TO ANNOUNCE OR NOT ANNOUNCE (THE ENGAGEMENT OF AN INVESTMENT BANK) – THAT IS THE QUESTION…
Dear Deal Guys,
“Wilson or Larry. What is your experience with public companies pre-announcing that they are engaging a banker or are otherwise exploring strategic alternatives when they are really shopping the company? I spoke to my [GC buddy of mine at a public company] and they did this awhile ago, essentially saying we are on the block, but couched it in terms of exploring alternatives, presumably to avoid Revlon. I am used to companies exploring discretely and then announcing once they have signed a def merger agreement and hope they can get a broad fiduciary out and low break fee. I am just curious as to your take on it and experience.”
Curious in Arizona
Dear Curious in Arizona:
We have had a number of pubco clients announce the engagement of bankers (“to explore strategic alternatives”) when the reality of some of those situations was to test the “shopping” waters. Given the many avenues that pubco might take upon the engagement of a banker, the mere engagement of same (absent other statements about shopping the company) is, in our view, not sufficient to create any duties (among board members anyway) akin to those seen in Revlon, etc.
Some additional thoughts: While inking a deal as you have done in the past and then exiting is not uncommon, the “strategic alternatives” method will allow pubco to see what interest is out there while possibly avoiding (i) the initial suitor feeling like a stalking horse (which they should feel like given your broad exit avenue and the low break up fees!), (ii) possibly committing pubco to a particular path (both at a macro level (i.e,, by putting pubco in play) and at a micro level (i.e, identifying specific deal terms, especially if you have to disclose the purchase agreement)), and (iii) a lot of the complexities of getting out of the signed deal.
Yours truly,
The Deal Guys
We wouldn’t be surprised if others had different experiences and opinions on this topic, so we encourage you to email either of us with your two-cents worth.
As we all know, buyers often insist, even after the seller has given 25 plus pages of exhaustive representations, that the seller also add a “full disclosure” representation. Inspired by Rule 10b-5, these provisions typically read something like this:
“No representation or warranty or other statement made by Seller or either Shareholder in this Agreement in connection with the Contemplated Transactions contains any untrue statement or omits to state a material fact necessary to make any of them, in light of the circumstances in which it was made, not misleading.”
Buyers will be very insistent that this representation is standard. Our 4th Annual Deal Points Study (see below for the Study parameters) found, however, that a full disclosure representation appeared in only 64% of 2003 deals. With sellers successfully keeping this representation out more than one-third of the time, buyers’ counsel should not be surprised in 2004 when faced with an emboldened seller claiming that this representation is not necessarily standard operating procedure.
4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).
(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )
Broc is blogging this newsworthy item as our heroes are too busy with their study to blog…
On April 6th, the US Court of Appeals for the DC District issued an opinion finding the SEC’s “cease-and-desist” order against WHX Corporation to be arbitrary and capricious. Some of you may recall that in March 1997, WHX launched a hostile “two-step” tender offer for Dynamics Corporation of America. WHX’s first-step tender offer for 19.9% – just below DCA’s pill threshold – was initially structured to include a “record holder” condition requiring DCA shareholders to be a holder of record on the record date for DCA’s upcoming annual meeting in order to be eligible to tender in the offer.
WHX’s goal was to acquire as many shares as possible with a right to vote at the annual meeting without triggering DCA’s poison pill. At the time, WHX’s lawyer contacted the SEC’s Office of Mergers & Acquisitions on a pre-commencement basis seeking guidance as to whether the proposed record date condition would violate the All-Holders, Best-Price Rule (i.e. Rule 14d-10). Despite the informal advice of a staffer in OM&A that such a condition would violate Rule 14d-10, WHX proceeded to launch its tender offer with the record holder condition intact. After a threat of an SEC enforcement action, WHX amended its offer to eliminate the record holder condition.
During the pendency of the offer, however, the SEC brought action against WHX for alleged violations of Rule 14d-10. An administrative law judge upon hearing the case ruled in WHX’s favor. Ultimately, WHX’s offer was unsuccessful because DCA was acquired by a white knight.
Nevertheless, a year later the SEC proceeded to issue a “cease-and-desist” order against WHX, prohibiting the company from committing or causing future violations of the rule. Here is a copy of the opinion finding the SEC’s action “arbitrary and capricious.” Thanks to Jim Moloney of Gibson Dunn for this fine recap and analysis!
