Print this page (printer friendly)
Private Equity Planning Your Exit
.aspx)
An inherent part of any private equity investment is the route by which the investee ultimately disposes of their equity stake in the company (an Exit). The anticipated exit route attracts detailed planning from a tax and legal point of view to fully protect the investor.
Typically, investors look for a return between 3 and 5 years after the original investment, although, investors will need to keep in mind that an exit from the outset can not be absolutely guaranteed as there are too many uncertainties that may arise. However, parties can try to put themselves in the best position to take advantage of the opportunities which arise by a comprehensive investment agreement and careful tax planning. It is important to consider the following:-
- The range of Exit methods commonly used and their advantages and disadvantages.
- Who decides the timing of the Exit.
- Provisions (either in the company’s Articles or investment agreement) that can be put in place to influence the outcome.
Exit Methods
The main exit routes for an investor include:-
- Public floatation
- Trade Sale
- Secondary Buyout (a sale to co-investors or other private equity providers)
- Break up and Distribution of proceeds (restructured and sold in parts)
- Redemption of shares (redeemable preference shares are redeemed)
- Portfolio sale (private investor seeking to sell a number of investments)
- Management buyout.
Key aspects of the Investment Agreement/Articles of Association
It is important to set the parameters for the exit from the outset of the investment, to minimise the potential for later tensions or disagreements on this subject between the investor and managers of the investee company. To clarify the exit terms and to protect the investor’s position legal advice should be sought at the outset. It is important that the investment agreement includes the following provisions:
- Exit control covenants detailing intentions of the investor and placing obligations on the management to use reasonable endeavours to arrange an exit before a certain date.
In practice this clause may be difficult to enforce due to the ambiguous meaning of ‘reasonable endeavours’. However, an exit covenant will at least help the parties focus on their intentions and the overriding objective of the investment.
- Exit Control triggers detail the following:-
- who has the right to enforce an exit, for example, a certain percentage of the shareholders;
- the method of establishing the sale price;
- who is allowed to sell their shares and when.
- Drag Along Rights enable the investor to require the sale of the entire issued share capital even if some shareholders disagree. This is important as the ability to sell the entire issued share capital of the company is critical in achieving maximum valuation.
- Tag Along Rights enable the investor to require their shares to be sold if a certain percentage of other shares are sold. These rights are important so the investor does not get left behind.
- Management Covenants seek to ensure that the management of the company adhere to proper business conduct and standards, for example, by placing an obligation on the management to produce regular management and financial information. This will maintain the value of the business and also allow the investor to monitor the progress of the business.
- Prohibition on sales: it is likely and advisable to prohibit the management selling shares without the investor consent. In addition, it is likely that the company’s articles of association will contain pre-emption provisions applicable to all transfers of shares save for certain exemptions.
- No warranty protection: as the investor does not have day to day involvement in the company, the investment agreement should state that no warranties will be given by the investor on an exit other than that it actually owns its shares.
- Limiting contingent liabilities: the exit sale agreement must be carefully drafted to ensure that the investor is not directly liable for any future liabilities of the company and that no obligations have been inadvertently accepted by the use of the words ‘jointly and severally’ in relation to the selling shareholders.
- Ratchet clauses will enable the managers to a higher percentage of the sale proceeds based on the target rate of return and timing of the Exit.
These clauses are intended to provide a framework for an exit transaction, to ensure that the investor’s expectations and requirements are documented and to ensure a constant focus on the exit through out the investor’s relationship with the company. The preferred exit routes documented in the investment agreement will depend on a number of factors including the business of the target company, time constraints, the target company’s business plans and tax planning.
Role of Legal Adviser
It is important to seek legal advice early to be armed with the correct information before any negotiations are held regarding the investment terms. Experienced legal advisors can identify and deal with the issues in a proposed investment and detail the best Exit routes for an investor in a concise and pragmatic way.
If you would like to discuss any of this information further please contact:
Matthew Crosse
E: matthew.crosse@tollers.co.uk
T: 01604 258100
2 Castilian Street
Northampton
Northants
NN1 1JX