In this Private Equity – 2023 Outlook, Wachtell reviews the key themes that drove deal activity in 2022 and expectations for 2023. On the financing side, the article describes some creative transaction structures that sponsors have been employing amid tumultuous credit markets. Here’s an excerpt:
– Buy now, borrow later. Some sponsors followed a “buy now, borrow later” path—up to and including all-equity deals, such as KKR’s buyout of April Group—writing large equity checks and planning to increase leverage when markets improve.
– You can take it with you… Also en vogue were deal structures that allow a target’s existing debt to stay in place post-transaction—for instance BDT Capital’s purchase of Weber. This approach, while “debt-efficient,” can limit buyout opportunities to more modest transactions, such as capping the new investment below 50%, and otherwise moderating consent and board rights to avoid tripping change-of-control provisions. Such was the case, for instance, in Kohlberg’s “secondary” transaction to buy a 50% stake of USIC from Partners Group.
– Seller notes. In certain situations, e.g., where the seller is a large strategic shedding noncore assets, buyers looked to “seller notes” and other forms of seller-provided financing to close the funding gap. For instance, Searchlight Capital Partners’ and Rêv Worldwide’s acquisition of Netspend from Global Payments was funded, in part, by Global Payments-provided financing.
The article also addresses recent trends in liability management transactions and the rise of direct lending.
Small deals can be expensive. In today’s cost cutting environment, it’s increasingly important to accurately estimate transaction costs, and this EY article highlights that many buyers aren’t budgeting enough and may be ignoring key factors when estimating integration costs. EY analyzed M&A transaction costs of 229 deals between 2010 and 2022 and determined that transaction costs are often driven more by the degree of change required than the size of the transaction.
The article highlights the following key considerations when estimating transaction costs:
– The size of the targeted synergy and amount of change needed
– Severance and employee-related costs, which can account for more than 66% of integration costs in some deals—while they mean cost savings in the future, the cost of acquiring talent needs to be considered as well
– While transaction costs may range from 1% to 4% of deal value, deals over $10 billion often have lower average costs as a percentage of value
– Integration costs can vary significantly by sector
As a fantasy and sci-fi nerd, this recent MoFo alert reminded me of a riddle from “The Hobbit”:
This thing all things devours:
Birds, beasts, trees, flowers;
Gnaws iron, bites steel;
Grinds hard stones to meal;
Slays king, ruins town,
And beats high mountain down.
The answer, of course, is time. And deals—stock-for-stock deals, especially—are yet another of its potential victims. As the alert notes, speed is the antidote to this deal risk, but rushing through diligence and negotiations presents its own risk. M&A practitioners must find the right balance. To that end, the alert presents a number of practical suggestions for signing on an accelerated basis, while running a thoughtful process. Here is an excerpt with a few of the suggestions:
– Do everything you possibly can before you engage with the other side. For a buyer, it should do all the analysis and due diligence it can before it approaches the target. As the target is publicly listed, it is required to file extensive amounts of information under securities laws. All of this information should be reviewed and understood by the buyer and its advisors. By completing a significant amount of the due diligence work before engaging, a buyer decreases the amount that needs to be done post-engagement and its now significant knowledge of the target will allow it to conduct more focused due diligence after engagement. This allows for a much quicker due diligence process while the parties negotiate the deal, without undermining the effectiveness of the buyer’s due diligence.
– If the circumstance presents itself, the buyer and target should consider first engaging shortly after quarterly earnings reports are released. This provides the parties with the benefit of the most recent information and a three-month period to reach a signing before the next earnings release.
– Consider avoiding a “testing the waters” or “small, slow concessions” approach to negotiations. These approaches will likely increase the timeline and run an increased risk of a leak.
Boards may face pressure from shareholders to publicly announce that they are considering strategic alternatives, including a sale of the company, but announcement comes with significant risks, some less obvious than others. This HLS blog post by Patrick Ryan of Edelman Smithfield, citing research from Jenny Zha Giedt at the George Washington University School of Business, acknowledges the potential benefits—a more robust process and possibly higher premiums—but notes that the significant consequences excerpted below, beyond share price impact and negative attention, often lead financial advisors to recommend against announcement:
– A public process consumes substantial time from directors and management, distracting them from overseeing and running the business.
– The company may face challenges retaining and recruiting employees.
