Private equity investors (PEIs) are often a good source of capital for companies looking to start, maintain, or grow their operations and can also provide significant operational and transactional expertise. Like other investors, PEIs operate with a primary goal in mind; that is, to receive a favourable return on their investment. However, PEIs generally seek to have a greater level of involvement in an investee company than other investors. Accordingly, PEIs commonly negotiate for certain governance rights in the company via a unanimous shareholder or limited partnership agreement in order to maintain a certain level of oversight over the investee company and protect their investment.
Although governance rights can take various forms, they commonly include: representation rights on the board of directors of the company (Board); the right to veto certain company decisions; and access to certain company information. Notably, these rights are not specific to any type of business organization (e.g., corporations, partnerships).
The optimal degree of control is largely dependent on the PEIs’ concerns and expertise relating to the investee company, the PEIs’ stake in the company (i.e., majority or minority), the strength of such company’s management and that company’s willingness to relinquish any such control.
Board representation rights
PEIs usually negotiate for the right to have at least one representative on the Board. Ancillary to this right, they also negotiate for the right to replace their representative or fill its vacancy should the initial representative cease to be a director. However, PEIs may also seek further rights such as:
- the quorum for Board meetings require their representative’s presence; and
- their representative serve on certain Board committees (g., audit committee, compensation committee, or reserves committee).
These rights help ensure that the PEIs have an effective voice in the direction and operation of the company and, therefore, their investment.
Special approval of certain company decisions
In addition to Board representation, PEIs may also negotiate veto rights by requiring that certain company decisions require the approval of the PEIs (e.g., decisions regarding the approval/implementation of the company’s budget for expenses and expenditures, the compensation and benefits of management or employees, and the termination or employment of management). These rights may appear in various forms, such as requiring the approval of (i) the shareholders; (ii) a super majority of the Board; or (iii) the PEIs’ representative.
Access to information
Perhaps the least invasive right that PEIs commonly seek is the right to access information that is within the company’s control but would otherwise not be provided to its shareholders or limited partners. Independently, this right may not provide PEIs with much control over the company and, therefore, their investment; however, in conjunction with other governance rights, such information can be extremely useful. Such information typically includes an operations and/or capital monthly statement, rights to visit the company, as well as any other information that PEIs may reasonably request.
The author would like to thank Nader Hasan, articling student, for his assistance in preparing this legal update.