GPs warned over exit clauses

John Bakie
04 May 2012

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GPs are being warned to ensure pre-emption rights on deals are properly drafted, after recent cases highlighted potential pitfalls.

Pre-emption rights are designed to ensure that existing shareholders in a company have the right to buy a selling party's shares before they are offered elsewhere. While they are a fairly standard part of many M&A deals, poorly drafted provisions could lead to problems for GPs looking to exit a portfolio company.

Malcolm MacDougall, head of private equity at Speechly Bircham, says recent examples have highlighted the need for investors to ensure any pre-emption rights are correctly drafted and understood. These provisions are usually designed to ensure shareholders are not forced to work with a potentially objectionable third party when an existing shareholder decides to sell or to keep ownership of a company within a specified group of investors. If the provisions are poorly drafted, they can lead to unexpected delays and complications when a GP tries to exit.

"While a single GP buyout would not usually require pre-emption rights (as the GP would expect a complete restriction on transfers without its consent), this is potentially a significant issue in deals where you have a number of private equity investors, as well as in the case of co-investments and joint ventures," explains MacDougall.

Pre-emption rights are part of an ongoing dispute between the Barclay Brothers and Patrick McKillen regarding their stakes in hotel operator Coroin Ltd. There has also been a recent example of a private equity exit being delayed by a minority shareholder claiming pre-emption rights.

The main issues GPs are likely to face are objections to a sale from a small shareholder, creating delays to the sale process, or fellow investors changing without their shares first being offered to existing shareholders, as a result of the transfer of holding companies not being caught by the pre-emption provisions.

"Having seen issues surrounding pre-emption rights surface twice recently, this has the potential to be a major issue for GPs and proper drafting and understanding is vital as this can impact the ability to execute a clean exit," MacDougall warns.