The narrow exit is priced at entry or not at all.

Some positions have one way out. A minority stake in a company whose majority holder has a pre-emption right over any sale. A stake in a regulated business where the regulator must approve any buyer, and the regulator has approved few. A position in a joint venture whose partner holds a right of first offer and the operational knowledge without which the asset cannot be run. A parcel inside a masterplan whose master developer holds a right of first refusal and a buy-back. In each the exit is not a market. It is a negotiation with a counterparty who knows the seller has nowhere else to go and, in most cases, knows the seller's term, the seller's lender's covenants and the seller's need for cash by a date. The narrowness is visible at entry, in documents the fund signed, and the only moment it can be priced is then.

This note sets out the four kinds of narrow exit and the document that creates each, what each counterparty knows and when, why the narrowness is visible at entry and invisible thereafter, the three things that can be done at entry and cannot be done later, the valuation discount and its disclosure, the continuation as the narrow exit's usual end, the register's reading, the lender's reading, a comparison, a worked position as a type, cases, what each party holds, the sequence, questions, terms and what to read.

The four kinds

The pre-emption. A shareholders' agreement gives the majority holder, or all other holders, the right to buy the fund's stake on the terms of any third-party offer, or at a valuation, before the fund may sell to the third party. Third parties know the right exists and do not bid, because a bid is a price the pre-emptor matches; the fund's only buyer is the pre-emptor, at the pre-emptor's price.

The regulatory consent. A licence, a concession or a sectoral law requires the regulator to approve any change in the persons who control the business above a threshold, and the regulator's approval is discretionary, slow and granted to persons it knows. The class of approvable buyers is short, and each knows it.

The partner's right of first offer. A joint venture agreement requires the fund to offer its stake to the partner first, and the partner's operational position makes the stake worth little to anyone else; the partner is the only buyer that can run the asset, and the right of first offer makes it the first and the last.

The master developer's or grantor's rights. A plot inside a masterplan, or a usufruct from a state body, carries a right of first refusal, a consent to any transfer, a buy-back if the programme is not delivered, and a class of permitted transferees the grantor approves. The grantor is the buyer of last resort and the gatekeeper of every other.

What each counterparty knows

The pre-emptor knows the fund's term, because the fund's documents were disclosed to it at entry or are public in the centre's register; it knows the fund's lender's covenants if it is a co-investor; it knows the valuation, because it receives the same reports. The regulator knows the timetable of its own approvals. The partner knows the asset's operations and the fund's dependence on them. The grantor knows the programme's dates and the buy-back's trigger. Each counterparty's knowledge is the price of the exit, and the fund that thought it would negotiate from strength in year six negotiates from a position the counterparty has been reading for five years.

Visible at entry, invisible thereafter

The pre-emption is in the shareholders' agreement the fund signed. The regulator's approval is in the licence the fund's counsel read. The partner's right is in the joint venture agreement the fund negotiated. The grantor's rights are in the grant. Each was read at entry, by counsel, for validity, and each was priced at nothing because the exit was years away and the return model assumed a market. After entry the rights sit in files nobody opens until the exit is planned, and by then they are facts the counterparty is waiting on.

The three things that can be done at entry

Widen the exit in the documents. A drag-along that binds the pre-emptor to join a third-party sale at the fund's price, so that third parties bid knowing the pre-emptor cannot block. A put option at a formula, so that the fund can require the partner to buy at a price set at entry. A sunset on the pre-emption after a stated period, or a conversion of the pre-emption into a right of first offer at a valuation the fund controls. A tag-along that lets the fund leave with the majority on the majority's terms. A pre-cleared class of buyers with the regulator, or a condition in the licence that approval not be unreasonably withheld for buyers meeting a test. A grantor's advance consent to transfer to permitted transferees meeting a test. Each costs something at entry, in price or in the counterparty's own concessions, and each is bought with the entry price rather than paid for at exit.

Match the vehicle's term to the counterparty's clock. A pre-emptor that has reason to wait will wait, and a fund whose term ends in the year the pre-emptor wants to buy cheaply has chosen its term for the pre-emptor. The term is set so that the fund is not forced to sell in a year the counterparty expects it to.

Write the narrow exit into the valuation. The net asset value reflects the discount a sale to the single buyer would bear, the valuer's instruction names the pre-emption, the regulatory consent or the partner's position as an assumption, and the register is not surprised at exit by a price below a valuation that assumed a market.

