Drafting Reserved Matter Schedules for Venture Capital Shareholders
Effective venture capital reserved matter schedules require clear voting thresholds, cascading subsidiary covenants, and fallaway provisions to prevent deadlock.
Dividend Pass through Covenants
Meaning
Clauses in a joint venture agreement mandate that a subsidiary must distribute its profits up to the holding company whenever specific liquidity thresholds are met. These dividend pass through covenants prevent the trapping of cash at the operating level, ensuring that investors at the parent level receive their pro rata share of earnings. The provision typically defines the exact percentage of net income that must be declared as a dividend after accounting for mandatory reserves and tax liabilities.
Cash Trigger
Distribution obligations often activate once the subsidiary maintains a cash balance exceeding its projected operating expenses for the following quarter. This calculation ensures that dividend pass through covenants do not cause a liquidity crisis for the operating firm. Management usually provides a certificate of compliance to the board of the parent company to verify that the payout does not violate local capital maintenance laws.
Such a mechanism forces the subsidiary to operate lean while providing the liquidity needed for debt service at the holding level.
Structural Position
Debt agreements at the parent level frequently rely on dividend pass through covenants to ensure the flow of funds from the actual revenue generating assets. If these clauses are absent, the parent company might find itself in technical default despite the group as a whole possessing ample cash. Lenders prioritize such protections during the due diligence phase of an acquisition or a refinancing project.
These clauses bridge the gap between the legal separation of entities and the economic reality of the enterprise.
Enforcement Power
Shareholder disputes often arise when the subsidiary board attempts to withhold cash for reinvestment rather than distribution. Minority investors use the specific language of the dividend pass through covenants to compel the board to act in accordance with the prior agreement. The clause effectively removes the discretion of the subsidiary management regarding surplus capital.