Change of Control

What is Change of Control?

A change of control refers to a significant change in a company's ownership and control. Moreover, a change of control in finance can affect creditor agreements and executive employment contracts, which protect investors and managers from material changes in the company's operations.

Change of control provisions are significant in contracts because they address how the parties in the contract will respond to changes in ownership, ensuring the conservation of interests and streamlining the contractual obligations.

This change in control can be a result of the following events:

• Sale of the organization's assets
• Mergers
• Transfer of shares
• Change in board members
• Change in shareholders

Other occurrences, such as consolidations, reorganizations, or other transactions in which one of the ones that follow takes place, may also be covered by the definitions of a change in control.

Change of control can be considered in the following conditions:

1. Over half of the board members are new;
2. Change in the shareholders who have the right to vote for more than fifty percent of the board.

The change-of-control clauses in contracts between companies typically cover the transactions above. However, as a party to an agreement, the individual should take precautions against other situations that could result in a change of control.

Any organization can use the change of control approach to prevent a competitor from acquiring their supplier through a merger or another company.

Understanding Change of Control

Change of Control can commonly be defined as severe alterations in the control or ownership of the company. However, it can also be defined in the following ways:

• Change of control can be any change in the ownership of the entity that takes place when any person or business, directly or indirectly, gains beneficial ownership of voting equity shares of the entity or the right to purchase such shares; 
• Any direct or indirect sale or transfer of virtually all of the entity's assets; 
• The board and a plan for entity liquidation or an agreement for sale following liquidation have received legal approval.

An entity's stakeholders are affected by a change in control, including: 

• all shareholders, such as minority positions; 
• debt holders and lenders, especially unsecured lenders; 
• senior executives, except if their contracts protect them from arbitrary changes to terms or conditions of service; 
• and the relevant regulatory environment.

The sale of a company's shares frequently changes the company's control, whether on the open market or in a separate transaction at a set price.

When extra shares or rights share capital are allotted to and purchased by current shareholders or outside applicants, this can happen via the primary market route. 

This could also occur due to converting a portion of convertible debentures and bonds or any planned arrangement outlined in a contract for the future transfer of shares.

Suppose the sale or acquisition of all or a sizable portion of the entity's assets is involved. For example, a change in control may result from a complete merger/ acquisition between individuals or corporate entities and any change in ownership of more than 50% of an entity's voting shares.

The purchase of a majority interest in a publicly traded company is subject to several corporate laws, listing agreements, disclosure laws, and guidelines of security exchange boards.

Some countries' senior executive employment contracts include a change in control clause, which offers excellent protection against arbitrarily defined termination when a different owner assumes management control of a company.

Navigating Change of Control Challenges

For some businesses, a change in ownership might be acceptable. However, if the agreement is intricate or pertains to a cutting-edge good or service, replacing or duplicating it with another business might be challenging.

Resistance To Change

Employees are often the victims of changes in control. They resist changes because they fear uncertainties, conflicts, and disruptions within the organization.

The uncertainty could be related to the number of people in the workforce that would continue to be employed and the portion that would be laid off. A changing organization may also lead to operational disruptions and the loss of clients and stakeholders who didn't favor a change of control.

Lack Of Leadership Support

The lack of proper leadership will make employees question the worth and trajectory of the change initiative. This will make it difficult for employees to accept a new environment, direction, and management, hindering the achievement of corporate goals.

If the target company is acquired, the controlling authority may decide it is not worth the risk that the control change will not mesh well with the organization, their project team, or the time and inconvenience involved in getting to know the new management.

Once the new managers have evaluated the company's resources, they might prioritize the project differently.

Lack Of Clear Objective

One of the most significant challenges in implementing a change of control is the obscurity surrounding the whole idea.

A lack of clear understanding of the goals behind the change of control can hamper the achievement of expected objectives as a result of its implementation.

Contract parties should consider the consequences before accepting a change-of-control clause because it could lower the company's value in the eyes of a potential acquirer. This is crucial for small and medium-sized businesses, in particular.

Under a change-of-control provision, a party must have enough time to plan and carry out a backup strategy, if necessary, before deciding what course of action it will take in response to the change in control.

Inadequate Communication

Poor communication regarding changes in employee management and ownership can lead to speculations, rumors, and a lack of trust among employees, which can lead to delayed implementation of organizational strategies.

Change-of-control clauses are inherently ambiguous without time restriction. If a party intends to discontinue the contract because of a change in control, it can do so before the contract's deadline approaches.

If there is an acquisition, the acquiring business should know from due diligence that there is a danger of termination and that the other party may leave without responsibility.

While retaining the right to terminate the contract, a party may attempt to ensure that the other party consents to the change, upholds the agreement, or offers some form of payment in exchange. 