Why the constraints are accepted at entry

The constraints are accepted because the asset is wanted and the counterparty will not sell without them. A family that sells a minority in its company keeps a pre-emption because it wants to choose its next partner; a regulator requires approval because the business is licensed; an operating partner keeps a first offer because it built the business; a state body keeps its consents because it owns the reversion. Each constraint is the counterparty's legitimate interest, and a fund that refused every constraint would buy nothing. The question is never whether to accept a constraint but at what price, with what cure, in what term, and the answer is the entry negotiation, where the fund has something the counterparty wants: its capital, now.

The cures, drafted

A drag-along is drafted with a trigger, a threshold and a floor: after a stated period, on a bona fide third-party offer above a stated return, the other holders must sell on the same terms, and the pre-emption is suspended for a sale under the drag. A put is drafted with an exercise window, a formula, a payment period and security for the counterparty's obligation to pay, because a put against a counterparty that cannot pay is a right to sue. A sunset is drafted as a date after which the pre-emption lapses or converts to a right of first offer at a valuation the fund's valuer sets. A tag-along is drafted to give the fund the majority's terms on the majority's sale. A regulator's reasonableness condition is sought at the fund's own approval, when the regulator is deciding whether to admit the fund and has a reason to agree terms for its exit. A grantor's advance consent names the class of transferees and the process for confirming membership. Each is a clause in the law of the asset's state, drafted by counsel there, and a cure drafted from a centre precedent is a cure the asset state's court may not enforce.

The counterparty's price for the cure

The counterparty charges for the cure in one of three currencies. A higher entry price, which the fund's model carries. A concession of its own, a longer term for the fund's board seat, a higher threshold for the drag, a longer exercise window for the put. Or a reciprocal right, a drag in the counterparty's favour or a put against the fund, which the fund prices in its turn. A cure bought at entry is a term in the entry negotiation like any other, and a fund that asks for it in the first meeting obtains it on terms it can read; one that asks in year six obtains nothing, because the counterparty's price then is the exit itself.

Where it surfaces

At the exit, when the only bidder is the pre-emptor and its offer reflects the fund's term.

At the regulator, when the approvable class is three and the approval is a year.

At the partner's first offer, at the entry price less the years.

At the grantor's consent, with no clock and a buy-back behind it.

At the valuation, which assumed a market until the sale disproved it.

At the continuation, forced by an exit nobody priced.

The cost of getting it wrong

An uncured narrow exit costs the difference between a market price and the single buyer's price, in the year the single buyer chooses, plus an extension of the term or a continuation with its process. It costs the manager's share accrued on a valuation that assumed a market. It costs the register's trust, which read a model. The cure costs a higher entry price or a concession, paid once, when the fund has the leverage of its capital. The comparison is the structure paper's, and a fund that makes it buys the cure.

The valuation discount

A position with one buyer is worth, to a willing buyer on a valuation day, less than the same position with many, and a valuation that ignores the difference overstates every holder's position and the manager's accrued share. The valuer's instruction names the exit constraint and asks for its effect; the report shows the value assuming a market and the value assuming the constraint; the committee reads both. A manager that has priced the narrow exit at entry has a valuation that already carries it, and no surprise at the sale.

The continuation as the usual end

A narrow exit discovered in year six becomes a continuation in year seven: the fund cannot sell to anyone but the counterparty at the counterparty's price, so it sells to the manager's next fund at a price the manager proposes, which is the conflict the continuation note reads. The cash holders receive a valuation they can dispute; the rolling holders take a position whose exit is still narrow; and the process that should have been a sale is a related-party transaction with an independent adviser. Some continuations are chosen for good reasons; the one forced by a narrow exit was chosen at entry by the documents nobody priced.

The register's reading

The register reads the exit constraints at subscription, because a fund whose positions have single buyers is a fund whose term, valuation and exit policy are shaped by them. The memorandum describes the constraints on the seed positions and the manager's policy on accepting them: a drag or a put as a condition of entry, a cap on positions with single buyers, a valuation policy that carries the discount. A register that read the policy knows what it subscribed to; one that read a deck of assets and a return model knows the model.

The lender's reading

A net asset value lender reads the exit constraints as its own enforcement's limits: a position the fund can sell only to its pre-emptor is a position the lender can sell only to the same pre-emptor, and the advance rate reflects it. A lender that reads a portfolio of single-buyer positions prices the facility as a loan to those buyers' patience.

