Understanding Exit Rights: An Investor’s Perspective

1. Key Exit Rights Introduction 1. Initial Public Offering (IPO) As much time and energy is spent entering into a business relationship, the same, if not more, One of the main reasons for IPOs to be a attention is paid to getting out of one. preferred exit route is that investors get access Although each company and its dynamic to public markets. It is a strategy where the between its shareholders differ on a case-to- company’s shares get listed on the stock case basis, the need for a suitable exit strategy exchange allowing the investors is universal. In any case, the primary objective of an investor is to divest his/its holdings and who’ve invested in a company during the pre- realize the return on investments made in a IPO to sell their shares for a profit. The company by exiting profitably. timelines and implementation of an IPO are generally strategized considering conducive market conditions and its potential impact on the public market over the coming years, i.e., the year the IPO is proposed to take place. The IPO may be executed as a ‘fresh issue’ or through an ‘offer for sale’ of existing shares or a combination of both. That being said, investors generally offer their shares in an ‘offer for sale’ in an IPO. As such, exit strategies are a highly crucial part While IPO might present investors with of undertaking investments for both private liquidity risks as insiders can be subjected to equity players and strategic business investors. lock-up restrictions or risk of being recognized The investment horizon is customarily pegged as ‘promoters’, it also offers several to 5-7 years. That being said, exit mechanisms advantages to the investors. It gives them are not always time-bound and often take room to negotiate favourable positions, shape as remedies available to investors, including priority to offer up their shares for owing to default by the investee company or sale and affirmative voting rights regarding IPO key promoters, thus prompting a likelihood of processes, among others. IPOs also enable an early exit. It is, therefore, essential to investors to leverage their contacts from the efficiently understand and negotiate the exit newly public company to assist future portfolio rights of an investor to guarantee maximum companies in several ways, whether by returns. acquiring customers or partners or initiating acquisitions. This article explains some of the key exit rights that investors possess to obtain considerable From an investor’s point of view, IPO clauses returns on their investments. should be structured in a way that provides the necessary flexibility to the investor to realign its exit strategy if need be. AlthoughIPO is a

2. lengthy process requiring the Securities and The investors can also adopt a secondary buy- Exchange Board of India (SEBI) approval, Small out wherein one investor can sell shares to and Medium Enterprises (SMEs) can undergo other strategic or financial investors. This exit SME IPO by listing their shares at BSE SME or NSE Emerge platform. right shortens the lifespan of the transaction, as the investor making the original investment might seek an early exit even before the 2. Third Party/Private sales company gears up for a trade sale or an IPO. However, investors find this exit strategy attractive as it provides them with instant liquidity. However, for any other strategic or financial investor to be involved in a secondary buy-out, the investee company should be positioned to show strong and continued shareholder value growth. This exit strategy provides an immediate exit and can be executed faster and more efficiently than an IPO. The reason why third-party or private sales 4. Mergers or Acquisitions have gained preference is due to minimal promoter intervention, as any limitations on Mergers usually involve court processes, while third-party sales are primarily contractual. an acquisition can be accomplished through Transfer restrictions include the Right of First the sale of assets or the sale of a company. It’s Offer (ROFO), Right of First Refusal (ROFR), co- common for investors to include a clause that sale rights, etc. It enables investors to bypass allows them to initiate an exit event if the complex processes and legal obligations under company they’ve invested in plans to merge Indian laws and exercise a significant amount with or acquire a business in a similar or of control over the whole process. However, competing industry. Investors may choose to when a private sale is from or to a non-resident exit partially or fully depending on the investor, care should be taken to comply with expected gains from the merger or acquisition. FEMA regulations administered by RBI. The By selling their portfolio to larger companies, pricing guidelines stipulated by RBI provide investors can realise a considerable return on that sale of shares from a resident to a non- their investment. resident shall not be less than the fair market value determined by international valuation 5. Buy-Back methodology certified by a Chartered Accountant or SEBI-registered Merchant Investors can negotiate for a mandatory buy- Banker. On the other hand, in the sale of shares out by the company promoter or a company from a non-resident to a resident, the said buyback clause at a pre-determined price. This floor cap applies as a ceiling instead. approach is usually adopted when the portfolio company has substantial cash reserves and can 3. Secondary Buy-out

3. acquire back shares from its investors. This The investors seek put option rights in the method offers investors prompt and efficient event of a failing IPO or any material default or exit while enabling the portfolio company to breach by the founders. For example, if Mr A, maintain its ownership percentage. However, an investor, has put an option over, say, 25% of it is essential to note that a company buyback his shares in the company, which he can requires adherence to complex regulatory exercise when the company becomes requirements before implementation. These insolvent. In such a case, he can sell his shares requirements may include restrictions on the to Mr B, the founder. Now B cannot refuse to funding sources for the buyback and the purchase shares from A. redistribution of profits, a cap on the buyback Conclusion amount, which cannot exceed 25% of the company’s free reserves and paid-up capital, All businesses require an investment to and the need to offer the buyback to all operate, and when investors inject money into shareholders, among others. a company, they aim to safeguard not only 6. Put Option their investment but also secure exit rights and generate profits. Investors have various exit The Put Option has gained widespread strategies at their disposal, which they can acceptance as an exit strategy in business select based on the portfolio company’s practice and is typically incorporated into requirements and market conditions. Investors Shareholders’ Agreements and Share should acknowledge the risks involved with Subscription Agreements as a “Put Option each approach and collaborate closely with the Clause”. The right to sell is not granted to portfolio company to determine the most shareholders by law but rather through suitable exit strategy. By choosing the contractual arrangements established appropriate exit strategy, investors can between the parties involved. Simply put, a put optimize their returns and provide start-ups option gives an investor a right (not an with opportunities to expand and compete obligation) to mandatorily require the globally. founders to purchase the shares held by such Our product SimplyTransact is just meant for an investor upon the happening of any you. Please reach out to our Product Head– specified event at a predetermined price. Thus, Ms. Shilpa Agarwal at the mail this provision allows investors to exit the ID shilpa@simplybiz.in or SimplyTransact@si company, but the decision to exercise this right mplyBiz.in to know more. remains entirely up to the investor’s discretion. The promoters are responsible for purchasing these shares at a fair value or a predetermined internal rate of return. Contact Us! Address: Address:1st Floor, Golden Heights, Plot # 9, Opp: Raheja, Mindspace, Hyderabad, Telangana 500081 Contact No: Contact No:+91 81210 11573 Email ID: Email ID:hi@simplybiz.in