Private equity has been in India for about three decades. During this time, the PE ecosystem has evolved and matured considerably. In the last several years the generally agreed legal positions are seeing a change and new constructs are entering the deal documents. In this article we will see some of the key positions that are changing, keeping the early stage deals at the heart of the discussion.
1. Cause: Cause is a list of identified events, on happening of which, the founder concerned would have to undergo identified consequences. These usually are loss of employment, shares and any official position (including directorship) in the company. Till the early to mid-2010s (around the e-commerce boom), Cause was a broadly worded clause identifying material breaches, misconduct, and fraud as a trigger event. This clause nowadays is less vague/generic and more specific. Even the specific triggers are also seeing an evolution. For instance:
Filing of an FIR against a founder moved to a filing of charge sheet (and further evolution to an actual conviction).
General breach of SHA moved to breach of specific clauses.
Automatic breach moved to cure periods, assessment by third party and principles of natural justice being followed.
This signals a shift in mindset and can be attributed to a combination factors like growing markets in India, founders finding more leverage, investors maturity, and documents replicating positions in matured markets like the UK and the US.
2. Governance: Governance matters are now taken more seriously but not necessarily in the way one might think. A growing trend seems to be investors wanting more control but without much fiduciary baggage. For instance, investors do try to gain governance rights like board seats, veto rights on certain matters, mandatory quorum requirements, and the like. The ones that do get such board seat rights are less and less likely to appoint their nominees to the board. A sceptic might see this as investors not wanting to be on the board of untested/new companies where some of the decision making is likely to attract issues of responsibility and unwanted associations (as even nominee directors have fiduciary responsibility towards the company and its stakeholders). Another instance is approval of financial statement as an investor approval matter. This does not find a place in today’s SHAs. This could be because of certain real life examples, where financial statements have been central point of controversy and dispute. And investors do not want to be seen as “approving” them in any way. The story in a nutshell seems to be Investors want to retain certain rights while still being at a distance if governance issues prop up.
3. Exits: Exits were seen as hard obligation of the founders and the company, after all, investors are answerable to their backers about financial returns. It’s now a settled position that exit is not a hard obligation but more a “best effort.” This does seem to be in line with the thesis that these investments are in untested/evolving technologies and products and private equity investors (at least for this part) share this thesis with venture capital investors. Besides, the foreign exchange regulations have mandates against guaranteeing assured exit price.
4. Put option: This is a relatively new phenomenon. Such a provision is finding its place ever so increasingly in the SHAs, which obligates the founder to buy shares from the investor(s) at the lowest possible price upon investors notifying them to do so. The usual reason for investors is to disassociate themselves from “undesirable companies.” These companies may be the ones that are going through internal struggles, are subject of bad publicity, or the investment by the investors may become untenable under any applicable law.
5. Liability: Indemnity and liability for a breach is perhaps the one thing that has evolved over time but not so substantially. The deal-making in India still does not, to a very large extent, differentiate between the founder and the company. Personal liability of a founder has reduced over time for instance, we find temporal and monetary caps being introduced, reps being tightly negotiated, W&I insurance finding its way into the mix and so on. But the founder is still jointly and severally liable (with company) for all losses. This is in stark contrast to what we see in developed economies. There is a discourse to bring this to global standards operating in developed economies, but it is hard to argue against the current position. The placement of investors (usually outside of India), Indian court system and a few other matters make it difficult to argue for parity. Entrepreneurial risk and things outside of a founder’s control can often get conflated with fraud and wilful breaches and growing concerns over governance is not helping it either.
For everyone involved, especially lawyers, it is a balancing act. Market standards are there for a reason. They provide efficiency in deal making and help find common ground. But standards themselves change over time, not because time has passed, but because there is a deliberate push, deal after deal, year after year.
About the author: Navjot Nagure is a Principal Associate at SKS Advisor.
Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.
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