Change of Control Advantages

With the aid of an organization's operating system and efficiency around the project deliverables and due dates, implementing a process for change control can assist in organizing their team. However, it is also essential to consider the effects of poorly managed change. 

A change management process can help management implement a resource management strategy or other work management objectives. Implementing a change control process also has advantages.

Increased Productivity

A change control process will clear up any ambiguity regarding project deliverables and enable the focus to shift from information gathering to actual execution. The aid of productivity software leads to improved productivity and efficiency.

Change control processes help the organization maintain the quality and continuity of the products and services, making sure that the change management has positively impacted the business and not contributed towards disruptions.

This strives to maintain and enhance the quality and quantity of the goods and services sold may lead to increased productivity. The amount of time spent on work-related activities means that productivity can only increase with a process.

Effective Communication

An effective change of control promotes effective communication and enhances the coordination between different departments. This promotes collaborations and alignments while implementing changes.

A change of documentation that is done right can help with communication problems. For instance, team communication can flourish when aims and goals are clearly stated. 

Remember that no change control process can resolve all communication problems. Work management software may be beneficial to centralize project communication. 

Sharing a change control process with executive stakeholders lets them quickly provide context for proposed changes.

Better Teamwork And Collaboration

Effective communication can enhance collaboration and be a benefit in itself. Project changes make collaboration and teamwork simpler. For instance, stakeholders have more time to concentrate on innovation and collaboration when changes are communicated for the first time. 

With clear communication, team members and stakeholders can spend more time putting information together than devising innovative solutions.

This teamwork and collaboration can speed up the development process by effectively and efficiently managing the changes in the business and its responses.

Improving Stakeholder Relationships

There might be instances when the stakeholders and management do not favor the change of control. However, there are also chances that stakeholders may approve of such a change in controls.

A proper change of control promotes controlled and open changes that help maintain investors' and stakeholders' relationships, ensuring modifications are done in a structured and agreed-upon way.

Reducing Costs And Time

A well-understood and managed change process will help the organization to save time and money that are related to the change of control. This will help the organization streamline operations and enhance capabilities with cost and time efficiencies.

Change of Control process's five steps

There are five essential steps when designing a change control process, just like the five project managerial phases. 

Despite some minor differences, all processes share a few essential components. Each of these fundamental steps, from request initiation to implementation, facilitates the smooth flow of change requests through the pipeline and helps avoid unneeded changes.

Some people find it easier to visualize the process when it is presented as a change control process flow. Whatever perspective the individual takes, the final determination of whether the change request is approved or denied will be made. 

Let's examine the five components of a successful change management process and what each step entails.

1. Change request initiation
2. Change request assessment
3. Change request analysis
4. Change request implementation
5. Change request closure

Here is an example change log to help individuals format their own and understand what to include. This example of change control includes: 

• Project ID
• The assignee of the task 
• Time limit 
• Priority status; 
• Progress status; 
• Type of change

Change of Control under different agreements

A change of control clause is frequently included in creditor agreements and executive employment contracts to protect investors and managers from material changes in the company's direction.

In addition, contractual agreements and supplier contracts are also events where a change of controls clause is used.

When a change in company ownership triggers one of these clauses, it may state that the lender may demand full repayment. 

Creditor Agreements

A change of control clause is frequently included in creditor agreements to safeguard the lender if a new owner acquires the business. 

A bank or any other lending institution may prefer to have all of the loan principal returned right away and cancel the loan because they are unsure of the creditworthiness of the new owner(s).

These clauses might be necessary because a change in ownership can alter the company's risk profile and put lenders at a higher risk of a borrower defaulting.

Employment Agreements

In executive employment agreements, the employment contract for senior executives prevents them from being fired in the event of a change in control.

The clause will ensure that they receive a sizable payout in the event of such termination if a materialistic change in the ownership of companies leads to their termination.

Executives may claim such a clause in their agreements because new owners may have a different perspective on the best course for the company.

In other words, the new owners may have a distinct corporate vision from the previous ones rather than necessarily believing the management team is not doing a good job.

Contractual Agreements

Change of control under contractual agreements is defined as the means to regulate the changes in ownership or control that may or may not impact the terms of the contract. 

Clauses under contractual agreements define the parties' rights and duties and ensure that their interests and rights are protected after a change of control.

Mergers and acquisitions are specific events that trigger a change of control clause.

The effect of the change in control on debt in both the target and the acquirer, as well as executive compensation agreements in both companies, should be taken into account during the M&A process and the negotiation phase.

Supplier Contracts

Supplier contracts in the context of change of controls protect suppliers in the event of change management. They create the right for suppliers to terminate a contract if there is a change in ownership.

This provision allows customers to protect their interests by ensuring the performance of contractual obligations remains the same even after a change in ownership and management.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Acquisition Premium

• Conglomerate

• Conglomerate Merger

• Control Premium

• High Finance