By constraint · by cure	Created by	What the counterparty knows	Cure at entry	Cost at exit if uncured
Pre-emption	The shareholders' agreement	The fund's term, lender and valuation	Drag-along; sunset; conversion to first offer at a valuation	The pre-emptor's price, in the year it chooses
Regulatory consent	The licence or sectoral law	Its own timetable	Pre-cleared buyers; a reasonableness condition	A year's delay to one of few approvable buyers
Partner's first offer	The joint venture agreement	The operations and the fund's dependence	A put at a formula; a tag-along; a buy-sell mechanism	The partner's price
Grantor's rights	The grant or the masterplan's instruments	The programme's dates and the buy-back	Advance consent to a class of transferees; an extension option	The grantor's consent on its clock, or the buy-back

A timeline, as a type

Month one: the position is identified; the shareholders' agreement's pre-emption, the licence's consent and the grant's rights are listed with their documents. Month two: the cures are priced in the entry negotiation: a drag after year four above a stated return, a put in year six at a formula secured on the counterparty's shares, a sunset in year seven, a reasonableness condition sought from the regulator at the fund's own approval. Month three: the entry price carries the cures; the fund's term is set at eight years; the valuer is instructed on the constraints and the cures; the memorandum describes both. Year three: the valuation carries the pre-emption's discount and the put's floor. Year five: a third-party bid above the threshold; the drag binds; the sale completes to the third party with the regulator's approval under the reasonableness condition in a quarter. The put is never exercised and the sunset never reached, and both were the reason the bid arrived.

The structure paper's page

The structure paper's exit page for each position carries: the constraints and their documents; the counterparty and what it knows; the cures negotiated, their drafting in the asset state's law and their price; the term set off the counterparties' clocks; the valuer's instruction on the constraints; the memorandum's description; and the decision, where a cure could not be obtained, to accept the constraint at a stated discount or to decline the position. The page is the register's answer to how the fund leaves each position, and a page that names a single buyer and no cure is a page the register reads as a continuation written in advance.

The policy on single-buyer positions

A fund's exposure statement or investment policy says what share of the portfolio may sit in positions with single buyers and uncured constraints, because a portfolio of such positions is a portfolio whose exit is a series of negotiations from weakness. A cap, a requirement that every position above a size carry at least one cure, and a valuation policy that carries the discounts: together they let a register subscribe to a fund that will hold narrow-exit positions knowing how many and on what terms. The policy is drafted at formation and the committee reads each admission against it.

The co-investor as the counterparty

A fund's own co-investor, invited alongside it into a position, is a counterparty with rights of its own: a pre-emption on the fund's stake, a tag on the fund's sale, a consent to a change of business plan. The co-investment agreement is drafted at entry with the same cures the fund asks of a majority holder: a drag binding the co-investor to a sale the fund leads, a buy-sell mechanism for the day the two disagree, and a carve-out for a lender's enforcement. A co-investor that holds a pre-emption and no drag is the fund's single buyer, and it was invited by the fund.

The Gulf counterparties, read closely

Gulf families selling minorities, state bodies granting usufructs, master developers allocating plots and operating partners in joint ventures each have their own customs about exit rights, and the cures are negotiated in those customs' terms. A family that will not give a drag may give a put at a formula, because a put is a promise to buy and the family intends to; a state body that will not give advance consent to any transferee may give it to a class, because the class is its own policy; a master developer that holds a right of first refusal may agree a period within which it must exercise, because its own programme needs certainty. Counsel in the state knows the customs, and the cures are drafted to what the counterparty will sign rather than to what a centre precedent expects.

The exit test for a narrow position

The exit test runs each route against the position: a sale to a third party, which the pre-emption, the consent and the first offer each reach; a sale to the counterparty, at its price; a distribution in kind, which carries the constraints to the holders; and a continuation, which carries them to the new vehicle. The test's result is a one-page answer to how the position leaves and at what discount, and the answer is given at entry, when the cures can still be bought.

The put's security

A put is worth the counterparty's ability to pay when it is exercised, and a counterparty that cannot pay in year six has given a right to sue. The put is therefore secured at entry where the counterparty will give security: a pledge over the counterparty's own shares in the company, an escrow funded progressively, a parent's guarantee, or a right to sell the counterparty's shares with the fund's under the drag if the put is not honoured. A put without security is priced by the fund at the counterparty's credit, and a counterparty whose credit the fund cannot read has given a put the fund cannot value.

