"Drag Along" and "Tag Along" rights are used by investors to facilitate their exit from an investment.

They are methods particularly favored by private equity firms, who almost always do their best to establish a clear exit strategy even before they decide on investing in a company.

A Tag Along is relatively non-controversial: it gives a shareholder the right (but not necessarily the obligation) to exit along with another shareholder when that other shareholder is exiting, usually on the same price and terms.

This helps avoid any shareholder involuntarily finding himself or herself with a different co-shareholder to originally expected. Tag Along rights are often requested by minority shareholders, as they allow them to then exit at the same time as majority shareholders, and to share the control premium (eg. investors are usually prepared to pay a higher price per share when they acquire control of a company).

Drag Along rights are more controversial. A Drag Along right gives the investing shareholder the right to force the other investor(s) to exit should the investing shareholder exit, once again, usually on the same price and terms.

For private equity investors, Drag Along rights are usually a sine qua non for any investment. Some private equity investors affectionately refer to their Drag Along rights as their "nuclear option." On the other hand, for many business owners, a Drag Along right represents a Damocles sword, a threat that they may be forced to sell their business if the investor decides to drag him or her along, usually at a valuation over which he or she has no control.

Unfortunately, perhaps a majority of owners of businesses who seek private equity investment for the first time are not even aware of the existence of Drag Along rights; very often when business owners find out about Drag Along rights being required by an investor, that is the end of the discussion.

Sometimes, that discussion is ended a little prematurely; it is worth spending a little time exploring whether there may be a compromise solution acceptable to all parties, which may mitigate (although not completely eliminate) the risk that business owners are dragged along against their will. This will require astute negotiation. A few examples of such compromise solutions might include a combination of the following measures:

• An obligation for investors to seriously attempt one or more methods of selling their interest without dragging along another shareholder;

• The Drag Along may be available only after the expiry of a particular time period (eg. after four or five years from the date of the investment);

• Exercise of the intent to exercise a Drag Along right may require advance notice to other shareholder(s). Such notice may also be structured to allow the remaining shareholders the right to purchase the shares of the shareholder giving notice according to a particular formula (eg. EBITDA multiple).

• It might be possible to structure a Drag Along in such a manner that it might be overridden by a right of first refusal (eg. where one investor negotiates an agreement to sell shares to an outside investor, the existing shareholders would have a defined period within which to step in and buy on the same terms). However, not every investor will accept a right of first refusal, as this may diminish the marketability of the investor's interest. Also, for a first right of refusal to be of real benefit to a shareholder, it will usually require a cash reserve in order to exercise it.

In a nutshell, the negotiation between an owner and investor with respect to Drag Along rights is a function of the relative bargaining strength of the parties and their negotiating ability. It balances the legitimate desire of an investor to exit from an investment at a time that suits them (minority investments in particular may be extremely difficult to exit without a Drag Along) with the legitimate right of a business owner not to have his or her interest in a business sold against his or her will.

A condition precedent (CP) prior to closing is a condition that must be satisfied by a party to a transaction, failing which the other party is not bound to close the transaction. In the context of buying or selling a company, it is usually the vendor of a business who must satisfy certain CPs before the investor is obliged to close; but there may also be conditions precedent that an investor must satisfy before the vendor is obliged to close.

On rare occasions, it is possible to close a transaction immediately upon signature of a Sale and Purchase Agreement (SPA); more often, however, there is a delay of a few weeks to a few months from the signature of the SPA to closing, primarily due to the need for parties to the transaction to satisfy CPs.

While it is impossible to provide an exhaustive catalog of all the types of CP that a vendor may need to satisfy, a sample of some of the more common CPs offered by a vendor could be:

(a)Obtaining consent of banks: Usually there is a clause in any bank loan agreement or similar financing facility that a change in ownership in and/or control of a company requires written consent of the bank(s). Vendors are usually reluctant to approach banks (and indeed banks are often reluctant to consider such cases) until there is a signed SPA.

(b)Client approvals: There are times when contracts with key clients also contain change of control provisions.

(c)Approvals from other selling shareholders: Sometimes other shareholders of the company being sold have pre-emption rights, which are best dealt with during this period.

(d)Obtaining approval of Competition Office: If Competition Office approval is required, most Competition Offices in Central Europe or in any other EU country are not prepared to consider an application until an SPA has been signed by all parties.

(e)Restructuring: At times, certain restructuring events must be carried out prior to closing, such as the creation of a holding company, or the transfer of a subsidiary or real estate that is not included in the transaction.

(f)Curing defects to title: Should the Vendor not have clear title to real estate or other assets, this can be made into a CP.

(g)Regulatory approvals: The transfer of ownership of a telecommunications or utility company, for example, often requires approval of the ministry regulating the industry.

CPs might also be used to provide the vendor with time to fix problems that emerged during due diligence (for example, if the company's environmental or other permits were not in order). It is better for a vendor to fix problems prior to or during due diligence, because failure to do so will either lead to postponement of signature of the SPA, or give the investor a possible exit from the transaction in the form of a CP.

