‘Right-of-Last-Offer’ or ‘Right-to-Match’ are also not uncommon.

Observations:

(a) Promoter’s ROFO
♦ 40% of the Companies have incorporated Promoter’s ROFO in their Articles. 25% of the above mentioned Companies have provided that if the sale of the shares to a third party is not completed within 6 months of the notice period, as provided to the Promoters, the Investor shall have to approach the Promoters again with the offer to sell the shares and the ROFO shall be operative again.
♦ 60% of the Companies considered for the survey have not provided for Promoter’s ROFO
(b) Investor’s ROFO:
♦ None of the Companies considered for the present research paper have incorporated an Investors’ ROFO.

Points to Ponder:

♦ This right is more favourable to the seller (in comparison to ROFR, as given below) as he has to approach the right holder only once, to determine the price and willingness to buy and it is not an iterative process.
♦ Sometimes, it is advisable to have a minimum percentage range above the offered price, within which, the seller cannot sell his shares to a third party and is required to compulsorily come back to offer to the right holder.

• 7. RIGHT OF FIRST REFUSAL (ROFR)

About the Clause:
Amongst shareholders, the right operates to provide one shareholder with the right but not the obligation to buy the shares being offered by another shareholder for sale after the seller has received offers from third parties and the offeree shall be entitled to purchase such shares if he can match the price being offered by the third party.

The selling shareholder shall provide the right holders with a notice, specifying the price at which the shares are being offered. If the right holders accept the offer, they shall purchase the shares in the proportion of their existing shareholding. If the right holders do not match the price, the selling shareholder can make the sale to the third parties and the price cannot be lower and the terms of the sale cannot be different from the ones offered to the ROFR right holders.

Like ROFO, Right of first refusal can also be classified as Promoter’s ROFR and Investor’s ROFR depending upon who is the right holder. A Right-of-Last-Refusal is also a model applied selectively.

Observations:

(a) Promoter’s ROFR
♦ 20% of the Companies have provided both the Promoters and the Investors ROFR. Thus, either of the parties shall be bound to offer the other, the shares to be sold.
♦ 10% of the Companies have provided the non selling Promoters a ROFR, once the Investors who have ROFR (in relation to sale by the selling Promoter) refuse to buy the shares. If the Promoters also, turn down the offered shares, the Company can offer to buy them back and in the event the buy-back does not happen, the shares can be sold to third party right holder.
♦ 70% of the Companies have not provided Promoters with a ROFR.

(b) Investor’s ROFR:
♦ 70% of the Companies have provided the Investors with a ROFR.
♦ 30% of the Companies have not provided Investors with a ROFR.

Points to Ponder:
♦ 30% of the Companies have not provided ROFR to the Investors, hence it is not compulsory for Investors to always have the right. However, it depends upon the negotiation and bargaining power as in 70% cases the Investors have ROFR.
♦ ROFR in the favour of Investors or Promoters, as the case maybe, tends to bring down the price of shares, as no third party would be interested in the Investor’s or Promoter’s shares as even after an extensive and expensive diligence process by the third party to discover the price for the shares, there remains a possibility that no sale will occur if the other party trumps the price offered by the third party.

• 8. TAG ALONG

About the Clause:
The right to tag along is a contractual obligation usually to protect the minority shareholder. In the event majority shareholder sells his stake in the Company, then the tag along right holder has the right to join the transaction and sell his stake in the Company. Tag along right operates to oblige the selling shareholder to include the holdings of the tag along right holder in the negotiations for sale of shareholding.

Observations:
♦ 70% of the Companies have provided the Investors with the right to tag along with the Promoters and 43% of these Companies allow Investors to offer only a proportionate number of their shares while exercising their right to tag along.
♦ 10% of the Companies have given tag along rights to the Promoters in the event the Investors are selling 95% of their shareholding;
♦ 10% of the Companies have given tag along rights to both the Promoter and the Investor.
♦ 10% of the Companies have not provided for tag along right in their AoA (via shareholders agreement or share purchase agreement).

Points to Ponder:
♦ Tag along rights may be used by an Investor if the Promoters decide to sell their shares in a good deal, in which case the Investor entity can sell its shares on terms similar to those offered to the Promoters.
♦ Moreover, sometimes investments may be made in a Company on the basis of the capabilities of its existing shareholders/Promoters and therefore, a tag along right is useful as it will provide the Investor with the opportunity to exit if the very reason for investment — the existing shareholders/Promoters are exiting the Company.
♦ As can be seen, from above, some Companies have restricted the tag along to a proportionate part of the total sale shares. For example, if a 52% shareholder is selling 1% of his shares then the right holder with 48% shareholding can sell only ‘1/52 X 48’ % of his shares. This is particularly advisable because in case only a minor proportion of shares are being sold by the member, then the right holder should not be able to burden his entire holding on such minor sale of shares.

