Valuation Adjustment Mechanism (VAM)is defined as an agreement of differences in valuation in the enterprise valuation activities. It refers to an agreement between the investor and the financing party to deal with future uncertainties after reaching an agreement. VAM protects the interests of the investors as well as injecting new vitality into financiers. It is one of the most important investment tools in the venture capital activities.
When the invested company achieves its goals, investors will raise the valuation accordingly; but if the goal is not achieved, the investor is entitled to certain compensation. In practice, such compensation is usually realized in the form of cash payment or equity transfer. Sometimes it can also be achieved by increasing or weakening the investor's control over the enterprise. Therefore, the parties who agree on the terms of the wager are betting on whether the enterprise can achieve certain goals in a certain period of time in the future. The chips of the wager are the equity, cash or company control rights and interests of both parties.
The purpose of VAM is to realize the rationality and fairness of investment transactions as much as possible. It is not only the protection umbrella for the interests of investors, but also plays a certain incentive role for the financiers. Therefore, VAM terms are essentially an investment instrument based on financial indicators, with the content of value evaluation with additional conditions, and with the result of equity or related equity adjustment. The purpose is to adjust the differences between investors and financiers on enterprise valuation in the future, so as to promote the conclusion of current transactions.
For example, a client, who owns a store, intends to open another store because of the good business performance, but there was no extra financial support. At this time, an investor has just arrived, promising to help the client open the second store, requiring a small portion of the profits. But if the second store fails to open, the client’s first store will be owned by the investor.
The VAM provides the maximum protection for the interests of investors. No matter whether the investment result is a loss or not, the financiers will always be the bottom of the table. This is the price that the financier will pay if they want to obtain large amounts of capital in a short time.
What are the benefits of VAM? The benefits generated by the VAM come from the uncertainty of the future benefits generated by the investment project. The purpose of the VAM is to maximize the fairness and rationality of the investment transaction. It not only provides investors with a protective umbrella, but also provides incentives for the financiers.
Here is the suggestion from lawyer, before signing the agreement, the investor and the financier should check and confirm whether they are qualified to sign the "VAM agreement", and correctly understand the advantages and disadvantages of the VAM agreement.
