Over the past year, as Canadian capital markets have regained their footing, Canadian private companies in search of greater liquidity have generally had a wider range of strategic alternatives to explore. One increasingly popular option is the "dual-track" or "parallel-track" IPO/M&A process, in which the company simultaneously pursues both an initial public offering and a negotiated or controlled auction sale process (or other specific sale process). Because market and economic conditions have not generally favoured dual-track processes in recent years, some boards and shareholders may find the concept relatively unfamiliar. The purpose of this article is to highlight, from a Canadian legal point of view, some of the potential benefits of pursuing a dual-track strategy for Canadian private issuers, Canadian portfolio companies of private equity groups and Canadian subsidiaries of multinational companies.
Factors to consider
Issuers considering a dual-track process must carefully compare the costs and benefits of pursuing such a strategy. They will need to consider and analyze not only the hard costs involved in completing a transaction (i.e. legal, accounting and professional advisors and related transaction expenses), but also the soft or opportunity costs of taking time from management and other key personnel of a business to participate in a transactional process that can be burdensome, complex and which realistically may not result in a transaction for the company.
Other significant considerations in a dual-track scenario are similar to those that are typically considered when making an "either-or" choice between an M&A sale process and an IPO:
- Partial or total exit: One of the most important things to determine is whether the desired liquidity transaction would result in a total divesture of the business by shareholders (perhaps leaving no ongoing management role for the existing principals). The alternative is a partial sale or planned two-step sale transaction (whether in an IPO or an M&A context) under which the controlling shareholders will maintain a controlling equity position (or at least a significant minority position) in the company and some or all of the existing principals will remain an integral part of management of the business.
- Liquidity issues: Another key consideration is whether the proposed exit strategy will produce instantaneous liquidity (total or partial) in the form of cash or freely tradable public company securities. In an M&A transaction, privately held illiquid securities can be exchanged for public company securities of the purchaser (freely tradable or restricted securities) or for securities of another private issuer (subject to resale restrictions). Similarly, a cash payment can either be subject to an escrow or holdback arrangement or fully paid at closing. In an IPO transaction, private issuer securities be sold for cash as part of a concurrent secondary offering, but the remaining securities can also remain subject to standstill or "lock up" arrangements or securities escrow provisions (whether imposed by stock exchanges, applicable securities laws or contractually by underwriters in accordance with market practice).
- Indemnity profile of sellers: The indemnity or liability profile of an entity and its directors, officers and shareholders depends on the process involved: a controlled auction can differ significantly in this respect from a negotiated purchase and sale agreement and each of these scenarios in turn differs from a public offering (with respect to an underwriting agreement or as a result of statutory liability under prospectus or registration statement).
- Time constraints: The time constraints applying to a sale process should be carefully compared to those that apply to an IPO. A fully marketed public offering typically takes 3 to 6 months to complete; a similar timetable would typically apply to a traditional controlled-auction process with customary regulatory approvals required to be obtained. Like a prospectus in a public offering, a sale process would typically utilize a comprehensive disclosure document on the issuer and its underlying business in the form of an offering memorandum. The timetable for a bilateral negotiated transaction could be significantly reduced without significant conditionality. In either case, the level of complexity increases (along with potential timing issues) to the extent that an IPO or M&A process involves multiple parties or multiple jurisdictions, including the existence of several regulatory authorities, different financial standards and overlapping legal regimes.
- Completion risk: The variables impacting the completion risk of an IPO are very different from those that tend to affect a negotiated sale transaction with one or more prospective purchasers. In each case these variables must be carefully monitored.