• 9. DRAG ALONG

About the Clause:
The right to drag along is a right that usually enables the right holder to force the other shareholders to sell his shares in the Company along with him. The right operates to protect the interests of the right holder as certain buyers are looking to have control over the Company and drag along rights aid in eliminating the minority shareholders.

Observations:
♦ 80% of the Companies have provided the Investors with the right to drag the Promoters, in the event the Promoters fail to provide the Investors with an exit within an agreed time period.
♦ 20% of the Companies have not provided the Investors with the right to
♦ None of the Companies have not provided Promoters with the right to drag along the Investors in any of the AoAs considered for the present survey.

Points to Ponder:
♦ A drag right becomes meaningful on the principle that there is greater marketability for a larger shareholding in the Company, as the drag enables sale of the Investor’s and the Promoters’ shares together, in comparison to only that of the Investor’s shares.

Though we have not come across any Articles where the Promoters have been given drag along rights, it would be pertinent to mention that if a Promoter has drag rights he would be benefited the same away as he will be able to sell a bigger shareholding and in effect transfer control of the Company to the new Investor and as explained earlier certain buyers are interested in acquiring controlling interest in the Company.

• 10. EXIT THROUGH OFFER FOR SALE IN AN IPO:

About the Clause:
The Promoters agree to carry out an IPO after the lapse of a certain period of time after the completion of the investment in order to provide an exit to the Investors as they are able to offer all of their shareholding in such IPO. If the legal requirements mandate that certain shares should be subject to lock-in, the Promoters’ shares shall be locked-in as required. Also, the Investors are not to be identified as the Promoters anywhere in the prospectus or at any time during the issue

Observations

♦ 90% of the Companies have incorporated initial public offer in their AoA as an exit for the Investors.
An IPO, Buyback by the Company, Purchase by the Promoters, Secondary Sale, Strategic sale to a competitor, etc. are some of the Exit Options generally prevalent. The complex Russian Roulette or Texas Shoot-out and other exit provisions are not generally seen in the Indian context
• 22.22% of these Companies have provided that the shares should be priced so as to provide the Investors with a specified internal rate of return (IRR).
• 66.66% of the Companies providing for an exit through an offer for sale in an IPO, have provided it as the primary exit route for the Investors.

♦ 10% of the Companies considered for the survey have not provided for IPO as an exit option for the Investors.

Points to Ponder:
♦ It is evident from the observations that an IPO is a standard option for an Investor exit and that most Investors have specified the time period by which they want the Company to provide such an exit.

• 11. EXIT THROUGH THIRD PARTY SALE:

About the Clause:
Third party sale is the exit option made available to Investors when the Company has failed to carry out an offer for sale in an IPO, thereby depriving the Investors of an exit or alternatively in a case where the Parties have consented for an exit before the IPO. If the Company has not carried out in an offer for sale in an IPO within the agreed upon time period, the Investors can cause the Company to identify a bona fide third party purchaser who shall purchase the Investor shares at a price acceptable to the Investors or pre-decided between the Investors and the Promoters, and provide the Investors with an exit from the Company.

Observations:
♦ 60% of the Companies have incorporated third party sale as an exit clause for the Investors in their Articles.
♦ 83% of the above mentioned Companies have provided that third party sale is to be employed to provide an exit if an IPO has not been carried out to provide Investors with an exit.
♦ 66.66% of the Companies which have provided for third party sale as an exit option have specified that the price per share should be determined so as to guarantee a specified IRR on the investment amount for the Investors.
♦ 40% of the Companies considered for the survey have not provided for third party sale as an exit option for the Investors. But the existence of such a clause may be implied in most of the cases.

Points to Ponder:
♦ In a majority of cases third party sale has been considered as the second preferred exit route for the Investors after an IPO for most of the Companies which incorporate exit through IPO as an exit route in the transaction documents.

• 12. EXIT THROUGH BUY-BACK:

About the Clause:
Buy-back of the Investor shares (partial or full) is another exit option provided to the Investor. The Investor causes the Company to carry out a buy-back of the Investor shares, subject to the existing regulations and laws and the Company is bound to buy-back the Investor shares. The price for the shares is to be mutually determined among the parties and if such mutual agreement is not reached, usually the valuation done by an independent reputed CA firm is considered to be acceptable. If owing to the existing regulations, all Investor shares cannot be bought in one buy-back, the Company shall buy back the shares in the subsequent years. Also, the Promoters and the shareholders agree to not offer their shares during a buy-back which has been initiated by the Investor.