Very often no CPs are provided by an investor to the vendor. To the extent that there are such CPs, these are usually "light." For example, the investor may need to take the signed SPA before his board, supervisory board, or investment committee for approval, and this may form the basis for a CP.

The time between signature of SPA and closing may also be used for the investor to meet with the management of the company being acquired, possibly negotiating and signing new employment agreements with management. For vendors it is important to note that during the period between the signing of the SPA and closing the target company must be managed in the ordinary course of business Any material transactions outside the scope of the ordinary business require the approval of the investor.

Although the SPA is almost always a legally binding agreement, my advice is not to count chickens before they hatch. There is many a slip between cup and lip.

There may be bona fide business reasons for CPs not being capable of being satisfied (eg. the bank does not approve transfer to the new owners).

Nor should the binding nature of the agreement be treated lightly - a party who does not use best efforts to close the transaction or who exercises bad faith will quite probably find himself or herself in litigation or arbitration, and probably on the losing end. Hence all parties are well advised to try very hard to satisfy the CPs.

At or prior to closing, the lawyers from all sides will go through all CPs as set out in the SPA and ensure that these have been satisfied. The CPs become part of the checklist required for closing. Indeed, if all CPs have been satisfied, both sides are usually legally bound to close.

When negotiating the purchase or sale of a company, the investor or purchaser will often insist on what is known as a Material Adverse Change (MAC) clause.

This article deals with three issues related to the MAC clause: 1) what is it? 2) When should it be sought by an investor or granted by a seller? 3) What happens if it is exercised by the purchaser?

1)What is it?
A MAC clause is a clause typically requested by the purchaser of a business to be inserted into a Sale and Purchase Agreement (SPA). It states that if the condition of the business being purchased materially deteriorates between the time of signing the SPA and the closing, the investor can call off the closing.

2)When should it be sought by an investor or granted by a seller?
For an investor, the longer the time to closing, or the more volatile the industry of the selling company, the more important a MAC clause may be. The MAC clause helps the purchaser to ensure that he obtains at closing what he signed up for in the SPA. Often, it is accompanied by a final due diligence immediately prior to the closing, or at least the right to obtain certain data in the period between the signing of the SPA and closing.

A seller should only grant a MAC clause if he or she is either very confident that there will be no deterioration in the business in that time, or if he or she is willing to bear the risk of such a deterioration annulling the transaction.

Such a clause essentially means that the risk arising from a deterioration in the business is transferred from the investor (who typically bears such risk after signing a binding SPA) to the seller.

3)What happens if it is exercised by the purchaser?
If the purchaser exercises the MAC clause (typically by providing written notice to the seller or the seller's legal council), the seller basically has two choices. He or she may either accept the purchaser's position (in which case there may even be a return of deposit required), or the seller may choose to litigate. The SPA would normally give guidance as to the jurisdiction whose laws will apply, and as to whether the appropriate remedy might be litigation in the court system or arbitration at a body such as the London Court of International Arbitration. Pursuing a legal remedy is not for the faint hearted, and may be extremely expensive.

On the positive side, at least in Anglo-Saxon case law, there is a considerable body of case law on what constitutes a MAC, meaning that a MAC clause is not something that a purchaser or investor can just arbitrarily exercise. There will likely be considerable expert testimony on both sides, as to whether there truly was adverse change, and, if so, whether such adverse change was truly material.

In the event that the court or arbitration panel decides that there was no MAC, there may be either an award of specific performance (ie. the investor must belatedly complete the purchase of the business), or there may be an award in damages. Because litigation or arbitration typically takes years, and any business typically changes considerably in the course of several years, courts and arbitration panels may lean more towards awarding damages rather than specific performance.

Ultimately, a MAC clause is a reflection of the negotiating strength of the parties in a transaction; an investor can only gain by it but for the vendor it can bring nothing but trouble.

Public Private Partnership (PPP) is a phrase often used but not always fully understood. A PPP may be described as a project jointly undertaken by a public body (ie. Government at any level from national to municipal) and one or more private enterprises.

Whereas the private party typically develops and operates the project and provides the entrepreneurialism and drive, the public body may contribute the land (eg. for a highway, railway, prison, hospital, etc.) and sets the rules of the game, in the public interest, by way of enabling legislation, regulation, or via tender rules.

For a PPP to be successful, there must be a well-defined public need (eg. in the case of a school, more than simply suggesting there is a need for a school building, also mapping out the number of students, the size of the classrooms, the recreational facilities required, etc. or, in the case of a bridge, defining the exact location of the bridge, the load that the bridge must bear, its life span, etc.).

Rather than the public body itself building the project, it would normally create a tender, defining in the tender documents what each of the public and private parties are expected to contribute to the project, the allocation of risks and rewards, etc.

