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Running for the door: What do you need to agree upfront about your exit?

07 October 2009

The principal reason for taking either development capital or additional investment into your business is to grow it and so have potential for a successful future exit.

It is easy to get carried away with the detail of the investment, but important to remember you must ensure it anticipates your ultimate exit, and that you are comfortable with how that will be achieved.

The first consideration is timing.

Many private equity or venture capital investors will expect a provision in the investment agreement stipulating the length of time over which the investment will last, and giving them the ability to force an exit after that time. Think about how this ties in with your own plans and aims, both for the business and personally. 

A typical period would be three years, although this can be extended to five or even seven in certain circumstances. The length of time will very much depend on the type of business you are operating and the stage at which investment comes in.

Second, consider the expectations of the investors.

Will they only agree to an exit when, for example, a certain multiple of earnings is achieved, leaving you unable to exit if that target is not achieved? Would one party be willing to roll over some of their exit money into a newly capitalised business (i.e. could you ask them to receive cash and shares in a new corporate vehicle)?

Prior to the credit crunch there was a very hot market in private equity secondaries – where one private equity fund would sell to another – and you may wish to have provisions within your investment documentation that govern what will happen in such an event.

Third, consider the method of exit.

Most investment agreements will be drafted in such a way as to permit either an initial public offering or sale to a third party buyer. Some will go further, and contain a requirement for the appointment of either a corporate finance adviser or a merchant bank to look at a possible sale or IPO.

Many private equity funders will insist on the ability to make these appointments themselves, without consulting the company or the other shareholders. Consider whether such a requirement is appropriate for your business and whether you would like to retain some control or say in this process.

A possible compromise is the incorporation of provisions into the investment agreement which require an exit committee to be set up to make decisions about how and when an exit will take place.

It is important to consider the basis on which this exit committee would be founded. Would it be a committee of the board or would representatives of the private equity funder not already on the board of directors be entitled to attend? What powers would this exit committee have? Would their recommendations be automatically deemed approved by the board of directors?

It is important, too, that provisions concerning a potential exit are contained in your investment agreement.

Shoosmiths has a great deal of experience advising both companies and private equity investors on the nature of these provisions, and how either party can be protected.

© Shoosmiths. This page is for general information: it is not legal advice. Please read our full terms and conditions for details of the disclaimers and exclusions which apply.

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John Finnemore

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