As equity valuations of public companies remain high in comparison to recent historical norms, the use of public company stock as an acquisition currency by SEC registrants in acquisitions of private companies will continue, particularly if interest rates continue to rise, thus increasing the costs associated with leveraged transactions. This blog explores legal considerations associated with the issuance of stock by a public company in connection with its acquisition of a private company.
Whether Public Company Stock Will be Registered
A target company whose equity holders will be issued stock in an acquisition will often assert that the issuance of stock in such acquisition should be covered by a registration statement. However, from the perspective of the acquiring company, the expenses and drawbacks of utilizing a registration statement must be carefully considered and, in many cases, will exceed the benefit from issuing registered stock. Key considerations include the following:
- In many cases, the public company (pubco) issuer will be able to get comfortable that the stock can be issued in a valid private placement under federal securities laws (under Section 4(a)(2) of the Securities Act and/or Rule 506) and state securities laws (which will be preempted if Rule 506 is utilized at the federal level except as to notice filings). Moreover, even if there are characteristics of the target company (targetco) equity holder base which may otherwise raise issues from a private placement perspective (e.g., a large number of equity holders, the existence of non-accredited investors, etc.), the parties often can limit which equity holders of targetco will be receiving pubco stock in the acquisition in a manner which will preserve a valid private placement.
- While shares issued by a pubco issuer in a private placement will be “restricted securities” under federal securities laws, this stock will be freely tradeable by the targetco equity holders after six months have elapsed under Rule 144 (assuming that the current public information requirements of Rule 144(c) continue to be met with respect to the pubco issuer), provided that such equity holders are not (and do not become) “affiliates” of the pubco issuer. Acquiring pubcos will often argue that it should not be necessary to register the issuance of stock in an acquisition in light of this relatively short holding period.
- A pubco issuer considering the possibility of filing a new registration statement in connection with an acquisition must consider not only the expense and timeline associated with filing a registration statement, but must also consider whether the filing of a new registration statement will trigger the requirement to file financial information regarding such pubco issuer which would not otherwise be required in the absence of such a filing.
- If a pubco issuer wishes to register the issuance of stock in connection with an acquisition, this issuance must be registered on a Form S-4 (or Form S-1). In this regard, a Form S-4 is not automatically effective on filing (unlike a Form S-3 for WKSIs). For a company that regularly issues stock in acquisition, an S-4 registration statement may, however, effectively function as an “acquisition shelf,” in that it can be used to register securities for future issuance in connection with acquisitions on a delayed basis.
- Companies may also register the resale of stock issued to targetco equity holders in an acquisition on Form S-3. For example, this may occur if the acquisition agreement requires the parties to enter into a registration rights agreement in favor of the targetco equity holders. In this scenario, the stock must be issued in a valid private placement; however, registering the resale of stock allows the stock to be resold by non-affiliates without being subject to the Rule 144 holding period noted above.
Other Legal Considerations
Whether or not stock in an acquisition is issued via a private placement or pursuant to a registration statement, there are various other legal considerations a pubco issuer will need to consider, including the following:
- From a Rule 10b5-1 perspective, whether the pubco issuer is in possession of material non-public information at the time the acquisition agreement is entered into. This may be an issue if, for example, an acquisition agreement is entered into during the quarterly blackout period of the pubco issuer shortly before the issuance of an earnings release by such issuer.
- Whether all or only a portion of the targetco equity holders will receive stock in the acquisition. This will often be driven by securities laws considerations, particularly if the stock is being issued in a private placement, and may be impacted by, among other things, the number of targetco equity holders, the accredited or non-accredited status of such equity holders, and the sophistication of such equity holders.
- Whether any offering memorandum will be provided to the targetco equity holders. Acquiring pubco issuers will often not provide any offering memorandum in this context on the premise that targetco equity holders will receive appropriate disclosure based on their access to the Exchange Act filings of the pubco issuer.
- The level of due diligence information regarding the pubco issuer to be provided to the targetco equity holders, which will be driven by both securities laws and business considerations (such equity holders will often be provided some level of due diligence access beyond the information included in the public filings of the acquiring public company).
- The extent to which the acquisition agreement will include representations and warranties regarding the business of the acquiring pubco issuer. For example, in this context, depending on the amount of the stock to be issued in the acquisition and other considerations, some acquisition agreements may not include any such business representations beyond (potentially) representations regarding the SEC reports and financial statements of the pubco issuer.
- The method for determining the number of shares to be included in the transaction consideration. In public company acquisitions of private companies involving stock consideration, it is common for the number of shares to be determined based on a fixed value formula (for example, the average closing price of the pubco issuer stock during some period of time prior to the closing).
- If there is a gap period between signing and closing, whether there are any provisions in the acquisition agreement addressing any significant fluctuations in the stock price between signing and closing, such as stock collars in acquisitions where a fixed value formula is being utilized, and/or any closing condition for the benefit of the targetco equity holders requiring the stock price to be above a certain level.
- In transactions where a large amount of stock will be issued by the pubco issuer, the parties will want confirm whether stockholder approval of the pubco issuer’s stockholders is required (as applicable) under NYSE and Nasdaq rules (which may require stockholder approval where public companies are issuing 20% or more of their outstanding common stock in the acquisition).
- Whether the stock will be issued on a taxable or tax-deferred basis (it is beyond the scope of this blog to discuss such tax consequences of issuing stock in acquisitions).