Investment project risk control is the focus of private equity fund risk control. If the risk of each investment project is controlled, the project investment risk of private equity funds can be controlled.
- Contractual constraints
The pre-agreed responsibilities and obligations of the parties are the legally effective risk avoidance measures that will be taken in all business activities. In order to prevent the company from infringing on the investor’s behavior and protect the interests of the investor, the investor will formulate various clauses in the contract in detail, such as formulating positive and negative clauses, clarifying what the company must do and what it cannot do, and prevent the company from being bound by the contract. The investment contract can also set clauses to protect the investor’s right and method to realize the investment, the conditions for adjusting the equity ratio, the priority of additional investment, etc., to prevent equity dilution.
- Segment investment
Segmented investment refers to the segmental control of investment progress by private equity investment funds to effectively control risks and prevent companies from wasting money. The allocation of investment funds should be done in stages according to the progress of the project, not all at once. Only provide the funds needed to ensure the development of the enterprise to the next stage, and reserve the right to give up additional investment and the right to preferentially issue stocks when the company issues additional financing. Only when the current phase of the project runs well and achieves the expected goals, the follow-up funds can be followed up in time, and the later projects can be started. If the enterprise fails to achieve the expected level of profitability, the investment ratio in the next stage will be adjusted, which is a way to supervise the operation of the enterprise and reduce the operation risk.
- Remedy for breach of contract
Generally speaking, in the early stage of project investment, private equity funds can accept the status of minority stake, and the management of the project company controls the majority stake, but investors can sign a voting rights agreement with the project company to maintain special voting rights on some major matters. When the management of the project company fails to operate the enterprise in accordance with the objectives of the business plan, the project company shall be held liable if it is found that the management has violated the agreement, provided obvious information errors, or discovered a large number of responsibilities.
Private equity funds can impose strict requirements on project companies. Common penalties or remedies include: adjusting the conversion ratio of preferred stock, increasing investors’ shares, reducing the project company’s or individual management’s shares, voting rights and board seats, transferring to private equity funds, dissolving management, etc.
- Equity ratio adjustment
In project investment, private equity funds use compound financial instruments such as convertible preferred shares, convertible bonds, bonds with warrants or their combinations to adjust the proportion of equity investment to reduce their own risks. Especially the use of convertible preferred shares, by adjusting the conversion ratio or conversion price between preferred shares and common shares, to adjust the equity ratio between private funds and project companies to meet the different goals and needs of private funds and project companies, It can not only protect the interests of investors, but also share the growth of the enterprise, and can also mobilize the enthusiasm of the project company to operate, promote the development of the project company, and obtain more equity.
The risk control of private equity funds should start from the source. In the initial stage of an investment project, investors should carefully investigate and research the investment project. During the investment process, the two parties sign detailed terms, agreeing on rights and obligations. If the investment company defaults, investors can take remedial measures. If the above risk control methods are applied to a certain extent, it is believed that the risks of investors can be avoided to a large extent.