Posted on

The Drag Along Clause in the Prenup

Maria owned a successful dairy products company that had been doing business for the last twenty two years. Her children had been pushing her to let in other investors into the business so that they could reduce their dependence on debt capital. The company had taken loans to enable the rapid expansion that the business had undergone following customer demand for their niche products. Her cousins Tom and Philomena had taken an interest in the business and put in some money in return for a 10% stake each in the company. This money had enabled critical manufacturing machines to be imported and the company was now one of the top producers of lactose free dairy products whose demand was growing in double digits every quarter.

Maria took the opportunity that the external investment provided to transfer another 20% of the company’s shares divided equally amongst her four adult children. As a majority shareholder at 60%, she could still make controlling decisions and count on her children to back her up in the event of a shareholder dispute with Tom and Philomena, fondly referred to as Tomlena by her children. But her decisions were subject to the shareholder agreement that Tomlena had insisted upon before they transferred the cash for their 20% stake. The agreement had included shareholder reserved matters like how much of the profits could be distributed as dividend and when such payment could occur. There was also a requirement that shareholder approval was needed for any company borrowing to ensure that the company did not over extend itself.

But a key clause that her lawyers had strongly advised her to include was a drag along clause. As the business had started getting noticed by potential private equity investors, her lawyer advised that she should put in the clause that would protect her in the event that the minority shareholders decided to block an acquisition of a majority stake by a third party. ‘How would this work?’ she had asked the lawyer. ‘By putting in a drag along clause, you become attractive to a third party buyer as it provides an opportunity for said buyer to get 100% of the company, without painful negotiations with potentially emotional minorities,’ explained the lawyer. Maria would have to ensure that any third party buyer provided the same price, terms and conditions to the minorities that she was receiving.

Maria didn’t like the sound of that. Tomlena had provided capital to the business at a critical time and on very soft loan terms. They had taken a punt that the business strategy to invest in manufacture of niche products would work and that bet had paid off well. Her children had also strong emotional ties to the business as it had educated them and employed some of them. Her lawyer saw the anxiety on her face. ‘Another option could be a tag along clause,’ he suggested. The tag along clause would offer minority shareholders the option but not the obligation to sell to a third party buyer of the majority stake. If Maria managed to negotiate a good price including a deal that had a combination of cash and share swaps with the acquiring party, the minority shareholders could participate in the same deal if they wished to sell their shares. ‘I do have to warn you that many investors do not like these kind of clauses when they find them during due diligence,’ her lawyer cautioned. ‘Institutional buyers do not like to be forced on the negotiating table with parties who do not have controlling interests and are presumed to be weaker from a bargaining standpoint. This might potentially cause a delay or be a deal breaker in the event you do find a buyer.’

Maria was in a quandary. She knew she wanted to eventually sell the business as her children had convinced her to retire early and do a trip around the world. ‘Look, you don’t have to take the difficult road right now,’ the lawyer advised. ‘We can put in a pre-emptive rights clause that gives the existing shareholders the first right of refusal in the event you want to sell. They will have an equal right to purchase your shares proportionate to their shareholding. So if they are unable to buy your shares at the valued price, then you can sell them to the third party buyer. Investors who are willing to deal with minorities would like this as it doesn’t force them to a negotiating table with minorities from the start.’ Maria met separately with her children and with Tomlena. They were all in unanimous agreement that if she sold her shares for good value, they would want out of the business as well. The drag along clause won the day and was inserted into the shareholder agreement. Maria could now focus on building a bigger business and preparing it for an eventual outright sale.

[email protected]

Twitter: @carolmusyoka

Posted on

Shylocks Come In All Guises

Many years ago as a rookie banker, a colleague of mine found us a get rich quick scheme that would help circumnavigate bank policy that prevented employees from doing any business outside of the bank. The colleague knew “a guy” who lent out money to individuals in dire need of help and “the guy’s” customer demands were growing faster than he could capitalize his business. My colleague approached a number of us in the bank to provide short term loans in exchange for some serious interest returns, ranging in the lower double digits. We did. Boy did we make good money! After three months, our loan was repaid together with the interest and, in keeping with the greedy nature of the human being, we asked “the guy” to place even more funds in his very enterprising venture. Remember we were bankers and knew the benefits of short term risks, which risks were being mitigated firstly by the acknowledgement of our debt in the form of “certificates” and the liquidation of the same in a fairly short ninety day period. Furthermore, or so we consoled ourselves, our bank was not into retail lending so there was really no conflict of interest. Finally, it was not “doing active business per se” as per the policy, as there was no restriction on where one could passively invest their funds.

Well, as with all such get-rich-quick schemes, there wasn’t such a happy ending. “The guy” now had a veritable source of easy money and got a little fast and loose on his lending policies meaning that repayment from his borrowers wasn’t being tracked as well as it should have been. The first sign of distress was when a repayment date for our loans came and passed with no funds being sighted, followed by a polite request to allow us “investors” to roll over the principal and interest. Being trained bankers, we saw trouble with a capital T for train-smash loading. We made it out of that fiasco with the skin of our teeth barely intact and a realization that we were actually shylocks in nice suits funding a knee-cap busting,  no guiding policies, catch-me-if-you-can shylock.

Many years later at another bank I worked in, the Human Resources (HR) department became concerned when their reception was getting filled with tough looking “guys” who were coming to demand repayment for loans to the bank’s employees that were not returning their calls. The problem was so endemic that the bank had to create a special program that allowed the numerous employees to breach their debt service ratio (where not more than 30% of an employee’s salary should be going to service bank loans) and get extra loans to pay off the shylocks. The purpose of the debt service ratio is to ensure that the borrower has enough disposable income to have a decent living free from the very real distress of having throat choking and bank induced liabilities that can affect their psychological wellbeing. But this is where it got interesting. Upon a quick review by HR of who the cheques to pay off the loans were being made to, since the bank was not foolish enough to release the funds directly to the delinquent employees, a number of the cheques were being made to other bank employees! As the Swahili wahenga aptly postulated, “Kikulacho ki nguoni mwako” or simply put: the enemy is always within.

