DealLawyers.com Blog

Here is an excerpt from an interesting article in the Investment Dealers’ Digest Magazine:

“Concerns about conflicts of interest and the current buoyant state of the debt markets have meant fewer M&A deals so far this year have come with much-criticized, but lucrative “stapled” financing attached, according to M&A professionals. “Banks are moving away from stapled financing,” said Philip Richter, a corporate partner with Fried Frank in New York.

Shifting free dynamics make this quite clear. Financing has been generating a growing share of the total fees in LBOs-up to 50% in 2005 from 38% in 2003, according to Freeman & Co., which estimates fees. But in deals in which advisers offer stapled financing, that financing accounted for 34% of total fees in 2005, down from 52% in 2003, according to Freeman.

Stapled financing is an offer to finance an acquisition made by an adviser to the target. The name comes from a sheet offering financing that is sometimes literally stapled to the term sheet of the deal.

By providing stapled financing, the adviser stands to collect both advisory fees from the target and financing fees from the buyer, which are usually larger. However, the staple generally offers less aggressive terms than the buyers could get by going to other banks, so many say that in the current easy financing market, a staple is often more trouble than it’s worth.

One reason that companies and banks are pulling back is that the practice recently has attracted some legal scrutiny, most prominently from a Delaware judge in a shareholder lawsuit over the buyout of Toys R Us, in which Credit Suisse worked both sides of the deal. The bank advised Toys R Us on its sale to a consortium of private equity funds, and also took part in the financing. While the Delaware judge did not say there was a conflict, he said the bank’s work raised eyebrows as it gave the appearance of conflict.

Critics, mostly independent boutiques, say that the practice can be downright harmful to the target. Because the fees on the staple are lucrative, the target’s bankers may show preference to the buyer that opts for the stapled package. And because the package is usually less aggressive, some argue that the target could end up being valued for less than it would be had a different buyer with a competing bid won the deal.

In fact, this argument also can be used against boards that go along with a stapled deal-some M&A lawyers now advise boards of companies that consider selling themselves to turn down stapled financing offers for fear of shareholder suits. In fact, shareholders in the Toys R Us case claimed that the company did not get as high a price as it could have.

In any event, lawyers believe a board offered a staple by its adviser should protect itself by getting another opinion. “If a bank provides stapled financing, the board will almost always bring another adviser because the target adviser may be conflicted,” said Richter.

That is not to say stapled financing is dead. One recent deal that has caught Wall Street’s attention is the $3 billion buyout of Education Management by a private equity consortium. It is not clear whether a formal stapled financing package is attached to the deal, but Merrill Lynch, which is advising the target, is reported to be also part of the financing group for the buyers. Merrill Lynch did not return a call.

Some large investment banks, such as Goldman Sachs and Morgan Stanley, say they continue to offer staples, but only when the client stands to benefit. Sometimes a staple can be used strategically to establish a floor for the financing, and buyers will then take the terms and shop around. Or it can be used when a company has a unique market niche or product that is not widely understood.”