A Guide to Private Equity - BVCA admin

The investment process
amount of capital is raised at above a minimum stock price. This protects preferred shareholders
converting from preferred shares to ordinary shares in connection with an IPO that is too small or has
no meaningful public market or liquidity for the shareholder.
Anti-dilution provisions
Anti-dilution provisions protect the preferred shareholder from dilution resulting from later issues of
shares, in connection with a subsequent financing round, at a lower price than the private equity
investor originally paid (known as a ‘down round’). Anti-dilution provisions in their most aggressive form
are set up such that the lower share price of the later share issue is applied to the original, higher priced
shares and the investor’s share holding adjusted as if he had invested at this lower price.
Redemption rights
Redemption rights require the founder or management team to buy back the private equity investor’s
shares by a specific date. These rights are used if the business does not generate the growth required
by the investor to give him his required capital gain. A multiple of what the private equity firm invested
may be required to be paid back to the firm.
Lock ups
Lock-ups specify how soon after a flotation the management team and the private equity investor can
sell their shares, which is important in making the shares attractive to public investors at the time of
the IPO.
Pre-emption rights
Pre-emption rights apply when a company proposes to issue new shares and existing shareholders,
such as the private equity investor, have the right to be offered a pro-rata part of the new shares
before they are offered to a new shareholder in a way that does not dilute the original private equity
shareholder. In relation to sales of existing shares, similar rights require a shareholder wishing to sell
shares to offer them first to existing shareholders before being able to transfer them to outsiders.
Board composition
The private equity firm has the right to have a seat on the board of directors.
Consent rights
Consent rights give the private equity firm the right of veto over a whole range of areas even though the
private equity firm may not have a majority of the shares with voting rights. Such areas could include
the recruitment of new members of the management team, purchase of new equipment, corporate
mergers and acquisitions, expansion overseas or into new markets, future finance raisings, issue of
stock options, borrowing levels and the sale or flotation of the company. The private equity investor
may set limits over which he wants the right of veto, for example new equipment purchases greater
than £100,000 or borrowing limits greater than £250,000.
Information rights
Information rights will require the company to provide the private equity firm with copies of the monthly
management accounts (including budget versus actual comparisons and explanation of variances),
updated monthly cash flow forecasts, audited annual accounts, annual strategic plan and budget etc.
Warranties
The term sheet may require the management team to warrant certain information which the private
equity firm is relying on in arriving at his investment decision. You will need to negotiate, with your
lawyer involved, the nature, extent and limit of these warranties and what happens if they are breached
in terms of indemnification (if the value of the company is reduced in the event of breach of warranty
you may have to compensate the investor for the reduction in value) or contractual damages (if it can
be argued that the shareholders have suffered no loss you might not have to pay the private equity
firm in connection with the breach).
36 A Guide to Private Equity