Like many other companies, a lot of VC portfolio companies have recently taken a big valuation hit due to the fallout from the pandemic – and to make matters worse, a lot of those companies need to raise capital right away. This one-two punch means that these companies face the prospect of going to market at a valuation that’s a lot less than the last time they raised money from investors.
That’s a “down-round” financing, and it’s about as much fun as a root canal – but if you have a client in this position, this Wilson Sonsini memo on navigating down-round financings is a very helpful resource. It addresses many of the key issues associated with down-rounds, Here’s an excerpt from the section discussing issues surrounding deal structure:
At a minimum, a down-round financing may trigger the anti-dilution provisions of existing preferred stock terms, which generally allow the relevant preferred stockholders to receive a more favorable conversion rate (for purposes of converting into common stock) if new stock is sold below a certain price. Such adjustments typically also involve a correlative improvement in the affected stock’s voting power. A company and investors considering a down round will want to consider the impacts of such adjustments.
Many certificates of incorporation provide that preferred stockholders can waive the application of such adjustments upon a specified vote of the existing stockholders, which may be of interest if the vote is obtainable. Where such a provision does not exist but there is a desire to avoid the application of anti-dilution adjustments, the company’s certificate of incorporation can potentially be amended to alter or avoid the adjustments. In that case, however, it is important to consider whether such an amendment triggers particular stockholder votes —including on a class- or series-wide basis—under the company’s existing protective provisions or under the Delaware corporate statute.
In addition to structural & technical issues associated with down-round financings, the memo addresses their impact on employees and existing investors; fiduciary duty considerations and litigation risks. It stresses that the risks of such a financing can be significantly mitigated by implementing common-sense and achievable process mechanisms, and that a solid and well documented process can also help position the company for future transactions.
This recent blog from Keith Bishop points out that one issue that is often overlooked when renegotiating the terms of outstanding securities is the fact that a change in their rights, privileges, preferences or restrictions may be subject to the securities laws.
Parties to a merger agreement are prohibited under US and foreign antitrust laws from closing a deal that is subject to antitrust review – or taking certain preparatory steps to combine the two businesses – prior to receiving appropriate antitrust clearances. This “gun jumping” prohibition doesn’t bar the parties from agreeing to reasonable interim covenants requiring the seller to operate its business in the ordinary course.
But due to the unprecedented challenges that businesses are facing during the Covid-19 crisis, many buyers want to coordinate more closely with sellers during the period between signing and closing, and may want to draw interim operating covenants more tightly in order to compel that coordination. This O’Melveny memo says that they need to be mindful of the risk that those efforts may violate applicable antitrust prohibitions on “gun jumping.” Here’s an excerpt:
The COVID-19 pandemic has forced many companies to depart from their past “ordinary course” operating practices based on both the need to comply with new legal obligations and to adjust for significant changes in supply and demand across industries. As merging companies navigate deal complexities exacerbated by COVID-19, they should carefully consider the following:
– The US and EU competition authorities have been and remain active in enforcing gun-jumping laws, while in recent years other competition authorities across the world, and notably in China, have become increasingly active.
– Merging companies should pay particular attention to covenants requiring the target company to share information with and seek approval from the buyer in order to engage in conduct outside of the ordinary course and inconsistent with past practices. Given the unprecedented steps many companies are taking in light of the COVID-19 pandemic, it is expected that there will be significantly more coordination and disclosure between merging parties than is typical—coordination that could potentially raise gun-jumping concerns.
– Although antitrust agencies acknowledge the unprecedented nature of the COVID‑19 pandemic, they also have made clear that the standard of scrutiny of potentially anticompetitive transactions and practices—like gun-jumping—will not be relaxed notwithstanding the difficult circumstances caused by the pandemic.
The memo discusses how regulators in the U.S., the EU, China, Japan & South Korea approach gun jumping issues, and identifies common interim operating covenants that may potentially raise gun-jumping considerations in the current environment.
There’s an old proverb that says “generals are always preparing to fight the last war.” I’ve blogged quite a bit recently about the apparent resurgence in poison pill adoptions, but this King & Spalding memo says that companies that place their faith in pills & other antitakeover measures to deal with activism are likely doing the same thing. Here’s the intro:
After years of tremendous economic growth, COVID-19 has unleashed unprecedented market volatility and extreme value dislocations for U.S. public companies. Senior management and directors are facing existential business model, strategic, and human resource challenges that are generational in scope. Some law firms and other corporate advisors have responded to the pandemic with a focus on implementing shareholder rights plans or “poison pills” and other traditional defensive measures as a principal corporate response to the pandemic, which has caught the eye of governance experts and media pundits.
