In this new edition of the popular Public Company M&A Primer, originally published in 2013, Ed Batts covers recent changes in the M&A process for public companies.
Are you considering bidding for a public company? Has your public company received an acquisition bid? What should you do?
Public/public mergers are highly choreographed affairs within confined conditions dictated by Delaware judicial decisions on the subject – to the extent a deal strays past such guardrails, it is subject to close scrutiny by both plaintiffs’ lawyers and judges in Delaware.
This article is a basic entry-level primer for those unfamiliar, or rusty, with public company mergers. These are general themes, and this list is not a substitute for review by knowledgeable counsel.
You will get sued: In recent years, more than 80 percent of public/public mergers have been subject to Delaware lawsuits – most of these stemming from purportedly deficient disclosure in publicly filed SEC documents. Such suits often settle in return for amended disclosure and payment of plaintiffs’ lawyers fees. Key areas are the background events to the transaction or the financial metrics and others focusing on conflicts of interest. More substantive suits often revolve around process – how and why a Target board weighed competing offers or whether the Target board was made aware of conflicts of interest. Accordingly, there is great incentive to listen closely to Delaware judicial precedent as well as SEC guidance.
There is a Buyer. And a Target. Although “mergers of equals” exist as an academic term, they rarely come to fruition. That said, while there is always a larger company and a smaller company, board composition of the combined company can be subject to negotiation. And in a case where a Target’s board has no appetite to sell at a given price, then, to avoid the entreaties of a prospective Buyer, the Target’s board must rely upon sound business reasoning – not merely knee-jerk indignant intransigence.
Confidentiality agreement/standstill: Before anything is discussed with the other party, there should be a confidentiality and standstill agreement in place. It should not be a generic NDA that you would use in other parts of your business and instead needs to be narrowly tailored for the acquisition context. Delaware rulings in recent years have demonstrated that very slight nuances in NDA language can have the effect of precluding various deal strategies later (including going public or hostile with an offer) – even though a party may have thought nothing of seemingly innocuous language at the time the NDA was executed.
The NDA protects each side from having its confidential information used against it if negotiations break down. When coupled with a standstill (which, among other things, prohibits each party from buying the stock of the other party in the open market), the agreement prevents a party from going hostile and only effecting a deal through a negotiated transaction with the Target board. Standstill provisions are absolutely vital (and completely standard) to protect a smaller Target from being bullied in the future.
Timeframe/structure: There are two routes to do deals, both of which are subject to detailed SEC rules. The ordinary public/public merger would be a “reverse triangular merger” in which Target is merged with and into a shell subsidiary of Buyer, and this Target survives post-closing as a wholly owned subsidiary of Buyer:
- Tender offers: Buyer publicly solicits Target’s shareholders to sell shares for a set price, or
- Merger: Calling a special stockholders meeting in which Target’s stockholders (and if the deal requires issuing more than 20 percent of Buyer’s outstanding stock, Buyer’s stockholders as well) vote to approve a merger of Target, usually into a subsidiary of Buyer.
While a merger/proxy solicitation used to be the preferred alternative to tender offers, since the SEC clarified tender offer regulation around the best price rule last decade, and more recently since Delaware amended its law on short form mergers in 2013, all-cash tender offers have surged back and are favored for their speed of execution. Proxy solicitations likely remain the preferred alternative for stock-for-stock transactions, as registering stock for a tender offer is a complex and little-used route.
Tender offers are potentially the quickest avenue to closing a deal and changes to Delaware law in 2013 have made tender offers even more attractive. In an ordinary third party tender transaction where at least 50% of Target’s outstanding shares tender their shares to Buyer, who then closes the tender, the Buyer can now immediately effect a back-end merger to cash-out the remaining shares that were not tendered. Previously, unless Buyer had achieved a 90% tender level (as opposed to 50%), Buyer would have had to solicit a stockholder vote after the tender offer closed, including a full long form merger and associated SEC proxy statement, which increased time and cost to a transaction. Delaware has, however, streamlined its process and this is no longer the case. Accordingly, these Delaware law updates also have eliminated the need for what had become the ubiquitous “top-up option” to get a Buyer over the prior 90 percemt threshold for a short form back-end merger.
That said, certain tenders remain “dual track” transactions, where Buyer and Target agree to do both a tender offer, but if the transaction may draw out over an extended period of time (such as for anti-trust clearance issues), revert to a proxy statement/stockholder vote because, unlike with a tender, once a stockholder vote is held, a Target no longer has the ability to terminate the transaction if a better deal comes along (also known as curtailing the “fiduciary out”).
