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When are exit rights triggered under SHAs 

Apart from being triggered upon failure of the company to undertake an IPO at the expiry of the intended investment horizon, exit mechanisms also get triggered if there is an event of default under the SHA. Usually, circumstances which would lead to an event of default are specifically mentioned under the agreement. Typical events of default usually are as follows:


1.Breach of representations or warranties


If any representations or warranties (made by the promoters or the company) as to the state of affairs of the promoters, the company or its business at the time the investment was made, are subsequently discovered to be incorrect.


You should recall that representations and warranties are statements which are expected to be true as of the signing date (date of execution of the agreement) and the closing date (the date when the investment is made, after all the preconditions specified in the SHA are satisfied).


2. Breach of a covenant or undertaking


A covenant is an undertaking about a future course of action. As a condition for receiving the investment, founders agree to carry out the business of a company in a particular manner. This is usually specified in a separate clause on covenants and undertakings. For example, breach of a covenant under the SHA to carry on only those activities which are permitted by law (and after obtaining necessary authorizations) can trigger the exit rights.


3. Occurrence of a ‘liquidation event’


A liquidation event could be defined in different ways. It can include the winding up of the business, or the sale / lease of a substantial portion of the assets of the company, and a transaction which leads to acquisition of control over the company by a third party buyer.


4. Occurrence of a material adverse change


Occurrence of any event (even after the investment has been made) that qualifies as a material adverse change, or events that are likely to result in a material adverse change, such as initiation of governmental or regulatory proceedings or inquiries can trigger exit rights.


(Hence, it is extremely important for founders to insist on a reasonably narrow and certain definition of the material adverse change clause during the negotiation stage.)


5. Breach of specific terms of the agreement


If any other term of the agreement is breached – for example, if an investor’s consent is not taken for a reserved matter, or if the founder is in violation of a non-compete clause.


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