Takeovers and Tender Offers – Mahon – Spring 2011

I. The Basics

  • A. The Players:
  • The Acquiror
  • The Target
  • Accountants
  • Investment Bankers
  • Large Portion of the deal
  • Will typically pitch potential ideas to interested parties
  • Gives a “fairness opinion” of deal
  • Attorneys
  • Like bankers, play large portion of stewarding the deal
  • Negotiate on behalf of their party
  • Identify and deal with regulatory issues
  • Due Dilligence:
  • The process of assessing the legitimacy of the transaction
  • Acquiror Concern Assess viability of target
  • Target concern Assess value of deal to them
  • Note:
  • The target, unlike the Acquiror, will also assess the potential “Fiduciary Duty” issues, and the duty owed to its minority shareholders
  • It is not uncommong for the BOD of the Target to actually retain their own, independent counsel that solely deals with Fidicuary Duty Concern
  • Issues lawyers should spot during process:
  • 1. Federal Security Laws
  • 2. Tax Implications
  • 3. Anti-Trust
  • 4. State Corporate Law
  • Relevant state (1) Code and (2) Common Law
  • Each state may have nuanced interpretations
  • 5. Industry Specific Regulation
  • 6. Environmental CERCLA liability
  • Note:
  • Deal with this by adjusting price of transaction
  • 7. Overall due diligence
  • B. Reasons for Transactions:
  • 1. Diversify business
  • 2. Horizontal integration
  • Gain the efficiency of size—economies of scale
  • Expand capacity
  • 3. Vertical Integration
  • Move up, or down the supply chain
  • 4. Eliminate Competitor
  • 5. Finding an undervalued asset or business
  • 6. Synergistic Benefits
  • 7. Enter new market
  • 8. Obtain Intellectual property
  • 9. Gain access to human capital (employees) and/or existing client base (customers)
  • C. The Basic M & A Timeline:
  • 1. The Initial Discussion
  • CEOs will meet, discuss potentials and general issues
  • Will lead to:
  • A. Confidentiality Agreement:
  • Determines what portions of the conversation is confidential
  • “All, and all discussion leads to is confidential”
  • Used so that discussion, and information given to attorneys, IBs and others will be either returned or destroyed
  • B. Stand Still Agreement
  • If the company is very worried about sensitive information
  • Will specify what the information is particularly allowed to be used for
  • EG:
  • You cannot use this information for a hostile takeover
  • 2. Letter of Intent (Memo of Understanding)
  • *Non-binding letter, documenting what will generally occur going forward
  • Why: if not binding, it is not disclosable per Securities Laws
  • Discusses what was discussed, and gets continuity, and negotiations moving
  • 3. Retention of Advisors
  • IB, Accountants, Lawyers
  • 4. Due Diligence
  • *The most important part of Attorney’s job
  • Generally will not negatively effect deal (especially for Public Corp., given all disclosures)
  • Note:
  • Even though Public Corps. Have substantial disclosure, and due diligence rarely discovers a ‘deal ender,’ it may affect the price of the transaction
  • What it entails:
  • 1. Acquiror will analyze Target extensively
  • Note:
  • Target will engage in extensive due diligence of:
  • A. Fiduciary concern of minority shareholders
  • B. If paid in Acquiror Stock, analyze Acquiror to assure value
  • 2. Contracts
  • Analysis of those material to the target
  • 3. Security Regulation Compliance
  • 4. Public Filings Compliance
  • Has the Target correctly filed them
  • 5. Environmental Compliance and Liability
  • 6. Employee Benefits
  • Given to specialized attorneys
  • Determining if Acquiror and Target benefit plans mesh
  • “Change of Control”
  • If certain key employees have such agreements, triggered by merger or takeover, may give those employees leverage to get some type of payout
  • 7. Ongoing litigation
  • 8. Property, Plant, and Equipment
  • 9. Patent and IP
  • 10. Debt and its contractual provisions
  • 11. Organizational Documents and Board meeting minutes
  • Note that if bylaws have issue, they are easy to fix
  • AIC issues require shareholder vote
  • Make sure correctly filed with Secretary of State
  • Note:
  • Due diligence is ongoing throughout the process
  • 5. Valuation
  • 6. Negotiation
  • Deal structure, price, and documents
  • The Lawyers Role:
  • a. Articulate, and document the intent of the parties’ on the business related issues
  • b. Advocate for your vlient in the drafting and negotiation
  • c. Continually keep your client informed of the negotiation
  • Constantly advising on the legal issues
  • d. Continued Due Dilligence
  • e. Coordinate and complete the Merger Agreement, and assorted closing documents
  • f. Target:
  • Assure that fiduciary duty issues are in place
  • 7. Prepare Closing Documents
  • Create Final agreement
  • “Time and Responsibility Schedule”
