Sidley Perspectives on M&A and Corporate Governance

STRATEGIC MINORITY INVESTMENTS IN PUBLIC COMPANIES PROVIDE PATHWAY TO VALUE-BASED DEALMAKING By Pran Jha, Joe Michaels, Jack Melamed, and Liz Buescher1 Dollar value and deal volume are not the only M&A measures that fluctuate when markets waver. As headwinds gather, dealmakers flock to creative types of transactions that are suited to the circumstances and involve manageable risk levels. In recent years, targeted strategic investments in public companies have again risen to prominence in response to market uncertainty. Prominent examples include State Farm’s and Google’s respective investments in ADT (2022 and 2020), PepsiCo’s investment in Celsius (2022), and Cigna’s investment in Bright Health (2021). These transactions—which generally involve strategics (rather than institutional, private equity, or other financial investors) acquiring between 5% and 40% of a public company’s stock on a friendly basis—can serve as an advantageous way to deploy or raise capital and enhance shareholder value for both the investor and the target company.2 As valuations fluctuate, financing markets tighten, regulatory scrutiny increases, and economic confidence wanes, these investments provide a circumscribed, agile, and efficient pathway to pursuing deals. But these strategic minority investments are not only suited for uncertain times; they can provide a unique value proposition in favorable economic environments as well. In many instances, these investments involve not only a financial investment coupled with typical corporate governance rights and obligations but also include accompanying commercial, development, or similar arrangements that can be drivers of growth for both parties. Sophisticated dealmakers keep strategic minority investments in their toolkit for all markets, and when structured and negotiated carefully, they can result in compelling opportunities. Investors and target companies that are well prepared and well advised with respect to the relevant issues can position themselves to execute on these opportunities when they arise. Key Features of Strategic Minority Investments Strategic minority investments in public companies involve a range of M&A, public company, and commercial legal considerations. Investment Structure. Strategic minority investments are typically structured as primary issuances of either common or preferred stock by the target company to the investor. Most of these transactions are completed as private placements exempt from registration with the Securities and Exchange Commission (SEC) under Rule 506 of Regulation D. However, if that is not available, then the parties will either need to rely on another private placement exemption or register the offering and sale of securities. Other alternatives exist, including structures involving secondary stock sales from existing investors (either directly or through a public tender offer) and stock repurchases by the target company. Valuation. The per-share pricing of a minority investment in a publicly traded company is subject to the market trading price, valuation analyses, and negotiation. It is not typical to see the types of control premiums that are prevalent in change-of-control transactions. Pricing at or around a weighted average market price (sometimes with a discount) is not uncommon. Among the benefits to the target company is a potential signal to the trading markets sent by an investment by a sophisticated market participant at a favorable valuation. As in all significant transactions, the target company’s board of directors must engage in a 1 Pran Jha and Joe Michaels are partners, Jack Melamed is a senior managing associate, and Liz Buescher is an associate in Sidley’s Chicago office who advise clients on M&A, corporate governance, and SEC disclosure matters. The views expressed in this article are those of the authors and do not necessarily reflect the views of the firm, its other lawyers, or its clients. 2 For purposes of this article, we distinguish between strategic minority investments and private investments in public equity (PIPE transactions), which are often undertaken by institutional, private equity, and other financial investors in a variety of circumstances involving, among other things, distressed or special purpose acquisition companies (SPACs). Sidley Perspectives | MARCH 2023 • 3 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Some strategic minority investments include a commercial, development, or similar arrangement between the investor and the target company that may serve as a potential source of value and collaborative partnership beyond the financing and earnings growth objectives of the standalone investment. robust and careful evaluation process with appropriate financial and legal advisors to satisfy its fiduciary duties. Transaction Terms. The stock purchase agreement governing a strategic minority investment typically contains provisions similar to those customarily included in agreements governing public company mergers. However, certain areas are likely to be streamlined and otherwise modified to reflect the nature of the transaction. Parties can expect basic mechanical provisions providing for the consummation of the investment, representations and warranties (with a limited survival period, if any), limited traditional indemnification obligations (if any), pre-closing covenants, closing conditions, and termination rights. Although much less common, the purchase agreement might also include termination fees, no-shop provisions, and similar deal protection provisions. Shareholder and Regulatory Approvals. It is important to analyze any required shareholder approvals and related timing implications, with particular consideration given to stock exchange and other rules applicable to stock issuances. In addition, parties must determine whether the transaction is subject to any U.S. or foreign antitrust, foreign direct investment, or other regulatory regimes, particularly in a climate of increased regulatory scrutiny. Corporate Governance Rights and Obligations. In an investment involving a meaningful minority stake, parties typically provide for corporate governance terms beyond those set forth in the target company’s organizational documents. The governance arrangements will depend on the particular circumstances, such as the deal size and dynamic