CAYMAN ISLANDS Law and Practice Contributed by: Simon Thomas, Richard Spencer, Alexandra Clynes and Sayak Bhattacharya, Campbells
• Right of First Refusal and Co-Sale Agree - ment; • Management Rights Letters; and • Director Indemnification Agreements. 3.5 Investor Safeguards Venture capital (VC) investors in the Cayman Islands typically secure critical rights to protect their investments in downside scenarios, such as company liquidation. These terms prioritise their financial recovery over other stakehold - ers like ordinary shareholders, founders, and employees. Below are the key terms and their implications. Liquidation Preferences • Priority in Asset Distribution: Preference shareholders (including VC investors) are typically entitled to receive a return of their investment (often 1x–2x the principal) before ordinary shareholders in a winding-up sce - nario. This is a standard feature of preference shares under Cayman law. (a) Ranking Order: After secured creditors (eg, banks) are paid, preference share - holders rank above unsecured creditors and ordinary shareholders, including employees and founders holding equity. Redemption Rights • Exit Mechanism: Investors can demand redemption of their shares if the company fails to achieve an exit (eg, IPO or sale) within a specified timeframe (typically two to five years). (a) Enforcement: If the company cannot pay, investors may issue a statutory demand and petition the court for liquidation (unless they have agreed to fund on a non-petition basis, which is rare). Failure to comply may provide grounds for a peti - tioner to approach the court for a just and
equitable winding-up. “Legally Available Funds” Defence: Companies may contest redemption claims by arguing insuffi - cient “legally available funds” , but courts interpret this narrowly (excluding funds needed for ordinary operations). Contractual Safeguards • Automatic Conversion Triggers: Preference shares may convert to ordinary shares upon the occurrence of pre-determined event (eg, a qualified IPO) or, alternatively, upon a liquidation event, if redemption is infeasible, ensuring investors retain residual claims after creditors. Governance Controls • Veto Rights: Investors often secure veto rights over major decisions (eg, asset sales, debt issuance, amendments to governing docu - ments or authorised share capital, issuances of security ranking pari passu or senior to the last issued preference share class) to prevent actions that could harm their position pre- liquidation. • Liquidation Petitions: Investors can initiate “just and equitable” winding-up petitions if mismanagement or deadlock jeopardises their interests, though this requires court approval. Anti-Dilution Protections • Down-Round Adjustments: Full-ratchet or broad-based weighted-average anti-dilution clauses protect investors’ ownership percent - ages in subsequent down rounds, indirectly safeguarding their liquidation payouts. Anti-dilution protections are widely used in Cay - man Islands VC financings, particularly for pre - ferred shareholders, as they safeguard investors
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