Private equity funds have long invested in fashion companies, and the fashion world has long been wise to the benefits brought by private equity. By way of example, Italian private equity group Clessidra recently acquired the Robert Cavalli fashion house. When commenting upon the acquisition of his company, Mr Cavalli noted that the private equity investment would “provide financial, managerial and human resources that will allow the company to grow further and face the challenges of the ever-evolving luxury market.”
However, before fashion brands get too carried away, it’s worth noting that in a typical private equity investment, the fund will request that the key managers (who are to remain as shareholders in the fashion brand), enter into a shareholders’ agreement with the private equity investor. Typically, this agreement and other legal documentation will result in the management team losing a degree of control over their business. Additionally, if the management team do not adhere to the provisions in this agreement, they may be held personally liable.
In this article we therefore consider some key issues which the management team should be aware of before accepting any cheques from private equity investors. For shorthand, we use the phrase ‘management team’ in this article to refer to the principal shareholders in the fashion brand who constitute the company’s management team.
Private equity investors will want to ensure that the company is operated effectively and efficiently, and will impose controls preventing the management team running it in such a way which could potentially erode the company’s value.
To this end, the shareholders’ agreement will contain various obligations that the management team have to adhere to, including the following:
- the right of the private equity investor to appoint at least one director (and sometimes also an observer) to the board of the fashion brand;
- a list of matters which the fashion brand and the management team cannot undertake without the consent of the private equity investor (these are typically most material matters which are outwith the general day to day running of the company); and
- a requirement that the private equity investor is provided with regular financial information about the brand’s financial performance (including management accounts, future business plans and budgets).
It is very likely that the private equity investor will request that the management team and the company give warranties in the shareholders’ agreement. A warranty is a statement of truth and fact about past or current events and matters. Commonly given warranties include statements as to the past running of the fashion brand, confirmation that the company owns all of its intellectual property, assurances that it is not involved in any litigation, and as to the accuracy of the brand’s accounts.
The warranties will be given by the management team for the benefit of the private equity investor, which means that if a warranty later proves to be untrue, the investor may be able to sue the management team for a breach of the warranty. Although these claims are not common, if such a claim was brought and the court found in favour of the private equity investor, the management team may be held personally liable and would be obliged to satisfy the claim from their own assets.
There are however ways in which the management team can improve their position – for instance they can request that their liability is capped at a certain amount, and they can disclose any known issues to the private equity investor, and they can ensure that any warranties and other obligations they undertake are carefully considered and negotiated.
It is likely that the shareholders’ agreement will also contain restrictive covenants, which are provisions which inhibit the way in which someone can act. They are used to protect investee companies and do this by restricting what an individual (usually a member of the management team) can do both during and after the termination of their employment. The most common types of restrictive covenants are non-compete (i.e. the employee agrees not work for or be involved with a competitor of the fashion brand) and non-solicit (i.e. the employee will not poach any of the fashion brands customers/suppliers/employees)
Great care should be taken when drafting restrictive covenants, as if their terms are too favourable to the fashion brand, there is a risk that they may be unenforceable. It would be prudent for the management team to negotiate with the private equity investor, aiming to minimising the impact of the restrictive covenants (most principally in relation to how long the covenants shall last for). Managers should be aware that they will be held personally liable if they breach their restrictive covenants.
As well as entering into a shareholder’s agreement, private equity investors will often want to ensure that the management team have each signed up to service agreements with the fashion brand. These agreements should cover the following:
- details of the employee’s remuneration structure (i.e. basic salary, terms of any performance related pay);
- notice period upon resignation/termination of that person’s employment;
- confirmation that the employee will work full time for the fashion brand;
- assurance that the fashion brand has sole rights to any intellectual property developed by an employee during the course of that person’s employment with the company; and
- any restrictive covenants the employee is bound by (similar to those in the shareholders’ agreement, as described more fully above).
It is usually important for a private equity investor to ensure that binding service agreements with the management team are in place which cover off the above points – clearly the investor doesn’t want the management team having the ability to walk away immediately after they make their investment.
Although private equity investment can give fashion brands a much needed cash injection and (quite often) business guidance and help as well, the management team need to be aware of the personal restrictions and potential liabilities which any such investor is likely to want.