What is a Preference Shares Investment Agreement?
A Preference Shares Investment Agreement is a contract for an investor to invest in a company and get preference shares in return. Please note: investment by preference shares is highly sophisticated. If you are not familiar with how preference shares work or how this investment agreement operates, you must seek legal advice.
Key terms in Shares Investment Agreement:
Reserved Matters List:
There are certain matters or actions which must not be undertaken by the company or its subsidiaries without the approval or special majority of the board or shareholders. In the case of reserved matters, special approval is required which is more than and above what is required by the general law. Such provisions afford protection to the minority shareholders who generally don’t take part or influence the decisions making process of the company where general approval is required by the law.
Pre-emptive Rights:
Shareholders of a company usually benefit from the pre-emption rights which give them a right to first refusal when new shares are issued by the company. Where the shareholders have pre-emption rights, they have an advantage over other potential investors because new shares are first offered to them. This means that the new shares can’t be offered to others without first being offered to the current shareholders. Whenever new shares are issued by any company, it needs to check whether pre-emptive rights exist or not.
Liquidation Preference:
Basically, liquidation preference relates to what happens to a company in the event of winding up. It tells us that in the case of winding up or a sale event of the company, how the surplus assets of a company should be distributed between its shareholders. During the winding-up scenario, the debt of creditors whether secured or unsecured must be settled first using the surplus assets of the company. This is also known as the waterfall provision due to the fact that the distribution order of the proceeds is clear from top to bottom.
What are the advantages of a Preference Shares Investment agreement?
Preference shares have a wide range of features as corporate indicate a set of features while issuing them. It is crucial that, at an early stage of the discussion, the parties have a good idea of the rights attached to (or any restrictions that apply to) the preference shares. Major rights that may be attached to preference shares include:
Allowance for preference shareholders: Preference shares have dividend provisions that are cumulative or non-cumulative. Most of them have cumulative, which means any dividend not paid by the company accumulates.
Preference shareholders have no right to vote: Preference shares do not normally confer voting rights in the annual general meeting of a company except in special circumstances.
Par Value: Most preference shares have a par value. When it does, the dividend rights and call price are usually stated in terms of the par value.
Callable Preference Shares: Normally, preference shares have no maturity date. But callable preference shares may be retired by the issuing company upon the payment of a definite price stated in the investment.
Preemptive right of preference shareholders: Common law statute gives shareholders, equity or preference, the right to subscribe to additional issues to maintain their proportional share of ownership.
Participating Preference Shares: Most of the preference shares are non-participating, meaning that the preference shareholders receive only his stated divided and no more.
Always bear in mind there is not a single set of rights or restrictions that is universal. Each provision is a matter of negotiation; therefore, it is important for you to understand the provisions and to negotiate them with the counterparty where appropriate.
What should be included in the preference share investment agreement?
These are the basic things that are included in a Preference Shares investment agreement.
- Details of the subscription, including the amount of investment and percentage of shares to be issued;
- Pre-money valuation and round size;
- Cap table;
- Rights and restrictions of the preference shares to be issued;
- The expected timeframe for the execution of the definitive agreement and completion of the subscription;
- Board composition after completion;
- Generic conditions precedent;
- Reserved matters and other provisions in shareholders’ agreement;
- Confidentiality; and
- Exclusivity (if applicable).
What are the differences between an Ordinary Share and a Preference Share?
An Ordinary Share gives shareholders the right to vote on important matters such as appointing directors and can participate in internal corporate governance through attending annual meetings and voting. Shareholders can receive dividends if the company has made profits and is also protected against the financial obligations of the company.
A Preference Share doesn’t give voting rights to its shareholders but they will be given preferred treatment over the ordinary shareholders and a fixed amount of dividend payment is paid to its shareholders. They also enjoy a priority right to be repaid if the company becomes insolvent or enters liquidation in the future.
What happens if you own preference shares in a company that goes bankrupt?
In the situation where a company goes bankrupt, various securityholders of that company will get claim over the company’s assets. How and in what order they receive it will depend on the security agreements signed and the rights given or mentioned there . Preference shares, usually get priority over common shares but their priority over Corportae bonds, Debemtures and other fixed-income securities are mostly lower.
Conclusion
Investors who want settled dividends for a constant period should consider preference shares investment agreement. If you’re looking to invest in such shares, make sure you’re familiar with the pros and cons related to them.
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