As you know, there is some debate out there in “deal land” as to the value of requiring the other side’s counsel to provide your client with a legal opinion. At the suggestion of one of our readers we decided this year to start tracking in our Study (see below for the Study parameters) the percentage of times that legal opinions were required in transactions. Our 4th Annual Deal Point Study (hot off the presses and just presented at The University of Texas Law School’s Securities and Business Problems Conference in late February) indicates that legal opinions were required of seller’s counsel in 68% of the transactions we reviewed and required of buyer’s counsel in 49% of those transactions. Are we surprised? Not really, and anyone who tells you that opinions are merely standard operating procedure would appear to be blowing the proverbial anecdotal smoke…
Next year, we plan to slice and dice this legal opinion analysis a little more to gauge, for example, the nature of the consideration paid in the transaction. For example (and just one of many), a recipient of equity as a portion or all of the purchase price might be realistic in insisting that purchaser’s counsel provide a legal opinion. Although, as you think about it, because our study is comprised of public acquirers the purchaser could reasonably argue that any opinion their counsel might give is just expensive window dressing to already fairly extensive public information. Conclusion? None. Still, the unsliced and undiced percentages do appear to indicate that legal opinions are not necessarily SOP.
4th Annual Deal Points Study Parameters: We reviewed acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database).
(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )
Here’s something useful on that (in)famous “rule of thumb” commonly used to price common stock in VC deals (compliments of Bart Jealous of American Appraisal Associates, Inc. bjealous@american-appraisal.com ):
“The below comes Gerry Mehm, the head of our Financial Valuaton Group in our San Francisco office. Let me know if you have any questions.
The Venture Capitalists in Silicon Valley have historically used the 10-to-1 ratio of preferred to common stock values when companies did their first round of financing. That is, money was raised by pricing the A Preferred at $1.00 per share, and options to purchase common stock would be granted to the founders and key employees with a strike price of $0.10 per share. But as the company progressed, the subsequent rounds of preferred stock are typically sold at higher prices ( $2.00, then $5.00, then $10.00, etc.), and the ratio of preferred to common would then be decreased from the 10-to-1 to 5-to-1 to 2-to-1, until the shares all had the same value at the IPO date (equal to the IPO price).
This “rule of thumb” was criticized by the SEC at the height of the high-tech IPO market in 1999. Companies were routinely required to record stock-based compensation expenses in their S-1 filings if they simply employed the rule of thumb. The analysis we performed was based on reviews of the S-1 filed at the time by comparable companies. That is, we pulled data on the capitalization history of the comps, and prepared tables showing the overall money raised, the ratio of values to money raised, and the ratio of preferred to common stock values which the SEC accepted. We then built tables showing how the client’s value would increase as more money is raised and spent on development. It was a “softer” valuation than one for a mature company with public comparables, but at the time it addressed most of the questions raised by auditors and the SEC.
The issue today would be to find good comps who have gone public recently, since the IPO market has been so weak. But I would continue to use this type of analysis rather than simply the rule of thumb you refer to.”
Best regards,
Bart Jealous
Vice President-Principal
American Appraisal Associates, Inc.
OK, all those who’ve faced a sell side ROFR -and like it – raise your hands. My guess is that I won’t see many hands, and you certainly won’t see mine.
All to often, our clients are too willing to give ROFR to buy a business without truly understanding the negative effect it may have on the their ability to maximize value in a sale. I’m really thinking about those “Trojan Horse” ROFRs that innocuously appear in transactions like licensing, supply, outsourcing, or corporate VC-backed deals.
In my experience, ROFRs in the M&A context is a poster child for the Law of Unintended Consequences. Let’s say you want to sell the business that’s subject to a ROFR. So finding a stalking horse isn’t so tough because it’s done all the time in sales under Section 363 of the Bankruptcy Code?
Ive found it’s a little tougher outside of bankruptcy, especially if target’s distressed or not particularly a belle-of-the-ball. To begin with, it just isn’t that easy to find a buyer who’s willing to devote the time, money, and effort to give seller a written binding and unconditional offer – without demanding a huge breakup fee and open-ended expense reimbursement. (Of course, there’s always that famous “hello fee” that buyout funds get for taking a look at a deal).
If you’re under pressure to sell the company and timing’s critical, don’t be surprised if all you can get is an LOI that’s subject to gaping walk rights like due diligence, financing, and even, board and shareholder approval (notwithstanding the fact that buyer may be closely held and you’re dealing with the CEO who controls the vote!).
You next send it off to the holder of that ROFR. Did the lawyer who negotiated the ROFR in the context of that supply agreement bother to add simple things like a short time frame under which the ROFR holder (“ROFR’er”) has to take the deal or that the ROF’er had to match or top all the terms of the offer. Does the match have to be identical or can the ROFR’er play horseshoes? How much of a modification of the stalking horse offer will trigger a new ROFR period? I could go on but it’s only re-living past painful memories.