– Relatedly, productivity can suffer as employees worry about things like job security and whether they’ll have to relocate in the event of a sale.
– Other stakeholders including customers, especially those with long-term contracts, often have concerns about how a sales process could affect them.
– Competitors may capitalize on the perceived instability following the announcement, costing you market share.
Whether a board chooses to disclose at the start of the process, or eventually makes a public statement once news has leaked or in the face of activist pressure, the blog presents some practical advice for a well-planned communication strategy to preserve shareholder value (see the post for details on each recommendation):
1. Identify likely stakeholder concerns pre-announcement and prepare a detailed and prioritized outreach plan to address them to the extent possible.
2. Acknowledge and place bounds on uncertainty.
3. Ensure consistency of messages when tailoring communications for various stakeholders.
4. Communicate with employees frequently and empower people managers.
Over on TheCorporateCounsel.net, John recently blogged about the SEC’s latest non-GAAP enforcement action. While we usually cover non-GAAP compliance matters on that blog, Regulation G enforcement actions are infrequent enough to be notable, and this enforcement action involved M&A related adjustments. Specifically, the SEC took issue with certain expenses that were improperly excluded from non-GAAP numbers as transaction, separation and integration-related (TSI) costs.
It’s been a couple years since we’ve had a non-GAAP enforcement action. Last week, the SEC reminded us that they’re still watching for problems. The Commission announced charges against a company for allegedly misleading disclosures about its non-GAAP financial performance in multiple reporting periods from 2018 until early 2020.
One of the things that got the company in trouble was allegedly failing to adopt disclosure controls & procedures specific to non-GAAP measures. The SEC says that led to misclassifications of excluded expenses and misleading disclosures of what exactly had been excluded. Here’s more detail from the 11-page order (also see this Cooley blog):
DXC also had insufficient processes to ensure that its business practices for classifying costs as TSI were consistent with the plain meaning of the company’s own description of those costs in its periodic reports filed with the Commission and in its earnings releases. The absence of a non-GAAP policy and specific disclosure controls and procedures caused employees within the business units and in the Financial Planning & Analysis area (“FP&A”) to make subjective determinations about whether expenses were related to an actual or contemplated transaction, regardless of whether the costs were actually consistent with the description of the adjustment included in the company’s public disclosures. As a result, DXC negligently misclassified certain internal labor costs, data center relocation costs that were unrelated to the merger, and other expenses as TSI costs.
Without admitting or denying the findings in the order, the company consented to a cease-and-desist order, to pay an $8 million penalty, and to undertake to develop and implement appropriate non-GAAP policies and disclosure controls and procedures. The SEC considered the company’s cooperation and remedial actions in accepting the settlement offer.
I blogged a few weeks ago that “disclosure controls” enforcement actions are trending. We all need to pay attention to the link between disclosure controls & disclosure content – including for voluntary disclosures – because the SEC certainly is doing that. As Lawrence noted last week on PracticalESG.com, the SEC’s interest in whether companies are accurately explaining what makes up the information they’re providing could also translate to scrutiny of ESG disclosure controls in the future.
A recent Stanford report on shareholder activism highlights some of the ways in shareholder activism and companies’ responses to it continue to evolve. In recent years, companies have frequently been admonished to “think like an activist” and identify & address potential weaknesses before activists leverage them into a successful campaign. This excerpt from the report says that’s proven to have been good advice:
As a result, more companies are looking at themselves through the lens of an activist and proactively taking actions that an activist would advocate (thereby weakening the argument for an activism campaign). Given that activists derive their power from gaining shareholder support, this means companies too are more likely to think in terms of maintaining shareholder support. Companies conduct preparedness exercises and advanced planning to discuss how they would respond, even before an activist engagement takes place. Preparedness also means that boards are much more conversant and comfortable with activism.
These practices took a dramatic step forward following the high-profile campaign between Nelson Peltz and Dupont, in which mega-cap companies realized they are not too big to become a target. Preparedness exercises have since proliferated to many large, medium and, in some cases, small-sized firms.
One result of this preparation is that companies have increased their success when campaigns come to a vote. According to statistics from FTI Consulting, whereas the activism slate historically has prevailed 50 percent of the time in a proxy contest, in recent years that success rate declined below 30 percent. Only around 30 directors are replaced each year in contested elections in the United States.
The report notes that how the universal proxy rules will affect these statistics remains to be seen, but says that boards will study early campaigns in order to learn how to improve their responses to activists in the new environment.
