Private Equity (PE): How Founders and Management Teams can protect themselves - it’s a marriage of convenience so make sure your pre-nup is watertight…

PE investors replacing CEOs and CFOs is not the exception, it is the norm. This is supported by data from AlixPartners, whose latest study showed nearly two-thirds of PE firms replace portfolio company CEOs during their hold period, with only 9% saying they "rarely" do so. Founders and management teams considering partnering with PE need to accept this reality, and plan for a break-up from day one. 

Part of the “bargain” with PE is that as a founder or manager you will need to accept that you can be terminated. You will also need to accept that it is a statistical likelihood that you will be terminated. The key is to ensure that you are as well protected as you can be if a split occurs, to preserve the value of your equity, to preserve your reputation and to give you enough leverage to avoid a messy break-up. 

Key Takeaways

• Negotiate robust contractual protections upfront: particularly around dismissal procedures, leaver provisions and equity value.
• Scrutinise investor step-in rights carefully: Ensure the triggers are objective, the consequences are defined, and the cure path is clear.
• A well-drafted "pre-nup" pays dividends: Strong equity and employment terms can deter a forced exit — or materially improve your exit terms.

What happened in the Big Motoring World case?

The recent judgment involving the founder of Big Motoring World (BIG) and Freshstream, a PE investor, is a cautionary illustration of this predictable dynamic. In that case, Peter Waddell, the founder, who had built a highly successful business, retained a 63% majority shareholding and continued as CEO, was dismissed for gross misconduct following Freshstream’s acquisition of a minority stake in BIG. Notwithstanding that the court upheld his dismissal, the removal of Mr Waddell as CEO was, on the statistics, a predictable outcome. What was not predictable was the manner in which it played out.  

The court found that Freshstream had formulated and executed a pre-conceived plan to achieve permanent control of the business, and Mr Waddell’s removal, without paying for a controlling interest under the call option (which  had been negotiated at the outset of the transaction for precisely the purpose of delivering control to Freshstream). The coordinated exercise of step-in rights, misconduct investigation provisions and employment termination powers, combined with a deliberate failure to address conduct issues as they arose, resulted in a finding of unfair prejudice. It was a very public and commercially destructive fallout that, we assume, both sides would have much rather avoided. 

Practical steps coming out of the Big Motoring World case?

The High Court is still to determine the specific remedies in the case. However, beyond the critical cornerstone protections around founders’ and managers’ economic interests (including leaver provisions and their impact on equity value) and the ability for founders and  managers to control or influence business strategy, two practical points stand out: 

1. Contractual guardrails around dismissal: robust procedural protections around termination or removal from the board are key. This includes ensuring that processes are conducted promptly, transparently and in good faith.  
2. Investor step-in rights: Step-in rights to protect a minority investor in the event of a material downturn in performance are a prerequisite for PE investors, and they are always a sensitive and emotive topic for founders/management teams. The key lesson from this case is that founders and management teams should focus carefully on ensuring there is objectivity as to what the triggers for step-in are (that they are objective rather than resting on the subjective opinion of the investor), what the consequences of step-in look like and how they can be cured such that the investor “steps out”. 

Invest in your transaction documentation

A messy divorce is not good for any of the parties involved. Ensuring that your equity and employment documentation negotiated with your PE investor is robust (and can act as your pre-nup) will pay enormous dividends. It may even prevent your termination if the price of doing so is too high for the PE investor. 

The Charles Russell Speechlys Private Equity Group offers market-leading independent and conflict-free advice to founders and management teams. Our coordinated legal, personal tax and employment advisory services are unrivalled. For further information on how to protect your position when partnering with PE, please contact Nadim Meer and James Paterson.