This recent Debevoise alert discusses the SEC’s continued focus on 13D amendments filed by private equity sponsors during take-privates. Item 4 of Schedule 13D includes the purpose of the acquisition of securities, and the Schedule 13D must be amended within two business days for any subsequent material change. The SEC often issues comment letters questioning the timing of a 13D amendment, often after comparing 13Ds to the “Background of the Merger” disclosure in the proxy statement. There’s some uncertainty as to how definite the plan or proposal must be before an amendment is triggered, and these SEC comment letters provide some helpful guidance on when a Schedule 13D should be updated. While the alert says the decision to amend depends on context and no single factor is determinative, it lists these examples of actions that the SEC believed triggered a duty to amend:
– working with lawyers and other shareholders to submit a proposal to the issuer’s board;
– deciding on a specific transaction structure;
– securing waivers from other shareholders to assist in an eventual transaction;
– discussing a third-party valuation report with officers and directors of the issuer;
– receiving information about issuer board meetings discussing matters relevant to the transaction;
– drafting an offer letter to the issuer with a “placeholder” offer price per share and providing such draft to outside counsel for review; and
– submitting an offer letter to the issuer.
Another question that often comes up is when a “group” is formed. Group members that are not 5% holders become subject to Section 13(d) reporting requirements based on the group’s total beneficial ownership, and existing filers are required to amend their filing to disclose the existence of the group. Since formation of a group will trigger prompt disclosure, sponsors should work closely with counsel when engaging in discussions in connection with a potential take-private transaction to avoid triggering group formation earlier than intended. The memo also reminds sponsors that making material arrangements like offer letters, lock-up agreements, voting and support agreements, and rollover agreements will trigger a Schedule 13D amendment.
When the SEC engages by issuing a comment letter or commencing a cease-and-desist proceeding or enforcement action, it may end up delaying the target’s stockholder meeting to approve the take-private transaction and/or result in civil monetary penalties, so getting this right is key. This memo and others like it are posted in our “Schedule 13D & 13G” Practice Area.
Spencer Stuart recently surveyed more than 360 directors to understand how boards prepare for and respond to activist campaigns — plus how individual directors assess and engage with activist slates. Here are some highlights:
– A majority of respondents (53%) have served on a board approached by an activist investor, a figure that rises to 65% among public company directors.
– When faced with an activist, 91% of public directors said their board engaged with the investor. A striking 44% said they added directors identified by the activist, and 40% reached a settlement.
– Nearly two-thirds (65%) of public directors view their boards as prepared for activist situations. To prepare for activist campaigns, 63% of public directors said they identified advisers and 62% enhanced shareholder engagement practices.
– 44% of public company directors would consider joining a slate . . . [J]ust 20% of public and private company directors were contacted to join an activist’s slate. Of that 20%, fewer than one in four (18%) ultimately joined the company’s board.
– What company-specific factors would influence a director’s decision to join an investor slate? Number one was belief in the activist’s strategy for the company (91%), followed by the opportunity to drive meaningful change (81%). Public company directors expressed significantly higher concerns about reputation (60%) than private company directors (43%).
Wachtell Lipton recently published a memo offering insights into the Trump administration’s approach to antitrust enforcement during its first six months. The memo notes that settlements are back on the table and that private equity & the energy sector no longer have targets on their backs, but it also says that the administration continues to endorse the kind of expansive interpretation of the antitrust laws that characterized the Biden administration’s approach. Here’s an excerpt:
The current administration has continued to endorse many of the substantive views of the Biden Administration. For example, Chairman Ferguson announced that the FTC would maintain the 2023 Merger Guidelines as its framework for substantive merger review. As we previously discussed, the 2023 Guidelines adopted lower concentration thresholds at which the agencies will presume a transaction violates the antitrust laws, and memorialized more expansive theories of harm than the prior 2010 Guidelines. The FTC also implemented the new, more burdensome HSR Form despite a pending challenge from the U.S. Chamber of Commerce. Chairman Ferguson has endorsed the new Form as a “win-win for all parties.”
