Skip to main content

Legal Capsule by Economic Laws Practice


Private equity – Shareholders’ rights and areas of potential disputes

Authors: Shyam Pandya, Shailesh Poria, Aasim Syed, Rashmi Ramnath
 

INTRODUCTION

Keeping pace with the evolution of private equity (PE) investments as a mainstream source of funding, there has been a commensurate increase in differences and conflicts with investee companies, promoters and other stakeholders. Such disagreements arise on multiple grounds, ranging from corporate governance, contractual rights & obligations, board nomination and investor exit amongst others. Many of these provisions are documented in a shareholders’ agreement (SHA) or an investment agreement. This article focuses on the key contractual legal rights and obligations in SHAs that engender disputes between PE investors and promoters as well as the effective mitigation, response and resolution strategies.

CONTRACTUAL RIGHTS AND OBLIGATIONS
PE Investors and the promoters typically negotiate their legal rights and obligations in relation to the following:
  • Pre-investment liabilities and status of the business, employees, pending litigations, existing contracts and tax & regulatory compliance: Representations and warranties (R&Ws) form the basis on which an investment is made by the PE investor in so far as factual matters for the period prior to the investment are concerned. From an investment transaction point of view, R&Ws are documented in the form of negative or positive factual assertions from the promoters (such as confirming if the investee company does not have any regulatory or third party litigation, if all material business contracts are subsisting and have not been terminated, or confirming that the books of accounts of the investee company reflect its true and accurate financial position). If there are exceptions to ensure that the R&Ws are not breached, the promoters furnish relevant factual disclosure in the form of a disclosure letter. From a documentation standpoint, PE investors usually insist on the promoters to back-stop a breach of R&Ws or a misrepresentation of R&Ws by way of an indemnity. Pursuant to this, should a breach of R&Ws occur, it gives the PE investor the right to seek monetary claims against the promoter.

  • Post-investment oversight – board nomination: Whilst as a minority financial investor, PE investors do not usually take the onus of day-to-day operations of the investee company, they usually insist on appointment of a nominee on the board of directors. Where the clause does not provide for requirement of approval of the other shareholder, the appointment must be immediate. Further, the presence of such nominees is also required to constitute a valid quorum for a meeting of the board of directors.
  • Veto rights of the PE investor and share transfer restrictions: Under the Companies Act (Act), certain actions of the company require consent of shareholders of the company either by way of an ordinary resolution (which requires a simple majority of the shareholders) or a special resolution (which requires ¾ of the votes in favor of that resolution). In addition to this, PE investors may negotiate to have veto on certain matters. This contractually negotiated right ensures that despite having a minority stake in the company, PE investors have the right to veto certain actions that could potentially affect their investment as well as influence certain critical decisions of the investee company. Usually, veto rights are in relation to raising further debt or equity funds, issuance of shares, approval of accounts, business plans and annual budgets, acquisition or divestment of new business, hiring or terminating key employees as well as statutory auditors. It is pertinent to note that the courts have allowed clauses in the articles that have a higher threshold than those of the Act where the Act is silent on that matter.
  • Exit rights: Exit related rights are critical for PE investors. Set out below are some of the key aspects of exit provisions and attendant judicial interpretation:

            - Obligation of promoter to provide exit on a ‘best effort’ basis: While exit rights are extremely important for investors, from the promoter’s perspective it is not an absolute obligation since exit is dependent on several factors such as macroeconomic conditions, regulatory framework affecting the industry and other conditions beyond the control of the promoter. In recognition of this aspect, the exit obligation of the promoters is negotiated to be on a ‘best effort’ basis, or exit terms and valuation are based on the approval of the PE investor.


  • Put option: Put options are structured in a way that empower the PE investor to require the investee company or the promoter to purchase the securities held by the PE investor at a pre-agreed price or at a fair market value, if the PE investor has not exited. Put option clauses are negotiated either to be on the investee company or personally on the promoters.
           - With regards to the investee company, the put option is implemented via a buy-back as per the provisions of the Companies Act. Under the Companies Act, the investee company is required to buy-back its shares or specified securities out of its free reserves, or the securities premium account or the proceeds of the issue of any shares or other specified securities. Additionally, the buy-back should be authorized by the articles of association and approved by ¾ shareholders of the investee company and cannot be more than 25% of the aggregate paid up capital and free reserves of the investee company in any financial year. There are other procedural conditions to be complied by the investee company for undertaking a buy-back of shares.

                - A put option in relation to promoters is governed by the Indian contract law and, if the investee company is a listed company, the regulations under the Securities and Exchange Board of India Act, 1992 and the guidelines and circulars issued by the Securities and Exchange Board of India (SEBI) are also applicable. Post October 2013, put options in relation to listed companies have been expressly permitted by SEBI subject to the following conditions: (i) the PE investor should hold the securities for a minimum of 1 year, (ii) the price for the sale and purchase of the security has to be in compliance with applicable laws, and (iii) the put option has to be settled by actual delivery of the underlying securities.

            - Non-resident PE Investor: If the PE investor is a person resident outside India in both the above circumstances, the provisions of the Foreign Exchange Management Act, 1999 and the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (FEMA 20R) are applicable. The pricing guidelines prescribed under FEMA 20R for a transfer of a shares by a person resident outside India (i.e. a PE investor) to a person resident in India (i.e. the promoter or the investee company) require such transfer to be at a price not exceeding (i) the price as per the guidelines and regulations prescribed by SEBI in case of a listed company and (ii) the price as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a SEBI registered Merchant Banker or a practicing Cost Accountant, in case of an unlisted company. 