Updating a “shelf” poison pill may be prudent depending on circumstances, but traditional defensive prescriptions alone are insufficient as a strategy and may distract senior management and directors from addressing the real issues arising from the COVID-19 crisis. A comprehensive corporate strategy addressing the company-specific business model, industry, human resources, stakeholders, and other enterprise risk is far superior to one that places undue emphasis on poison pills. The best poison pill, in our view, is one that gathers dust on the shelf because a company’s proactive corporate strategy makes the pill unnecessary.
The memo’s bottom line is that “traditional defensive approaches are insufficient and can provide a false sense of security. It suggests that companies adopt a holistic strategy that focuses on active monitoring of their shareholder base, regulatory changes and market trends; comprehensive & proactive efforts to preempt threats through engagement, self-evaluation, board refreshment, routine shelf pill updating; and development of on-the-shelf mitigation strategies for key risks.
This Wilson Sonsini memo reviews CFIUS’s activities during the first quarter of 2020. The memo says that the first few months of the year held few surprises – new regs were rolled out, the pace of filings remaind steady, and enforcement activity largely focused on China-related deals. But this excerpt says that a number of other trends have surfaced as 2020 has progressed:
COVID-19. The world-changing pandemic has resulted in a CFIUS slowdown for two distinct reasons: (i) with investors exhibiting caution in uncertain times, there are fewer transactions; and (ii) CFIUS staff, while continuing to work, have reduced the pace at which they accept cases for review, which can have significant implications for transaction timing. There are, however, reasons to think the pre-COVID-19 pace of CFIUS filings will eventually resume or even increase.
Enforcement. Perhaps related to the current slowdown in cases under review, CFIUS enforcement staff have been contacting a number of transaction parties that did not make CFIUS filings for transactions that closed over the last few years. CFIUS reaches out in such cases to assess whether it has jurisdiction over past transactions and whether there is sufficient national security concern to prompt CFIUS intervention (which ultimately can lead to forced divestment, conditions on the governance or operation of the U.S. company, and/or monetary penalties). Anecdotal evidence suggests the frequency of such CFIUS outreach is increasing.
Jurisdiction. Over the last several months, CFIUS staff also appears to be more frequently determining that filed transactions are outside CFIUS’s jurisdiction. With new, complex jurisdictional rules, this growth trend is not surprising, as CFIUS presumably wants to conserve resources and convey to the public its interpretations of the new jurisdictional rules. However, CFIUS’s general opacity regarding the reasons for its jurisdictional dismissals seemingly undermines the goal of clarifying the jurisdictional rules.
In discussing the apparent uptick in enforcement, the memo says that it is unclear whether CFIUS will focus exclusively on transactions in which the investors have ties to China or Russia, which has been its past practice, or whether – in light of the expanded mandatory filing requirements – it will broaden its focus to review cases involving investors with ties to other countries.
Yesterday’s blog focused primarily on Sycamore Partners’ claim that it is entitled to walk away from its deal with L Brands based on the agreement’s MAE clause, but Sycamore also alleges that violations of certain interim covenants independently give it the right to terminate the transaction. This Freshfields memo focuses on interim covenants, and says that in the current environment, dealmakers would be smart to focus on them too. Here’s the intro:
Against the backdrop of unexpected developments arising from the COVID-19 pandemic, parties with signed, but not yet closed, M&A transactions are taking a closer look at potential openings for claims of breaches and failures of closing conditions. It seems the initial instinct has been to look for a “material adverse effect” (“MAE”), but given that most MAE definitions exclude effects resulting from macro- and industry-wide developments, as well as changes in law, that do not disproportionately impact the target company, those looking to rely on pandemic-induced MAEs may have their work cut out for them.
We suspect that the area where there will be more good faith disputes in pending transactions, and the greatest need for creativity in negotiations of not-yet-signed agreements, will be in the interim or “ordinary course” operating covenants. Compliance with these provisions is typically brought down in the closing conditions subject to a mere “in all material respects” standard, which does not carry with it any of the carve-outs that are typically seen in the definition of MAE and which render the MAE clause immune from most pandemic issues.
The memo goes on to note that these covenants typically include qualifying language, and that the details on how those qualifications are supposed to work in a particular agreement are “where the action will lie” in deal litigation. The memo also addresses the lessons that dealmakers should draw from Vice Chancellor Glasscock’s Cooper Tire decision when they draft and negotiate these provisions.
Yesterday, Sycamore Partners filed a declaratory judgment action in Delaware Chancery Court seeking to terminate its agreement to buy a majority stake in L Brands’ Victoria’s Secret business. To make a long story short, the parties entered into their deal in February, then Covid-19 happened & L Brands took the kind of draconian actions with its Victoria’s Secret business that many other retailers did – it shut stores, furloughed workers, imposed significant pay reductions, slashed new merchandise receipts and didn’t pay its April rents.
