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MBO and MBI investment agreements - issues to consider

Investment agreement checklist

We have set out below some of the key points designed to assist both the MBO management buy out team, a management buy in team MBI and the vendor and owners of the target company.

Overview

back to topPreliminary considerations

  • Is more than one investor being approached to make the investment? If so, should each investor be required to sign a confidentiality agreement.
  • Consider whether the investor (or the preferred investor if several are canvassed) should be given an exclusive negotiating period.
  • Are enforceable rights to be given to third parties under the Contracts (Rights of Third Parties) Act 1999?
  • Will there be a single round of investment, or has the investor agreed to make a second round of investment available on the same terms as the current investment?
  • Does the company require interim funding while the terms of the investment are being finalised? If so, on what basis? In early stage investments this often takes the form of convertible loan notes.
  • Prepare heads of agreement for the investment and, if relevant, heads of agreement for any separate interim funding.

back to topParties

  • Who are the appropriate parties to the investment agreement (the agreement)?
  • Consider how the agreement will operate if there is a syndicate of investors. For example, will a lead investor be appointed?
  • Does the investor require flexibility to enable other companies within its group to hold shares in the company? If so, consider how widely such provisions are drafted, should they extend to any company within the investor's group or only to named entities?
  • Confirm details of the target company, the directors, the founders (if different), the investor, and all other shareholders.
  • Confirm details of the number and class of shares to be held by each shareholder.

back to topConditions

  • Is completion of the investment conditional (for example, satisfactory completion of the due diligence exercise or the target company's managers entering into new service agreements (in a from acceptable to the investor) with the target company).
  • Is shareholder approval needed? For example, to increase share capital or to amend the target company's articles of association.

back to topWarranties, disclosure and limitations

  • If exchange and completion of the investment agreement are not simultaneous, will the warranties be repeated at completion? If so, and if further disclosure is permitted, consider what remedies the investor should have if the disclosure shows that there has been a material adverse change in the target company's business in the interim period. For example, consider whether the investment agreement should include a material adverse change clause.
  • Who will give the warranties? Generally, they are given by the target company and its founders and directors (the managers) (collectively referred to as the warrantors). Consider whether all of the managers will give the warranties, or only those involved in the daily running of the target company's business.
  • How, if at all, will the warranties be limited? Common limitations include:
  • the time period during which the investor can bring claims;
  • the buyer's knowledge
  • a cap on the total amount of warranty claims;
  • a cap on each manager's liability (for example, consider a limitation of three times salary or remuneration); and
  • a deminimis level that must be reached before the investor can bring a claim.
  • Consider the disclosure process.
  • Will the warrantors have joint liability or several liability for the warranties?
  • Should there be a separate deed of contribution to apportion any liability under the warranties among the managers?
  • Can the benefit of the warranties be assigned to future buyers of the target company or to any other member in the investor's group?
  • What remedies are available to the investor for a breach of warranty; for example liquidated damages or rescission.
  • Consider warranty insurance cover.
  • Should the managers waive any right that they may have to sue the company?
  • Consider the scope of the warranties and whether some (or all) of them need to be qualified in some way (for example, by qualifications such as "so far as the warrantors are aware").

back to topBoard, observers and information

  • What rights will the investor have to appoint directors to the board? Consider how many directors the investor will be entitled to appoint. Will the appointment be effective immediately on completion, or will it be expressed as a right in the investment agreement?
  • Will the investor director have the right to appoint any person to act as his alternate director?
  • Will the investor have the right to nominate an observer to attend board meetings? Consider whether this right is instead of, or in addition to, the appointment of a director.
  • What management information (including business plans, management accounts, budgets and board papers) will the investor director (or any alternate or observers) have access to? (The investor may insist on access to all relevant information and board papers.)
  • Consider how much information the investor director (or any alternate or observers) are entitled to disclose and/or disseminate to the investor and/or other members of the investor group.
  • Will the investor director be paid for its services? If so, on what basis? Consider the frequency of reviews, will they be index linked and will reasonable out of pocket expenses be paid? Will observers also be reimbursed for reasonable out of pocket expenses?
  • Does the company maintain an adequate insurance policy for each director? If not, will such policies be put in place following the investment?
  • What quorum and notice requirements will apply for board meetings. For example, does the investor director (or an alternate or observer) have to be present in order for the meeting to be quorate?
  • Consider how the appointment of a chairman of the board will be determined and will the chairman have a casting vote or any other special powers or rights?
  • Consider which matters will be reserved for decision by the board itself.
  • Will there be any specific requirements concerning the location and frequency of board meetings?

back to topConduct of the business

  • Consider whether new and/or additional controls should be included in the investment agreement and put in place following the investment for example:
  • obliging the target company to maintain effective and appropriate accounting systems?
  • obliging the target company to maintain adequate insurance for its business?
  • the target company should (if it doesn't already) produce monthly management accounts. Consider whether the investment agreement should include a provision specifying the format of the management accounts.
  • will the investor (or its appointed director) have unrestricted access to the target company's books and records or will access be restricted to certain items?
  • include an obligation requiring minutes to be prepared and circulated to the directors after each board meeting. Consider whether copies of these should also be sent to any observers that the investor is entitled to appoint and/or directly to the investor itself; and
  • consider including a time limit for preparation of year end accounts (for example, four months following the year end).
  • Will certain matters be reserved to the investor for determination? This level of consent is usually required for fundamental issues (and may also extend to any subsidiaries of the target company) and may include:
  • significant acquisitions and disposals by the target company;
  • declaration and payment of any dividends;
  • material changes to the target company's business
  • significant expenditure by the target company; and
  • entering into unusual or long term contractual commitments or any contract that is outside the target company's usual course of business.

back to topShares and transfers

  • How many classes of shares will there be?
  • Following the investment, to what extent does the investor require the ability to transfer its shares in the target company to other entities within its group?
  • If transfers are permitted:
  • consider whether pre-emption rights apply;
  • consider whether any transfers should be permitted free of pre-emption rights. For example, the managers may be able to transfer their shares to close family members and the investor may be able to transfer its shares to other members of the same group; and
  • ensure that the transferee of the shares has to execute a deed of adherence to the investment agreement.

back to topEmployees

  • Are the managers required to enter into new (or more formal) employment arrangements as a result of the investment?
  • Consider whether any restrictive covenants in the manager's service agreements should also be repeated in the investment agreement. Should the investment agreement also include an additional obligation on the managers to comply with the terms of their service agreements?
  • Consider how the managers will be incentivised to stay with the target company. For example, will good leaver/bad leaver provisions be introduced in the target company's new articles?
  • What (if any) share option or incentive schemes are proposed for both the managers and the target company's other employees?

back to topExit

  • Consider how exits will be dealt with.
  • Consider requiring the company to notify the investor of any approach that is made to it by a third party to buy the target company or its business and assets.
  • Consider including provisions in the investment agreement that the investor will not give any warranties on an exit (other than as to its title to the shares that it holds in the target company).

 

This paper is designed to provide a summary of the issues addressed. Therefore, it is not intended as a detailed commentary on the relevant law and any comments made should not be acted upon without first taking specific legal advice.

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