The worst part is that ROFR’er could “match” the bid but is only interested in driving away the stalking horse so ROFR’er could re-trade the deal as the sole bidder. Is the ROFR’er required by contract or common law to deal in good faith? So many questions, so few answers…
I don’t know about anyone else but if I’m on the potential sell-side, I always resist requests for ROFRs and try to educate the client to watch out for those “Trojan Horses.” If I have to give one, then it’s much better to give a right-of-first-offer. Of course, if I’m on the ROFR’er side, I like the leverage that a ROFR creates so I always think it’s an inifinitely reasonable request that, errrrr, “Ive never seen anyone have a problem with giving.”
In a recent conference call, opposing counsel’s rather unimpressive “negotiating voice” served up a vivid reminder that delivery is almost as critical as the message.
Yep, I’m talking about those tell-tale signs in someone’s voice that telegraphs weaknesses in one’s positions and otherwise emboldens the sharks who smell blood. With so many of our negotiations being conducted over the phone, it reminded me that I must be really careful of how I sound to the other side (in fact, after this particular conference call, I authorized my colleague to shoot me if I ever stuttered like our poor opposing counsel).
In my typical stream-of-consciousness rambling, I thought I’d throw out some “deadly sins” that can turn an otherwise competent deal lawyer into a deal-killer (all of which I’m sure I’m guilty of — many times over):
1. (Intentional) Stuttering and other Mental Stall Tactics. No, I’m not making fun of people who have a real speech impediment. I’m talking about otherwise eloquent lawyers who subconsciously stutter in negotiating sessions. Ever caught yourself saying “I-I-I…” just to buy some time to formulate your thoughts? Sure, you may be nervous or not entirely sure of your position, but why would you want to possibly send a message that’s interpreted by the other side that you’re either (i) unprepared; (ii) – or worse- don’t know what you’re talking about; or (iii) – even worse – have no conviction in your or your client’s position? Even worse are the negotiators who stutter intentionally as a matter of style. I recall a colleague at my old firm who learned his trade from a partner who stuttered because he naturally stuttered. The junior lawyer- who otherwise was very well spoken – switched into his stutter-style whenever he started negotiating with opposing counsel. Little did junior lawyer know that he was probably encouraging the other side to be more aggressive. Have you ever thought: “OK, it doesn’t sound like he’ll stick to that position, let’s just hammer a little more?” Lesson: hesitancy in your voice kills.
Errr, I-I-I will continue – ummm – rambling – ummmm– on this topic –ummmm– next blog. Better yet, if you have any anecdotes to share on this, email me at wilson.chu@haynesboone.com.
Thanks to IRS tax-shelter regs imposed mid-last year, we deal lawyers were begrudgingly modifying confidentiality provisions of most agreements, including acquisition related agreements, exclude certain tax-related matters. Under those regulations, participation in a “confidential transaction” resulted in reporting and record-keeping requirements. To avoid these burdens, parties were being advised to expressly authorize disclosure of tax treatment and tax structure.
GOOD NEWS!! On December 29, 2003, the IRS issued new regulations that significantly change what is considered to be a “confidential transaction” for these purposes. Under the new regulations, the definition of a “confidential transaction” is limited to transactions in which an advisor who is paid a significant fee places a limitation on disclosure of the tax treatment or tax structure of the transaction. Confidentiality obligations that are imposed solely by the parties to a transaction will not cause a transaction to be a “confidential transaction” for purposes of these regulations. There is some uncertainty about how these new rules will be applied to transactions in which a participant is both an advisor and a principal, such as certain financial transactions in which a commercial bank or investment bank is both an advisor and a party to the transaction.
These new regulations are effective for transactions entered into on or after December 29, 2003, and they may also be relied on for transactions entered into on or after January 1, 2003 and before December 29, 2003. Accordingly, the tax confidentiality carve-out language that had become standard in commercial agreements is generally not needed. In addition, the failure to include the language (or the inclusion of ineffective language) in prior agreements should not have any adverse consequences.
Thanks to Vicki Martin, tax partner at Haynes and Boone, for this guest blog.
With the dawn of a new year Wilson and I find ourselves in the middle of preparing the next installment (this year’s being the 4th…my how time flies when you’re reviewing documents) of our annual M&A Deal Points Study. As such, we would like to take this opportunity to solicit suggestions from you as to any particular area(s) you would like for us to review and include as part of this year’s Study. Those familiar with the Study will remember that we examine acquisition agreements relating to public company acquisitions of private companies with transaction values of between $25M and $150M (pulled from the LiveEDGAR M&A Database). For those of you who are not aware of the Study (which we lovingly refer to as the “BS Detector for the M&A Sector”) and would like a complimentary (i.e., FREE) copy, please email Wilson or me (wilson.chu@haynesboone.com or lglasgow@gardere.com ).
Yes, we’re still alive and will resume blogging with reckless (good thing this blog can’t be construed as legal advice – I hope) abandon after the first of the year. I hope everyone is having a great holiday break and I extend our best wishes for a banner, deal-crazy 2004!