Protecting investors

July 28, 2014

Investment – a business cannot grow without it but getting it, particularly in a competitive market, is not always straightforward.  Any investor looking at your business will seek to boil down what it is that you have that makes your brand sell.  More often than not the answer to that question will be a particular individual that is central to the business either in design – Burberry = Christopher Bailey?  Versace = Donatella Versace? - or in management and direction. 

Dov Charney was “exited” from American Apparel and is reported to have walked back through the door almost immediately in a similar position.  It might be considered that Sir Philip Green is more important to the success of Arcadia, than the make up of Topshop’s collection.    

If an investor identifies someone they consider is critical then an important part of any deal will be making sure that they have guarantees about that person’s continued involvement or protection for if they decide to go in circumstances good or bad.  The business of investors is to make the money they put in pay for itself.  Generally, a private equity investor will be looking at a 3-5 year period for an investment giving little leeway for sales to go down and then recover.  

Below are some of the protections which an investor, in our experience, will be looking for:

Control

Usually, the investee company and all its shareholders (including the investor) will enter into an investment/shareholders’ agreement when the investment is made.  Often, this sets out specific matters which cannot be undertaken without the prior approval of the investor, including the hiring or removal of key executives or the alteration of their remuneration or other material terms of their employment.

The investment/shareholders’ agreement (and the investee company’s constitutional documents) may also provide that upon the occurrence of specified events the investor’s rights will be enhance.  This can include increased voting rights at board/shareholder level, the entitlement to require accelerated repayment of its stake or allowing the investor to effectively appoint a man of their choice if the business is considered to be in trouble. 

The purpose of these provisions is not of course to enable the investor to unnecessarily interfere with the management’s conduct of the business of the investee company, but rather to ensure that the investor can step in (and exercise greater executive influence) if there are significant changes which may potentially threaten the value of the investment.

For instance, Fat Face is now considered to be a private equity success but in 2010 when everything was not going so well a cash injection was needed to keep the banks at bay.  While its backer Bridgepoint put up the money, it also wanted to be assured that Anthony Thompson was in place to take forward the business.

Restrictive and Other Covenants

Often upon leaving brands, key individuals will choose to take some time out before coming back into the market.  For instance, in 2011 Tamara Mellon left Jimmy Choo 6 months after its acquisition by Labelux.  But it was two years before she launched her own eponymous brand.

Restrictive covenants are a way to prevent shareholders/key employees from competing with the company, or from poaching the company’s customers, suppliers and staff in the short/medium term.

Restrictive covenants will only last for a specified period after they leave the company (usually up to 24 months).  Both the investor and the investee company should also ensure that service agreements contain gardening leave provisions, so that if a key employee leaves, he can be required to serve out his notice period away from his place of work – this reduces the opportunity for the employee to solicit business for a new employer by contacting the company’s existing customers/suppliers, or misusing the company’s confidential information or intellectual property prior to his departure.

You may think that having sold your brand you can go and enjoy the money on a beach, drinking a cocktail but an investor may have different ideas.  Founders or key individuals who are part of a business before the acquisition can also be locked in by making payment of part of the purchase price conditional upon them sticking around – generally referred to as an “earn out”.  These can last any time from 6 months to 5 years but it can mean that the price of booking the plane tickets would be very high!  

The price of being bad

Usually, the constitutional documents of an investee company contain provisions requiring departing employees who are shareholders to offer their shares for sale, to the other continuing shareholders and, sometimes, to the company itself.

But often how people are treated will depend on if they are good or bad leavers and this will be linked to why they go.  As a rule of thumb, employees who leave in breach of their contracts of employment or who are lawfully dismissed by the investee company are categorised as “bad leavers”.  The important differentiator is that “good leavers” are usually entitled to receive market value for their shares, but “bad leavers” may only receive the face or par value of their shares or the amount they paid for them when they were acquired.

The investor may also look to “claw back” part of the purchase price paid to a departing employee, where that employee was treated as a “good leaver” on departure but subsequently became “bad” by joining a competitor, in breach of the restrictive covenants contained in his service agreement or the investment/shareholders’ agreement.

Where a departing executive holds options (but not existing shares) in the investee company, an investor will usually expect the options to lapse automatically on departure – again, to avoid any former employee having any continuing stake in the future business.

But overall the issue for investors will be what is needed to protect their investment.


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Peter Faber
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pfaber@foxwilliams.com

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