What is Change of Control?
In finance, a Change of Control occurs when there is a material change in the ownership of a company. The exact criteria that determine such a change can vary and are defined by law and through contractual agreements. A change of control clause is often included in creditor pacts and executive employment agreements to protect investors and managers from major changes in how the company is run.
Change of Control in Creditor Agreements
It is common for creditor agreements to include a change of control clause to protect the lender in case the company comes under new ownership. Such clauses may stipulate that the lender can demand to be repaid in full upon triggering of the clause by a change in company ownership. Unsure as to the creditworthiness of the new owner(s), a bank or other lending institution may prefer to immediately have all of the loan principal returned and cancel the loan.
Such clauses may be necessary as new owners can change the risk profile of the company and cause lenders to be in a situation where there is a greater risk of the borrower defaulting.
Change of Control in Employment Agreements
Senior executives may have a clause in their employment agreement to protect them from termination if there is a change of control. If a material change in the ownership of the company results in them being fired, then the clause will ensure that they receive a significant payout in the event of such termination.
Executives may insist on such a clause in their agreement due to the risk of new owners having a different view as to the proper direction for the company. In other words, it may not necessarily be the case that the new owner believes the management team is doing a poor job, but simply that the new owners have a different corporate vision.
Mergers and Acquisitions
One of the most common ways for a change of control clause to be triggered is through mergers and acquisitions (M&A). During the M&A process and the negotiation period, it’s important to consider the impact of the change of control on debt in both the target and the acquirer, as well as executive compensation arrangements in both companies.
Learn more in CFI’s M&A Modeling Course.
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