Serving As Shareholder Representative
The lead investor in private equity transactions may assume the role of shareholder representative for any number of reasons. They are often most familiar with the day-to-day operations and working capital calculations of the selling company. They might own the majority share of the money at risk during the post-closing period and therefore want to maintain control over the process. That said, there is significant downside.
Risks and Obligations of Being an Agent
The representative is an agent of the former shareholders and has a legal obligation to ensure that these shareholders’ best interests are represented. The deference given to directors under the “business judgment rule” might not be available when economic interests differ. This means there may be a substantial risk in serving as the shareholder representative if the representative’s economic interests differ from those of other shareholders—e.g, as a result of liquidation preferences or differing needs for liquidity. If so, the protections board members get with the business judgment rule may not be available.
Serving as shareholder representative is one of the few roles a person can assume in which there is a material risk of doing nothing wrong but nevertheless becoming personally targeted in litigation. A buyer can sue the representative if the buyer’s indemnification claim made under the acquisition agreement is not settled out of court. Regardless of outcome, being named as a party to a lawsuit has unpleasant consequences: the distractions and cost of litigation, negative impacts on one’s ability to get a loan or insurance, and undesirable disclosure requirements. Furthermore, most funds would prefer to avoid a public fight with a buyer they may see again on future deals.
Simply not serving as representative can eliminate this risk. In Mercury Systems, Inc. v. Shareholder Representative Services LLC, the judge ruled against an attempt by a buyer to include both the representative and the selling shareholders as defendants in a class-action suit. This firm, as representative in this case, argued successfully that it was the only proper defendant.
Forming a New Company is Not a Solution
Forming a new company to serve as shareholder representative has several pitfalls. Setting up a new company is time-consuming, expensive and distracting; and, after closing the entity must file annual reports and tax returns, and then eventually be wound down. It is questionable whether the new entity would actually eliminate personal liability. Also, there is still the matter of performing the work of the shareholder representative and taking responsibility for the time-consuming tasks involved.
Retaining Control Without Serving as Shareholder Representative
By engaging an independent post-closing representative the shareholders can mitigate these risks and still maintain control. A well-crafted engagement agreement can define what the representative must do, what communications the representative is required to provide, and what consents are required before taking certain actions. Thus, the fund and other shareholders are able to contractually retain the desired level of control while shedding the burdensome aspects of the job. Increasingly, sellers are turning to this solution to avoid the risks, engage experts who can operate more efficiently, and eliminate distractions from time better spent elsewhere.
Read more about on this issue from the perspective of law firm Akin Gump Strauss Hauer & Feld LLP.
Download the SRS Acquiom white paper, How Private Equity Manages the M&A Post-Closing Process.