Recently, an article about "the worst entrepreneur" widely circulated on the Internet has once again aroused people's hot discussion on investment and financing business, especially the terms of repurchase rights. This paper will combine the relevant laws and regulations of our country, the court judgment documents and the investment and financing projects we participated in before, sort out the main contents of the repurchase right clause, related risks and corresponding solutions, hoping to provide reference for founders and investors.
one
Background of the repurchase right clause
In the equity investment and financing business, the redemption clause, also known as the redemption clause, refers to the right of investors to ask the target company and/or founder to buy back the equity of the target company at a certain price according to the agreement reached in advance.
Because the duration of private equity investment funds is agreed at the time of establishment (usually consisting of investment period and withdrawal period). As of the expiration of the duration, the fund manager needs to realize the equity of the invested company he holds and liquidate the fund property. Therefore, in the investment and financing agreement signed with the target company and the founder, investors generally agree that a number of investors will withdraw from the channel to protect the rights and interests of investors.
Common exit channels include the public offering and listing (IPO) of the target company on the stock exchange, the merger and acquisition of the target company by a third party, or the repurchase of relevant equity by the target company (or founder). In the first two ways, there are third-party buyers other than investors and founders, and the founders or target companies do not need to pay for themselves. However, when investors exercise the right to buy back, the interests of the founder, the target company and the investors are opposite. Once the repurchase negotiation breaks down, the parties can resort to law. At that time, the repurchase rights clauses signed by investors with founders and target companies in their early years may become a sharp weapon to safeguard their own rights and interests, or a poison pill to hide traps.
two
Main contents and negotiation points of repurchase right clause
For the convenience of discussion, let's take the following repurchase right clause as an example to illustrate the main contents and negotiation points of the repurchase right clause.
Repurchase right.
N. 1 In any of the following circumstances, the investor has the right to request the target company (or founder) to buy back all or part of the equity of the company held by the investor at that time. The founder shall ensure that the above requirements of investors are approved by the shareholders' meeting and the board of directors of the target company:
1) The target company fails to complete the initial public offering and list on the stock exchange recognized by investors before X, X, X;
2) The operating income (or net profit, or other financial indicators) of the target company in XX years is less than XXX yuan;
3) The founder or target company fails to fulfill its main obligations under the investment agreement, or materially violates its statements, warranties and commitments under the investment agreement; or
4) The founder or target company has problems of integrity such as fraud.
N.2 If the investor exercises the repurchase right according to Article N, the repurchase price shall be the higher of the following amounts:
1) During the investment period, multiply the annual return on investment by X% (simple interest/compound interest) to calculate the sum of income and investment principal (excluding the profit distribution or dividend paid by the target company to investors) from the delivery date to the date when all the repurchase price is paid to investors; or
2) The net assets of the target company corresponding to the investor's equity ratio as of the date when all the repurchase price is paid to the investor.
N.3 If the investor exercises the repurchase right according to Article N, the investor shall send a written notice to the target company. The target company (and/or founder) shall implement and complete the repurchase within x months from the date when the investor sends the repurchase notice (subject to the date when the target company receives the notice).
N.4 The repurchase obligation undertaken by the founder under Article N shall be limited to the total income obtained by the founder from the disposal of all the company shares held by him based on fair market value.
It should be noted that the above example only contains the main necessary contents of the repurchase right clause. In practice, the repurchase rights clauses signed by investors with founders and target companies will stipulate more specific commercial terms.
1
Repurchase mode
"The target company undertakes the repurchase obligation" or "the founder undertakes the repurchase obligation" mentioned in the above examples are the two most common repurchase methods. On this basis, a variety of repurchase methods are also derived, such as "the target company and the founder share the repurchase obligation" and "the target company bears the repurchase obligation and the founder bears the supplementary responsibility". Because the above derivative repurchase methods are also based on two basic repurchase methods, they are not within the scope of this article for the time being.
(1) The agreement that the target company undertakes the obligation of share repurchase is valid if the cause of invalidity cannot be determined.
From Suzhou Industrial Park Haifu Investment Co., Ltd. to Gansu Shi Heng Nonferrous Resources Reuse Co., Ltd., Gangdiya Co., Ltd. and Lubo to apply for retrial (the Supreme People's Court (20 12) MintiziNo.1No.), and then to the Supreme People's Court 20/KLOC-0 on October 8, 2009. The Minutes of the Civil and Commercial Trial Work Conference of the National Court > People's Republic of China (PRC) Notice (hereinafter referred to as "Minjiu Article") finally gives clear guidance on whether the target company can become a qualified subject of share repurchase obligations.
"Nine Minutes of the People" holds that the agreement that the target company undertakes the obligation of share repurchase is effective without legal invalid reasons. However, it should be noted that the confirmation that "the target company can buy back shares" is only the beginning for investors to exercise the right to buy back. In the process of actual repurchase of shares held by investors by the target company, the related repurchase behavior between the target company and investors also needs to comply with the provisions of Article 35 (on shareholders not withdrawing their capital contribution), Article 142 (on mandatory provisions of share repurchase) and Article 166 (on mandatory provisions of profit distribution) of the Company Law. In other words, the fulfillment of the repurchase right of the target company must meet the enforceability requirements stipulated by law-if the repurchase price advocated by investors is within the distributable profit range of the target company, it can be paid directly by the target company; If it exceeds the distributable profit range of the target company, it will be paid after completing the capital reduction procedure of the target company.
