Very often, the first shot fired in a take-over bid battle is when the potential acquiror of a public company calls the target’s CEO or Chair and asks for a meeting to discuss a matter of "mutual interest." One scenario is that the potential buyer will express admiration for the target company, disclose that they are already a significant shareholder (maybe just below 10 per cent, so that no insider or early warning report has been filed), and propose that the two parties enter into formal discussions to explore whether an outright purchase, or maybe a merger, might be in the best interests of both parties. At some point toward the end of that conversation, the potential bidder will table a letter addressed to the target company, the purpose of which is to sweep the target into as firm an embrace as possible — this is the so-called "bear-hug" letter.
This article will offer some comments on what to watch for in such letters, and will outline some responses for a target company’s board and management to consider.
Typically, that first letter will introduce the potential bidder, as well as its investment banker and lawyer, and may or may not set out a proposed price for a transaction. In addition, it will contain the following elements:
- a statement that the letter, and the related conversations, are meant to be strictly confidential, and that if the target company is prepared to move forward, a non-disclosure agreement should be signed by both parties as soon as possible;
- a statement that the proposal is non-binding, and that legally enforceable commitments will only arise if and when formal contracts are entered into;
- a request that the potential bidder be allowed access to material documents and to senior management at the target for the purposes of conducting due diligence; and
- a request that the target deal exclusively with the bidder for some relatively short defined period of time (depending upon the time needed for diligence, usually a few weeks to a month).
What Public Disclosure is Needed?
If the initial contact has been made on the basis of a non-binding proposal, together with a request from the bidder to keep the discussions confidential until an agreement is reached, most lawyers are comfortable with the advice that the initial contact does not amount to a "material fact" or a "material change" that requires an immediate press release by the target public company. This makes sense. Securities regulators recognize that premature disclosure can be just as inappropriate as late disclosure for a publicly traded company. It is not desirable for the trading price of the target’s stock to shoot up briefly on take-over bid speculation, only to crash shortly thereafter when no transaction actually materializes. Generally, the preferred approach is to wait until the bidder is firmly committed to proceeding with a bid before public disclosure is made.
On the other hand, just because a proposal is non-binding and the potential bidder has asked for confidentiality, this does not mean the target company must keep the approach confidential. Sometimes, strategically, the target might prefer to issue a press release disclosing that an unsolicited approach has been made as well as the nature of the proposal (emphasizing that it is non-binding), and advising shareholders to await further developments. At least in the short term, such a press release will likely cause the target’s share price to rise. It will also likely attract the attention of other potentially interested parties, and may lead to a competitive bidding process if other strategic or financial buyers choose to get involved.
Disclosure issues can be complicated and difficult. They are highly fact-specific, and no general guideline will be correct in all cases. The guidance of experienced professional advisors, financial and legal, will be beneficial to both management and the board of directors.
Is a Sale Inevitable?
The fact that a public company is approached by a potential bidder with a take-over bid or merger proposal does not mean the target board must immediately put the company up for sale. The board’s legal fiduciary duty is to act in the best interests of the company (whether it is a publicly traded corporation or an income trust or a partnership), and there may be a variety of reasons that the board feels take-over bid discussions at this time are not in the best interests of the company. Perhaps the bidder is offering a very low price that the target board knows it could never support. Perhaps the bidder is being opportunistic by making its approach at a time when stock markets generally are down, or the target company has just come off an unusually bad financial quarter. The target board may conclude that it is not the right time, nor in the best interests of the company, to entertain acquisition or merger discussions.
If the target company board rejects the acquisition proposal, this, of course, is not necessarily the end of the matter. In the absence of a standstill commitment, the bidder is always free to go public and make its offer directly to the target company shareholders. Management and the target board may recommend that shareholders reject the offer, but ultimately it will be the shareholders who decide.
How Serious is This Bidder?
One important factor for the board and management to consider in deciding how to respond to a bear-hug letter is the apparent determination and state of preparedness of the potential bidder. Have they assembled a team of advisors? Is the proposal subject to financing, or is the financing already in place? Do they need due diligence, or are they ready to proceed without it? Have they identified all necessary regulatory approvals, and do they have a well-formulated plan to obtain them?
It is usually safe to assume that the potential bidder has alternative strategies planned out depending on how the target reacts to the initial proposal. The bidder will prefer a negotiated transaction, if possible, so that they can enjoy some deal protection (such as a break-fee) under a transaction agreement with the target before the rest of the world hears about the transaction. If that is not possible, however, because the parties are far apart on price or other terms, a potential bidder that is rebuffed at that initial meeting or shortly thereafter may well have anticipated that response and prepared its take-over bid circular and other materials in advance so as to be in a position to immediately launch its bid. The bidder’s objective, of course, is to move quickly and allow the target company only the minimum 35-day period prescribed by law to seek out "white knights" or otherwise respond to a hostile bid.
Should We Go Exclusive?
Bidders always ask that the target deal with them exclusively. In some cases, where a very attractive price is being offered, strategically the bidder and target are an obvious fit, and the financial advisor is prepared to advise the board that an auction or other process is unlikely to surface greater value for the shareholders, a target company may agree to deal with one party exclusively for a relatively short period of time. As noted above, management and the board of the target cannot agree to sell the company, of course; only the target company shareholders can do that. The board can endorse a deal and recommend that shareholders support it, but once the proposed transaction is announced, there will be a period of time during which other parties can come forward and make superior proposals. Target boards sometimes feel justified in negotiating with one party, confidentially and exclusively, so as to get a favourable transaction launched into the market. If some third party then proposes an even better transaction, that’s a good thing for target company shareholders.
What are the Next Steps?
If the unsolicited approach by the bidder takes the target company by surprise, there are a number of matters for management and the board to consider right away. The full board of directors will likely want to be apprised of the situation. An experienced M&A lawyer is obviously needed. In order to assess the financial merits of the proposal, professional financial advice may be called for. Does the board of directors need to strike a special committee to deal with potential conflicts or logistical issues? If there is no shareholder rights plan, should the board adopt one? Should an electronic data room be created for the benefit of this bidder, or perhaps others?
Public companies are approached regularly by third parties exploring possible purchase or other transactions. Many such discussions come to nothing. For the target company, however, giving some advance thought as to how management and the board might respond allows everyone to react in a calm, deliberate manner. This state of preparedness usually serves the target company and its shareholders well.