In addition, FEMA 20R specifically provides that the guiding principle would be that the person resident outside India is not guaranteed any assured exit price at the time of making such investment/agreement and shall exit at the price prevailing at the time of exit. “Hence, put options on the investee company or the promoters cannot be at a pre agreed price or return and will need to be at the price prevailing at the time of exit.” 




Popular posts from this blog

VC Interview: Shailendra Singh of Sequoia Capital India

In a recent interview to Venture Intelligence, Shailendra Singh discussed some of the firm’s newer investments in the early stage segment including in the online payments space, the progress at a few existing portfolio companies and the active role the firm is playing in helping its portfolio companies scale and succeed in India and globally. Prior to joining the firm in 2006, Singh was a strategy consultant at Bain & Company in New York and before that, an entrepreneur in the digital media industry.

Venture Intelligence: How does Sequoia go about identifying potential early stage investments in India? Is there anything different you are doing today than, say, a couple of years back?

Shailendra Singh: There is a lot more focus on technology investing and early stage investing. In general, as you might remember a few years ago, we were doing primarily growth investing but in the past 18-odd months, we have had a very strong focus on early stage and that’s continuing. In terms of how…

PE investments in 2018 crosses $33-B to set new all-time high

Big Ticket investments in consumer apps Swiggy & Byju’s dominates year-end activity, even as investments in Core Sectors slow down
Private Equity (PE) investments in India rose to their highest ever figure of $33.1 billion in 2018 (across 720 transactions), according to data from Venture Intelligence (http://www.ventureintelligence.com), a research service focused on private company financials, transactions and their valuations. While PE investments have already surpassed the previous high - $24.3 Billion across 734 deals in 2017 - in the first nine months of 2018, the mega investments in Consumer Internet & Mobile startups such as Swiggy and Byjus towards the year-end, helped the 2018 total vault by 36% year-on-year. (Note: These figures include Venture Capital investments, but exclude PE investments in Real Estate.) The year witnessed 81 PE investments worth $100 million or more (accounting for 77% of the total investment value during the period), compared to 47 such transac…

ChrysCapital and Sequoia Capital India grab two awards at APEX’19 PE-VC Awards

Mumbai, India, Feb 27, 2019: ChrysCapital and Sequoia Capital bagged two awards each as part of the “Awards for Private Equity Excellence” (APEX)event organized by Venture Intelligence. 

ChrysCapital bagged the Private Equity Fund Raise of 2018 Award (Closed $850 M Fund VIII within 4 months of launch) and the Private Equity Investor of 2018 Award (for its Exits from LiquidHub with 4x in dollar terms (within 4 years of its $53-M investment), AU Small Finance Bank with 11.5x return,  Torrent Pharma with 2.95x, City Union Bank with 2.83x, L&T Infotech with 2.56x)

Sequoia Capital India won the Early Stage VCInvestor(the firm registered 10x+ exits in Byjus Classes and SCIOInspire) and VC Fund Raise of 2018 (the firm closed an almost $700-M Fund VI).


Award Winners at APEX'19 PE-VC Awards

The event opened with a Fireside Chat with Kiran Reddy, CEO of SPI Group interviewed by his long time friend and colleague Vineeth Vijayraghavan.



Snapshots of the Awards Ceremony: (L-R) Gopal Srinivasan, …

Private Equity investments up 26% to $10-B in Q1’19

Press Release
Private Equity and Venture Capital firms invested a record $10.1 Billion (across 159 deals) during the quarter ended March 2019, according to data from Venture Intelligence, a research service focused on private company financials, transactions and their valuations. The investment value increased 26% compared to the $8.0 Billion (across 208 transactions) recorded in the same period in 2018 and 39% higher than the immediate previous quarter (which had witnessed $7.3 Billion being invested across 178 transactions). (Note: These figures include Venture Capital investments, but exclude PE investments in Real Estate).
The latest quarter witnessed 23 PE investments worth $100 million or more (with 6 of them $500-M or above) compared to 17 such transactions in the same period last year. Infrastructure related companies (especially in Energy, Roads and Telecom) accounted for 48% of the investment value during the period - accounting for $4.9 Billion (across 16 deals), compared t…

EY tops League Table for Transaction Advisors to Private Equity deals in 2018

Avendus, JP Morgan claim the No.2 & No.3 slots; PwC claims top spot including other advisory services
EY topped the Venture Intelligence League Table for Transaction Advisor to Private Equity Transactionsin 2018. EY advised PE deals worth $4.9 Billion (across 17 qualifying deals) during the period. Avendus ($2.9 Billion across 18 deals) and JP Morgan ($2.2 Billion across 2 deals) took the second and third spot. Barclays ($2 Billion across 3 deals) and KPMG ($1.7 Billion across 7 deals) completed the top five in 2018.
The Venture Intelligence League Tables, the first such initiative exclusively tracking transactions involving India-based companies, are based on value of PE and M&A transactions advised by Transaction and Legal Advisory firms.
EY advised deals during the year include Macquarie's $1.5 Billion investment in NHAI Toll-Operate-Transfer (TOT) Bundle and Blackstone's investment in Indiabulls' commercial assets in Mumbai. Avendus advised deals include the Nasp…