Equity investment agreements: Key terms for financed parties

Since a private equity/venture capital (PE/VC) firm (the investor) usually does not have a direct hand in the management of an investee enterprise (the target company), in negotiations between it and the financed party it will usually demand various special rights that take priority over the founding shareholder in order to protect its interests. What kinds of pressure do these special rights provisions place on the financed party? To what degree can the financed party accept such provisions? The author proposes to provide a brief summary below and offer some advice from the perspective of the financed party.

Director seats. The investor may demand a seat on the board of directors and a veto to prevent the founding shareholder from harming the interests of small shareholders, i.e. the investor. The financed party can take these measures to prevent the investor from affecting the normal operations of the target company: (1) setting a minimum share requirement for such provisions to enter into effect; (2) flexibly arranging the matters to be resolved by the board of directors and the shareholders’ meeting; and (3) elimination of certain protective terms once business performance achieves certain targets.

Preemptive right and right of first refusal. The former refers to the investor’s preemptive right of subscription when the target company carries out a capital increase or new share offering. The latter refers to the investor’s preemptive right of acquisition, all things being equal, when the founding shareholder or other shareholders propose to transfer equity to an outside party. Preemptive subscription is divided into subscription for subsequently offered new shares based on the proportion of shares held, and subscription for all such new shares. The financed party should set a reasonable percentage in light of the company’s stage of development at the time in question and the resource strengths of the investor.

Wang Yuzhong is a partner at Boss & Young