Both agencies also have active merger litigation. The DOJ continues to pursue the United Health/Amedisys and American Express GBT/CWT Holdings challenges brought by the prior administration. In March, the FTC sued to block GTCR’s proposed acquisition of Surmodics, citing favorably to the 2023 Merger Guidelines in support of its allegation that the transaction is “presumptively unlawful.”
The memo also says that Big Tech and healthcare remain areas of focus and that, like other agencies, the DOJ and FTC are closely aligned with the Trump administration’s policy agenda. It also discusses the growing role that state AGs are playing in merger enforcement.
I thought this recent blog from Sheppard Mullin about navigating the differences between US & UK market practice for M&A transactions was pretty interesting. The blog highlights differences in the way dealmakers in the two markets approach purchase price adjustments, due diligence, management equity incentives, MAC clauses, and other deal terms. This excerpt points out the differences in how US jurisdictions and the UK treat sandbagging:
US Approach. In acquisition agreements in the US, it is common to encounter a “pro-sandbagging” clause. A pro-sandbagging provision allows a party to recover for breaches of representations and warranties even if the party had prior knowledge of the breach, whether before signing or between signing and closing. This clause is a frequent point of negotiation in deal-making. A common alternative is for the acquisition agreement to remain silent regarding sandbagging, which, depending on the state law governing the acquisition agreement, would not foreclose a party from recovery if the party had prior knowledge of another party’s breach.
Sellers, conversely, advocate for an “anti-sandbagging” clause to be included in an acquisition agreement, stipulating that a party cannot recover for breaches of representations and warranties if the party had prior knowledge of the breach. The rationale is that the parties should negotiate any implications of the breach that affect the value of the business prior to signing. In practice, though, anti-sandbagging provisions rarely make it into a final acquisition agreement.
UK Approach. English law tends to favor “anti-sandbagging” clauses in acquisition agreements. English case law supports this position, suggesting that a buyer who knows of a breach is considered not to have relied on the warranty’s accuracy, or to have no or minimal damages, as they are assumed to have assessed the value of the shares or assets knowing the warranty was false. Anti-sandbagging clauses typically restrict the attribution of knowledge to the buyer’s core deal team, excluding knowledge held by external advisors.
The memo also discusses differences between the way the UK & US structure the sale process. In contrast to the US practice of using letters of intent and exclusivity periods to complete confirmatory due diligence before entering into a definitive agreement, UK buyers are often required to submit fully binding offers with committed financing, and to have completed their due diligence beforehand.
A recent article by Troutman’s Stephanie Pindyck Costantino and P. Thao Lee discusses how private equity continuation vehicles have evolved in recent years. This excerpt discusses market trends:
SPC: Broadly speaking, many asset classes are experiencing longer hold periods as sponsors continue to seek avenues to provide value. We are seeing numerous assets come to market that are a subset of a larger multi-asset portfolio where the sponsor believes there is value to be derived.
There are some geographies that are not attracting as much investor interest right now, but sector-wise, the appetite is pretty broad. Industries like healthcare and industrials, alongside key sectors of energy and real estate, continue to be of interest.
TL: More broadly, we are all going to have to consider how certain asset classes will react to the US administration’s tariff policies, as well as the response of other countries to those policies. If sponsors have portfolio companies that are susceptible to tariffs, we will probably see sponsors critically reviewing those portfolio companies and mapping out a holding or exit strategy for them.
In certain circumstances, the question will come down to whether the sponsor can hold the portfolio company for a successful long run if tariffs will have an adverse impact on its supply chain and profitability. Industrials and manufacturing, as well as companies that rely on cross-border supply chains, could increase their appetite for secondaries as a result. We will likely start to see more of those assets coming to market as sponsors look for creative ways to address current market challenges.