  • Assigns tasks that need to occur prior to closing
  • Assigns responsibility to according parties
  • 8. Get Board of Director Approval for Transaction, and Authority of CEO
  • 9. Shareholder Approval, if required
  • 10. Closing
  • Agenda will list what documents
  • D. Potential Issues in Pricing:
  • Generally:
  • The transaction will take a lot of time to close  “Time Delay”
  • Because this process is long, the price agreed to in negotiation has the potential to change due to the value of the firm or its stock changing in the meantime
  • EG: Stock acquiror shareholder view deal poorly…may dilute them or be bad business…as acquiror stock price decreases, due to selling, now value target receives (assuming stock) decreases
  • Price adjustments assist the process
  • Potential Price Terms:
  • 1. Fixed Exchange Ratio:
  • The ratio of shares the target gets is specifically enumerated in the contract
  • Note:
  • Target bears all the risk of stock price decreasing
  • Acquiror gets predictable exchange rate
  • For these reasons, not the most common
  • 2. Floating Exchange Ratio:
  • Ratio of shares equals a fixed $ amount
  • So, to continue $ amount, the ratio fluctuates to meet it
  • 3. Price Collar:
  • A hybrid of a fixed ratio and a floating ratio
  • The ratio is fixed, but if changes by a certain agreed-to amount:
  • The ratio will shift
  • Post-Closing Adjustments:
  • 1. True Up:
  • The price of the target will adjust based on the balance sheet of the target at closing
  • If the balance sheet is above a certain agreed-to number  Acquiror Pays more
  • If below a certain number Acquiror pays less for firm
  • 2. Earn-Out:
  • If the target is willing to sell, but anticipates the year following transaction to be extremely successful
  • Target is purchased, but based on next-years earnings target shareholders are entitled to certain $ that was agreed to or % of income
  • Typically limited to 1 year
  • 3. Contingent Value Right (CVR):
  • If the target is paid with Acquiror stock, it may also be given a CVR
  • If some agreed-to condition occurs, CVR acts like IOU and payment of money is made to Target
  • EG:
  • Target accepts stock payment and CVR. CVR may entitle Target to cash payment, if acquiror stock drops by X % in certain time

II. Transaction Structures:

  • See Structures Handout
  • Basic Structures
  • 1. The Statutory Merger [DGCL §251]
  • The Process:
  • Acquiror pays shares or cash to Target shareholders
  • Acquiror gets Assets and Liabilities as a matter of law…incorporated into surviving entity
  • Target Dissolves
  • Target shareholders get cash, or are now shareholders of Acquiror
  • Requires Shareholder Vote: A Majority of the outstanding shares of parties in Merger must approve
  • 3 DGCL Exceptions to Stockholder vote in Merger:
  • 1. Small-Scale Merger:
  • Acquiring stockholders are not required to vote if
  • A. their rights are not modified at all and
  • B. Shares are not diluted by more then 1/6 (hold at least 83% post-merger)
  • 2. Upstream or Short-Form Merger:
  • Neither side votes (parent or subsidiary) if:
  • Board of Parent Corporation approves merger and
  • Parent holds > 90% of subsidiary stock
  • Note:
  • If downstream, and subsidiary survives, requires shareholder of parent vote
  • 3. Holding Company
  • Tax Implications:
  • Generally if Cash Transaction  Taxable to Shareholders
  • If Stock transaction  Not taxable
  • Requirements of Board of Directors [§251]
  • 1. Board must pass “Agreement of Merger” citing its approval
  • 2. Statement of Advisability
  • 3. *Best Interest of Shareholder
  • although not required, makes sense…as it appeases any fiduciary duty concerns
  • 4. Submit to Shareholder Vote
  • Again, Majority of all outstanding unless exception applies
  • 5. File Merger Agreement with Secretary of State
  • Stockholders’ Appraisal (Dissenter) Rights [§262]:
  • Generally:
  • the right of stockholders to petition a court to determine the fair value of their shares
  • In merger, target shareholders may be unhappy with the value they received…
  • This, modernly, gives minority shareholders, especially those who are given cash, a defense against being squeezed out unfairly
  • When it Applies in Delaware:
  • Only Applies in Mergers
  • 1. §251 Statutory Merger
  • 2. Short-Form Merger
  • Does not apply to asset sale or stock acquisition
  • “Market Out Exception”
  • Appraisal rights are not applicable to Public corporations who enter into Stock-Swap Merger
  • *Only applies to public corporations if Cash-Merger
  • 3 Requirements:
  • 1. Dissenting Shareholder must have not voted for transaction [Must vote against]
  • 2. Dissenting Shareholder must hold shares from date of demand of appraisal through date of transaction completion
  • The Delaware Process:
