As you know, there is some debate out there in “deal land” as to the value of requiring the other side’s counsel to provide your client with a legal opinion. At the suggestion of one of our readers we decided this year to start tracking in our Study (see below for the Study parameters) the percentage of times that legal opinions were required in transactions. Our 4th Annual Deal Point Study (hot off the presses and just presented at The University of Texas Law School’s Securities and Business Problems Conference in late February) indicates that legal opinions were required of seller’s counsel in 68% of the transactions we reviewed and required of buyer’s counsel in 49% of those transactions. Are we surprised? Not really, and anyone who tells you that opinions are merely standard operating procedure would appear to be blowing the proverbial anecdotal smoke…
Next year, we plan to slice and dice this legal opinion analysis a little more to gauge, for example, the nature of the consideration paid in the transaction. For example (and just one of many), a recipient of equity as a portion or all of the purchase price might be realistic in insisting that purchaser’s counsel provide a legal opinion. Although, as you think about it, because our study is comprised of public acquirers the purchaser could reasonably argue that any opinion their counsel might give is just expensive window dressing to already fairly extensive public information. Conclusion? None. Still, the unsliced and undiced percentages do appear to indicate that legal opinions are not necessarily SOP.
4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).
(Comments? Gripes? Pls feel free to email us: firstname.lastname@example.org or email@example.com )
Here’s something useful on that (in)famous “rule of thumb” commonly used to price common stock in VC deals (compliments of Bart Jealous of American Appraisal Associates, Inc. firstname.lastname@example.org ):
“The below comes Gerry Mehm, the head of our Financial Valuaton Group in our San Francisco office. Let me know if you have any questions.
The Venture Capitalists in Silicon Valley have historically used the 10-to-1 ratio of preferred to common stock values when companies did their first round of financing. That is, money was raised by pricing the A Preferred at $1.00 per share, and options to purchase common stock would be granted to the founders and key employees with a strike price of $0.10 per share. But as the company progressed, the subsequent rounds of preferred stock are typically sold at higher prices ( $2.00, then $5.00, then $10.00, etc.), and the ratio of preferred to common would then be decreased from the 10-to-1 to 5-to-1 to 2-to-1, until the shares all had the same value at the IPO date (equal to the IPO price).
This “rule of thumb” was criticized by the SEC at the height of the high-tech IPO market in 1999. Companies were routinely required to record stock-based compensation expenses in their S-1 filings if they simply employed the rule of thumb. The analysis we performed was based on reviews of the S-1 filed at the time by comparable companies. That is, we pulled data on the capitalization history of the comps, and prepared tables showing the overall money raised, the ratio of values to money raised, and the ratio of preferred to common stock values which the SEC accepted. We then built tables showing how the client’s value would increase as more money is raised and spent on development. It was a “softer” valuation than one for a mature company with public comparables, but at the time it addressed most of the questions raised by auditors and the SEC.
The issue today would be to find good comps who have gone public recently, since the IPO market has been so weak. But I would continue to use this type of analysis rather than simply the rule of thumb you refer to.”
American Appraisal Associates, Inc.
OK, all those who’ve faced a sell side ROFR -and like it – raise your hands. My guess is that I won’t see many hands, and you certainly won’t see mine.
All to often, our clients are too willing to give ROFR to buy a business without truly understanding the negative effect it may have on the their ability to maximize value in a sale. I’m really thinking about those “Trojan Horse” ROFRs that innocuously appear in transactions like licensing, supply, outsourcing, or corporate VC-backed deals.
In my experience, ROFRs in the M&A context is a poster child for the Law of Unintended Consequences. Let’s say you want to sell the business that’s subject to a ROFR. So finding a stalking horse isn’t so tough because it’s done all the time in sales under Section 363 of the Bankruptcy Code?
Ive found it’s a little tougher outside of bankruptcy, especially if target’s distressed or not particularly a belle-of-the-ball. To begin with, it just isn’t that easy to find a buyer who’s willing to devote the time, money, and effort to give seller a written binding and unconditional offer – without demanding a huge breakup fee and open-ended expense reimbursement. (Of course, there’s always that famous “hello fee” that buyout funds get for taking a look at a deal).
If you’re under pressure to sell the company and timing’s critical, don’t be surprised if all you can get is an LOI that’s subject to gaping walk rights like due diligence, financing, and even, board and shareholder approval (notwithstanding the fact that buyer may be closely held and you’re dealing with the CEO who controls the vote!).
You next send it off to the holder of that ROFR. Did the lawyer who negotiated the ROFR in the context of that supply agreement bother to add simple things like a short time frame under which the ROFR holder (“ROFR’er”) has to take the deal or that the ROF’er had to match or top all the terms of the offer. Does the match have to be identical or can the ROFR’er play horseshoes? How much of a modification of the stalking horse offer will trigger a new ROFR period? I could go on but it’s only re-living past painful memories.
The worst part is that ROFR’er could “match” the bid but is only interested in driving away the stalking horse so ROFR’er could re-trade the deal as the sole bidder. Is the ROFR’er required by contract or common law to deal in good faith? So many questions, so few answers…
I don’t know about anyone else but if I’m on the potential sell-side, I always resist requests for ROFRs and try to educate the client to watch out for those “Trojan Horses.” If I have to give one, then it’s much better to give a right-of-first-offer. Of course, if I’m on the ROFR’er side, I like the leverage that a ROFR creates so I always think it’s an inifinitely reasonable request that, errrrr, “Ive never seen anyone have a problem with giving.”