Proxy solicitations for a special stockholders meeting historically were the most sure way of ensuring deal consummation in one step – as long as 50.1 percent of the shares of the Target vote in favor of a merger, the merger can be immediately consummated. However, proxy statements for special meetings often receive greater SEC scrutiny and, unlike with a tender offer, disclosure documents cannot be finalized/mailed until the SEC’s review has been complete. The process may take 15 or more days longer than a tender offer – while this period at first blush may seem small, it can generally appear an eternity to a Buyer if alternate bidders are in the wings and possibly engaged in a post-signing bidding war with topping bids.
Documentation: In a friendly deal, both structural alternatives require a negotiated, complex acquisition contract (and accompanying disclosure schedule). After executing the contract, a tender offer requires the filing of an offer to purchase on Schedule TO by Buyer (and Target’s disclosure on Schedule 14D-9), whereas a merger agreement requires a Form S-4 registration/proxy statement which registers the deal consideration stock (if applicable) and contains the stockholder meeting disclosure for Target (and Buyer where applicable due to Buyer stock consideration in excess of 20 percent of Buyer’s capitalization). In a hostile transaction, Buyer will bypass merger agreement negotiations (and Target’s board) by going straight to Target’s stockholders through the filing of a tender proposal on Schedule TO with the SEC.
Due diligence: A cash deal (such as an all cash tender offer) will require diligence by Buyer on Target, but not vice versa. Conversely, a deal in which the consideration is only, or in part, Buyer’s stock requires “reverse” diligence by Target on Buyer. Large deals with well-established companies may take limited diligence since counsel will argue that the public filings are sufficient. On the other hand, a Target that is a small public company with limited leverage may be required to produce extensive diligence before Buyer is comfortable going forward.
Regulatory review: Almost all public company Targets will be large enough to meet the transaction size test for a Hart-Scott-Rodino (HSR) antitrust filing. Assuming no substantive issues, a transaction is normally approved within about 45-60 days (which runs simultaneously, and often co-terminus, to the tender offer and proxy statement timeframes listed). Either US or foreign (EU or unique jurisdictions) antitrust issues have the potential to cause delay.
Board role: For Targets, outside directors have a key role in any change of control. Best practice is to have the Target board immediately appoint a committee of three (or so, but more than that number can become unmanageable given the tight timeline and need for availability) to essentially run the process. This is not a strict “special committee” which is a term of art for a highly regulated situation where the Target is being taken private by management or other conflicts of interest exist.
A transactional committee of convenience allows for a smaller group of directors, generally those on the Target board who are independent but also deal savvy, to supervise the process and make nimble tactical decisions while protecting against any appearance of conflict of interest by management. In fact, any change of control discussions, no matter how seemingly nascent or exploratory, should be vetted with and directed by the Target board (or its transactional committee) and any management to management discussions about future management composition or compensation should definitely be avoided; no matter how generalized or routine such communication may appear at the time, they can be made to seem inappropriate in retrospect.
Financial advisors: A “fairness opinion” from an investment bank (IB) will be advised under Delaware practice to be delivered to the Target stockholders (and in some cases a separate IB will need to deliver an opinion to the Buyer stockholders). The majority of IB fees are contingent upon closing. Bankers are very useful in both negotiating upfront, as well as lending credibility for the record (again, litigation protection). For example, in a stock-for-stock deal, there always is the question of whether “collars” (prescribed ranges in which the shares of each company can float prior to closing without creating a termination right)are appropriate. The earlier there is a selection “bake-off” and bankers are involved, the better. In light of a relatively important 2014 Delaware case where an investment bank was found to have liability for flawed analyses, investment banks in the future are likely to be more careful than in the past about the level of rigor used in the fairness opinion process, including being more skeptical in evaluating underlying financial assumptions and data.
Track the process: Make note of all meetings and contacts (including via telephone) between management teams, boards and outside advisors – with just time/date/place and general description. Such a timeline becomes crucial when drafting disclosure documents, or, unfortunately, if litigation arises.
Secrecy: Confine knowledge of this activity to a small group – the circle of trust will need to expand in tranches over time, but initially, it need be only a couple of folks. Public leakage is dangerous as it may drive up Target’s pre-signing trading price and thus erode the signing-date price premium, which can be optically problematic even if the historical trading averages indicate a healthy premium. In addition, after a transaction closes, stock exchange regulatory authorities routinely poll participants at both Buyer and Target, as well as their legal and financial advisers, with lists of stockholders who traded immediately prior to the announcement of a deal, in order to police insider trading.