Shareholders United - Tackling the issues of minority corporate investment
It took some time, but Sir Jim Ratcliffe’s Ineos Group has acquired a 25% stake in Manchester United football club. When working on a transaction, there is frequently the temptation to see completion as an end point, but with investments it is just the beginning of the story.
The issues associated with an incoming minority shareholder are very different (and in some ways more complex) than with a full sale of a business. In Manchester United’s case, the picture is further complicated by the way that Manchester United PLC is listed on the New York Stock Exchange.
In this article, we’ll focus on the main issues which frequently arise from a new investor (often institutional, such as a venture capital or private equity fund) becoming a minority shareholder in a private limited company.
Understanding the basics
It’s critical to understand the fundamentals of the transaction and how the parties’ economic interests will change because of the deal.
To start with, are any of the existing shareholders intending to realise their interest and receive any cash? That would typically involve a transfer of shares, but transactions regularly involve a mixture of share transfers and fresh investment into the business. In terms of the investment, who is subscribing? What are they subscribing for? Are all subscriptions taking place at one time, or are there multiple tranches of investment planned?
It is also important to appreciate how the business will continue to be financed. Investors often prefer to invest through debt rather than equity. There are various reasons for this but the most common are that:
i) debt can provide better rates of return for the investor;
and ii) the investor can reduce their risk by insisting on a security package over the assets of the business.
An ongoing relationship
The nature of an investment is that the existing shareholders and management will need to work with the incoming investor. The company’s articles of association will help to regulate those relationships, but a shareholders’ agreement may also be desirable (especially where the parties wish to keep elements of their agreement confidential).
A minority investor will seek a degree of negative control over the decision making in the company. It would be much less common for such an investor to demand positive or day-to-day control of the business – that level of control is normally reserved for a majority shareholder. As a note, this is one thing which makes the Manchester United situation unusual – Ineos clearly have a direct influence on the football side of the operation.
Some of the key matters which need to be addressed are:
- Composition of the board – the number of directors needs to be determined as well as if any shareholder/s will have the ability to appoint one or more individuals to sit on the board. Institutional investors will usually insist upon being able to maintain at least one director and they may also want the ability to appoint a non-voting observer.
- Rights of pre-emption for fresh investment – an investor may want a contractual right to be able to subscribe for further shares in the company before they are offered to other shareholders or third parties. This can sometimes be tied to an already planned second tranche of investment or be limited to a certain time duration. From a company point of view, this needs to be thought about carefully. Granting such pre-emption rights may make it more difficult to attract future investment from other investors.
- Share transfer rights and restrictions – typically an investor (and certainly an institutional investor) will want a degree of certainty regarding the ownership of shares and who they are working with. It is common for the company’s articles (and/or a shareholders’ agreement) to prescribe when shares may be transferred and, also, when they must be transferred. In situations where the founders of the business are also directors these provisions are usually aimed at deterring the founders from leaving. How strongly they are weighted in favour of an investor is a matter of negotiation.
- Information rights – an investor will usually ask for the right to receive regularly various items of information regarding the company’s operations. This will likely include a range of financial information such as monthly management accounts, cash flow projections, and the year- end accounts with an annual report. From a director’s point of view, it is important to be certain that you will be able to provide all such information before you give such rights.
- Restrictions on founders – a founder will be expected to devote all their professional energy to the business, unless agreed otherwise. This is usually documented in a shareholders’ agreement. In addition, there will typically be restrictions upon the founders for a period after they leave the business – these are often known as non-compete clauses or restrictive covenants. This is intended to be another incentive for the founders to remain in the business. Such provisions much be reasonable for them to be enforceable - what is reasonable will depend upon the specific circumstances.
- Consent rights – these are essentially rights of veto over key matters relating the business, and they are drafted so that the investor is required to give consent before any such matters can be actioned. At their most basic, they would usually include: any changes to the articles of association, any changes to the capital structure of the company, the taking on of any debt outside of the normal course of business, any changes to the board of directors, and any changes to the business plan or core activities of the business. However, they can be much more wide-ranging depending upon the business in question and the respective bargaining strengths.
Taking Advice
Taking on new investment is vital for businesses to scale-up, grow their operations and maximise their potential. It is vital, however, to address the key issues associated with an incoming shareholder early. To ignore these matters gives rise to the risk of ending up on the back foot during a negotiation and an investor insisting upon a stronger series of rights than was expected. Furthermore, an agreement which fails to adequately cover these points can make future disagreements more difficult to resolve to the general detriment of the business.
How we can help
For more information about the issues in this article, please contact our corporate team.
Sir Jim said becoming a co-owner was "a great honour and comes with great responsibility".
"This marks the completion of the transaction, but just the beginning of our journey to take Manchester United back to the top of English, European and world football, with world-class facilities for our fans," he said.
"Work to achieve those objectives will accelerate from today," the 71-year-old added.”
