Investor – Promoter Disputes are not a thing of the present. They have been causes of concerns for Investors as well as promoters for years now. The most recent one to join the bandwagon were the shareholders of Signature Bank who have filed a proposed class action suit against the Signature Bank and three of its former senior executives, alleging that the Signature Bank had falsely represented to them about the healthy financial position just three days before it was taken over by a state regulator. Other earlier instances of disputes are conflict between Bain Capital and Texas Pacific Group and the promoters of Lilliput Kidswear Ltd. on grounds of lack of corporate governance and financial mismanagement. The dispute ultimately led to the filing an application by Lilliput for corporate debt restructuring. It also severely tarnished the image of the Lilliput brand and led to the closure of many of its outlets in 2012. Similar issues of financial mismanagement also came up in New Silk Route and Baring PE Asia backed KS Oils.
Some of the contributing factors for such disputes is lack of proper due diligence by investors, race between the investors and the promoters for control in the investee company and lesser emphasis by promoters on corporate governance. It is therefore imperative for the investors to:
- Conduct a proper legal, financial due diligence and an Environment Social and Governance (ESG) audit before making an investment into the company.
- Background checks on the promoters and the management of the investee company.
- Legal, Secretarial and financial audits at regular intervals of time.
The aforementioned measures will not only protect their investment in the investee company but also reduce the chances of a conflict between the parties.
It is also critical that investors plan their exit strategy at the time of investment itself. Some of the popular exit modes are:
- Private Arrangement: This option is preferred as there is not much interference from the promoters side for such exits. Restriction on such sale are generally embedded in the Investment Agreements and these can be in the form of put and call options, Rights of First Refusal or Rights of First Offer etc. However, in case FDI is involved in such arrangements, the sale will need to adhere to the pricing and other guidelines provided under the Indian foreign exchange control laws and SEBI regulations (in case of a listed company).
- Corporate Restructuring: In case the investors become aware of any plans by the investee company to undergo a merger or an acquisition then the investors can take this as an opportunity to make a complete or a partial exit from the investee company after evaluating the potential profits that such restructuring can bring to such investors.
- Put Option: The investors may also explore the option of having a mandatory Put Option in the transactional documents so that they can exit in the event of a material breach of the contract by the promoters and the investee company.
- An IPO is an easy exit option for Investors. They may explore this option after the lock in period of their investment comes to an end. Many a times IPOs yield more returns to investors than their initial investment.
It is also essential for the investee company and its promoters to choose the right investor. The process should not be restricted to financial valuations but should also extend to other important factors such as the contacts of the investor, brand image, mentoring and other factors. The promoters will also need to decide on the extent of control that they are willing to divulge to the investors, board seats reservations for investors, veto rights, limitation of liability, non-compete, non-solicitation, limitation of liability, etc.
Business ventures are actually an extension of the partnership principle. Hence the promoters must regularly give financial and other business updates on a regular basis to the investors so that the investors develop confidence in the venture. The investors should be made a part of the critical business decision making of the company. These small steps can go a long way to avoid the chances of disputes between the investor and the promoters.
Having said that the Covid pandemic followed by the global financial crisis that is currently looming over us it is critical for both the investors and the promoters to make smart and intelligent business decisions after evaluating all scenarios and after conducting a proper due diligence. Seeking good legal counsel and assistance in drafting of the transactional agreements and for conducting due diligence would be a good approach by both the parties to the transaction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