SPC: We also see a lot of discussion around various tax regimes, both domestic and abroad, and what they mean for various asset classes and entities that hold different types of assets. The impact of those regimes will vary depending on the location of the assets, the location of buyers and sellers, the holding period for the assets, and how investment in those assets was structured. We are seeing robust discussions about restructuring as sponsors try to anticipate what might be coming down the line from a policy perspective. Lastly, from an asset class point of view, we are seeing a lot of interest in private credit secondaries.
The article also discusses the current state of the secondaries market, drivers of deal flow, the implications of current market trends on terms and structuring, and the evolution of buyside appetites for continuation vehicles.
This recent ClearBridge presentation addresses some of the key factors to keep in mind regarding M&A-related executive compensation issues both before and after closing. Here’s an excerpt from the discussion of pre-closing efforts to identify, incentivize, and retain key talent:
As part of the M&A process, it is important for both the target and acquiring companies to identify the key talent through the close, and for the post-close company, to take inventory of retention hooks and identify any gaps in the retention and incentive objectives.
If gaps are identified, companies may use certain tools to address concerns, including:
−Cash retention bonuses tied to deal close (or period beyond deal close)
−Equity grants with long-term vesting (and/or tied to performance goals / transaction close)
−Enhanced severance provisions upon a qualifying termination in connection with the deal
−Post-transaction covenants (e.g., guaranteeing pay levels for one year post-close
Market Commentary: Companies will typically approve M&A award pools as a percent of deal size; the pools are typically <1% of deal size, although the percentages are often higher for smaller deals, private companies, or companies undergoing a disposition strategy (i.e., selling individual business units separately). In assessing award structures, companies should determine their objectives and aim to strike a balance between “pay to stay” with “pay for performance”.
Other pre-closing topics include change-in-control & severance agreements, treatment of outstanding incentive plan awards and disclosure requirements and execution. Post-closing topics covered in the presentation are compensation philosophy and peer group, go-forward pay levels, incentive plan designs and compensation-governance policies.
The latest edition of Wachtell’s 136-page white paper, “Intellectual Property Issues in M&A Transactions” includes a new chapter devoted to artificial intelligence. Among other things, that chapter discusses AI-related reps and warranties. Although it acknowledges that many AI-related issues may already be addressed by the “standard suite” of IP reps, it notes that there is a trend toward including reps specifically addressing uses of AI technology and related risks. This excerpt addresses the specific topics that may be covered by those AI-related reps:
Depending on the context, these may include representations and warranties that:
– require identification of the use of AI in the operation of the business, including as incorporated into, or used in the creation of, products or other material assets and IP, and in the making of any material decisions, including with respect to hiring, firing, and other potentially sensitive use cases;
– neither the acquisition or use of training data for an AI system nor the output of the AI system infringes third-party rights or laws, including the DMCA;
– the business has not sought patent protection for inventions made in whole or part by AI (except where a human inventor has made contributions sufficient to obtain a valid patent for such inventions);
– the business has not sought or claimed copyright in works authored in whole or in part by AI (except where a human author has made contributions sufficient to obtain valid copyright protection for such works);
– the business has taken reasonable measures to protect against potential biases of AI systems and comply with relevant regulations;
– the business has taken reasonable measures to prevent unauthorized access, inadvertent disclosure, and exfiltration of confidential information or sensitivedata through the use of AI; and
– the business’s use of AI has not resulted in adverse consequences, claims, or investigations.
In addition to addressing transaction-specific issues like reps and warranties and due diligence, the white paper’s AI chapter provides an overview of the emerging legal issues and risks associated with the development of AI models and infringement by model outputs, the legal status of AI-generated intellectual property, and AI governance frameworks and regulations.
