We’ve posted the transcript for our “2024 DGCL Amendments: Implications & Unanswered Questions” webcast. Our panelists – Hunton Andrews Kurth’s Steven Haas, Gibson Dunn’s Julia Lapitskaya & Morris Nichols’ Eric Klinger-Wilensky – provided their insights into this year’s controversial DGCL amendments. Topics addressed included the amendments’ implications for governance and acquisition agreements, the interplay between fiduciary duties and contractual obligations, and unanswered questions resulting from the amendments.
Here’s a snippet from Steve Haas’s thoughts on how the ability to include provisions for lost premium damages in merger may influence the drafting of specific performance language:
“Next drafting point, the final one under this ConEd, or Crispo category, is the issue of specific performance. Surely parties will continue to prefer specific performance as a remedy in a busted deal over monetary damages. The synopsis says that the statute is not intended to exclude any remedies that are otherwise available. With that said, merger agreements may want to expressly say that notwithstanding the company does have the right to seek loss premium damages, the parties still agree that monetary damages will be inadequate, and that the parties are entitled to seek specific performance. Maybe that’s a drafting nuance, but I wouldn’t be surprised to see more agreements acknowledge the damages section, but still saying very specifically that the parties are agreeing that specific performance is the chosen remedy.”
Members of this site can access the transcript of this program. If you are not a member of DealLawyers.com, email sales@ccrcorp.com to sign up today and get access to the full transcript – or sign up online.
According to a recent PitchBook article, strategic buyers are increasingly willing to pay through the nose for assets held by private equity funds – and a lot of those funds are increasingly looking to strategic buyers to supply an off-ramp for their investments. This excerpt explains the dynamic:
Corporate buyers, with the ability to tap cash on their balance sheets, stock, or investment grade debt, have greater flexibility and a lower cost of capital to fund larger acquisitions. In addition, corporate buyers expect to achieve cost and revenue synergies from an acquisition, positioning them to pay high multiples for ideal targets. Lured by these greater premiums, PE firms are more often looking to exit through sales to strategic buyers versus IPOs or sponsor-to-sponsor transactions, according to a recent survey of PE fund managers and portfolio-company CFOs by BDO USA. The firm mainly advises fund managers in the middle market and upper-middle market.
The article says that 57% of respondents to the BDO survey would pursue sales to strategic buyers for exits in the next 12 months, up from 33% last year. Only 9% expect to pursue exits through IPOs, compared to 29% last year, and fewer respondents said they expected to sell to other PE sponsors than last year.
A new SSC Intralinks report says that dealmakers are rapidly incorporating AI tools into M&A transactions and have very positive views on AI’s potential to generate value in the deal process. This excerpt discusses how AI tools are changing how deal teams:
AI tools are already changing the ways that surveyed dealmakers work. Indeed, only 23 percent say AI has not yet had a meaningful impact on their day-to-day role. And even in Latin America, where AI tools have gained relatively less traction, fewer than a third of dealmakers (32 percent) say they are in this position.
The good news is that the impact of AI to date has been largely positive. For example, 62 percent of respondents say that AI is creating new opportunities for dealmakers. Many of these opportunities are discussed in more detail throughout this report, but it is increasingly clear that AI tools are valuable at every stage of the deal process, from target sourcing to post-deal integration.
Moreover, AI also has a role to play in supporting some of the ancillary tasks of dealmakers. Not least, 58 percent of dealmakers say AI tools have enhanced their reporting capabilities. The ability to execute deal-related work in this way represents an important opportunity in its own right. More broadly, dealmakers are excited by the productivity improvements that AI now promises. Almost half of respondents (44 percent) say that AI tools have already improved their M&A teams’ efficiency. As implementations gather pace, that figure is likely to increase.
The report says that AI is likely to have its greatest impact in deal origination and in post-closing integration. By providing data-driven insights, AI tools can help dealmakers make better-informed decisions, investigate a much broader universe of potential targets and streamline the process of narrowing these down to the most attractive potential transactions. Post-closing, AI tools can help expedite integration planning and execution through automated workflows, intelligent systems and improved cultural alignment.
According to this excerpt from a recent McDermott Will memo, the hard-line approach to merger review taken by antitrust regulators has resulted in a significant number of abandoned deals across multiple industries:
Recent reports indicate that, over the past three years, companies have abandoned 37 deals in the face of FTC pressure. Some were abandoned prior to formal enforcement actions and others were post-complaint. These abandonments spanned industries including pharma, defense, healthcare, energy and technology. Among them, in May 2024, Atlus Group abandoned its purchase of Situs Group’s real estate valuation business.
Assistant Attorney General Jonathan Kanter has separately stated that 21 deals were abandoned following merger investigations by the DOJ, indicating an even stronger link between regulatory action generally and further expanding the count of abandonments.
The memo says that since many deals involve multiple regulators, it’s sometimes difficult to pinpoint the specific actions that led the parties to abandon a deal. However, it says that these reports confirm that abandoned deals are on a “historic upswing” & emphasizes the importance of breakup fees in evaluating and allocating risk.
