Deal Professor Steven M Davidoff in an open letter to Facebook's founder - Mark Zuckerberg highlights some important rights which Venture Capitalists normally enjoy when they fund companies. Highlights from the letter -
"I read with great interest your recent interview with Kara Swisher at the D6 Conference. I was particularly struck by your answer to Ms. Swisher’s question about whether Facebook, the popular social networking site you created, can be sold by your venture capital co-owners without your approval. Your response: “I don’t think so.” Your answer made me think of something my own professor at London Business School once said to me: “The day you take a venture capital investment is the day you sell your company.” Venture capital firms are not Warren Buffett — they have limited-term funds and compensation mechanisms that encourage them to exit their transactions once a company reaches maturity. So, is it true that your co-owners can sell without you or otherwise push through an initial public offering of Facebook without your approval as chief executive officer? Well, the answer is maybe."
While the founder said "I don't think so", the Professor says "Maybe". Why is it so? Mainly because of the legal covenants which normally accompany every VC investment. One of the important right is the drag along right. Accordingly to Investopedia a drag along right is "a right that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller. This is designed to protect the majority shareholder. Because some buyers are only looking to have complete control of a company, drag-along rights help to eliminate minority owners and sell 100% of a company's securities to the buyer." This issue is explained further in Feld Thoughts.
The Indian Context
In the Indian context, I don't know whether these are practically possible. May be amongst hundreds of transactions, a few might have actually happened when the founder(s) also are inclined to sell out. In a country where the promoters vision starts and ends with their family, and with lax compliance/enforcement environment (notwithstanding the numerous Acts which have been passed regularly by the Central & State legislatures) and a genuine fear that its better to avoid going to Courts for enforcing rights - the current thinking is that it may take around 15 - 20 years (assuming it goes all the way upto Supreme Court) to get justice and even if something positive comes, will there be anything left to implement / salvage .... All these factors inhibit legal recourse and push people towards an amicable out-of-court settlement.
Interestingly, while everyone talks about the multi-baggers that they have had in their portfolio, hardly anyone actually shares information on investments which went sour. There is also a prevailing wisdom that losers come first and its better to concentrate on winners rather than losers. Thus, even in cases involving losers, though the agreement may provide for various rights, still the VCs might prefer not to exercise them, and would rather try to limit the loss/damage and try to get as much as possible and as quickly as possible. In that event, if the founder(s) are not so honest people, they can make use of this general thinking and try to limit the exit proceeds as low as possible, but not so low that the VC would think it is better to go to court to enforce the agreement.
It might be possible and more effective to enforce the rights enshrined in the agreement where there is a separation of ownership and management. In the Indian context, that (generally speaking) does not appear to be the case, thus frightening potential buyers (mainly due to poor corporate governance standards, especially in smaller firms where the distinction between the owner and the company is often blurred). To that extent, though Indian VCs too have same / similar rights, I doubt how many of these rights are actually exercised and enforced.