This Davis Polk memo says that the plaintiffs’ bar has discovered Section 203 of the DGCL – the Delaware Takeover Statute – and has recently been asserting claims based on alleged non-compliance with its requirements in M&A litigation. That statute restricts second stage merger transactions & other business combinations between a target corporation and an “interested stockholder” – which it defines generally as someone who acquired a 15% or greater stake in the target without the prior approval of the target’s board of directors.
As this excerpt from the memo explains, plaintiffs are alleging that a “meeting of the minds” on voting agreements and similar support arrangements between a potential buyer and major stockholders occur prior to the board’s authorization of the deal and result in the buyer becoming an interested stockholder:
Plaintiff stockholders are claiming that discussions and negotiations for a support agreement (i.e., a commitment to tender into a tender offer or vote in favor of a merger) or a rollover agreement (i.e., an agreement to take equity in the surviving corporation or its parent in a merger, in lieu of the merger consideration paid to other target stockholders) between an acquirer, on the one hand, and stockholders of the target who either individually or collectively own 15% or more of the target’s voting stock, on the other, resulted in the formation of an agreement, arrangement or understanding between the acquirer and those stockholders (and therefore the acquirer has ownership of that stock for purposes of Section 203) without receiving prior approval by the target’s board.
The plaintiff stockholders are essentially arguing that these discussions evidence a “meeting of the minds” among the acquirer and those stockholders for the purpose of tendering, voting or rolling over equity. And the claim is that Section 203 was triggered because this meeting of the minds occurred at a time prior to approval by the target board of the merger agreement.
The memo points out that if a friendly deal inadvertently runs afoul of Section 203, that opens up a great big bag of snakes – including heightened stockholder approval requirements and potential breaches of the target’s reps & warranties in merger agreement.
Fortunately, the memo says that Delaware courts have been hesitant to accede to plaintiffs’ efforts to expand the reach of Section 203 beyond hostile deals, and have generally rejected arguments that negotiations around support agreements resulted in the buyer becoming an interested stockholder in advance of board approval. It also offers up recommendations on how boards and their advisors can structure the negotiation process to reduce the risk of these allegations.
Bad luck streak in dancing school Down on my knees in pain I’ve been breaking all the rules Swear to God I’ll change. . .
I think the last couple of lines of that verse are pretty on-point, because if Delaware’s recent case law has a theme, it’s that buyers can’t assume that the Delaware courts will bail them out when it comes to restrictive covenants that they knew likely “broke the rules” when they negotiated them.
Many buyers have opted to push the envelope on non-competes because they assume that, if challenged, the Delaware courts will “blue pencil” their covenant into something that’s enforceable. In fact, Delaware courts are reluctant to do that in the face of unreasonable non-compete terms. The Intertek decision is the latest example of this. The case involved a non-compete that prohibited the defendant from competing with the buyer “anywhere in the world.” Although Vice Chancellor Will acknowledged that Delaware has enforced relatively broad restrictive covenants in connection with the sale of a business, she said that those covenants still “must be tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests.”
She concluded that the non-compete at issue here failed that test, and also rejected the plaintiff’s call for her to blue pencil the agreement. This excerpt explains her reasoning for striking the non-compete instead of revising its terms:
Intertek urges me to “blue pencil” the non-compete provision if I conclude that it is unreasonable in breadth. Although the Court of Chancery has, at times, blue penciled expansive non-competes to supply judicious limitations, it “has also exercised its discretion in equity not to allow an employer [or covenantee] to ‘back away from an overly broad covenant by proposing to enforce it to a lesser extent than written.’”
In my view, revising the non-compete to save Intertek—a sophisticated party—from its overreach would be inequitable. “[A] court should not save a facially invalid provision by rewriting it and enforcing only what the court deems reasonable.”
The Delaware Chancery Court’s response to recent efforts to persuade it to revise unreasonable non-competes suggest that dealmakers who operate under the assumption that the best way to proceed is to take aggressive positions when negotiating restrictive covenants would be wise to take Warren Zevon’s advice and swear to God they’ll change.
Last week, in In re Mindbody Stockholder Litigation, (Del. Ch.; 3/23), Chancellor McCormick held that Mindbody’s former CEO and its acquiror were jointly and severally liable for $44 million in damages to the company’s former stockholders due to the CEO’s breach of his fiduciary duties arising out of the sale process & misleading proxy disclosures.
