The training clause in the marriage contract of a family business
Maria owned a successful dairy company that had been in business for 22 years. Her children had pushed her to let other investors into the business so they could reduce their dependence on loan capital.
The company had taken out loans to enable the rapid expansion the business had experienced following customer demand for its niche products. His cousins Tom and Philomena had taken an interest in the business and invested the money in return for a 10% stake each in the business.
This money had enabled critical manufacturing machinery to be imported, and the company was now one of the leading producers of lactose-free dairy products with demand growing by double digits every quarter.
Maria used the opportunity presented by the outside investment to transfer an additional 20% of the company’s shares, divided equally between her four adult children.
As a 60% majority shareholder, she could always make controlling decisions and count on her children to support her in the event of a shareholder conflict with Tom and Philomena, affectionately called Tomlena by her children.
But its decisions were subject to the shareholders agreement that Tomlena had insisted on before transferring the money for their 20% stake.
The agreement had included matters reserved for shareholders, such as what share of profits could be distributed as a dividend and when such a payment could take place.
There was also a requirement that shareholder approval was needed for any company borrowing to ensure that the company did not overstretch itself.
But a key clause that his lawyers had strongly advised him to include was a drag-in clause. As the company was beginning to get noticed by potential private equity investors, her lawyer advised her to insert the clause that would protect her in case minority shareholders decided to block a third-party acquisition of a majority stake.
“How would that work? she had asked the lawyer. “By inserting a pull-in clause, you become attractive to a third-party buyer because it offers that buyer the opportunity to get 100% of the business, without painful negotiations with potentially emotional minorities,” the attorney explained.
Maria would have to ensure that any third-party buyer provided the same price, terms and conditions to the minorities she received. Maria didn’t like the sound of that.
Tomlena had provided capital to the company at a critical time and on very favorable loan terms. They had bet that the business strategy of investing in manufacturing niche products would work and that bet had paid off.
Her children also had strong emotional ties to the company as she had educated them and employed some of them. His lawyer saw the anxiety on his face.
“Another option could be an accompanying clause,” he suggested. The tag-along clause would offer minority shareholders the possibility but not the obligation to sell the majority stake to a third-party buyer.
If Maria was successful in negotiating a good price, including a transaction that involved a combination of cash and stock exchanges with the acquirer, minority shareholders could participate in the same transaction if they wished to sell their shares.
“I must warn you that many investors do not like these kinds of clauses when they find them during due diligence,” warned his lawyer. “Institutional buyers don’t like being forced to the negotiating table with parties that lack control and are presumed to be weaker from a bargaining perspective. This could potentially cause a delay or be a deciding factor in the event that you find a buyer. »
Maria was in a dilemma. She knew she wanted to sell the business eventually because her children convinced her to retire early and take a trip around the world.
“Look, you don’t have to take the hard road right now,” advised the attorney. “We can put in place a pre-emption rights clause which gives existing shareholders the first right of refusal in the event of a sale. They will have an equal right to buy your shares in proportion to their shareholding. So if they are unable to buy your shares at the assessed price, you can sell them to a third-party buyer. Investors who are willing to deal with minorities would like this because it does not force them to a minority negotiation table from the start. »
Maria met separately with her children and Tomlena. They all agreed that if she sold her shares for a good price, they would also want to get out of the business.
The drag-out clause prevailed and was inserted into the shareholders’ agreement. Maria could now focus on building a bigger business and preparing it for an eventual outright sale.
[email protected] Twitter: @carolmusyoka