  • 1. Corp must notify shareholder of right, 20 days before Corp submits transaction to SH approval
  • 2. Dissenting SH must notify corp prior to vote of intent to dissent
  • 3. If Vote ratified, Corp has 10 days to notify those dissenting shareholders that correctly notified Corp of their appraisal rights
  • 4. SH has 120 days to petition court to demand value determination
  • How is Value Determined:
  • Weinberger v. Weinberger:
  • Determine the Fair value of the shares
  • Does not include speculative value from merger
  • Does include future elements which are capable of proof as of the date of the merger
  • As π, argue that future elements are not speculative…
  • Control Premium
  • The cost to acquire the last remaining shares
  • Dissenting SH argue that their shares are worth more, as they are more wanted…but will be difficult to argue that they deserve premium above that which as paid to already-purchased shares
  • Cede and Co. v. Technicolor:
  • F: 2 step acquisition occurred. Dissenting shareholders held shares through stage 1. Acquiror, post stage 1 but pre-merger began selling pieces of corporation for huge amounts of $, and bettering its efficiency
  • R:
  • Value to Dissenting Shareholder is of the going concern
  • In 2 stage acquisition, pre-merger, value was added to the going concern which was not ‘speculative’ and was proven
  • The added value, pre-step-2-merger, is value that should be included in dissenting shareholder appraisal of share value
  • 2. The Asset Acquisition [DGCL § 271]
  • The Process:
  • Cash or Stock is paid to the Target for Assets
  • Target then gives cash or shares to its shareholders
  • If stock, Target shareholders become shareholders of acquiror
  • Typically: Target then dissolves, shares cancelled
  • Assets & Liabilities:
  • While typically one can negotiate for just the assets, it is possible that the liabilities will also attach
  • De-Facto Merger
  • If a court accepts the argument, it may consider an asset acquisition a De-Facto merger (as it does resemble a merger) and include the A L
  • This is largely in part due to the protection of the creditors
  • So that they are not left with liabilities and no assets
  • Heilbrum:
  • In Delaware, Courts will not recharacterize an asset acquisition as a de-facto merger
  • Acquiror SH can argue
  • If they didn’t get to vote, may protect them
  • Target SH can argue
  • But if substantially all, they did vote
  • Voting Issues:
  • Target:
  • Target SH do not vote, unless §271, the sale involves ‘all or substantially all of the assets’
  • Hollinger v. Hollinger Test:
  • 1. The Sale of Assets quantitatively vital to the operations
  • 2. Substantially effects the existence and purpose of the corporation
  • If unsold portion is substantial, viable, ongoing, portion of corporation then sale is not subject to §271 vote
  • Target SH will probably vote for dissolution of corporation so arguably will have to vote anyway
  • Note:
  • If both votes needed, combine into 1 vote
  • Majority of all votes entitled to be cast
  • Acquiror:
  • Don’t have to vote unless stock-for asset acquisition
  • Certain Exchanges require SH vote, if diluted by > 20%
  • Majority of votes cast
  • Requirements of the Board of Directors:
  • 1. Approve, and “Acquisition Agreement”
  • 2. In the best interest of the corporation
  • 3.* Although not required, get ‘in best interest of the shareholders’
  • 4. Submit to Shareholder Vote, if required
  • Distinction between Merger and Acquisition
  • If applicable, avoiding the shareholder vote
  • Position of target equity holders post transaction (most mergers are stock)
  • 3. The Stock Acquisition
  • The Process:
  • Acquiror deals directly with shareholders of Target
  • Can be for Cash or Stock
  • If all of stock acquired:
  • Target becomes Wholly Owned Subsidiary
  • If >50%:
  • Target becomes Partially Owned Subsidiary
  • Voting:
  • No vote from Target, as they either accept or reject the offer from Acquiror
  • If Shares are paid for stock, Acquiror SH may gain right to vote per Exchange rules
  • If they are diluted by > 20%
  • Distinction from Merger
  • 1. Shields Parent corporation from liability of target
  • It remains subsidiary, and Parent, as SH, has Limited Liability
  • 2. Keeps the Target intact
  • Many contracts are predicated on break-ups, and other clauses
  • By purchasing the stock of a target, and it becoming a subsidiary, it is a cleaner transaction as entity continues
  • 3. Target SH do not vote
  • Acquiror SH do not vote unless exchange rules
  • §203: The Delaware Anti-Takeover Provision:
  • Rule: Prevents “business combinations” between an interested stockholder (owns at least 15%) and the target corporation for 3 years, unless exception applies
  • 3 Exceptions:
  • 1. If Board of Directors pre-approves combination, prior to becoming interested SH