Observations:
♦ 80% of the Companies in our survey sample have incorporated buy-back into their Articles. 50% of these Companies provide for buy-back in the event they have failed to provide an exit to the Investors through an IPO.
♦ 25% of the Companies providing for a buy-back, have specified the IRR on the investment amount which the Investors seek to obtain from the buy-back.
♦ 20% of the Companies considered for the survey have not provided for buy-back as an exit for the Investor.

Points to Ponder:
♦ A buy-back has regulatory restrictions and limits as prescribed under Company Law and any guidelines, rules and regulations thereto and it might be possible that the Company may not be able to provide complete exit to the Investor in one year and hence may not provide an immediate exit to the Investor.
♦ A buy-back is the last option for the Company to provide an exit to the Investor as it drains the Company of its financial resources and it generally gives a lower internal rate of return.
♦ Generally, the Investors do have a right to choose multiple exit options and hence, they may choose to exit through the buy-back route for the remaining proportion of their shareholding, which they have not been able to exit through any of the modes stated above.

• 13. PUT OPTION AND CALL OPTION

About the Clause:
Put option is a contractual right (but not an obligation), wherein the right holder, has the right to sell a fixed number of shares at a fixed price within a specified time. For the Investor, put options also present an exit opportunity.
Call option is a contractual right (but not an obligation), wherein the right holder has the right to buy a fixed number of shares at a fixed price within a specified time.

Observations:
(a) Put Option
♦ 40% of the Companies in our survey sample have provided put option to the Investors to be exercised against the Promoters. 25% of these Companies have specified the IRR on the investment amount that they want from selling their shares when exercising their put option.
♦ 60% of the Companies have not provided Investors with a put option.
♦ None of the companies have provided the Promoter with the Put options.
Legality and Enforceability of ‘Put’ and ‘Call’ Options has been an issue of legal debate. The recent SEBI circular permits (subject to certain riders) prospective usability of some of these as far as listed companies are companies. The Companies Act, 2013 are holds-up this concept and allows inter-se arrangements between shareholders of a Company.

(b) Call Option
♦ 10% of the Companies have provided Promoters with the call option to buy the Investors at a price lower than the market price, in the event of default by the Investor.
♦ 90% of the Companies have not provided Promoters with a call option.
♦ 10% of the Companies have provided the Investors with call option to provide an exit to the Promoter.
♦ 90% of the Companies have not provided Investors with a call option.

Points to Ponder:
♦ Incorporation of put option in favour of the Investors in effect can amount to a personal guarantee given by the Promoters and may not be advisable in an investment agreement where the Investor is supposed to bear the risk of any losses in his investment and not the Promoters.
♦ Giving such a right is the worst case scenario for the Promoters of a Company as then the investment loses its colour as an investment and it becomes more of a Promoter guaranteed borrowing by the Company.
♦ Promoters would not like to buy-back at such ‘put’ prices, which are generally higher than the fair value of the Company shares or the worth of the Company as put option will be exercisable only in the event when either the Company is not able to buy-back or other exit options cannot be availed.
♦ Call options are rare in transaction documents, however depending on the understanding and need, the same can be incorporated.

• 14. LIQUDATION EVENT

About the Clause:
The term ‘liquidation event’ has been used to denote the winding up of the company, appointment of a provisional or official liquidator, a voluntary liquidation, a merger, acquisition, amalgamation, change in control, consolidation, transfer in any manner of all or substantially all of the Company’s assets or other transaction or series of transaction in which the shareholders of the Company will not retain a majority voting power of the surviving entity.

Observations
♦ 70% of the Companies in the Sample have defined a liquidation event. 71.4o% of these Companies have provided that the Investors shall receive payment from the proceeds 0f liquidation, in preference to other shareholders.
♦ 20% of the Companies have not made any specific provisions for a liquidation event, instead they have provided for liquidation of the Company during winding up and the distribution of the proceeds among the shareholders in proportion to their shareholding.
♦ 10% of the Companies have made no provisions for liquidation event or winding up.

Points to Ponder:
♦ Most of the Companies have provided for a liquidation event to denote cases wherein all or substantially all of the Company’s shares or assets shall get sold to third parties or change of control or any other transaction in which the Company’s existing shareholders will not be the majority shareholders in the surviving company.
♦ As can be inferred from the available data, the Investors receive preference over other shareholders, with regard to distribution of proceeds of the liquidation or winding up. However it might be worthwhile to note that such preference (if at all) should extend only to the extent of the investment and normal return relating to the Investor.

• CONCLUSION

Though there is a clear trend in most of the clauses as to ‘what is fairly standard clause’, there are clearly instances when Companies, Promoters and Investors have been able to dodge the trend and drive home clauses which they found more acceptable and favourable to them. Hence the Parties need to make sure that they understand the risks associated for themselves in each of the clauses and also keep in mind that if they have the bargaining power they should negotiate for clauses beneficial for them which some of the Parties above have been able to drive home in a private equity deal.

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