Sycamore contends that these actions breached several of L Brands’ reps and warranties & violated interim operating covenants and that, as a result, certain closing conditions cannot be satisfied. Those closing conditions relate to L Brands’ compliance with its covenants and the requirement that its reps & warranties continue to be true and correct, except for failures to be true and correct that have not resulted in a “Material Adverse Effect.”
At first blush, MAE-based argument sounds like it might be a loser – the Transaction Agreement contains a specific carve-out for “the existence, occurrence or continuation of any pandemics . . .” (p. 10). But Sycamore doesn’t rely on the part of the MAE definition that contains that exclusion. Instead, it points to the highlighted language in the Transaction Agreement’s definition of a MAE:
any state of facts, circumstance, condition, event, change, development, occurrence, result or effect (i) that would prevent, materially delay or materially impede the performance by Parent of its obligations under this Agreementor Parent’s consummation of the transactions contemplated by this Agreement; or (ii) that has a material adverse effect on the financial condition, business, assets, or results of operations of the Business, excluding, in the case of clause (ii), any state of facts, circumstance, condition, event, change, development, occurrence, result or effect to the extent directly or indirectly resulting from … (H) pandemics…
Sycamore argues that the pandemic exclusion does not apply to the highlighted part of the definition, and that as a result, “any state of facts, circumstance or event” that would prevent or materially impede L Brands performance of its contractual obligations constitutes a Material Adverse Effect causing a failure of the closing condition.
The language that Sycamore points to isn’t necessarily unusual, but as Berkeley’s Steven Davidoff Solomon tweeted, it’s an aspect of a MAC clause that has never been litigated in Delaware. In Alison Frankel’s article on the case, she quotes Michigan’s Albert Choi as commenting that “the apparently limited scope of the pandemic carve-out ‘seems to make (Sycamore’s) arguments stronger.’”
L Brands issued a press release responding to Sycamore’s complaint, and to nobody’s surprise, it thinks Sycamore is all wet. L Brands’ position is that “Sycamore Partners’ purported termination of the Transaction Agreement is invalid,” and the press release says that it will “vigorously defend the lawsuit and pursue all legal remedies to enforce its contractual rights, including the right of specific performance.”
Whether Sycamore wants out of any deal & is willing to fight this out in court – or whether this is just part of an intricate price renegotiation dance – remains to be seen. But whatever happens, my guess is that we’re going to see more cases like this as the economic impact of the Covid-19 crisis deepens.
This Mintz memo says that although the Covid-19 crisis has created significant disruptions for pending & planned M&A deals, it has also created opportunities for PE funds to answer middle-market companies’ need for debt financing. Many of these companies are now facing financial covenant and payment defaults under existing financing arrangements, and need to reset covenants & add tranches of new debt to provide the liquidity that they need.
The current uncertainties in the financial markets have created opportunities for new investors to provide debt financing to companies on attractive terms. This excerpt discusses the opportunities for PE funds to participate in refinancings of senior term debt:
From the perspective of a distressed company with a senior credit facility in default, or in danger of default, it is preferable to amend or refinance the existing debt to obtain terms that it can comply with on a go-forward basis. This is the fastest and most straightforward method of both solving for ongoing defaults and providing liquidity.
Distressed companies may seek to amend or refinance to revise the following provisions, among others, of their senior documentation:
– Principal payments (amortization holidays, or reductions)
– Interest payments (interest payment holidays or PIK toggle)
– Waiver of certain mandatory prepayments to preserve liquidity
– Financial covenant reset or elimination of certain burdensome financial covenants
– EBITDA add-backs relating to market conditions (non-recurring COVID-19 items)
A refinancing may also be preferable from the perspective of a potential new lender. A refinancing removes the senior term lender as a competing creditor with greater collateral rights in a downside and puts the new lender in the control position.
There are also situations where an existing credit facility may not be in default and the existing senior lender is not anxious to be taken out, but is still unwilling to provide additional liquidity. This additional liquidity may be necessary for a company to maintain its business plan (permitted acquisitions, for example) and can be provided as an additional tranche or incremental term loan by a potential new lender. The new lender would receive the benefits of a senior secured position and would share in any collateral pro rata with the existing senior lender.
The memo notes that because the senior lenders sit on top of the heap when it comes to payment & security arrangements, these financings provide a lower return that some alternative ways of providing debt financing, including mezzanine and DIP financings & “credit bidding” in bankruptcy Section 363 sales – all of which the memo also addresses.
R.W. Baird just issued its Global M&A Report covering last month’s deal activity – and the report says that it was as bad as you thought it was. Here’s an excerpt:
The COVID-19 situation has shifted most key variables for M&A activity into negative territory, with this dynamic becoming apparent in the M&A data for March. The global deal count in March fell 20.5% to 2,019, which was below the LTM mean of 2,489. Dollar volume decreased 45.7% to $162.2 billion, trailing the LTM average of $230.7 billion. In the middle market, the number of transactions was down 21.1%, and dollar value declined 32.8%.
