Legal Aspects of Private Equity and Venture Capital LPA, fund structure, Liabilities .. Jyoti Sagar J Sagar Associa

1. Legal Aspects of Private Equity and Venture Capital (LPA, fund structure, Liabilities …..) Jyoti SagarJ Sagar Associates, Advocates & SolicitorsGurgaon New Delhi Mumbai Bangalore Hyderabad

2. Outline Introduction Fund Structures Liability The Investee End Process Typical Docs Term Sheet Investment Agreement / Shareholders Agreement Typical Legal Issues

3. Outline Introduction

4. “Look, I’m not saying it’s going to be today. But someday – someday - you guys will be happy that you’ve taken along a lawyer”

9. Private Equity Fund Structure

10. FVCI Regulatory

11. Share Pricing restrictions not applicable to FVCI – pricing of shares in VCUs allowed at mutually agreed price Modified Lock-in period of 1 year in case of pre-issue capital Flexibility to structure the capital of the VCU given that FVCI can invest in debt securities issued by VCUs which are outside the ambit of ECB regulations 100% foreign investment in VCUs is permissible under automatic route by FVCI – The ‘same field’ restrictions under Press Note 1 (2005) do not apply Registered FVCI is a Qualified Institutional Buyer - 60% of the issue size of a public offer of a unlisted company is specifically allocated to the Qualified Institutional Buyer.  Benefits for SEBI registered FCVI

12. Regulated by and to be registered with SEBI VCF generally structured as trusts Fund raising through private placement No restriction on investors - Indian, Foreign or non-resident Indian : with FIPB approval Investments cannot be made in certain sectors No listing of units on a recognised stock exchange till the expiry of three years from the date of issuance Domestic Venture Capital Funds (VCF)

13. VCF Regulatory

14. Could be extended - usually to permit time for an advantageous exit from a particular underlying investment Initial Closing - usually when minimum threshold commitments are received Final Closing - usually a specified period of time from the initial closing during which other investors may commit Minimal Amounts paid upfront at the time of commitment – cash calls and draw downs within a certain period from the initial closing – popularly called the Commitment/ Investment Period. Typical Features of Funds

15. Failure of an investor to honour commitment forfeiture of existing investments other investors being offered an opportunity to subscribe proportionately to additional shares of the Fund Two classes of shares management shares held by the fund manager which have all the voting rights investor shares issued to all investors, which provide for return of capital and have limited voting rights. Restrictive norms in the investment pattern – some examples limit on nvestment in a particular company (size and as a percentage of the fully diluted stake in the target company) Geography Sector or industry.  Typical Features of Funds

16. Investment Managers get remunerated for managing funds: garnering the capital from investors, identifying potential investments and acquisitions Supervising and overseeing the management of the investee companies Handling exits Investment Mangers are remunerated with A management fee (usually 2%) of the funds under management; and A share in the returns called “carried interest” or simply, “carry”) upon achieving a certain threshold (called the “hurdle rate”) on the overall fund investments Typical Features of Funds

17. Indian advisory services company is usually set up to which under an agreement with the Investment Advisors provides non-binding advice to the overseas Investment Manager for potential acquisitions sources deals for the Fund For tax planning purposes essential that there is documentary evidence that the recommendations of the Indian Investment Advisor are in no manner binding on the Investment Manager control over the investment decisions is not made in India Typical Features of Funds

18. Liability of Fund Managers etc

19. Liability: Investor actions against Fund Managers Precedents overseas - particularly in U.S. jurisdictions Instances include: Fraudulent Misrepresentation Control Person Liability Breach of Fiduciary Duty Negligence Negligent Misrepresentation Promissory Estoppel Aiding and Abetting Fraud and Fiduciary Duties

