This Akerman memo reports on the environment for private equity funds under $1 billion in size. While middle market M&A remains robust, this excerpt says that new capital for these smaller funds is getting harder to come by:
While the amount raised during H1 2018 by U.S. sub-$1B funds declined somewhat (and from a record in H1 2017), the number of such funds raised plummeted precipitously (to the lowest number since the financial crisis). Fundraising for the broader market diminished only marginally, leading the number of funds raised during H1 2018 at this smaller end of the market to account for less than 25% of funds raised in the overall market—a proportion not seen since the financial crisis. As was the case with the broader market, the fall-off in the number of funds raised was more dramatic than the fall-off in the aggregate dollars raised, reflecting a trend towards larger funds.
The memo notes that limited partners’ increasing desire to put larger amounts of capital to work efficiently has created some fundraising headwinds for these smaller funds.
One of the many conditions that Section 355 of the Tax Code imposes on spin-offs is that, immediately before the spin-off, the parent and the subsidiary must be engaged in an “active trade or business” & have been engaged in such business for at least five years. That condition ordinarily includes the collection of income, which makes it difficult for most developmental stage companies to qualify.
This Latham memo suggests that a recent statement suggests that the IRS is considering a possible change to the “active trade or business” condition that would potentially open the door for spin-offs involving developmental stage companies. Here’s an excerpt:
The recent IRS statement addresses the application of the active trade or business requirement to businesses engaged in R&D activities, regardless of whether they currently generate income. The statement notes that the IRS has “observed a significant rise in entrepreneurial ventures whose activities consist of research and development in lengthy phases,” during which no income or negligible income is collected. Despite not collecting income, these businesses expend significant financial resources and perform day-to-day operational and managerial functions — factors that the IRS notes have historically evidenced the conduct of an active business.
The memo says that IRS & Treasury are now considering issuing guidance as to whether entrepreneurial activities — such as R&D — could qualify as an active trade or business, even if those activities haven’t yet generated income. The IRS is soliciting comments on the issue, and the memo also notes that, in the meantime, it will consider requests for private letter rulings on the active trade or business requirement for corporations that have not collected income.
Earlier this year, I blogged about how some language in a recent Delaware Supreme Court decision has caused practitioners to question the long-held assumption that Delaware is, as Vice Chancellor Laster once put it, “affectionately known as a ‘sandbagging’ state.” Weil’s Glenn West has a recent blog discussing this new-found uncertainty. He suggests that parties may want to address sandbagging directly in their acquisition agreement – and includes the following model “pro-sandbagging” clause:
No Waiver of Contractual Representations and Warranties. Seller has agreed that Buyer’s rights to indemnification for the express representations and warranties set forth herein are part of the basis of the bargain contemplated by this Agreement; and Buyer’s rights to indemnification shall not be affected or waived by virtue of (and Buyer shall be deemed to have relied upon the express representations and warranties set forth herein notwithstanding) any knowledge on the part of Buyer of any untruth of any such representation or warranty of Seller expressly set forth in this Agreement, regardless of whether such knowledge was obtained through Buyer’s own investigation or through disclosure by Seller or another person, and regardless of whether such knowledge was obtained before or after the execution and delivery of this Agreement.
Glenn acknowledges that in the days before silence on the sandbagging issue became the preferred option in Delaware contracts, getting a seller to sign-on for a clause like this was like pulling teeth. What’s his recommendation for buyers in the new environment? Pull harder:
If the seller does not wish to expose itself to the vagaries of extra-contractual claims based on what the seller might have known or might have told the buyer outside the four corners of the agreement, why should the buyer? Why does the buyer’s purported knowledge of the breach of any of the seller’s express, contractual representations and warranties eliminate even the limited remedies against the seller that were bargained for by the buyer?
This November-December issue of the Deal Lawyers print newsletter was just posted – & also sent to the printers – and includes articles on:
– Akorn v. Fresenius: Delaware Chancery Court Upholds MAE-Based Termination
– Delaware Supreme Court Clarifies MFW’s Ab Initio Requirement
– Carve-Out Transactions: Negotiated Issues & Diligence Matters for Buyers
– Delaware Chancery Holds Contractual Appraisal Waivers Valid
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Intralinks’ recently released its annual “M&A Leaks Report.” Once again, the report makes for interesting reading – it analyzes deal leaks over the period from 2009-2017, and breaks them down by world region, country & business sector. The report also looks into the effect of leaks on the premiums paid, emergence of rival bidders & time to closing. Here are some of the highlights:
– Leaked deals have significantly higher premiums than non-leaked deals. In 2017, targets in leaked deals achieved a median takeover premium of 34% vs. 20% for non-leaked deals. This 14% spread was higher than in 2016, when the difference was around 12%.