Global M&A dollar metrics tracked under prior-year levels in Q1 2020. Announced dollar volume contracted 38.2% to $513.1 billion, while the number of deals was down 7.5% to 6,740. In the middle market, the year-to-date transaction total declined 7.0%, and dollar value was 15.8% under the prior-year level.
Public leveraged debt markets were effectively shut during most of March, and although there were some deals in early April, the report says that direct lenders with committed funds are likely to be the primary source of leveraged funding until the Covid-19 situation sorts itself out.
The good news is that it looks like those folks are still lending. The report says that the number of deals completed in March “approached the deal flow of preceding months, albeit at higher prices and lower leverage,” and that many private credit providers now have more bandwidth to assess new deals for borrowers with manageable risk profiles.
Earlier this month, the FTC unanimously voted to challenge Altria Group’s acquisition of a 35% stake in e-cigarette vendor JUUL Labs. This Jenner & Block memo says that the FTC’s action appears to be the first time that the agency has filed an administrative complaint seeking to unwind a minority investment in a competitor without also announcing a simultaneous settlement. That means this may end up being the FTC’s first litigated case involving a minority stake. This except from the memo lays out the FTC’s allegations:
The FTC challenges the parties’ $12.8 billion equity deal and non-compete agreement. The Commission specifically alleges that the agreements constitute an unreasonable restraint of trade in violation of Section 1 of the Sherman Act and Section 5 of the FTC Act, and substantially lessened competition in violation of Section 7 of the Clayton Act.[
Altria is a leading producer and marketer of traditional tobacco products, such as Marlboro cigarettes. JUUL Labs, a startup company, popularized new e-cigarette products. By July 2018, JUUL had attained a reported value of $15 billion. According to the complaint, it was around that time that Altria sought to invest in JUUL. Prior to the deal, Altria and JUUL allegedly monitored each other’s prices and competed vigorously in the national market for e-cigarette sales. According to the FTC complaint, in late 2018 JUUL surpassed Altria and its ‘traditional tobacco’ competitors to claim the top market share.
In December 2018, Altria acquired a 35% stake in JUUL in exchange for approximately $12.8 billion, raising JUUL’s valuation to $38 billion. The deal contains a six-year non-compete provision, which JUUL allegedly sought to prevent Altria from competing with its own e-cigarettes. Weeks prior to the deal’s announcement, Altria discontinued its “MarkTen” e-cigarette product—a move the company claims to have made due to concerns about children vaping, but the FTC alleges was a result of the transaction.
The memo says that this action highlights the potential antitrust issues associated with minority investments in competitors – even those that don’t confer effective control. It cautions that in the current regulatory environment, businesses are “well-advised to consider the antitrust deal risk arising from such acquisitions, which may become the subject of an FTC administrative action if they tend to ‘substantially lessen competition’ under the Horizontal Merger Guidelines.”
As I’ve previously blogged, a number of law firms have recommended that boards consider adopting poison pills in response to the Covid-19 crisis-induced market turmoil. According to this DLA Piper memo, many companies appear to have followed that recommendation last month:
For the past few years, rights plans have increasingly come under attack by prominent shareholder advisory services, and the number of companies with active rights plans has declined. As of December 31, 2019, there were only 160 US companies with an active rights plan.
During March 2020, there were 22 adoptions (17 traditional and 5 NOL) by US companies. To put this in context, the number of traditional rights plans adopted by US companies in March was more than five times the number of traditional rights plans adopted in any single month since January 2017. The previous high since January 2017 was three, which occurred seven times in this period.
The memo also reviews the terms of the traditional rights plans adopted last month, and concludes that most of them are more aggressive than plans that were in-place at the end of 2019. For instance:
– 59% of March plans utilize a two-tier trigger (which applies different triggering thresholds to activists and passive investors), compared to 9% of plans in place at year-end;
– 100% of March plans include a derivative trigger (which is intended to prevent “under the radar” accumulations of stock), compared to 51% of plans in place at year-end;
– 35% of March plans include “Acting in Concert” language, up from 16% of plans in place at year-end;
– 6% of March plans includes a 5% ownership trigger – which is uniquely low outside of the context of NOL pills.
Nearly all of the rights plans adopted last month were of the short-term variety (less than one year), so they didn’t trigger any proxy advisor-imposed shareholder approval requirements. Speaking of proxy advisors, last week I blogged about ISS’s greater flexibility toward these plans during the current crisis, and Glass Lewis has also recently announced that it would take a “pragmatic approach” to the adoption of short-term pills during this period.