PEERING THROUGH THE CO-INVEST FOG: PRIVATE EQUITY INVESTMENTS AND OTHER ISSUES IN CO-INVESTMENT. Moderator: Andrew Kling, Schiff Hardin LLP

Transcription

1 PEERING THROUGH THE CO-INVEST FOG: PRIVATE EQUITY INVESTMENTS AND OTHER ISSUES IN CO-INVESTMENT Moderator: Andrew Kling, Schiff Hardin LLP Panelists: Kristen Danyluk, Allstate Investments Jenna Jenson, Thrivent Financial Christina Melendi, Morgan Lewis LLP Nicole Rives, Sullivan & Worcester LLP ACIC Spring Forum 2017

2 I. Overview of Presentation an interactive discussion of key issues surrounding equity coinvestments from the perspective of various transaction parties (personified by role playing panelists). Description of matters within and outside of the scope of our presentation. II. Structure A. Direct Equity Co-Investments in Three Acts 1. Structure 2. Protective Provisions 3. Exit B. Introduction of Roles A. Co-Investment Vehicles (or not) B. LLC or Corporation issues presented C. UBTI/ECI and Blocker issues D. Commitment Letters E. Subscription Agreements F. Side Letters III. Protective Provisions A. Core Rights 1. NB: Core protections are those that are needed regardless of the size of investment (whether measured by dollar amount or percent of total capitalization). Some commonality exists in what is core across the spectrum of institutional investors, but differences arise as different institutions have different hot buttons 2. NB: When thinking about total cap, consider not only the size of the equity coinvestment in relation to the total equity invested, but also the combined size of the equity coinvestment together with the total amount of related debt invested. 3. Common Core Rights: i. Exit Rights discussed below ii. Preemptive Rights a. Scope. Do preemptive rights apply only to issuances of securities by the company or also its subsidiaries? If preemptive rights do apply to issuances by

3 subsidiaries, do related equity co-investor rights carryover (e.g., if subsidiary securities are issued will there be tag rights available as to such securities)? Do preemptive rights apply only to issuance of common equity securities, any equity securities or any security whether debt or equity (including options, warrants, convertible securities, etc))? What exceptions or carveouts to preemptive rights are acceptable (e.g.: issuance in connection with MIPs (perhaps with an express cap); equity kickers for new debt (issued to non-affiliate/third parties in an arms length deal); securities issued as consideration for acquisitions or in connection with JV or partnership arrangements; customary issuances to Directors; etc.)? b. Over-Allotment Rights iii. Information & Inspection Rights a. Note interplay with information/inspection rights in related debt agreements (if applicable) b. Core requirements may include: I. Annual Audited Financials (consider NAIC issues) II. Quarterly Unaudited Financials III Annual Budget IV. Rights to Reasonably Request Further Information V. Tax Related Items for Partnership/LLC investments: K- 1s and other needed tax reports (if applicable) within requisite timeframe (e.g., days); quarterly estimates of taxable income VI. Inspection and Consultation Rights (subject, perhaps, to cost, number of visits and/or other limitations) and access to capital accounts including shareholder names, addresses and investment amounts VII. Other? Note that on occasion delivery of board packages is provided in lieu of a board observer right as a compromise. c. NB: Avoid minimum hold requirements iv. Governance a. Consent Rights (if any) I. Note distinction between consent rights at the Board level and at the shareholder level

4 II. Sample consent rights see Annex A attached b. Waiver (or Not) of Fiduciary Duty Claims I. Consider implications disclaimers and exculpations (and indemnities) as to the sponsor in the capacity as a board member or otherwise (particularly as to the members of the board in an LLC as to which contract terms of the LLC agreement may override otherwise applicable state law requirements) -- Old Days Typical LLC Clause: The managers shall have the same fiduciary duties, including the duties of care and loyalty, as such persons would have if such persons were directors of a corporation organized under the Delaware Corporation Law. --Today? II. Disclaimer of Duties by Co-Investors (e.g., relating to status as a lender and, if holding a board seat, other duties (e.g., relating to corporate opportunities)) c. Board Seat(s) d. Board Observation Rights I. Scope: --All Board Packages and other distributions as and when distributed --Include Board of all subs? Cover only Primary Board (s) --Require Minimum # of (face-to-face) meetings per year? At least one/quarter? --Include all Board Committees? Permit exclusion of only specified committees (e.g., Compensation or Audit Committees)? II. Expense Reimbursement Rights --Contrast Board Fees, discuss D&O and indemnity protections