I summarized the facts of the case, which were pretty egregious, in an earlier blog addressing the defendants’ motion to dismiss. The plaintiffs alleged that the target’s CEO, Richard Stollmeyer, intended to tip the playing field in favor of his preferred private equity bidder, Vista Equity Partners, and failed to disclose a variety of material conflicts to his own board.
Those conflicts also weren’t disclosed in the merger proxy, and neither were the target’s positive fourth quarter results – even though the target had those results were in hand prior to the vote. Chancellor McCormick concluded that this failure rendered the proxy’s description of the merger consideration as representing a 68% premium to the then-current trading price of the Company’s shares misleading.
Although other standards of review were potentially available, the Chancellor determined to evaluate the CEO’s conduct under Revlon. She found that it fell far short of what his fiduciary duties required and was sufficient to taint the board’s entire process. She also found that Vista was liable for aiding & abetting the disclosure violations in the proxy materials. This excerpt from Debevoise’s recent memo on the decision summarizes her reasoning:
According to the court, the case presented a “paradigmatic” Revlon claim: Stollmeyer suffered a disabling conflict as a result of his interest in near-term liquidity as well as his expectation of lucrative post-merger employment by what would be a Vista portfolio company. According to the court, this led Stollmeyer to tilt the sale process by driving down Mindbody’s stock price and giving Vista informational and timing advantages over other bidders. The court also found that the board, unaware of Stollmeyer’s conflicts, failed adequately to manage them.
The court did not permit plaintiffs to advance a claim against Vista for aiding and abetting the sale process-related fiduciary duty breaches because plaintiffs failed to plead that claim until after trial. The court did hold, however, that Vista, which had a contractual obligation to correct any omissions in the proxy materials, aided and abetted the disclosure violations, which the court found to be an independent source of liability for both Vista and Stollmeyer—in addition to their making Corwin defense inapplicable,
Vice Chancellor McCormick held that the evidence demonstrated that Vista would have paid $37.50 had the CEO not “corrupted the process,” and the difference between that amount and the $36.50 per share actually paid by Vista formed the basis for her damage award against the CEO. She held Vista jointly and severally liable for the same amount, observing that although the precise amount of the harm stockholders suffered as a result of the misleading disclosures couldn’t be clearly established, “a $1 increase in the per share price would not have rendered the deal undesirable for Vista, nor would it represent a windfall to the class.”
On Friday, Corp Fin finished its long-awaited build-out of the Tender Offer Rules & Schedules CDIs by issuing 34 CDIs addressing a wide range of interpretive issues. As anyone who’s ever researched tender offers knows, most of the Staff’s guidance has been scattered across the old Telephone Interps & other locations on the SEC’s website, with only a handful of topics addressed in the CDIs. All of that guidance has finally been consolidated into a single location. The intro to the page provides some insight into where all of the new CDIs came from:
These Compliance and Disclosure Interpretations (“C&DIs”) comprise the Division’s interpretations of the tender offer rules. Many of the C&DIs replace the interpretations previously published in the Tender Offer Rules and Schedules Manual of Publicly Available Telephone Interpretations, Excerpt from November 2000 Current Issues Outline, and Excerpt from March 2001 Quarterly Update to Current Issues Outline (namely, C&DIs 101.05 through 101.16; 104.01; 104.02; 130.01 through 130.03; 131.01 through 131.03; 144.01; 146.01; 149.01; 158.01; 161.01; 162.06; 162.07; 163.01; 164.01; and 181.01). C&DI 101.04 replaces Question 2 in the Schedule TO section of the July 2001 Interim Supplement to Publicly Available Telephone Interpretations.
As this Gibson Dunn blog points out, there’s not a lot that’s new here in terms of substantive guidance. Still, there’s so much that’s new to this page on the SEC’s website that I think you may find this version that I dug up from the Internet Archive showing what the page looked like before Friday’s changes helpful. Members of DealLawyers.com can also access this redlined copy of the CDIs that I posted in our “Tender Offers” Practice Area.
By the way, I know that many of our readers will be in attendance at the Tulane Corporate Law Institute later this week. I’ll be there as well and hope to have a chance to meet you during the conference. I’m easy to find – just look for a guy who appears to be a cross between Butterbean & Sir Topham Hatt!
