In the lifecycle of any private company, particularly in the early and growth stages, investors eventually seek to realise returns on their investment. A well-drafted Shareholders’ Agreement (SHA) plays a critical role in facilitating this by setting out the terms under which investors can exit the company. From trade sales to IPOs and put options, exit provisions offer clarity, protection, and commercial certainty to all stakeholders.
In this article, we explore the most commonly used exit mechanisms for investors under shareholders’ agreements, along with key legal and practical considerations.
Trade Sale
A trade sale involves the sale of the company, or a controlling stake in it, to a third party, often a strategic buyer operating in the same sector. In such a scenario, investors typically participate by selling their shares alongside the founders or majority shareholders.
Legal Insight
SHAs often include provisions obligating all shareholders to co-operate in a trade sale, particularly where a majority has approved the transaction. Investors may also negotiate minimum return thresholds or veto rights on unfavourable terms.
This blog is a part of our The Essential Guide to Shareholders’ Agreements: Protecting Interests and Ensuring Smooth Governance of Companies Blogpost.
Initial Public Offering (IPO)
An IPO represents an opportunity for investors to exit the company by offering their shares to the public through a listing on a recognised stock exchange.
Key Considerations:
- SHAs may provide for a defined IPO timeline.
- Investors typically negotiate for registration rights or equivalent rights depending on the jurisdiction and the ability to sell all or a portion of their shares post-IPO, subject to regulatory lock-in requirements as per the jurisdiction.
- Founders may be restricted from selling their shares for a certain period to maintain market confidence.
Buy-Back of Shares by the Company
Subject to statutory requirements, a company may repurchase its own shares, offering investors a direct exit mechanism.
Legal Framework:
- Buy-backs must comply with jurisdiction-specific corporate laws (e.g., solvency tests and approvals).
- SHAs may include buy-back rights triggered by defined events such as non-achievement of business milestones or investor deadlock.
Put Option
A put option grants investors the right to compel the company or in some cases, the founders or promoters to purchase their shares at a predetermined price or valuation formula.
Use Cases:
- Where an IPO or trade sale has not occurred within an agreed timeframe.
- In cases of material breach, deadlock, or a change in business direction.
Drafting Guide: Price calculations often use fair market value or a multiple of EBITDA or invested capital.
Tag-Along Rights
Tag-along rights ensure minority investors are not left behind in a sale by allowing them to sell their shares on the same terms as the majority.
Investor Protection:
- These rights are crucial where founders seek to exit, as they prevent dilution or entrapment of minority interests.
- SHAs may specify the percentage threshold and notice period for invoking such rights.
Drag-Along Rights
Drag-along rights empower majority shareholders (often including lead investors) to compel minority shareholders to sell their shares in a third-party sale.
Purpose:
- To facilitate full control transfer to a buyer who demands 100% equity.
- Ensures clean exit without holdouts from minority shareholders.
Best Practice: These clauses should be drafted carefully to balance exit flexibility with protection for minority interests.
Third-Party Sale or Private Secondary Sale
Investors may independently sell their shares to external parties, subject to the terms of the SHA.
Common Restrictions:
- Right of First Refusal (ROFR): Existing shareholders have the first right to buy the shares on the same terms and price as offered by the third party purchaser.
- Right of First Offer (ROFO): The selling investor must offer shares to existing shareholders before negotiating with third parties.
These provisions preserve internal control and reduce the risk of unwanted third-party shareholders.
Redemption Rights
Redemption rights enable investors to require the company to repurchase their shares upon the occurrence (or non-occurrence) of defined events.
Examples:
- Failure to complete an IPO within a specified period.
- Material change in business operations or regulatory compliance issues.
Note: Not all jurisdictions permit redemption of shares, and companies must adhere to capital maintenance rules as per the relevant laws of their jurisdiction.
Conclusion
Exit provisions form the cornerstone of investor protection in shareholders’ agreements. Whether through a structured sale, public listing, or contractual rights such as put options and drag-along clauses, these mechanisms ensure that investors have a clear path to liquidity.
From both the company’s and investor’s perspective, it is vital that exit clauses are tailored to reflect commercial intent, regulatory compliance, and the strategic growth stage of the business.