In September 2022, the 2nd Cir. adopted a bright line rule holding that only target stockholders have standing to assert Rule 10b-5 claims based on the target’s disclosures relating to a merger. Last week, in Max Royal LLC v. Atieva, Inc. (9th. Cir.; 8/24), a 9th Cir. panel endorsed the 2nd Cir.’s position. Here’s an excerpt from the opinion’s summary:
Plaintiff-investors alleged that electric car company Atieva, Inc., d/b/a Lucid Motors, and Lucid CEO Peter Rawlinson made misrepresentations about Lucid that affected the stock price of Churchill Capital Corp. IV, or CCIV, a special purpose acquisition company in which plaintiffs were shareholders and that later acquired Lucid. The district court held that plaintiffs had statutory standing but dismissed the action for failure to allege a material misrepresentation.
The panel affirmed on the ground that plaintiffs lacked Section 10(b) standing under the Birnbaum Rule, which confines standing to “purchasers or sellers of the stock in question.” Agreeing with the Second Circuit, the panel held that, in a case of alleged misstatements made in advance of an anticipated merger, purchasers of a security of an acquiring company do not have standing under § 10(b) to sue the target company for alleged misstatements that the target company made about itself prior to the merger between the two companies.
Over on the Business Law Prof Blog, Ann Lipton observes that in reaching this decision – which involved a deSPAC transaction – the 9th Cir. overlooked the implications of the SEC’s recent SPAC rulemaking, which treats the target and the SPAC as co-registrants of the securities being offered in the deal.
In Hyde Park v. FairXchange(July 30, 2024), the Chancery Court addressed an appraisal petition filed in connection with Coinbase’s acquisition of a start-up securities exchange. Despite a flawed sale process, Vice Chancellor Laster concluded that the deal price was the “least bad” option for valuing the target. Here’s an excerpt from Fried Frank’s memo on the decision:
The court compared FairX to an ancient coin, rare baseball card, or piece of art—stating that such non-cash generating assets are worth whatever someone is willing pay for them. We would note that, for an early-stage company with a disruptive plan and no track record, the deal price reflects, almost entirely, not going concern value as a stand-alone enterprise, but the target’s option value—that is, what the buyer was willing to pay for the chance that a company with no cash generation and no track record may be worth billions in its near-term future. Moreover, in FairX, the deal price also was unreliable because the sale process was seriously flawed, with value clearly “left on the table.” The court viewed the deal price as the “least bad” methodology for determining fair value in this context, however.
Vice Chancellor Laster considered both a DCF analysis and a valuation based on the terms of previous rounds of the target’s financings. However, he concluded that the projections used in the DCF analysis were too speculative, and that the dynamics of the negotiation process for private financings made the valuations implied by those transactions unreliable. He also declined to use the results of a variety of other analytical approaches, including a comparable transactions analysis and internal valuations, due to concerns about their reliability.
Last week, I blogged about Vice Chancellor Laster’s opinion in Seavitt v. N-Able, (Del. Ch.; 7/24). One of the more interesting aspects of his opinion addressed the permissibility of language in N-Able’s certificate of incorporation making certain of its provisions “subject to” the terms of the stockholders’ agreement that was at issue in the case. The defendants argued that this was permitted by Section 102(d) of the DGCL, which provides that:
Any provision of the certificate of incorporation may be made dependent upon facts ascertainable outside such instrument, provided that the manner in which such facts shall operate upon the provision is clearly and explicitly set forth therein. The term “facts,” as used in this subsection, includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the corporation.
Vice Chancellor Laster disagreed that the “ascertainable facts” language of Section 102(d) was broad enough to permit the incorporation by reference of a stockholders’ agreement into a corporate charter. This Paul Weiss memo summarizes the key points underlying his reasoning:
– “Facts ascertainable” are not “provisions ascertainable.” The court reasoned that Section 102(d)’s reference to “facts” ascertainable outside a charter does not include outside “provisions” or other incorporation by reference of a broad, substantive nature. According to the court, “facts ascertainable” refers to specific inputs and are not a vehicle for introducing substantive provisions. According to the court, the examples of “facts” given in the statute (i.e., “the occurrence of any event” or “a determination or action by any person or body”) supported its conclusion.
While the court distinguished and took no issue with references to private agreements for limited facts (e.g., the identity of parties or whether there has been a breach of the agreement) or references to laws and regulations (e.g., the definition of “affiliate” in the U.S. Securities and Exchange Act of 1934), a Delaware corporation cannot simply create substantive charter terms through an external, private document.
– Public unavailability of private agreements. The DGCL requires charters to be publicly filed, but not a private agreement. The court reasoned that the public nature of charters makes basic information about the corporation available to both investors and third parties, but incorporating provisions by reference to non-public documents frustrates that statutory purpose. Furthermore, while federal securities laws might require public companies to file their governance agreements, that fact does not affect the interpretation of the DGCL applicable to all Delaware corporations.