5 III. Limitations; e.g., expect limitations as to (reasonably) protect attorney-client privilege and/or conflicts of interest IV. Minimum Hold Issues v. Affiliate Transaction Protections a. Note interplay with affiliate transaction protections in related debt agreements (if applicable) b. Consider dollar threshold tests and requirements for independent approval (e.g., approval by the equity co-investor or approval by a majority of non-sponsor related institutional investors or a majority of all investors other than the sponsor and its affiliates or approval by all or a majority of all of the independent board members) and, possibly, advance notice of any (material) affiliate transaction vi. Amendment Rights a. NB: Critical to Protecting Negotiated Rights b. NB: Typically need strong protection against modification by Simple Majority Vote; e.g.: vii. Other Possible Matters I. Protection Against Discrimination (but not enough; e.g., preemptive rights or elimination of rep&warranty limitations) II. Require Prior Written Consent for any modification that (materially and) adversely affects rights and in any event- -for any modification of Core Protections a. Fees Sharing (but not fee burdens such as breakup and reverse breakup fees) b. Expense Reimbursement Rights c. MFN Rights/Access to Side Letters d. Capital Call Issues e. Company Reps & Warranties f. POA issues I. Require blanket exclusion?

6 II. If not excluded, require express and narrow scope III. If not excluded, consider requiring advance (e.g., at least 3-5 business days) written notice g. Specialty Area Issues (outside this scope of this outline); e.g.: (1) Tax issues (including UBTI & ECI issues), (2) VCOC issues, and (3) Fund allocation issues IV. Exit A. Permitted Transfers 1. Scope: Typically, limited--as opposed to unlimited--transfer rights will apply. Transfer rights may include transfers: a. to affiliate? also to any managed account, investment fund or other vehicle for which an institutional holder is an investment advisor or portfolio manager? 2. Limitations: 3. ROFO/ROFR b. to any LPs c. pursuant to specified sell-down plans identified at closing d. in connection with transfers of related debt investments e. to transfer to members/partners upon liquidation f. pledge rights (direct and indirect) g. required as a result of regulatory reasons h. otherwise with sponsor s prior consent not to be unreasonably withheld, conditioned or delayed a. avoid/limit legal opinion delivery condition a. avoid application to institutional co-investors (overkill) b. seek rights as institutional co-investor to participate pro rata in any rights sponsor has (e.g., for management purchases); otherwise a backdoor exception to preemptive rights 4. Put Rights (tied to debt maturity or otherwise)

7 B. Drag Rights (i.e., the right of the sponsor to drag other shareholders along in a sale) 1. Scope: a. sale of the company to a third party (100% of equity/all or substantially all of the assets); note: not unusual for sponsors to try to peg the trigger at some other threshold that is less than sale of the entire company even though the argument for the need for a drag in such situations is diminished 2. Terms & Conditions: a. same (economic) terms & conditions as apply to the sponsor 3. Necessary Institutional Minority Investor Rights: e.g., a. Limited Reps & Warranties (e.g., fundamentals only and no business reps)? b. Exclusion from any non-solicitation requirements, any non-compete requirements or any other restrictive covenants other than customary confi covenants (that, in any event, are no more burdensome than those agreed to by the equity co-investor in the existing agreement)? c. Requirement that any indemnification or other recourse is only on a several (not joint and several) basis (other than for the personal/fundamental reps). Note issues as to protecting the mothership d. Requirement that liability is capped at lesser of pro rata share of any claim and (cash) proceeds received e. Requirement for cash consideration only (or carryover rights as to any non-cash consideration received) C. Tag Rights (i.e., the right to tag along on a sale of securities by others) 1. Scope: a. all sales by sponsor ( tied at hip ) including, of course, redemptions but excluding: (i) transfers to affiliates? Probably, okay as long as affiliates sales are also subject to ongoing tag rights so not a leakage or backdoor way around tag rights (ii) designated carveout amounts? May be okay on case by case basis (should be resisted as a market norm or else starts creep of ever increasing size of automatic carveout); if okay, need consider