– For the 10 countries with the most M&A activity, the top three for deal leaks in 2017 were Hong Kong (21%), India (14%) and the U.S.(9%). The bottom three countries for deal leaks in 2017 were France, Germany and South Korea – all of which had no deal leaks during the year.
– TMT(12%), Consumer (11%) & Retail (11%) were the leakiest industry sectors, while Financials (6%), Real Estate (6%) and Energy & Power (3%) were the most tight-lipped.
The study cautions that despite the economic incentive to leak, regulators worldwide are increasing regulatory and enforcement efforts against what they consider to be market abuse, including M&A deals leaks.
It appears that the universal proxy many activists have longed for may actually tip the scales in favor of management in a proxy fight. In a presentation at Schulte Roth’s annual activist investing conference, Starboard Value’s CEO Jeff Smith illustrated this potential outcome using a hypothetical scenario in which an activist nominates 5 candidates to a board comprised of 8 seats. This excerpt from a recent “Activist Insight” newsletter walks through that scenario:
In a traditional proxy contest using two cards, votes will be weighted to the dissidents if shareholders feel strongly about the need for change but the three management nominees running unopposed would almost certainly be elected. A proxy contest using a universal ballot might mean investors are a bit pickier, with the result that fewer of the dissident nominees are elected – hence why companies have been keener to use a universal ballot in situations like SandRidge Energy, which faced having its entire board replaced.
A universal ballot, however, could also lead to freakish results. In a fight involving a short slate against a full one, there are enough possible outcomes for every single candidate to receive over 50% of the shares. The side running the full slate – let’s assume it’s the company – could promote different candidates to different shareholders and split the vote, romping to victory.
Here’s Starboard’s slide deck illustrating the possible outcomes of this hypothetical. As a solution, Smith suggests dividing the universal proxy into 2 sections. One of these would feature an equal number of candidates for contested seats, while the other would contain the uncontested nominees. While this would “make the proxy fight a simple first-past-the-post race,” the newsletter points out that it also would limit the degree of shareholder choice afforded by the universal ballot.
Starboard isn’t the first to point out that a universal proxy might have the unexpected effect of favoring management. As we blogged shortly after the SEC issued its universal proxy proposal, a study reviewing recent proxy fights suggested that the rule would’ve modestly favored management had it been in place at the time.
Most state LLC statutes do not expressly provide for appraisal rights, but many permit these entities to provide those rights in their operating agreements. This recent blog from Lowenstein Sandler’s Steve Hecht & Rich Bodnar discusses the ability of minority LLC investors to obtain appraisal rights by contract – and this excerpt lays out some of the reasons why they might want to consider that approach:
Many states, including New York, allow the members of an LLC–as an example–to include appraisal rights in the operating agreement. While we often cover appraisal on this blog as a statutory remedy focused on shareholder protection, negotiated appraisal rights can be a part of a corporate lawyer’s suggestion box in trying to get a deal done. A minority investor concerned about his or her minority status may be comforted by an appraisal rights mechanism in the foundational documents. Similarly, an investor who is contemplating a minority investment may wish to negotiate for an appraisal provision precisely because it can give an “out”–and, at minimum, bargaining power–if the minority investor sees issues with an otherwise-aboveboard merger.
The blog notes that a minority investor may be willing to do some horse-trading to obtain these rights at the time of its investment. For example, it may be willing to give up the right to seek to enjoin a potential transaction in exchange for a viable post-closing remedy such as a contractual appraisal right.
Here’s an interesting blog from Cooley’s Michal Berkner about some of the differences between UK & US purchase agreement terms for private company M&A. The blog highlights different approaches to reps & warranties, indemnification, post-closing adjustments, bring-down conditions and post-closing covenants. This excerpt addresses our old pal “sandbagging”:
Acquisition agreements governed by Delaware law sometimes contain provisions expressly acknowledging that a party’s right to recover for breaches of representations and warranties of the other party is not affected by any knowledge of such breach by such party, whether obtained prior to signing or between signing and closing. This heavily negotiated provision is known as a pro-sandbagging clause.
