Unit study guide · NISM Series XIX-A
Investment Process and Governance of Funds
15 questions in this unit
What this unit covers
- What is the main purpose of deal sourcing in a private capital fund’s investment process?
- Which question is primarily part of commercial due diligence on a potential investee business?
- Which matter is most directly examined through legal due diligence before an investment?
- What is a central governance purpose of an investment committee in a fund?
- What does a tag-along right generally allow a protected minority shareholder to do?
- What does a drag-along right generally permit when its agreed conditions are satisfied?
- What is the main purpose of a pre-emption right on a new share issue?
- Which contractual right most directly helps an investor review an investee company’s ongoing financial performance?
- What is the primary function of representations and warranties in an investment agreement?
- What is the purpose of a condition precedent in an investment transaction?
- Which statement about a term sheet’s legal effect is most accurate?
- A fund’s agreement requires its consent before the investee issues new shares or sells a major business division. Ordinary purchases within the approved budget remain with management. What do these reserved-matter rights provide?
- Two funds run by the same manager can both invest in a scarce opportunity. The manager proposes allocating it entirely to the fund paying the higher fee, without applying its allocation policy. What is the main governance concern?
- A portfolio borrower breaches an agreed financial covenant. The agreement allows specified remedies and a documented waiver process, and it does not say every breach causes immediate repayment. What should the fund do first?
- An investor chooses either a non-participating ₹20 crore preference or 25% of ₹120 crore equity exit proceeds. Which choice gives the higher receipt?
Key ideas
From the practice bank · 1
What is the main purpose of deal sourcing in a private capital fund’s investment process?
Deal sourcing identifies potential investments that may fit the fund’s mandate. A sourced opportunity still needs assessment and approval. Remember: Finding a deal is the start of evaluation, not its completion.
Hint Place sourcing before detailed assessment and negotiation. Common mistake: Treating access to a deal as evidence that it is a good investment.
XIX-A-067From the practice bank · 2
Which question is primarily part of commercial due diligence on a potential investee business?
Commercial due diligence examines whether the business has a viable market and sustainable economics. This is different from verifying legal documents or custody records. Remember: Assess business quality separately from legal and operational checks.
Hint Focus on the business’s market, customers and economics. Common mistake: Assuming that valid paperwork proves the business model is sound.
XIX-A-068From the practice bank · 3
Which matter is most directly examined through legal due diligence before an investment?
Legal due diligence examines matters such as ownership rights and material litigation. A commercially attractive business may still have significant legal problems. Remember: A business can be commercially promising but legally difficult to invest in.
Hint Look for rights, obligations and disputes that may affect the transaction. Common mistake: Allowing enthusiasm for business growth to replace legal checks.
XIX-A-069From the practice bank · 4
What is a central governance purpose of an investment committee in a fund?
An investment committee supports a structured process for reviewing and deciding on investments. Its existence does not by itself guarantee compliance or performance. Remember: A committee is a governance mechanism rather than a performance guarantee.
Hint Consider how proposed investments are challenged, authorised and recorded. Common mistake: Assuming that committee approval removes the need to assess the decision process.
XIX-A-070From the practice bank · 5
What does a tag-along right generally allow a protected minority shareholder to do?
A tag-along right generally lets a protected minority shareholder join a qualifying majority sale on the agreed terms. Its scope depends on the transaction documents. Remember: Tag-along rights help minority holders participate in specified exits.
Hint Recall the right that lets a minority investor accompany another shareholder’s exit. Common mistake: Confusing a right to join a sale with a right to force other holders to sell.
XIX-A-071From the practice bank · 6
What does a drag-along right generally permit when its agreed conditions are satisfied?
A drag-along right can require other shareholders to participate in a qualifying sale when its agreed conditions are met. It is different from a minority holder’s option to tag along. Remember: Drag-along rights can compel participation, subject to agreed safeguards.
Hint Focus on the exit right that can bring other shareholders into the same sale. Common mistake: Assuming that a drag-along right is merely an optional invitation to sell.
XIX-A-072From the practice bank · 7
What is the main purpose of a pre-emption right on a new share issue?