In July, we blogged about some of the key provisions of the One Big Beautiful Bill Act that M&A practitioners need to understand and take into account when negotiating pricing, transaction structure and deal terms. How are those changes likely to impact the way deals are structured? This Woodruff Sawyer blog — and the Rivkin Radler alert it highlights — discuss how the Act may reshape deal structures and impact RWI placement and coverage. Here’s a summary of their thoughts:
– Buyers will be even more incentivized to push for asset deals. The Act restores a Tax Cuts & Jobs Act provision that allows buyers to deduct 100% of the cost of depreciable tangible assets immediately. This can mean “higher cash flows in the critical early years post-acquisition, faster return of capital and stronger after-tax ROI.” It also means a stock sale is even less attractive to buyers and “harder for a seller to justify, absent a particular non-tax reason for doing so.” Woodruff Sawyer says:
Traditionally, asset deals are less frequently covered by RWI due to limited risk transfer. However, not all asset deals are created equal. We may see more creatively structured asset deals that transfer more risk while still capturing the advantages of the asset structure.
– More benefits of rollover equity. The Act updates the treatment of Qualified Small Business Stock (QSBS), providing a tiered approach to the years held to qualify, increasing the exclusion cap and taking a more flexible approach around corporate reorganizations and rollovers. This may make rollover equity more attractive while making RWI less attractive because “high rollover percentages often trigger pro-rata payouts in certain circumstances. While 100% payouts ($1 loss equals $1 of payment) are available for investor-level losses, only pro-rata payments (if the investor owns 47% of the company, for example, a $1 loss attracts only a 47-cent payment) are available for operational-level losses. This makes coverage far less attractive for clients.”
– Targets in favored industries will be highly sought-after. The Act could impact the types of companies that make attractive targets. That’s because the Act “restores full, immediate expensing of domestic research and development spending, reversing the TCJA’s five-year amortization requirement.” So R&D-heavy companies, including those in industries like AI, biotech and advanced manufacturing, “look stronger on paper.” Plus, the 100% deduction for qualified assets might shift buyers’ views on companies that require heavy upfront investment or have strong IP portfolios.
For buyers, these changes shift the ROI calculus and should lead many buyers to adjust their models to reflect these tax-boosted returns. For sellers, they create an opportunity to reframe historically off-putting high capex numbers as a feature, not a bug, highlighting them as a driver of long-term value creation.
FTI Consulting’s M&A, Activism and Governance Team recently released its 4th Annual Shareholder Activism State of the Market (available for request). The report looks at “fundamental influencers of the shareholder activism market, including the implications of an explosion of new activist funds, the challenges activists have in winning board seats in proxy contests and what the data says about the new leadership at ISS.”
Here are key points from their analysis from the summary:
– A further expansion of settlements being made privately. Over 70% of settlements were reached before an activist’s position was revealed publicly, a record over the past decade.
– A continued speed of settlement. Settlements reached after an activist made its position public took, on average, 46 days to settle. This is slightly up from last year but well below the pre-universal proxy average of 71 days.
– A focus on committees. Over the past year, nearly a quarter of settlements included the creation of a special committee.
– Activists win more seats via settlement. Since universal proxy, 58% of settlements reached were for two or more Board seats, but in 62% of proxy fights activists won less than 2 seats.
Marty Lipton’s latest post on the HLS blog is an updated version of the firm’s alert ” Dealing with Activist Hedge Funds and Other Activist Investors.” The blog includes detailed discussions of tactics and themes deployed by activists, advance preparation, and responding to an activist approach.
One of the things that stood out to me was this fulsome list of what companies should be doing to monitor for activist activity.
– Employ a sophisticated stock watch service and monitor Schedule 13F filings.
– Monitor Schedule 13D and Schedule 13G and Hart-Scott-Rodino Act filings.
– Monitor parallel trading and group activity (the activist “wolf pack”).
– Monitor activity in options, derivatives, corporate debt and other non-equity securities.
– Monitor attendance at analyst conferences, requests for one-on-one sessions and other contacts from known activists.
– Monitor investor conference call participants, one-on-one requests and transcript downloads.
– Monitor company website traffic for unusual activity, including visits by known activists or their advisors or media outlets.
While I think most companies are monitoring most, if not all, of these things, I suspect there are a number of small- and mid-cap companies that may not have someone “putting it all together.” I could particularly see website traffic (and, I’d add, social media traffic) not being reported to the folks who own the “monitoring activists” task.