– Circumvention of stockholder vote on charter amendments. The court observed that DGCL Section 242 requires both board and stockholder approval of charter amendments, whereas incorporation by reference of private party agreement provisions permits the contracting parties to amend their agreement on their own and thereby amend the charter automatically. According to the court, this would circumvent Section 242, thereby depriving stockholders of their voting rights.
Last week, I blogged about how PE sponsors have been accumulating quite a bit of dry powder since the beginning of 2024, but that it’s been the big players that have reaped the largest windfall. Now, it looks like these large sponsors are turning to the middle market, which has long been the domain of smaller PE funds. Here’s an excerpt from a recent MiddleMarket.com article:
A confluence of factors have made mid-sized deals particularly attractive for dealmakers of all sizes. Competition is heating up and it’s compelling all players to reassess their strategy. Here’s how it’s playing out.
“What we’re finding, and frankly what I’ve been surprised by having come from a much bigger fund, is we’re actually seeing quite a bit of competition at businesses that I wouldn’t have thought, from a size perspective, that billion-dollar-plus funds would be looking at,” says John Block, co-founder, CEO of Unity Partners, a Dallas-based mid-market PE firm.
Block defines companies with Ebitda from $20 million to $100 million as “classically middle market.” He’s watched this segment become more crowded in recent years. “We’re seeing quite a bit of competition where people are playing down market, even billion-dollar-plus funds in the five to 20 million Ebitda range, which has been surprising.”
Beau Thomas, managing partner at Agellus Capital sees a similar trend. “The processes for even smaller companies, as low as $10 million of Ebitda, remain very heated with larger funds coming down market. This is despite elevated interest rates, fundraising challenges, and the political backdrop,” he says. Agellus is a lower mid-market PE firm based in Clayton, Mo.
The article says that the decision of larger funds to target smaller companies has had a knock-on effect, resulting in traditional middle market players looking at smaller deals than they have in the past.
A recent Nixon Peabody memo provides an overview for emerging companies of the differences between the use of convertible debt and simple agreement for future equity for early stage financings. This excerpt addresses which of the two financing vehicles may be the preferred alternative for a particular company:
Both notes and SAFEs delay the valuation discussion since there isn’t a valuation upon issuance of the note or SAFE (although valuation may loosely be discussed if a valuation cap is to be agreed to). Delaying agreement on a valuation may provide emerging companies with more flexibility to keep the exercise price for options (based on the fair market value of the underlying stock) low, thereby making options more valuable as a tool to better attract talent. In addition, both convertible notes and SAFEs typically don’t include a change to the board of directors beyond a significant holder being a board observer, and the holders will not be considered shareholders with voting or other shareholder rights.
Still, SAFEs offer a few additional advantages to the company relative to convertible notes. They do not accrue interest or have a maturity date, and because SAFEs are not debt, their holders are not creditors. SAFEs also benefit from having a few well-understood industry forms, which could help streamline negotiations over notes. As a result, in all cases, SAFEs are the preferred mechanism for companies. Of course, at the end of the day, the investor may insist on a convertible note, and a company’s preference for a SAFE is only as good as the SAFE’s ability to attract investors.
That last sentence is a pretty good summary of the “golden rule” that every emerging company should keep in mind when negotiating with potential investors – “those who have the gold make the rules.”
In the current deal environment, private equity sponsors are increasingly looking for alternative ways of generating liquidity for their investments. A partial exit, in which the sponsor liquidates part of its investment in a portfolio company while retaining an ongoing interest in the business, is one increasingly popular alternative. This recent Foley blog addresses the potential benefits and challenges associated with partial exits. This excerpt provides an overview of some of the reasons why a sponsor might consider a partial exit:
There are several reasons why a firm might choose to do a partial exit instead of waiting for the exit event, including pressures from investors to generate liquidity. Firms have been holding onto their portfolio companies for extended periods since the end of the “zero interest rate” environment, which can lead to pressure from their investors. Bain & Company’s Private Equity Mid-Year Report states, “While exits also appear to have arrested their freefall, activity has landed at a very low level. And as limited partners (LPs) wait for distributions to pick up, most funds are still struggling to raise fresh capital.” A partial exit provides immediate liquidity that can be utilized to either invest in new opportunities or return capital to investors, helping manage the fund’s lifecycle.
There can also be a highly strategic component to a partial exit depending on who purchases an interest in the asset. A strategic investor can often bring in new expertise, resources, or access to new markets that can aid in the company’s growth. Suppose the investor brings complementary strengths to the partnership. In that case, it can also guide the company’s direction, positioning the company for the kind of growth that can lead to an exit at a much higher valuation down the road.
Finally, a partial exit provides a valuable mark to the portfolio’s valuation for the general partners and their marketing to new and existing LPs for the next fund.
Challenges associated with a partial exit include the need to ensure an alignment of interests between the sponsor and the incoming investor so that there is a clear strategic vision for the portfolio company, as well as the complexities associated with establishing an acceptable balance of control and decision-making authority between the sponsor and the new investor.