8 additional conditions (e.g., (1) sale by sponsor cannot exceed specified percentage of sponsor s initial investment (e.g., 5-10%), (2) in any event, sponsor must maintain ownership over 50.1 % and control the Board, (3) sale price cannot exceed price paid at initial closing, and/or (4) sale must be completed within specified timeframe (e.g., 6 months after the initial closing)) b. perhaps, sales by other large stakeholders or even any and all investors 2. Terms & Conditions: a. Same (economic) terms & conditions as apply to the sponsor (or selling investor) 3. Over-Allotment Rights 4. Necessary Institutional Minority Investor Rights: e.g., D. Registration Rights 1.Scope: a. See above re Drag Rights. Discuss sponsor argument that protections should be less in a tag than in a drag b. Look for loopholes to plug (e.g., blocking any ability to avoid protections by either making one or more Permitted Transfers to a person followed by disposing of all or any portion of such party s interest in any such person or by transferring the securities of any entity whose primary purpose is to hold (directly or indirectly) the relevant securities; consider safety net provision to bar a sponsor from making a transfer with the intent and purpose of avoiding the restrictions otherwise applicable) a. Demand Rights? b. S-3 Rights? c. Piggyback Rights? 2.Terms and Conditions E. Blocker Issues F. Workout Issues a. tied at hip (eg, lockups, cutbacks, etc.)

9 Possible Consent Rights 1. amending the certificate of incorporation, bylaws or similar organizational document of the Company or any Subsidiary of the Company or amending the terms of any stockholder agreements; 2. causing or permitting a voluntary election by the Company or any of its Subsidiaries to liquidate or dissolve or wind up or to commence bankruptcy or insolvency proceedings under applicable law or causing or permitting the adoption of a plan with respect to any of the foregoing; 3. acquiring (in one transaction or a series of related transactions) the capital stock, other equity interests or assets of any entity or disposing (in one transaction or a series of related transactions) of material assets of the Company or any of its Subsidiaries or the capital stock or equity interests of the Company or any of its Subsidiaries; 4. entering into any agreement, amending or effecting any transaction between the Company or any of its Subsidiaries, on the one hand, and any affiliate of the Company, on the other hand, other than any transaction in the ordinary course of business and reasonably determined by the Board to be on an arms -length basis; 5. entering into, amending or terminating any material agreement, arrangement or understanding of the Company or of its Subsidiaries, including any such agreement, arrangement or understanding providing for payments in excess of $[ ]; 6. forming or otherwise establishing a new Subsidiary; 7. launching, terminating or changing the principal lines of business of the Company or any of its Subsidiaries; 8. approving the annual budget and business plan for the Company and its Subsidiaries (the Business Plan ) or any material revisions thereto or deviations therefrom; 9. incurring capital expenditures exceeding the amount expressly budgeted for capital expenditures in the Business Plan by more than $[ ]; 10. incurring or assuming any indebtedness in excess of $[ ] or granting a lien or encumbrance on any property of the Company or any Subsidiary; 11. establishing any management incentive plan or program or approving any increase or decrease in the aggregate size of the incentives issuable thereunder; 12. redeeming or repurchasing any equity securities of the Company or any Subsidiary (other than from management investors following their termination of employment in accordance with the plan documents as in effect or pursuant to negotiated put/redemption rights belonging to relevant investment security);

10 13. authorizing, creating (by way of reclassification, merger, consolidation or otherwise), subdividing or issuing any equity securities of the Company or any Subsidiary (or in each case securities or rights convertible or exchangeable or exercisable for equity securities), other than (i) the issuance of equity securities pursuant to the existing management incentive plan and (ii) the issuance of equity securities by any Subsidiary to the Company or to another Subsidiary; 14. engaging or terminating the employment of senior officers of the Company, including, without limitation, the [President and Chief Executive Officer, the Chief Financial Officer and the Chief Operating Officer] (collectively, Senior Management ) of the Company or any of its Subsidiaries, agreeing to any material change to the compensation or benefits of any member of Senior Management, or otherwise entering into transactions with members of Senior Management outside of the ordinary course of business; 15. recapitalizing or reorganizing the Company or any of its Subsidiaries or any of their respective capital stock; 16. settling any individual litigation, arbitration, investigation or dispute to which the Company or any of its Subsidiaries is a party involving the payment by the Company or any of its Subsidiaries or an amount in excess of $[ ] or involving any admission of liability or culpability; 17. making any investment in or loan or advance to, or making any guarantee for the benefit of, any person or entity (other than a wholly owned Subsidiary); 18. increasing or decreasing the number of Board Members or establishing any committee thereof; 19. declaring or paying any dividend or other distribution in respect of any equity securities of the Company or any of its Subsidiaries other than dividends or distributions paid to the Company or any of its Subsidiaries; 20. entering into an agreement with respect to or consummating a change of control transaction such as a merger, consolidation, stock sale or initial public offering; and 21. amending or terminating any D&O insurance which covers a designated director. CH2\