Ed Batts

Public company M&A: a short, practical primer

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 boundary 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 plaintiff’s 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. Our goal is to look at some of the events most often encountered in the process of bidding for a  public company.

High probability of litigation: 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 documents. 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 weighs competing offers or whether it is 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.  This 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 board. This agreement is 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:

  1. Tender      offers: Buyer publicly solicits Target’s shareholders to sell      shares for a set price, or
  2. 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.

Tender offers are potentially the quickest avenue to closing a deal. If it is clear that enough of Target stockholders are likely to tender their shares to get to the minimum threshold of either 90 percent of outstanding shares (thereby enabling a short-form merger in Delaware without further approval) or a bit lower percentage where a top-up option kicks in (generally 80-90 percent – this triggers an option, based on authorized shares outstanding, to allow the Buyer to “purchase” additional shares of Target – but where such money is essentially just round-tripped at the closing), then a tender offer may take a week post-signing of an acquisition contract for the drafting/filing of disclosure documents, and 20 business days for mandatory consideration by stockholders.  Tender offers often do not receive as many SEC comments and do not usually require recirculation of disclosure documents as a result of comments (or restarting of the tender clock). If a deal fails to achieve 90 percent of Target’s outstanding vote tendered (or the top-up percentage), but does get at least 50 percent of Target’s stock tendered, then often a Buyer will buy the majority position and then call a special stockholders meeting where it will force a merger that squeezes out the remaining minority stockholders at the tender price. This additional step can add up to 60 days to the process in order to call the special meeting and mail a proxy statement.

Proxy solicitations for a special stockholders meeting are 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 actually 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.

Proxy solicitations used to be the preferred alternative to tender offers, but since the SEC clarified tender offer regulation around the best price rule last decade, tender offers have surged back and are favored for their speed of execution by strategic (non-private equity) Buyers. Financial Buyers (private equity [PE] firms) often cannot do a stand-alone tender offer becausetheir debt financing sources do not like the prospect of a non-wholly owned Target if only 50.1 percent is reached, even if only for a brief time until a special meeting can be held. In recent years, however, a hybrid dual structure for PE firms also has emerged whereby a Target agrees to a tender offer while simultaneously preparing a proxy statement to be used if the tender offer fails to reach 90 percent or the top-up option threshold.

Documentation: 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).

Due diligence: A cash deal 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 the 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 the 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) anti-trust 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) anti-trust 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.

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 the Target’s pre-signing trading price and thus erode the sizing-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.