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.
Sidley recently analyzed all late-stage director contests at Russell 3000 companies in the last eight years — which includes five years pre-UPC and three years post — to understand the impact of the SEC’s universal proxy rule on contested elections. As these excerpts from their report show, the assumption that UPC would make it easier for activists to win seats didn’t exactly come to fruition as expected. The impact has been more nuanced.
The “floor” on activists’ electoral success has risen. At least one activist nominee was elected in 48% of UPC elections, up from 39%. Half of these successes have been limited to a single seat, an increase from 10% to 24% of total elections.
The “ceiling” on activist success has collapsed. Shareholders have supported at least half of the dissident slate in only 24% of UPC elections, down from 39%.
The average number of activist candidates elected under the UPC is down 22% (1.1 to 0.9 seats), and the average when a dissident wins at least one seat is down 37% (from 2.9 to 1.8 seats).
Management success has ticked down while remaining typical. “Clean sweeps” (full-slate elections) by management continue to be a majority of contested elections under the UPC (52%, down from 61%).
Activists are more often withdrawing their slates after ISS and Glass Lewis back management (13% of late-stage proxy contests under the UPC withdrew after proxy advisor recommendations, up from 9%)
Activists are more often withdrawing their slates after ISS and Glass Lewis back management (13% of late-stage proxy contests under the UPC withdrew after proxy advisor recommendations, up from 9%)
Activist clean sweeps have effectively vanished, falling from 29% of pre-UPC contested elections to none aside from the proxy contests at Masimo.
The memo says the “net effect” of these data points is that “activist victories have increased in frequency but compressed toward single-seat outcomes.” This memo and others analyzing UPC are posted in our “Proxy Fights” Practice Area.
An article in the NYU Law Review links greater antitrust enforcement to a decrease not just in M&A but also IPOs. It says “startups have responded to the antitrust crackdown not by choosing a different exit but by choosing no exit.” A summary in the HLS blog describes this link and the alternatives that “startups” are pursuing.
Between 2012 and 2019, enforcers challenged only three startup acquisitions.
It says this had a “chilling effect” that “spread across Silicon Valley, putting would-be acquirers, founders, and VCs on notice that acquisitions by large incumbents were risky.” But this didn’t push more startups to pursue IPOs.
[W]hile IPOs and acquisitions both provide liquidity, they are not perfect substitutes. The price that a startup commands in an acquisition may exceed the valuation it can achieve in an IPO because of synergies, economies of scale and scope, or the premium incumbents are willing to pay to eliminate potential competitors. The IPO market is also highly cyclical, so going public at the wrong time could be costly. And heightened antitrust scrutiny can reduce the value of an IPO by undermining one of its main advantages: access to publicly traded equity that can be used as currency for future acquisitions.
“Startups,” acquirers, founders and VCs have turned to other means to meet their goals.
In an employee tender offer, a startup lets its employees cash out some or all of their shares while the startup remains private. Secondary sales of startup shares used to be small deals, and they were typically limited to founders or other key employees. But now rank-and-file startup employees can sell their shares, and the secondary market for startup equity has multiplied in value.
Continuation funds let VCs stay invested in their portfolio companies longer than traditional venture funds allow. And as a result, startups face less liquidity pressure and can postpone exits.
Thwarted acquirers have also figured out strategies to evade merger enforcement. One of their strategies is a new structure that we call a centaur—a private company that is funded primarily by public company cash flows. The two largest centaurs are OpenAI and Anthropic, the companies behind ChatGPT and Claude. OpenAI has raised $13 billion from Microsoft, and Anthropic has raised $8 billion from Amazon and $3 billion from Google. Corporate VC investments by operating companies have been rising for the last two decades. But the centaur structure goes beyond traditional corporate VC by crowding out other investors and tying the fate of the startup and the public company with a deep commercial partnership. These deals allow Big Tech to access cutting-edge technology—and exercise influence over potential competitors—without an acquisition.
Another strategy is the reverse acquihire. In this kind of deal, a large tech company persuades the founders and key employees of a startup to quit en masse. Then it hires the former employees and makes a payment to the shell of the startup they left behind, which is ostensibly a fee to license the startup’s tech but is really a means to pay off its VCs. A reverse acquihire is an acquisition in substance but not form. And it’s becoming popular—Microsoft, Amazon, Alphabet, and Meta have all used it.
In Sohovich v. Avalara, (9th Cir.; 3/25) the 9th Circuit reversed a district court decision and allowed a plaintiff to move forward with allegations that disclosures in a target’s merger proxy concerning ISS’s favorable recommendation of the transaction violated Rule 14a-9. Here’s an excerpt from a Goodwin newsletter article on the decision:
In an unpublished, non-precedential decision, the Ninth Circuit largely affirmed the lower court’s dismissal, agreeing that many of Avalara’s statements leading up to the purchase were inactionable puffery and neither objectively false nor misleading. But the Ninth Circuit disagreed with the District Court’s holding that the plaintiff failed to “adequately plead the objective falsity or misleading nature” of certain of Avalara’s statements and reversed the dismissal of the plaintiff’s claims that were predicated upon theories that the company (a) misled the public by claiming that a report from a proxy advisory firm recommended the sale, while omitting various warnings about the sale in the same report, and (b) omitted inorganic growth from its projections in the proxy statement.
First, the Ninth Circuit noted that, crediting the plaintiff’s allegations as true, it was plausible that Avalara might have downplayed concerns about the acquisition that the proxy advisory firm, Institutional Shareholder Services (ISS), expressed in its report. The Ninth Circuit noted that the fact that “some of the [ISS] report’s unfavorable excerpts” were made public in an SEC filing by a third-party did not relieve Avalara’s obligation not to make false or misleading statements about the report. And, although it was true that the report recommended the sale, reducing it to simple approval could still be misleading without the context provided by the doubts also included in the report.
The memo says that the case is a reminder that efforts to gloss over or ignore negative aspects of third-party statements excerpted in proxy materials can be construed as involving material omissions, and that companies should be cautious when excerpting those materials and consider whether their selective excerpts might be construed as misrepresenting the third party’s overall message.
Deal delays due to extended antitrust merger reviews were a hallmark of the Biden administration’s skeptical – and sometimes outright hostile – approach to M&A. According to this recent McDermott Will newsletter, that’s changing, and the agencies are emphasizing the importance of getting out of the way of deals that don’t raise significant issues:
Consistent with the current, more business-friendly attitudes of the FTC and DOJ toward dealmaking, the two agencies also are making efforts to allow nonproblematic mergers to proceed more quickly. The FTC has brought back the practice of granting early termination of the Hart-Scott-Rodino (HSR) waiting period, a practice the FTC suspended under the Biden administration. FTC Commissioner Holyoak has stated that requests for early termination will help reduce the workload of FTC staff and help parties close transactions more quickly.
Since restarting the early termination program, the FTC has granted more than 100 early termination requests. Assistant Attorney General (Antitrust Division) Gail Slater has stated that the DOJ has been looking for other ways to speed up the merger review process, as well. FTC Chair Ferguson said that the FTC “must get out of the way quickly” when a merger would not violate antitrust laws, to avoid bogging down innovation and interfering with the free market. These statements stand in contrast with the approach of Biden administration enforcers, which was to try to slow down dealmaking generally.