What are Negative Control Provisions?

A negative control is a right to block some undesirable outcome. The negative control provision is often a part of a venture investor agreements and is exercised though the use of veto rights. Typically, this provision is called the protective provisions that allow the venture capitalists to unilaterally block different corporate actions of the company.

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How do Negative Control Provisions Work? 

In a company, the decisions are generally taken by the majority of the board and the majority of the shareholders through a vote. The venture capital funds generally hold a minority position in a company, thus they have the negative control provision. They can exercise this right to stop an action that goes against their interest. Including a negative control provision in an investment- agreement is a standard practice to protect the interest of the venture investors. 

The negative control provision covers a number of areas including dissolution, sales or merger of the company, sale of the assets, changing the company's charter, issuing senior or pari passu securities, giving away dividends, redeeming securities, taking a loan and changing the number of directors of the company. Generally, an upper limit of loan is mentioned in the agreement. The venture investor can intervene only when the threshold is crossed. 

The negative control provision is designed to provide veto right to the investors for protecting their investments. It prevents the majority shareholders to decide something that may diminish the venture investors equity. 

A venture investor may choose to exercise this right on the occasion of the shutting down the company of selling it at an unsatisfactory price. Also, if the company decides to borrow an amount of money that creates heavy debt load and put the equity investment at risk the negative control provision can be implemented by the investor.

 Issuing senior or pari passu securities may adversely impact the value of the investors' liquidation preference or it may lead to significant ownership dilution. The investor can prevent this by utilizing the negative control provision. The inclusion of negative control provision is negotiated during the investment round. The investor and the company agree on the terms to be included in the negative control provision. 

The company may want to narrow down the protective provision to limit the blocking right to a charter amendment. The terms are to be negotiated in a way so that the investor can protect their investment from potential risk without blocking the company from raising venture capital in the future.