Negative Control Provisions Definition
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.
A Little More on Negative Control Provisions
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 investor’s 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.
References for Negative Control Provisions
Academic Research on Negative Control Provisions
- · On the uses of corporate governance provisions, Danielson, M. G., & Karpoff, J. M. (1998). Journal of Corporate Finance, 4(4), 347-371. This article discusses extensively the use of the corporate governance provisions initially written in the late 80s. This resulted in building a complex governance structure for the big public trading company.
- · The evolution of airline ownership and control provisions, Chang, Y. C., Williams, G., & Hsu, C. J. (2004). Journal of Air Transport Management, 10(3), 161-172. The objective bid of this article is to explain in details how the ownership rules have changed and how the government and the airlines have responded positively to these changes. The prospect for easing ownership rules under the subject of multilateral, bilateral and plurilateral arrangements are discussed. In conclusion, the view expressed by the International Civil Aviation Organisation at the recent Worldwide Air Transport Conference presents an empirical solution to change into the rules of ownership.
- · Bank managers’ heterogeneous decisions on discretionary loan loss provisions, Lobo, G. J., & Yang, D. H. (2001). Review of Quantitative Finance and Accounting, 16(3), 223-250. This article researched the three major motivations for discretionary behavior concerning loan loss provisions, which signaling, capital management, and income smoothing.
- · Control considerations of newly public firms: The implementation of antitakeover provisions and dual class shares before the IPO, Field, L. (1999). This article is about a hypothesis using a large sample of US firms issues initial public offerings (IPOs) and gives on control consideration for the firms. It was discovered that over 45% of firms that implemented the IPOs also includes the bylaws in the corporate charters or antitakeover provisions, furthermore more it was found that a little bit over 5% decides to go public with multiple classes if outstanding stocks.
- · Can’t cap corporate greed: Unintended consequences of trying to control executive compensation through the tax code, Miske, R. (2003). Minn. L. Rev., 88, 1673. This article discusses the significance of corporate governace and the results which affects the executive pay packages and proposes fundamental reform which is used as a measure to solve all these failures. The proposal submitted by Jesse Fred and Professor Lillian Bebchuck is a stimulation of a wealth attracting literature.
- · Share repurchases, shareholder rights, and corporate governance provisions, Jiraporn, P. (2006). The North American Journal of Economics and Finance, 17(1), 35-47. These solid agency theories were carried out to explore how the strength of shareholders rights can be influential to any repurchase activities. The empirical analysis revealed that firms with weaker shareholders rights to repurchase always ends up repurchasing fewer stocks. Furthermore, the results revealed that no evidence was found on dividend substitutions and it can be translated to buybacks cannot be substituted for dividends
- · The disciplining effect of the internal control provisions of the Sarbanes–Oxley act on the governance structures of firms, Goh, B. W., & Li, D. (2013).. The International Journal of Accounting, 48(2), 248-278. This article studies the internal control provisions under the Sarbanes-Oxley Act(SOX), and it’s discipline effect on the governance structures of organizations. It was discovered that members of the audit committee and directors outside the firm’s that disclose material weaknesses (MWs) according to Section 303 of SOX are most likely to leave the organization compared to their counterparts in a matched sample control organizations that don’t have such weakness, and there is a chance they might lose more due to outside directorships compared to their counterparts in the control organizations.
- · The effect of change-in-control covenants on takeovers: Evidence from leveraged buyouts, Billett, M. T., Jiang, Z., & Lie, E. (2010). Journal of Corporate Finance, 16(1), 1-15. A discovery was made concerning the change in control covenants and how it affects the probability of being a Targeted in a non LBO takeovers, though the impact wasn’t felt.
- · Extraordinary antitakeover provisions and insider ownership structure: the case of converting savings and loans, Boyle, G. W., Carter, R. B., & Stover, R. D. (1998). Journal of Financial and Quantitative Analysis, 33(2), 291-304. The insider ownership and antitakeover provision both affect the organization vulnerability to take over, its manager’s incentives, utilities and its value. We also discussed the simultaneous determination of the insider ownership and the takeover protection by using the data collected from mutual saving and loan association s, by converting all stocks to forms. Ownership is negatively related to the amount of extraordinary antitakeover provisions at a lower level of insider ownership; ownership is not relative to the number of antitakeover provisions at higher levels of insider ownership. These results are comparable to insider entrenchment.
- · Differential valuation implications of loan loss provisions across banks and fiscal quarters, Liu, C. C., Ryan, S. G., & Wahlen, J. M. (1997). Accounting Review, 133-146. This research paper discovered that the loan loss provisions are positively related to the bank stock returns and future cash flows, conditional on less optional information concerning loan defaults. It was also discovered that these positive valuations only had implications on loan loss provisions for low regulatory capital banks in the fourth fiscal quarter.
- · Convertible bond design and capital investment: The role of call provisions, Korkeamaki, T. P., & Moore, W. T. (2004). The Journal of Finance, 59(1), 391-405.