English law governed acquisition agreements often contain provisions that provide that a party does not have a right to recover for a breach of warranty of the other party to the extent the non-breaching party had knowledge of such breach prior to closing. This is known as an anti-sandbagging clause. English case law also suggests that a party generally does not have a right to recover for a breach of warranty of the other party to the extent the non-breaching party had knowledge of such breach prior to closing.
The buyer in such a case is deemed not to have relied upon the accuracy of such warranty, or to have no or de minimis damages, as such buyer is presumed to have valued the shares or assets on the basis of its knowledge that the warranty was untrue. Anti-sandbagging clauses typically limit the group of people who are deemed not to have knowledge of breach to the key deal team of the buyer, excluding attributing to them knowledge of outside advisers.
While dealmakers should have a working knowledge of the differences between the two jurisdictions, the blog acknowledges that the question of which jurisdiction’s law will govern often depends more on practical factors, such as the desire for a home jurisdiction for dispute resolution, the location of the business or the jurisdiction in which it’s organized, and tax considerations.
For most deals, everything starts with a non-disclosure agreement. In order to provide insight into market practice when it comes to NDAs, the Business Law Center surveyed the terms of 143 NDAs filed on Edgar & dated between 1/1/14 and 3/31/18. Here are some of the findings:
– The most common agreement term was 24 months. One agreement remained in force for 120 months (the longest term), and one for only three. Twenty agreements did not specify a termination date, implying a perpetual term. Twenty-three others provided for, or implied, perpetual survival of the NDA’s confidentiality provisions.
– Delaware law governed the largest portion (62%) of these agreements, an additional 22% were written under New York law. Unilateral agreements were more likely than mutual agreements to be governed by New York law.
– Reflecting the fallout from the Delaware Chancery & Supreme Court decisions inVulcan v. Martin-Marietta, “use provisions” have evolved significantly over the period surveyed. 2014’s use provisions convey a general sense of how confidential information should be used, but like the language at issue in Marietta/Vulcan, fail to give precise direction. In contrast, 2018’s use provisions are more uniform and more specific. In six of 2018’s nine NDAs confidential information is to be used “solely for the purpose of” or “solely in connection with” evaluation of a proposed transaction. These six agreements also enumerate the activities that constitute evaluation.
– 83% of the agreements surveyed had a non-solicitation clause preventing the recipient of confidential information from poaching the other party’s personnel. The duration of the non-solicitation period varied from six to 36 months, with twelve months being the most common period.
– 80% of the agreements surveyed included standstill provisions. The length of the standstill period varied considerably, from 45 days to three years. The most common term was twelve months.
– 64% of agreements with standstills included a “don’t ask, don’t waive” clause, but only 23% did not include a “carve-out” allowing the party bound by the standstill to privately communicate alternative proposals or, more commonly, by a “fall-away” automatically terminating the standstill in the event of a competing offer. Some deals had both provisions.
The survey also addresses other common NDA provisions, and reviews the differences between the terms of unilateral & mutual NDAs.
According to Dykema’s “14th Annual M&A Outlook Survey,” dealmakers are more optimistic about the prospects for M&A activity in 2019 than they’ve ever been in the history of the survey. The survey found that 65% of respondents expect the M&A market to strengthen over the next 12 months – that’s up from 39% last year.
Other highlights include:
– Automotive, energy & consumer products are the sectors where respondents expect to see the most deal activity. For the first time in 4 years, technology and healthcare dropped out of the top 3 sectors.
– 46% of respondents said a Democratic victory in the House would be somewhat or very positive, while 36% said it would be somewhat or very negative. On the Senate side, 48% saw a Democratic takeover as positive, while 36% said it would be somewhat or very negative. The “meh” vote was 19% for the House & 17% for the Senate.
– Only 33% of respondents chose availability of capital as the strongest M&A driver – that’s down from 55% in 2017. 31% cited general U.S. economic conditions, while favorable interest rates, financial markets and changes in U.S. tax laws, were each cited by 11% of respondents.
The survey also said that respondents were particularly bullish about private company M&A and deals below $100 million. That wasn’t the case for larger deals – only 26% expect growth for deals exceeding $100 million, while 41% expect deal volume to diminish.