This was a tough call for HR. Remember, their most difficult employee lifestyle challenges by this time were the odd baby mamas or cast-away wives that would show up at the reception presenting court issued garnishee orders for child support on a male employee’s salary. There was no policy per se about bank employees conducting the business of shylocking or, for that matter, farming those services out to their colleagues! Anyway, there was no happy ending to this debacle. Once the shylocks were paid off and the HR reception finally got some natural light, quite a number of the delinquent employees simply went back to other shylocks and borrowed some more now that their shylock debt slate was clean. As the English wahenga also aptly postulated, “You can take a donkey to the river, but you can’t make it drink”. Borrow wisely this year and, if you’re in the business of investing, apply wisdom for the same!

[email protected]

Twitter: @carolmusyoka

Posted on

Right of Reply from SMEs

[vc_row][vc_column width=”2/3″][vc_column_text]Last week I wrote the true story of Moraa, an enterprising furniture manufacturer that just wanted her government to help her grow her business locally as well as find new export markets. What I didn’t expect was that I would be opening the floodgates to responses from other readers who suffer from a similar angst as Moraa. For instance JGM penned:

“I have made a lot of noise from way back about these investor conferences which we spend a lot of money to hold yet we do not do the same for our own local investors. We do not invite them to county meetings to discuss how to grow together. Instead you have all manner of government agencies harassing them. You wonder what the definition of an investor is. Like hawkers, they don’t have to be arrested and their merchandise confiscated. Just charge them the levy they were supposed to pay and tell them to leave unauthorized space. But recognize they put up their own little money hoping to get a return. That is an investor. In fact the average hawker is one of the most intelligent forms of an investor, as he has to factor in a risk most other businesses don’t: deliberate government crackdown! If these county guys would call us we have roundtables and meetings and agree on a common agenda, we would gladly pay them more levies for them to deliver service.”

JGM does have a point. Hawkers are investors. They may be at the bottom of the food chain, but they are business people trying to make an honest living. It would be far more innovative to treat them as potential growth enterprises than to beat them down daily and view them as the nuisance they are perceived to be. KM is a young man who I once employed and he left as he was bitten by the entrepreneurial bug. At less than 30 years old, he and a friend set up a microcredit agency about five years ago. He exemplifies the face of the Kenyan hustler as he writes: “Carol, I’m so happy you wrote this morning’s article. The SME is struggling to get access; we are harassed by KRA at each and every turn. Literally Nairobi County camps at either of my two branches and there is always a new licence or ‘fee’ I have not paid! Maybe we should create a lobby for SME’s? I have several horror stories.” But clearly not enough horror stories to make him want to close shop because he is passionate about his business. For now he’s all about maintaining his entrepreneurial sanity.

Meanwhile, back at the Murang’a County ranch, KG sent me this missive: “Dear Carol, I am involved in the small-scale production of juice in Murang’a County with all intentions of scaling up. My frustrations can be summed up as follows:
I have been having the runaround with KEBS for the last four months and not because my product failed but just trying to get the certificate after paying Kshs 5800/=. KRA would want me to pay excise duty on the juice but they have 17 requirements for me to fulfill before they grant me a licence. Some are reasonable and straightforward but let me highlight a few of what I consider ridiculous (maybe they need to put on sneakers and see the work we are doing)
• Valid security bond for the protection of excise duty
• NEMA certification
• Letter from the county government showing the factory is in a designated industrial zone.
• Licence fee of Kshs 50,000 for me to pay taxes!
My business is an SME for heavens sake! In view of the above what am I to do? Operate under the radar thus stifling my growth? Or do I remain small?
Kindly share some of this issues with the wider public and perhaps some sense may start prevailing.”

As Jeff Koinange aptly puts it, “You can’t make this stuff up!” Good people: these are real Kenyans who have ideas and capital and are willing to pay taxes if that will enable them to grow their businesses, employ more people as well as create a supply chain that grows with them and strengthens the economy. Please note that not a single one of them has requested for money in the now ubiquitous ‘naomba serikali’ fashion. MW writing from the heart of Nairobi’s hustler district sent in his two cents: “Hi Carol! Thanks for hitting the nail on the head on how to grow this economy in today’s Business Daily! I am a small offset printer on Kirinyaga road and I often wonder what those who run this country think about us small business people. It is obvious that these businesses employ the majority of Kenyans. If you cross beyond Moi Avenue the population increases in quanta and so do the daily transactions, albeit in small denominations! The government needs to do little things like making life bearable for the Jua Kali Mechanics by building them sheds, provide water, toilets, and perhaps organize them into co-operatives that could buy modern tools so that their work can graduate to industrial standards. My point is these top shots have no idea what Kenya is all about. They just think about foreign investors! If we are having problems investing in our own country how will foreigners fare?” I wanted to give MW a hi-five as he summarized every SME owner’s frustrations: if the locals cannot succeed in doing business at home, what makes the government think that a foreigner will fare better?
To their credit, two different chaps from the Export Processing Zone sent me lengthy emails to disabuse me of the notion that they are unhelpful. Both were eager to meet with Moraa and provide some assistance. I linked up Moraa with them promptly. Kenyans just want a hassle free local business environment through which they will build their enterprise on the back of their own capital and sweat. Government can do it.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]