Private equity (PE) investors are tightening their grip over promoters by falling back on protective provisions in definitive agreements, as terms between PE investors and promoters worsen with every passing day following the financial downturn.
PE investors, in their urgency to invest in companies, have taken a number of risks over the last couple of years. Customary provisions and protective measures were brushed aside, lawyers in the know say.
Ashish Jejurkar, partner, M&A and private equity, at Luthra & Luthra Law Offices, said, “Investors are not willing to take the kind of risks they were taking earlier. They are asking for break fees, tighter material adverse change clauses, increased lock in of promoters’ shares and full anti dilution provisions.”
They are also investing in participatory preference shares, linking convertibility of instruments to performance milestones and increased affirmative rights, said Jejurkar.
Investors are not only looking upon themselves as bankers, but as ones who would like to work shoulder to shoulder with promoters in the business of companies they invest in, he added.
Escrow of promoters’ assets is also being increasingly resorted to. As per the escrow agreement, the custody of promoters’ assets is kept with a third party or escrow agent. The assets are released and made available to promoters, based on the company’s performance. “Such escrow agreements would incentivise promoters to perform at their best,” said Jejurkar, adding that investors are not leaving any stones unturned to ensure that companies they invest in are profitable.
According to another Mumbai-based lawyer involved with PE deals, investors are seeking more veto rights in decisions made by promoter groups.
“They do not want to be scapegoats owing to certain decisions made by promoters. Hence, they seek more veto rights in agreements.”
Default options, such as call options and put options, are being implemented on a broader scale nowadays.
More investors are considering implementing put options, in cases where they have the right to ask promoters to buy investors’ shares at premium prices, as mentioned in the agreement.
As per call options, promoters can be asked to sell their stake to investors.
The commonly resorted to provisions are invoking material adverse effect and default clauses and conversion ratios linked to performance milestones.
Options on promoters as well as clauses relating to security cover are being invoked. The fall in business, accompanied by a steep fall in valuations, is making life difficult for the PE investors, sources said.