These points illustrate one of the main challenges of a dual-track process, specifically that those participants involved in such a process will generally have to be willing to accept any of a very wide range of possible outcomes, particularly with respect to their ongoing participation in the entity. Of course, this somewhat naïvely supposes that a dual-track process is invariably carried out with the intention of securing the best deal, no matter which side of the IPO/M&A divide it comes from. Traditionally, that has not always been the case: the IPO announcement has often been used to force potential acquirors out of the woodwork with a view to encouraging a negotiated sale. However, over the past year, in a climate where the emphasis has been on finding investors of any description, some commentators have observed that the dual-track process is more frequently being employed with no preconceptions about the outcome.1
Advantages of a dual-track approach
Dual-track processes are well-known in Europe and the U.S., with particular prominence in certain industry sectors, such as technology, that have been forced by the weak economic climate to shift from what has traditionally been a more exclusive focus on IPOs.2 Where a dual IPO/M&A sale process is a practical alternative for a company in Canada seeking liquidity, the case for pursuing it is equally compelling here. Among the more significant underlying advantages are:
- Greater transaction certainty: Pursuing a dual-track strategy provides greater transaction certainty in the event that an issuer is not able to access the capital markets in a timely manner, e.g. because of underwriters' objections or unanticipated delays arising from regulatory processes of stock exchanges or securities authorities;
- Better pricing and multiples: Pursuing both paths will ideally create price tension that produces a more robust competitive process in terms of the pricing of securities in an IPO and/or enhancing negotiated multiples on the sale of a business - for example, where IPO investors are encouraged to pay a premium price because private equity has shown an interest in the company that suggests a possible future bid;
- Lower valuation uncertainty: Academic studies have pointed to the reduction in valuation uncertainty resulting from IPO filings as a major reason for the higher acquisition premiums typically attained through dual-tracking, noting that private targets with higher valuation uncertainty, such as low-profitability companies in research-intensive industries, are traditionally among the major users of the dual-track process;3
- Less impact on timetable: Moving forward simultaneously with an IPO and a sale process ensures alternative liquidity options without negatively impacting the transaction timetable in the event that one strategic alternative ceases to be available to an issuer;
- Complementary strategy: The legal requirements of an IPO process and the preparation of a comprehensive disclosure document with the requisite financial information assists with, and can be complementary to, the M&A process. The two processes are not mutually exclusive. Due diligence investigations can also be streamlined without incurring additional transaction expenses;
- Protection of stakeholders: Pursuing a parallel process allows the issuer flexibility in ensuring that the desired treatment for employees, customers, suppliers and other key stakeholders is achieved;
- Efficiency: Being engaged in both processes imposes competitive and time discipline on the participants in each of an IPO and a M&A negotiated or controlled auction sale process; and
- Flexibility for unexpected events: A dual-track approach gives issuers the flexibility to switch to another course of action should any of a range of unexpected extraordinary events occur (e.g. CEO termination, inability to obtain an auditor's report or to complete the requisite audited financial statements, deficiency in an expert report, inadequate funds to meet working capital requirements, etc.). Pursuing both an IPO and a sale process as part of an issuer's exit strategy ensures that fewer issuers will be subjected to unilateral determinations not to proceed with a transaction in the late stages of a controlled auction process by a prospective bidder or an IPO transaction by a financing syndicate member.
In addition, even in the "worst case" scenario - i.e. where the IPO does not go ahead and no buyer materializes - the IPO process may act as a profile-builder for the company, putting it on the radar of potential acquirors who may keep it in mind for further consideration when economic conditions have improved.
Minimizing cost duplication
While the cost of pursuing a dual-track strategy may at first instance appear to be "double", potential economies and efficiencies can be exploited to ensure that the increased incremental costs of a dual-track strategy are only marginally higher than a single-track strategy. For example, costs can be minimized for a dual-track strategy by
- Retaining experienced transactional, financial, accounting and legal advisors to assist in leading the processes;
- Using key dedicated and experienced personnel of the issuer to establish and manage the processes;
- Creating, populating and maintaining a fully integrated and robust global electronic data site for completion of transactional due diligence by underwriters, lenders, prospective purchasers and their advisors; and
- Cross-utilization of work product (e.g. disclosure documents) for both processes.
In all cases, the key to minimizing cost duplication lies in planning the process carefully in advance.
Situations in which a dual-track process may not be feasible
In many instances, it may turn out that one of the alternatives (IPO or an M&A sale process) is simply not available to an issuer as a result of:
- The nature of the industry in which the issuer operates or the underlying business not being suitable to prospective purchasers or a capital markets transaction;
- The jurisdiction in which the business operates being in a state of conflict or unrest;
- The existence of past legal or regulatory compliance issues, or other similar extenuating circumstances, with respect to one or more key stakeholders;
- The added burden of a dual-track process in situations where management is already preoccupied with other significant "core" business related issues;
- Inadequate financial records or the risk of restatement of the financial statements of the business; or
- Other significant risk factors such as expected changes in applicable law or accounting practices.
In addition, in most distress transaction scenarios, participation in an IPO process will generally not be available, yet in such scenarios the complexities of a M&A transaction can be significantly increased due to the involvement of a statutory bankruptcy and insolvency regime with court supervision of the sale process or as a result of the utilization of alternative less customary sale processes such as stalking horse bid processes or live auctions. Conversely, in a down market such as we experienced in 2008, earnings deterioration, lower multiples for certain targets and/or industries and limited or reduced credit availability made effecting a sale transaction on the desired commercial terms very challenging. Under such conditions, a poor response to an IPO could potentially deflate the enthusiasm (and offers) of potential acquirors.
Following the economic uncertainty in late 2008 and in early 2009, several multinational companies seeking liquidity utilized this strategy in Canada for their Canadian subsidiaries as part of the implementation of various strategic alternatives. At the end of the day, each issuer will need to consider its own unique objectives, together with the objectives of its key stakeholders, the environment in which its business operates and its ability to realistically pursue both avenues given its existing resources, management team, board of directors, the existing state of its business and other key situation-specific variables.4