(2) If there are no other invalid reasons, the agreement that the promoters undertake the obligation of share repurchase is valid.
To sum up, the target company may face many difficulties in undertaking the obligation of share repurchase in practice. Therefore, some investors prefer to ask the founders to undertake the obligation of share repurchase.
The founder's compulsory repurchase is essentially a kind of equity transfer transaction, that is, the founder accepts the equity of the target company held by the investor. If there is no reason why the contract stipulated by China law is invalid, the agreement that the promoters undertake the obligation of share repurchase is valid and binding on the parties.
However, when the founder undertakes the obligation of share repurchase, it may bring great financial pressure to the founder, and in extreme cases, it may endanger the founder and his family property. We will further analyze the related risks and propose solutions below.
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Trigger conditions of repurchase right and repurchase price
The above example lists several common situations that trigger repurchase rights. The trigger conditions stipulated in the terms of repurchase right are generally closely related to the operating conditions of the target company and the performance of the investment agreement between the target company and the founder. If any of the above situations occur, it means that the actual operating conditions of the target company have undergone major adverse changes, which will greatly reduce the probability of the target company completing the IPO or being acquired by a third party. Therefore, investors need to withdraw from the company by exercising the repurchase right.
In addition, there are several agreements on the calculation method of repurchase price in the terms of repurchase right. Some investors demand to calculate the repurchase price according to a certain annualized rate of return, and some investors choose the form agreed in the example.
It should be noted that when investors, founders and target companies resort to law because of disputes related to the terms of repurchase rights, the court will pay attention to the trigger of repurchase rights agreed in the investment and financing documents and the rationality of the repurchase price during the trial of the case. Therefore, investors should also consider the possibility of obtaining judicial support when setting relevant terms with the founder and target company.
three
Whether to limit the founder's repurchase obligation?
As mentioned above, if the investor and the founder agree that the founder shall undertake all or part of the repurchase obligations, the founder may face greater financial pressure. In order to reduce their own risks, the founder may request to limit the repurchase obligation.
In the investment and financing cases we handle, some investors can accept the proposal of "limiting the founder's repurchase obligation" put forward by the founder; There are also some investors who demand that "the founder can only limit his repurchase obligation under certain circumstances", that is, only when the founder has no intention or gross negligence can the founder undertake the repurchase obligation to the extent of the company equity he holds; In addition, some project investors do not accept the arrangement that restricts the founder's repurchase obligation.
three
Main risks and risk control of repurchase right clause
Investors, target companies, founders and related parties all have their own concerns about the terms of repurchase rights: investors are worried that the target companies or founders will not fulfill their repurchase obligations, or they will not be able to fulfill their repurchase obligations due to their limited ability to pay; The founder is worried about becoming the next "worst entrepreneur" defeated by the repurchase right clause; The target company is worried that the cash flow will be tight or even exhausted because of fulfilling the repurchase obligation, which will eventually affect the development of the target company.
According to our previous negotiation experience on behalf of investors, founders and target companies, combined with relevant laws and regulations and judicial practice, it is suggested that the possible risks of the repurchase right clause can be evaluated from the following angles, and the risks should be controlled as much as possible.
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Suggestions for investors to control the risk of repurchase right clauses
For investors, the risk of the repurchase right clause may come from two aspects: on the one hand, there are defects in the clause itself, which makes it difficult to start and promote the repurchase procedure (that is, procedural risk); On the other hand, the target company or founder does not have enough cash to fulfill the repurchase obligation, even if the investor wins the case, it will not be able to actually get the repurchase price in full (that is, the entity risk).
Because the entity risk has gone beyond the scope of law and contract, this article will not discuss it for the time being. In order to prevent and reduce the procedural risk of the repurchase right clause, it is suggested that investors can improve the repurchase right clause from the following angles:
(1) When the target company undertakes the repurchase obligation, the details of the profit distribution or capital reduction procedure can be clarified, and the cooperation obligation and liability for breach of contract between the target company and the founder can be clarified;
(2) Strive for the founder or the third party to assume supplementary responsibilities for the repurchase obligations of the target company (or provide guarantee, guarantee and other credit enhancement measures);
(3) Setting reasonable trigger conditions and repurchase price of repurchase right;
(4) If the founder undertakes the repurchase obligation, it is suggested to clarify the procedural details of equity transfer, and clarify the cooperation obligation and liability for breach of contract of the founder.
2
Suggestions on controlling the risk of repurchase terms by founders and target companies
For the founder and the target company, the possible risks arising from the repurchase right clause can be reduced from the following angles;
(1) Evaluate whether the repurchase price is reasonable and the probability of triggering the repurchase right in the future according to the business model, operation situation and industry development trend of the target company;
(2) Pay attention to the degree of causality between the trigger of repurchase right and the business behavior of the target company, the behavior of the founder and its obligations and responsibilities;
(3) If the founder undertakes the repurchase obligation, it is best to limit the founder's repurchase obligation to reduce the risk that the founder's personal property and family property will be implicated because of the repurchase obligation.
After more than 20 years' development, venture capital and equity investment have become more and more important financing channels for start-up companies, playing an indispensable role in helping enterprises develop and the industry prosper. Investment agreements and terms, as a bridge connecting startups and investors, play an important role in safeguarding the rights and interests of all parties. As a lesson from the past, we hope to help investors, founders and startups go higher and further after participating in many investment and financing projects and accumulating many lessons.