Should shares offered by a leaver always be taken? In this article, we explain why investment companies generally do not want to enter into a purchase obligation.
If you’ve been involved in contract negotiations with investment firms over investments in privately owned companies, you may have experienced discussions about good leaver and bad leaver clauses. These clauses affect persons who hold a minority interest and who also hold a management (management) position in the company in which there is an interest. They usually imply that such a manager is obliged to offer his shares in the company in question for sale – to the main shareholder, to all other shareholders pro rata or to the company itself (then it is a redemption) – if that manager’s employment ends.
The price at which the share offering is to be made depends on whether the manager is a good loser or a bad loser. These concepts are not clearly defined; they are negotiated, and the result is usually that the bad-leaving concept contains a degree of guilt that is lacking in good-leaving. A good offender should usually offer his shares at ‘fair market value’ – although this is often not so easy to determine – and a bad offender should offer at a lower value.
Offer obligation and purchase obligation
In this contribution, I focus on something that is continuously demanded by managers or their lawyers, and that is that the manager’s obligation to make an offer is offset by a purchase obligation from the person / persons to whom the offer is to be given. Of course, this sounds very sensible, but it is always very difficult for investment companies. Why are they making such a fuss about it? The main reason is that they themselves want to be able to decide whether they want to buy additional shares at a later date. Entering into an obligation to do so is contrary to this.
And it is especially difficult if the investment company invests from a fund with a limited duration. The institutional investors who have invested the fund’s capital expect the fund to be wound up within ten years – however, an extension of one or two years is sometimes allowed. Within the limited period, the fund’s managers must call up the capital that the investors have committed to, invest in a number of companies, deliver a return by actively guiding these companies in their growth and realize through the companies in which the capital is invested, after plan to sell at the right time and at the best possible valuation.
In the agreements that the investment company enters into with the underlying investors, it is usually stipulated that the first five years of the fund’s existence are used to invest the promised capital, and the last five years (plus a short extension) are used to harvest . The shares must then be sold and the proceeds paid out to investors, usually in the short term.
Refuses to connect
And therein lies the core: In the second half of the fund’s life, it must be sold, and it is not the intention to buy additional shares. And then an investment company should refuse to commit in advance to buying shares offered by an auctioneer. This purchase obligation can arise if a manager dies unexpectedly – and can also prove to be expensive if the deceased qualifies as a good emigrant. If this happens towards the end of the fund’s term, there will be no money available to buy the shares offered by the auctioneer.
As an alternative, it is sometimes agreed that if a leader becomes a good leaver through death, a commitment to action arises; not for the investment company, but for the company itself – that is: procurement – to buy in the interest of the deceased manager. Legal (and often contractual) restrictions apply to procurement, so that obligation may not be an absolute must. But in many cases, it’s an elegant compromise.
Author: mr. HL (Herman) Kaemingko
This article appeared in F&A Actueel 2022, Edition 8.