A position, as a type

A fund takes a minority stake in a Gulf operating company whose majority holder is a family with a pre-emption in the shareholders' agreement. At entry the fund negotiates, for a price, a drag-along binding the family to join a third-party sale above a stated return after year four, a put at a formula exercisable in year six if no sale has occurred, and a sunset on the pre-emption in year seven. The fund's term is set at eight years so that year six is not the last year. The valuer is instructed on the pre-emption and the put, and the net asset value carries the put's formula as a floor and the pre-emption's effect as a discount until the sunset. The memorandum describes the position's constraints and the cures. In year five a third party bids above the return; the drag binds the family; the sale completes to the third party. Had no bid arrived, the put in year six would have set the price, and the family would have known it from year one.

Four cases, as types

A fund takes a minority stake with a pre-emption and no cure, on a return model that assumed a sale to the market in year five. In year five the only buyer is the pre-emptor, who offers a price that reflects the fund's term ending in year six. The fund extends the term; the pre-emptor waits; the fund sells in year seven at the pre-emptor's price, or rolls the stake into a continuation at a valuation the cash holders dispute.

A fund takes a stake in a regulated business on a licence that requires the regulator's approval of any buyer, without reading the regulator's record of approvals. At exit the class of approvable buyers is three, each of whom knows it, and the approval takes a year; the fund's term ends in the year; the sale is to the one of the three who was ready.

A fund enters a joint venture with an operating partner that holds a right of first offer and the only management team that can run the asset. At exit the partner is the buyer, and the partner's offer is the fund's entry price less the years; the fund has no put and the partner has no reason to pay more.

A fund prices every constraint at entry: a drag, a put, a sunset, a pre-cleared buyer class, a grantor's advance consent, a term set off the counterparties' clocks, and a valuation that carries the discounts. The exits run on the cures, and the register was shown the cures at subscription.

What each party holds

The manager holds the reading of every exit constraint at entry, the decision to buy the cures with the entry price, the term set off the counterparties' clocks, and the valuation policy.

Counsel holds the drafting of the drag, the put, the sunset, the tag and the advance consents, in the law of the asset's state.

The counterparty holds its rights, and its knowledge of the fund's position.

The valuer holds the instruction that names the constraints and reports their effect.

The register holds the memorandum's description of the constraints and the policy.

The lender holds its own reading of the constraints as its enforcement's limits.

The sequence

1. Every exit constraint on a proposed position is listed at entry: the pre-emption, the consent, the first offer, the grantor's rights, each with its document.
2. The cure for each is priced: a drag, a put, a sunset, a tag, a pre-cleared class, an advance consent, and the price is paid in the entry price or the counterparty's concessions.
3. The fund's term is set so that no counterparty's expected year is the fund's last.
4. The valuer is instructed on the constraints and the cures, and the net asset value carries them.
5. The memorandum describes the constraints and the manager's policy on accepting them.
6. The structure paper names the counterparty, the right, the cure, its price and the decision.

Questions a manager asks

Will a majority holder give a drag-along. For a price, above a return, after a period, usually; a majority that will not has told the fund who the buyer will be.

Is a put at a formula realistic. Where the counterparty wants the fund's capital now and can pay later, yes; the formula is negotiated at entry and is the fund's floor.

What about the regulator. Its record of approvals is read at entry, and a licence condition that approval not be unreasonably withheld for buyers meeting a test is asked for at the acquisition, when the regulator is approving the fund itself.

Can the valuation simply assume a market. It can, and it will be wrong on the day of sale by the constraint's discount, with the manager's share accrued on the error.

Is a continuation the answer. It is the usual end of an uncured narrow exit, and it carries its own conflict; the answer was at entry.

Does the register care at subscription. An institutional register reads the seed positions' constraints and the policy; one that does not has subscribed to a return model.

Terms used

Narrow exit: a position whose buyers are few or one, by reason of a right or a consent.

Pre-emption: the other holders' right to buy on the terms of any third-party offer.

Drag-along: the fund's right to require other holders to join a sale.

Put: the fund's right to require the counterparty to buy at a formula.

Sunset: the expiry of a pre-emption after a stated period.

Advance consent: a grantor's or regulator's consent in advance to transfers to a class of transferees.

What to read

The shareholders' agreement, the joint venture agreement, the licence and the grant for each position's exit constraints; the valuer's instruction and the valuation policy; the memorandum's description of the constraints; the net asset value facility's enforcement test. On this site, the exit design room under Structures, the worked structure on a narrow exit and the co-investment room.