EVCA Handbook Professional Standards for the Private Equity and ...

18 EVCA Handbook Professional Standards for the Private Equity and Venture Capital Industry3.3.4. Investment decisionQuestionHow should a decision to invest in a Portfolio Company be reached bya GP?ExplanationAny decision by a GP to make an investment involves an appraisalof the opportunity and an evaluation of the risks versus the rewardsof the opportunity. The information on which this decision will bebased will usually have been gathered and critically appraised withinthe team of executives working on the transaction during the duediligence phase. The quantities of information, however, will normallybe so great that it will need to be summarised before it is presentedto the Investment Committee or other decision-making body of theGP that ultimately decides whether or not to make an investment.Undertaking a successful due diligence exercise that confirms thevalidity of the underlying assumptions of a business plan will notgenerally be sufficient in itself. LPs look to the experience of thesenior executives of a GP to add value to the due diligence exerciseby critically evaluating the information collected by applying theirdepth of business and investment experience.RecommendationThe results of the due diligence exercise and the GP’s seniorexecutives’ recommendations should be distilled into a comprehensivewritten investment proposal which accurately reflects the potentialof the target company, addressing a range of both financial andnon-financial factors. As part of this process, consideration willalso have been given as to whether the proposed investment fitsthe investment criteria and complies with the investment restrictionsin the Fund documents. The investment proposal is an importantdocument; not only does it provide a written record of the informationconsidered in making an investment decision, but it will typicallycontain the core investment thesis that will continue to provide theyardstick by which the success of an investment will be judged duringits regular review by the GP.Investment decisions should be made by suitably senior andexperienced personnel of the GP; normally these individuals willform an Investment Committee. Typically, the experienced individualsresponsible for evaluating and proposing an investment will not beinvolved in making the final investment decision. If there are anysignificant changes to an investment proposal, further review,evaluation and additional approvals may be required.It is good practice to use the underlying reports from which theinvestment proposal is drawn to form an important source documentfor strategic review and performance for the Portfolio Companies.3.3.5. Structuring investmentsQuestionWhat factors should the GP consider when structuring andnegotiating an investment?ExplanationInvestments by Funds can be structured in many ways. In some casesthe Fund may be a passive minority investor in a Portfolio Company,while in others, the Fund may obtain substantial or indeed full controlover the Portfolio Company. In determining how the investmentsshould be structured, consideration should be given to the jurisdictionin which the investment is to be made, the investment strategy of theFund and whether the investment is to be the acquisition of a minorityor majority interest in a Portfolio Company.The Fund may also need to carefully consider its position and strategywhen investing alongside other parties (e.g. as part of a syndicate) andwhether it owes any duties or obligations to others as a result.It is possible for the structure of an investment to impose liabilitiesand responsibilities on the Fund beyond those envisaged and anysuch restrictions will typically be thoroughly investigated with thehelp of the Fund’s lawyers.RecommendationThe GP should structure and negotiate each investment made by theFund in such a way so as to ensure that it meets both the obligationsto and the interests of the Fund.When structuring any investment the GP should take steps tominimise any adverse tax or other consequences. For example, theGP should take into consideration ERISA requirements where thereare US based ERISA LPs, of any investment for the Fund and its LPs,which may require certain information and observer/board rights tobe obtained in respect of the Portfolio Company.3.3.6. Responsibilities to other shareholders in the sameor other classes of shares and to bondholdersWhether as a shareholder in the Portfolio Company, or throughprovisions agreed in the Investment Agreement, the Fund hasownership responsibilities and should exercise those responsibilitiesproactively and in a way that continually supports the value of theFund’s investment.QuestionHow should the Fund conduct itself in relation to other investors in thePortfolio Company?ExplanationIn some jurisdictions, it is common practice in the Industry for differentclasses of investors to acquire different types of securities accordingto their relative position in the transaction, the nature and level ofthe risk they are taking on and the relative value they are bringingto the investment.The returns for each type of security, whether equity or debt,will typically vary depending on certain outcomes. It is thereforepossible that conflicts may arise between holders of different classesof securities if expectations are unclear or based on erroneousassumptions, or if actual Portfolio Company performance is notas projected at the outset.RecommendationThe negotiation of shareholder rights should be conducted openlyand with clarity among all investors in the Portfolio Company.Due consideration should be given in advance to potential areas ofconflict and where conflict does arise, the resolution of that conflictshould, to the extent possible, be conducted fairly and in such a waythat the outcome does not impact the value of the Portfolio Company.