The advantages of PPP from the public perspective are manifold: first, it reduces the amount of public expenditure required, thereby helping to reduce financing needs and deficit. Second, bringing in a private sector party to manage the project usually allows for a more entrepreneurial and flexible form of management than is typical for an entirely public project. Third, certain risks are better absorbed by the private sector than by the public sector (eg. if expected demand does not materialize, if there is litigation against the project, etc.) And fourth, full ownership of the project and any real estate or assets associated with the project will usually revert to the government after a predefined period.

As a good example, PPP projects in the highway sector may save billions of Euros of public expenditure. The quid pro quo is that users of the highway will need to pay a toll for a defined period, to defray the costs of construction, operating costs, and to ensure a reasonable return for the private operator. There is actually a certain degree of justice in making the users of a particular highway pay for the use of that asset, rather than having society at large pay for the project.

However, what happens if the toll is set too high? That can create a social backlash, causing a loss of popularity for the Government; excessive tolls may also cause demand to diminish, meaning that the number of users required to break even or generate a return does not materialize, and that the project may lose money.

In other words, in the case of most PPP projects, careful analysis is required prior to implementation, involving extensive market studies, to estimate the optimum and socially-acceptable pricing. Tenders should be carefully constructed to create healthy competition so as to keep costs in check.

The cost of the project can also be borne by the public body, as opposed to the end consumer; this would be the case in the case of a PPP for a fire department, prison, ambulance service, etc. In such cases, poor design or implementation may also result in excessive costs, that are "buried" (eg. not directly in the public eye). Therefore, the two options of directly providing the service or outsourcing it via a PPP must be carefully considered by the public authority.

With most Central European governments trying to comply with the Maastricht criteria (eg. keeping indebtedness below 60% of GDP and the deficit below 3% of GDP), PPP represents an excellent mechanism to boost growth and employment, accelerate the funding of infrastructure, harness the creativity, dynamism, and funding capacity of the private sector, and allow the population to enjoy an improved standard of living and productivity. What is often lacking in the public sector is the knowhow to design and implement these very sophisticated tenders, and there is the potential for corruption to increase projects costs and risks and consequently costs to the consumer. Nevertheless, Central European governments at all levels are only scratching the surface when it comes to exploiting the full potential of PPP and we need to see big changes in the future, throughout the region.

In previous articles I wrote extensively about the merits of competitive processes when selling companies or raising equity. However, as with Latin verbs, there are exceptions that strengthen every rule. So in what situations would a non-competitive process be more likely than a competitive process to result in a successful sale?

The first two situations that might arise are both investor-driven. First, an investor may put such an attractive offer on the table that as the owner you may be tempted to forego other negotiations. Second, an investor may insist that there not be a competitive process, for whatever reason (eg. they are not prepared to engage advisors and undertake the effort of Due Diligence unless they have exclusivity).

If either of these situations arise, you should ask yourself the following questions:

• How sure are you that the offer you have received is truly exceptional (especially if you have not yet received competing offers or a valuation)?

• What is the opportunity cost of your time? How much of a setback will it be if you spend several months negotiating with one party and yet the negotiations fall through for whatever reason?

• What is the opportunity cost in terms of passing up other potential investors? Have other parties been identified? If so, have they intimated a valuation range? Will they still be around and interested in negotiating after several months have passed?

There are, as I see it, three other scenarios which might justify considering a non-competitive process:
The third is where maximization of transaction proceeds is not your objective and you have a particular loyalty to one investor, such as, for example, you want to reward your senior management for a long history of dedicated, loyal service, by selling to them via a Management Buy Out. Under this scenario though, (as with any scenario where you are providing exclusivity), it is important that you be clear with yourself in realizing that you are unlikely to maximize transaction revenues.

Fourth, you may be very concerned about sharing confidential information with a large number of investors. In my opinion, however, there are strategies for dealing with confidentiality in the context of a competitive process in the vast majority of situations (for more details see our article on confidentiality at www.europhoenix.com/library).

Finally, you may have another shareholder with a right of first refusal. This can be problematic, particularly if the wording of the rights make it difficult to sell your interest to third parties, and you may have little choice but to at least attempt a negotiation with the party holding the rights of first refusal. In such cases, the holders of first rights of refusal usually believe that they hold the upper hand in the negotiation and it is a challenge in such situations to strengthen your own negotiating position.

Should you grant any party exclusivity, give careful consideration to the duration of the exclusivity.

You may want to pin them down on a written valuation (eg. in the form of a Term Sheet), and even stipulate that in the event that they attempt to reduce the valuation, the exclusivity may automatically expire.

Having put forward five situations where a non-competitive process might be appropriate, I would still advise business owners to try every means possible to sell your business via a competitive process, particularly if maximization of transaction revenues is among your objectives. If you do close a non-competitive sale process, how will you ever know that there was not another investor out there who would have been prepared to pay more or provide better terms?

In conclusion then, it is best to view a non-competitive process as a fallback situation when a competitive process is not possible.