20. Liability: Case Law Fraudulent Misrepresentation: Bank of America versus Bear Stearns (Fund Managers) on grounds of concealment that the funds were suffering substantial withdrawal requests from investors and was in imminent danger of collapsing Control Person Liability: works in conjunction with a fraudulent misrepresentation claim In re Bayou Hedge Fund Litigation, suit by investors against investment advisor for fraud, breach of contract, and breach of fiduciary duty. The investment turned out to be in a ponzi scheme, which triggered the litigation

21. Liability: Case Law Promissory Estoppel: In Veras Capital Partners, plaintiffs admitted the existence of an investment contract with the fund, but claimed that oral promises were made to them, which were misrepresentations, and resulted in financial damage to the investors Aiding and Abetting Fraud and Fiduciary Duties: In Bullmore, liquidators of two hedge funds brought an action alleging that the defendant asset management company had assisted the fund manager’s fraudulent scheme

22. Liability: Emerging Issues Poor due diligence resulting in financial losses for the investors Corporate Governance issues in the Fund and their portfolio companies Insolvency of a portfolio company. Investee company and or sponsors alleging negligence by the PE / VC companies in the management of portfolio company Complaints by Minority shareholders of portfolio companies, especially at exit stage Professional malpractice – gross negligence in respect of decisions – particularly exits

23. Liability: Indian Context No court precedent so far of claims against Fund Managers or PE’s or VC’s As market matures and legacy issues arise, claims and liabilities similar to other jurisdictions will surface Complexity of structures would add to the problem Regulatory breaches such as non compliance of non-compliance with sectoral caps, violating FIPB approval ,or investing in prohibited sectors Claims could include those brought by injured investors as well as Regulators The role of the Indian Advisory Companies and their potential liability could come under the scanner

24. The Investee End of it

25. The Investee End - Process Regulatory concerns if any Term Sheet Due Diligence Investment Agreement SHA

26. The Investee End - Process When do you bring in the Lawyers!

27. “Would everyone check to see they have an attorney? I seem to have ended up with two.”

28. Intended to be non-binding Convenient starting point Sets out the basic parameters Investment and type of instrument/s Management and Information rights Exit options Next steps such as DD Non-binding but cannot be wished away Thus requires careful thought and analysis Term Sheet

29. Due diligence – checking the state of the investee company - business, financial and legal Legal DD typically covers Corporate Matters Commercial Contracts Real Property Intellectual Property Litigation Regulatory Matters Employment Due Diligence

30. Investment Agreement Go or No Go decision – freezing valuation Subscription or purchase or combo – appropriate documents Reflecting the DD Results Conditions precedent Reps and Warranties : absolute and qualified Conditions subsequent / Undertakings Indemnities Closing Material Adverse Event, Walkaway rights & termination

31. SHA SHA governs relationship with the sponsors Rights and obligations Affirmative Actions/Veto Nominee Director/s Management structure Information rights Anti-dilution Share transfer restrictions/rights – ROFO or ROFR Exit Mechanisms: call, put, tag, drag, strategic sale, IPO Breach and consequences Termination and consequences

32. Some Legal Issues

33. Legal Issues Potential difficulty in specific enforcement of certain provisions of investment agreements/SHA Slavish copying of US formats with expressions and concepts not applicable to India Ratchet/Return True-Up mechanisms – interplay with regulations Enforcement of Tag Along, Drag Along and other share transfer restrictions in (unlisted) public companies Pricing issues in Tag Alongs, Drag Alongs and Put and Call Options Enforceability of IPO exit clauses

34. Think Global but act local!! “I didn’t realize, Your Honour. I assumed the law here was the same as in New Jersey. As you may know, dog eat dog is permissible there.”

35. Legal Issues Private company vs public company Inclusion of terms in Articles of Association Indemnity vs damages measure of indemnity reimbursement under indemnity clauses for breaches of representations and warranties? Enforceability of Sponsor guarantees for reps and warranties and undertakings of the investee company Execution risks of logistics - simultaneous exchange of monies for shares: use of escrow structure in case of foreign investors Role and responsibility of Investor Nominee Directors

36. Thanks for your attention jyoti@jsalaw.com