Corporate Finance Law | In most cases, the greatest financial rewards that private investors see as a result of their investment come not via regular income from the business, but as a lump sum when they end their involvement with the business.
The amount of money that is received at this stage can often depend on how well the investor has planned their exit strategy.
Corporate Finance Law – Planning Your Exit As a Private Investor
Corporate Finance Law Exit strategies
There are a number of exit routes for private investors, each of which has its own advantages and disadvantages. The most common are:
- Public Flotation
- Trade Sale
- Management Buyout
A management buyout is where key individuals and staff members are offered the option of securing finance to purchase all or part of the interest which is held by the businesses owners or investors.
This is often an attractive option when coupled with an agreement that the investor will retain a minority shareholding or will continue to receive income from the business for a number of years because control of the business will pass to people who are familiar with the market and who can maximize the future revenues which the investor will draw.
Corporate Finance Law Maximizing the Sale Price of the Investment
Calculating the value of an investor's shareholding in a business and the price for which he can sell this stake is more complicated than just working out the value of the business as a whole and then pro-rating this.
The price which can be achieved is affected by a variety of factors and it is advisable for a private equity investor to take steps to try and control as many of these factors as possible from the outset of their investment.
Major factors which will affect the price an investor can achieve for the disposal of his investment include:
- Information reporting
The more information which a private investor has available about the functioning of a business, its prosperity, and projections for the future, the better able he will be to plan his exit to achieve the maximum return on his investment.
- Exit by other shareholders
A sale by other shareholders can have the effect of increasing the desirability and value of the investor's stake in the business, but if all other shareholders sell to a single person creating one shareholder with a super-majority, the investor's own minority shareholding could be devalued because it's influence will decrease.
These factors can be achieved through a variety of legal means, such as a shareholders' agreement, alteration of the business's constitution, attaching particular rights to shares held by the investor, and writing obligations into directors' service contracts.
Because a private equity investor is injecting a substantial amount of much-needed capital into the business in which he invests he will be in a strong position to negotiate favorable terms even if he is only obtaining a minority shareholding.
Controlling the Factors
There are a number of important rights which the investor should make sure he has when making an investment as these can be invaluable tools in controlling those factors which cause the value and achievable sale price for his investment to fluctuate.
- ‘Drag-Along' and ‘Tag-Along' rights – ‘Drag-along' rights allow the investor to force other shareholders to sell their own stake in the business at the same time as he sells his own. This allows the investor to maximize the sale price as he can guarantee the purchaser a majority stake – effectively selling control of the company even though he does not hold a controlling share himself. ‘Tag-along' rights enable the investor to prevent his own shareholding from being devalued by a mass sale of shares by other shareholders by forcing those shareholders to require any potential buyer to also purchase the investor's shares at the same time.
- Prohibition and Preemption rights – These rights allow the investor to prevent other shareholders from selling their own stake in the business, or alternatively to force other shareholders to offer to sell their stakes to the investor before offering them to outside buyers. Usually, the clause which confers this right on the investor will set the method by which the pre-emption sale price is set.
Because of the complexities involved, this is an area in which investors are advised to take legal advice. This should always be sought before the investment is made, as if appropriate protections and provisions are not set in place at the outset, it can be difficult for the investor to secure these at a later date.
Advice should be sought from a solicitor or barrister who specializes in this area of law.