During the private equity boom of 2005 to 2007, the so-called "go shop" provision emerged as a new deal-making device as private equity buyers sought the benefits of exclusivity, while directors of target companies sought to satisfy their Revlon duties to conduct an adequate sale process.
A recent study conducted by faculty at Harvard Business School, published in the May 2008 edition of The Business Lawyer, offers the first significant empirical examination of the effectiveness of go shop clauses. The study finds that, in certain types of transactions, go shops have a positive effect both on the number of occasions in which alternative bidders surface and on the ultimate returns to shareholders.
The Traditional Sale Process
Traditionally, boards have satisfied their Revlon duties to obtain the highest price for shareholders by canvassing the market to identify serious bidders, holding a formal or informal auction process and signing a purchase agreement with the winning bidder. Those agreements have typically included a no shop clause preventing the target from talking to other parties unless the target board's fiduciary duty so required (the so-called "fiduciary out").
Private equity buyers dislike auctions because, unlike strategic buyers, they generally believe that they have no inherent advantage over other private equity purchasers in a competitive auction process. Private equity firms also typically avoid expending significant due diligence resources without a better-than-average chance of closing the transaction, and therefore generally seek exclusivity before undertaking due diligence.
On the other hand, selling boards of directors have a fiduciary duty to get the highest price, and employing a process that grants exclusivity to a single bidder without a market canvass can be legally problematic.
How Go Shops Work
Enter the go shop provision – which turned the traditional approach on its head. Rather than canvassing the marketplace first, the seller negotiates and signs an agreement with a single bidder, announces the transaction, and then takes a period (typically 30 to 60 days) to shop the business to try to find a higher bidder. While the traditional route uses a market canvass followed by exclusivity with the winning bidder, the go shop clause grants exclusivity to an initial bidder followed by a market canvass.
Although go shops became more frequent during the height of the private equity boom, commentary from practitioners was often skeptical, criticizing go shops as "cosmetic" devices that superficially discharge the board's Revlon duties while really not providing for a meaningful auction or market canvass.
The Harvard Study
The Harvard study examined buyouts of 141 US-based public companies with a deal value larger than US$50 million announced between January 1, 2006 and August 31, 2007. It included only transactions in which at least one private equity firm was part of the buyout group and thus excluded transactions in which the initial buyer was a "strategic" player.
The study contains a number of interesting findings including the fact that go shops were being used in two distinct fashions. The study describes "pure" go shops, in which negotiations are conducted and an agreement concluded with a single buyer, followed by a period of time in which the seller is free to seek a higher bidder. A "pure" go shop was used in approximately 60 percent of the studied transactions.
The remaining transactions in the study involved so-called "add on" go shops. In this variation, a limited market canvass was conducted before exclusivity was granted to a single bidder and then a definitive agreement entered into with that bidder. The target board of directors then pursued a final postsigning opportunity to canvass the market through a go shop provision.
Not surprisingly, "pure" go shops yielded new bidders on more occasions than did "add on" go shops in which there had already been a market canvass.
Other significant findings from the Harvard study include:
- Private equity firms account for the vast majority of go shop provisions – approximately 84 percent, which is greater than private equity's share of M&A deals overall. One possible explanation for this disproportion is that the private equity firms valued presigning exclusivity more than did strategic buyers, while strategic buyers valued postsigning exclusivity more highly because of the implications for market, customer and employee disruption.
- There is a significant difference between management buyouts (MBOs) and other types of transactions in terms of a go shop provision's effectiveness in surfacing alternative buyers. Six higher bidders appeared in the sample set for non-MBO transactions, while no new bidders surfaced in MBO transactions. This reflects an apparent reluctance of buyers to disrupt a transaction in which management has already selected an equity sponsor.
- It appears that sellers do make a meaningful effort to contact alternative bidders during the go shop period. Investment bankers contacted an average of 39.6 additional bidders in pure go shop situations and an average of 33 additional bidders in add on go shop situations.
- Notwithstanding this broad shopping effort, the study found that, in add on go shop scenarios, an average of only 1.5 parties signed a confidentiality agreement, and in pure go shops, an average of only 3.2 parties signed a confidentiality agreement as a predicate to a due diligence examination of the target.
- The Harvard study found that returns to target shareholders in pure go shop transactions were improved by approximately 5 percent, while there was no meaningful difference between add on go shop deals and no shop deals.
The Harvard study suggests that the go shop provision could have utility when negotiated carefully and structured to meet the needs of the particular transaction. Thus, it appears that the go shop architecture developed during the 2005 – 2007 private equity boom may continue to have a place in M&A transactions in the coming years.