This post was inspired by the recent squabbles between Health Plus and Alter Semper Capital, with regard to the agreement to inject $18 million to expand the pharmaceutical branches of Health Plus Limited.
In 2018, there was a 5 year investment agreement between Alta Semper Capital and Health Plus Ltd in order for the latter to expand its company operations with a pledge of $18 million. However, only $10 million had been dispensed, with Alta Semper refusing to disburse the rest. Mrs Bukky George of Health Plus Ltd brought legal action against Alter Semper Capital. When legal action is brought, obviously it is no longer pleasant between the parties, so things like the attempted/alleged removal of the founder from the day to day running of the Health Plus Limited could easily have been anticipated, given the participating rights of Alter Semper Capital. It is also important to note that the issue of a hostile take over could never arise because take overs are only possible with public companies.
This present saga shows the importance of the negotiation and due diligence stages in private equity investment deals as well as properly ascertaining whether you can count on the investor to operate in good faith at all times. Where one cannot count on this good faith, it would be better for a founder to hold out for an investor they are more comfortable with.
Where a founder decides to proceed with an investor, there may be certain clauses that should be inserted in the investment agreement to ensure founders are protected. Yes, it may seem that a founder’s company’s expansion possiblilties are at the mercy of an investor’s funds, but founders need to have a clear head in order to recognise and prevent themselves from getting into situations where they are backed into a corner.
It is therefore important that certain clauses are inserted into their private equity investment agreements. We will look at some of them below:
1. ESCROW CLAUSE
You must also ensure that in your private equity agreement, the private equity investor or partner must provide working capital and cash injections at specific dates , and where that fails, mediation/arbiration should kick in before litigation so as to preserve the atmosphere of the partnership. Now how can you do this? With an escrow clause.
The escrow clause could specify the particular payment systems to be used for the transfers and ensure the mandatory use of those escrow facilities (an escrow account) to ensure that every penny promised by the investor automatically comes in as and when due. This means that the investor’s funds would be held by the payment system in escrow, awaiting the disbursement date to the founder’s company.
2. INDEMNITY CLAUSE
Normally, indemnity clauses protect investors from misrepresentations made by founders. But an indemnity clause may be used in the reverse to protect founders from losses suffered where the investor fails to make the pledged cash and working capital injections. This will also make it easier where a founder chooses to take the litigation route.
It can be provided that should the investor fail to provide the equity injections, the founder is to be indemnified for any loss suffered by the business.
3. NO COMPETITION CLAUSE
A clause must be inserted into the agreement with both parties that the investor shall not directly or indirectly get into any agreement or business arrangement that competes with the investment project .
4. PARTNER PARTICIPATION RIGHTS
In order to determine this, the founder must ascertain their level of comfort they have with the prospective investor to determine whether the investor will have full, capped or non participation rights. This will also apply to the voting rights. The investor must ensure that whatever special purpose vehicle is created to merge the interests of the parties does not disfavour the founder in terms of percentage vis a vis control.
The percentage of equity the investor could be capped in a way that can have with the company, as well as provide for the percentages to begin to shift in favour of the founder even within the duration of the investment. That is, as the investor is being repaid, their shares are gradually being bought out.
Ensure that no clause gives the investor unnecessary control over decision making in the company, so much so that it could grind the company’s operations to a halt.
It would be better for the situation where the founder has voting control, that is more than 50% if it is only one investor coming in or more than 30% if there are 2 investors.
Another solution ould also be a good idea to publicly list the company, so the founder is not at the mercy of one or a few investors. It is however critical that you get a legal adviser when deciding the financing options for your company when you want to expand.
5. PRO-RATA RIGHTS
Where the founder has no choice but to start with the only investor they have gotten, the pro-rata rights clause could be inserted into the investment agreement to provide an option (the right, but not an obligation) for initial investors to invest in future rounds in order to maintain their ownership, which would be diluted otherwise. This means that the founder’s company or going concern will be open to subsequent rounds of investment injections by otherprospective investors.
5. NON ASSIGNMENT
Ensure that no party may transfer or assign any of their shares/stock without the knowledge and consent of the other party until the investment period is over.
6. REPRESENTATIONS AND WARRANTIES
Ensure that the focus is not only on the founder to give warranties. The investors should also give representations and warranties as to the contributions he or she will make to the business being bought into and the time frame for that.
Now with all said and done, the investor might still have the upper hand as he may not be willing to sign such an agreement, leaving you at their mercy. In such cases, other financing options such as crowdfunding and listing on a local or international stock exchange might be worth considering.
1. Marsha L., 17 Term Sheet Clauses to Know During Deal Negotiation, https://www.cose.org/Mind%20Your%20Business/Money/17%20Term%20Sheet%20Clauses%20to%20Know%20During%20Deal%20Negotiation.aspx
3. A. Mcknight, The Law of International Finance
4. P. Wood, Law and Practice of International Finance