A pre-emption right gives existing holders an opportunity to participate in a new issue and preserve their ownership proportion. The holder may need to contribute additional money to exercise it. Remember: A right to protect ownership proportion is not free protection against dilution.
Hint Consider what new shares do to an existing investor’s percentage ownership. Common mistake: Assuming that an existing percentage is preserved without any further subscription.
XIX-A-073From the practice bank · 8
Which contractual right most directly helps an investor review an investee company’s ongoing financial performance?
An information right provides access to the agreed financial and operating reports. Access helps monitoring but does not itself confer day-to-day management control. Remember: Information rights support monitoring without necessarily giving operational control.
Hint Choose the right linked to access to reliable operating information. Common mistake: Assuming that an exit or payment-priority right also provides regular information.
XIX-A-074From the practice bank · 9
What is the primary function of representations and warranties in an investment agreement?
Representations and warranties provide contractual statements about specified facts and conditions. Their remedies depend on the agreement and applicable law. Remember: Contractual factual assurances are not a substitute for diligence or a return guarantee.
Hint Separate statements about the business from forecasts about its future. Common mistake: Reading a warranty about a fact as a promise of investment success.
XIX-A-075From the practice bank · 10
What is the purpose of a condition precedent in an investment transaction?
A condition precedent is a specified requirement that must be satisfied before the relevant closing obligation arises. Any waiver must follow the agreement and applicable law. Remember: A pre-closing requirement should be checked before the relevant funds or rights are transferred.
Hint Place the condition on the timeline before completion of the relevant step. Common mistake: Treating a condition precedent as something that can always be dealt with after closing.
XIX-A-076From the practice bank · 11
Which statement about a term sheet’s legal effect is most accurate?
A term sheet may contain binding provisions even when its main investment terms are non-binding. Confidentiality or exclusivity provisions may have a different stated effect from the commercial outline. Remember: Determine legal effect from the terms, not the label alone.
Hint Read the binding-status wording of each relevant clause. Common mistake: Assuming that every term sheet is either entirely binding or entirely non-binding.
XIX-A-077From the practice bank · 12
A fund’s agreement requires its consent before the investee issues new shares or sells a major business division. Ordinary purchases within the approved budget remain with management. What do these reserved-matter rights provide?
These rights protect the fund by requiring its consent for specified major decisions. They do not automatically transfer all operating decisions to the fund. Remember: Reserved matters protect defined decisions rather than every business activity.
Hint Distinguish a veto over listed matters from complete day-to-day control. Common mistake: Treating a limited consent right as complete management control.
XIX-A-078From the practice bank · 13
Two funds run by the same manager can both invest in a scarce opportunity. The manager proposes allocating it entirely to the fund paying the higher fee, without applying its allocation policy. What is the main governance concern?
The manager’s fee incentive creates a conflict that may distort allocation between the funds. The manager should apply its disclosed conflict and allocation arrangements rather than improvise a fee-based preference. Remember: An allocation decision must not be driven solely by the manager’s compensation.
Hint Ask whose interests are driving the allocation decision. Common mistake: Assuming that a disclosed conflict no longer needs to be managed.
XIX-A-079From the practice bank · 14
A portfolio borrower breaches an agreed financial covenant. The agreement allows specified remedies and a documented waiver process, and it does not say every breach causes immediate repayment. What should the fund do first?
The fund should assess the breach and follow the agreed remedy or waiver process. A covenant breach has the consequences specified by the relevant agreement and applicable law. Remember: Read the actual consequence of a covenant breach.
Hint Use the actual contractual consequences rather than a universal assumption. Common mistake: Assuming that every covenant breach triggers exactly the same remedy.
XIX-A-080From the practice bank · 15
An investor chooses either a non-participating ₹20 crore preference or 25% of ₹120 crore equity exit proceeds. Which choice gives the higher receipt?
Choosing the proportional share gives the higher receipt of ₹30 crore. Preference alternative = ₹20 crore. Proportional alternative = 25% × ₹120 crore = ₹30 crore. The non-participating terms do not allow both amounts. Remember: A non-participating preference and a conversion alternative must not be added together.
Hint Calculate both permitted alternatives without combining them. Common mistake: Calculating a participating payout when the stated right is non-participating.
XIX-A-081