October 25, 2005

Mulling the Pros and Cons of Stapled Financing

Some thoughts from Kevin Miller of Alston & Bird: A recent article highlighted some of the pros – as well as some cons – of stapled financing, but could have paid greater attention to the following points:

In the “Toys ‘R Us” decision, Vice Chancellor Strine – after criticizing the decision of the Toy’s board to allow its financial advisor to finance the winning bidder – noted that: “By stating this, I do not want to be perceived as making a bright-line statement. One can imagine a process when a board decides to sell an entire division or the whole company, and when the board obtains a commitment from its financial advisor to provide a certain amount of financing to any bidder, in order to induce more bidders to take the risk of an acquisition. These and other scenarios might exist when roles on both sides for the investment banker would be wholly consistent with the best interests of the primary client company.”

In addition to inducing more bidders, stapled financing can provide the following additional benefits to a seller:

– speedier consummation of a transaction, because the provider of stapled financing will have completed or nearly completed its financing due diligence and will have obtained or be well advanced in obtaining internal approvals to provide the necessary financing commitments;

– the creation of a financing floor that prevents winning bidders from attempting to renegotiate the purchase price based on a deterioration in the terms of the financing available from their third party sources of financing; and

– greater certainty of consummation as a result of the demonstrated capacity of a select group of investment banks to successfully market and sell the significant amounts of high yield securities necessary to finance leveraged acquisitions, particularly the larger transactions.

Stapled financing is routinely used by financial sponsors, the most sophisticated market participants, when they choose to sell businesses that may be attractive to other financial sponsors.

Investment banks have developed a number of policies to address potential conflicts of interest including:

– refusing to offer stapled financing when representing a special committee evaluating a management buyout; and

– effectively requiring sellers to obtain fairness opinions from unconflicted financial advisors by either refusing to provide fairness opinions when they are offering financing or conditioning the rendering of a fairness opinion on the Seller’s receipt of a fairness opinion from a second financial advisor.

Finally, it is worth noting that the “Toys” sale process did not involve stapled financing. The term “stapled financing” is generally used to describe prepackaged financing made available to bidders as part of an auction process. In “Toys,” the seller’s financial advisor was not authorized to offer financing until after the auction was over and the winning bidder selected, significantly reducing the risk that the seller’s financial advisor would tilt the playing field in favor of a particular bidder.

In sum, a properly functioning and rational board of directors may conclude that the benefits of stapled financing outweigh the risks.