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.
Last month, CFIUS issued its 2023 Annual Report to Congress. The report highlights key indicators of CFIUS’s activities and process, including the complexity and volume of its cases. The report says that there were 233 written notices of transactions filed with CFIUS in 2023 that it determined to be covered transactions, and that a subsequent investigation was conducted with respect to 128 of those 233 notices. The parties ultimately withdrew the notice and abandoned the transaction in 14 of these instances, either for commercial reasons or after being unable to identify mitigation measures acceptable to CFIUS and the parties involved.
There are a whole bunch of numbers in this report, and I could go on like this for quite a while, but that would be really tedious. Instead, I’m just going to point you in the direction of Davis Polk’s memo on the report and offer up an excerpt from that memo identifying some of the report’s key takeaways:
– Complex filings are not getting any easier (or shorter). As discussed above, the time to resolve investigations continues to increase, despite growth in CFIUS resources and staffing. In our experience, the increase in the number of questions from and information requested by the Committee during an investigation continues to drive longer timelines.
– Mitigation measures continue to expand. While the share of notices that resulted in the imposition of some form of mitigation measures remained the same as in 2022 (roughly 18%), it is significantly higher than in 2020 (12%) and 2021 (11%). Moreover, CFIUS’s indicative list of mitigation measures continues to expand, tracking changes to typical NSAs. Expansion has focused largely on data security and increased information and reporting requirements.
– Expect non-compliance with mitigation measures to be more heavily scrutinized and penalized. As discussed in our recent client update, CFIUS has increasingly focused on enforcement, and the Treasury Department issued a notice of proposed rulemaking earlier this year to amend its compliance and enforcement provisions to sharpen its enforcement authorities. Consistent with this trend, in 2023, CFIUS assessed or imposed four civil monetary penalties for noncompliance with material provisions of mitigation agreements, double the total number of previous penalties in the entire history of CFIUS, and issued its first formal finding of a violation of the mandatory filing requirements.7 The report notes that CFIUS member agencies increased investment in monitoring and enforcement resources in 2023.
– Shifting trends in non-notified transactions. CFIUS has made clear that investigating non-notified transactions is a priority of the Committee. As forecasted in the Committee’s 2022 report, though, the total number of non-notified inquiries has continued to decline, from 135 in 2021 and 84 in 2022 to 60 in 2023, as the Committee uses its increased investigative resources to work through a backlog of historical transactions.8 That said, the percentage of non-notified inquiries resulting in a formal request for a filing is trending upwards from ~6% in 2021 and ~13% in 2022 to ~22% in 2023, and we expect that CFIUS will continue to closely monitor for transactions of interest.
In Fortis Advisors v. Medtronic Minimed, (Del. Ch.; 7/24), the Delaware Chancery Court dismissed claims by a sellers’ representative that the buyer wrongfully deprived the target’s former stockholders of a $100 million contingent milestone payment. The Court rejected the plaintiff’s claims based on the earnout provision’s unusually buyer-friendly language concerning the buyer’s obligations with respect to the achievement of the milestone.
The merger agreement contained language stating that the parties intent was that “development, marketing, commercial exploitation and sale of the Milestone Products” could be exercised by the buyer in accordance with its business judgment and in its “sole and absolute discretion.” It went on to say that the parties acknowledged that the buyer’s ability to exercise its discretion “may have an impact on the payment of the Milestone Consideration.”
While the agreement also provided that the buyer could not “take any action intended for the primary purpose of frustrating the payment of Milestone Consideration,” it also said that the buyer would not “have any liability whatsoever to any [former target stockholder] for any claim, loss or damage of any nature that arises out of or relates in any way to any decisions or actions affecting whether or not or the extent to which the Milestone Consideration becomes payable.”
The plaintiff alleged that the buyer’s decision to defer hiring new salespeople, commencing a marketing program and refusing to pursue regulatory clearance and sales of a particular product were actions intended to frustrate payment of the Milestone Consideration. However, the Court concluded that “[d]eferring action and refusing action are functional opposites of “tak[ing]” action.” If the buyer had covenanted to use reasonable efforts to achieve the milestone, the Court said that those omissions might carry more weight, but not with the buyer-friendly language contained in the agreement.
The Court observed that the unusual language in the contract put the plaintiff in the position of having to satisfy a pleading burden that it just could not meet:
The Court first notes the unusually heavy burden that Fortis contractually imposed on itself. This is not a case where Medtronic covenanted to use “best efforts,” “commercially reasonable efforts,” or even “good faith efforts” to achieve the First Milestone. To the contrary, in an arm’s-length transaction, Medtronic secured for itself sole discretion to take actions that Medtronic knew would frustrate the First Milestone, so long as the action had some other primary purpose. Fortis freely assented to that arrangement. The Court is not aware of any Delaware precedent applying such a buyer-friendly contingent payment scheme, and the parties cite to none.
Thus, while Fortis is correct that Delaware law imposes a “‘minimal’ and ‘plaintiff-friendly’ standard” at the pleading stage, Fortis must contend with a voluntarily undertaken contractual standard that is far from plaintiff-friendly. To meet that standard, Fortis cannot simply raise an inference that Medtronic acted in a way that had the purpose or effect of defeating the First Milestone, Fortis must plead facts that raise an inference that Medtronic acted with the primary purpose of defeating the First Milestone. Fortis fails to raise the latter inference.
While the Court dismissed the plaintiff’s claims relating to the earnout, it allowed the plaintiff to move forward with claims that the buyer wrongfully withheld amounts held in an escrow account based on the buyer’s alleged untimely assertion of indemnity claims.