  • 2. Transaction that makes Interested SH, gives himat least 85% of stock
  • 3. Board of Directors approves the business combination after person becomes interested shareholder, and 2/3 of outstanding stock votes for it
  • Other ways around it:
  • 1. Don’t opt in
  • 2. Put in by-laws, and have Board of Directors opt-out
  • This avoids the shareholders voting on the provision
  • Complex Structures:
  • 4. 2-Stage Acquisition
  • The Process:
  • 1. Stock Acquisition
  • Acquiror gains >50% of Target shares, to become partially owned subsidiary
  • 2. Squeeze Out Merger (Cash)
  • Form Subsidiary, and merge Target into subsidiary (avoids liabilities)
  • Effect:
  • 1. Because uses Subsidiary, only Board of Parent votes for merger (not Parent SH)
  • 2. Because owns >50%, votes, as SH of target, for the merger
  • 3. Cash-Merger, squeezes out minority as they hold no equity anymore
  • Why:
  • Speed: Once the stock-acquisition is completed, the acquiror can merge at its convenience
  • Faster then a triangular merger (the corollary to 2-stage) as first stage is faster to complete then regular statutory merger or asset acquisition
  • 5. Forward Triangular Merger:
  • The Process:
  • 1. Create Subsidiary
  • fund it with cash or stock
  • 2. Merge Subsidiary and Target
  • Like regular statutory Merger, stock or shares go from Subsidiary to Target SH, and Target sends A&L to subsidiary
  • Parent BOD approves the merger of its subsidiary
  • Why:
  • 1. Isolates Liabilities from parent
  • 2. Avoids Acquiror SH vote
  • With subsidiary merger, only parent BOD is required to vote
  • 6. Reverse Triangular Merger:
  • The Process:
  • 1. Parent Creates Subsidiary
  • fund with cash or stock
  • 2. Target Merges into the Subsidiary
  • Target continues on and Subsidiary dies
  • Parent corp gets shares of Target
  • Subsidiary sends stock or cash to Target
  • Target now becomes wholly owned subsidiary of Parent
  • Why:
  • 1. Keeps Target intact—avoids dissolution and more clean of transaction
  • 2. Isolates Liabilities from Parent
  • 7. Recapitalization:
  • The Process:
  • Parent Drops down a subsidiary
  • “Downstream Merger” as Parent merges into the subsidiary
  • Parent dies, and subsidiary exchanges new stock to parent Corporation shareholders for A+L
  • Now, former CS and Preferred SH own shares of new-company
  • Vote:
  • Note that SH of merging parties must vote
  • BOD will vote for Subsidiary and
  • SH of Parent will vote
  • Why:
  • Avoid the Preferred shareholder vote if they lack specific voting rights
  • Through the subsidiary, they are then given new shares in exchange for their preferred ones
  • Preferred Shareholders:
  • To protect themselves, their dividends, and cancellation of their rights by merger, Preferred Shareholders should contact for it
  • Elliot Assoc. v. Avatex (DE):
  • 1. If there is contract that allows for vote on the change or alteration of Articles of Incorporation, the elimination of AIC through merger triggers it
  • 2. Any rights, preferences, limitations on preferred stock that are distinguishing must be expressly and clearly stated
  • 3. Rights of Preferred shares are not presumed…creature of contract
  • 8. LBO
  • See handout

III. Acquisition Documents:

  • Preliminary Documents:
  • 1. The Confidentiality Agreement
  • Will broadly define what information is to be kept private
  • Discussion
  • Interview of employees
  • Information generated
  • Will be enforceable as to confidential information, but:
  • Clause will state that does not obligate party to deal or to further negotiate
  • When Closing occurs, there may or may not be information that continues to be confidential
  • Closing documents will supersede this
  • 2. Letters of Intent
  • Following a successful beginning to negotiations, the Acquiror and Target will often enter into LOI
  • Basics:
  • Will indicate nature of contemplated transaction and summarize basic terms—payment, conditions of closing
  • Due Dilligence, Regulatory approval, and other terms
  • Generally, these are made non-binding
  • But—can make it binding with open ended terms…agreeing on the broad terms, with small stuff to be filled in later
  • Even if unenforceable, there may be sub-parts that are made enforceable
  • “No Shop” clauses: prohibiting negotiation with others
  • “Break up Fee”: If negotiations are terminated, for instance, pay a fee of X$, that is not the exclusive remedy
  • AIG v. Alaska Industries Hardware:
  • F: After a letter of intent was made, and it stated that efforts would be made to complete the transaction, an agreement was made and passed around. Acquiror refused to sign. However, he went to final dinner to celebrate, and actions and evidence seemed to show he accepted, although never signed
  • R: In some instances, evidence will bypass a LOI lack of enforeceability
  • Promissory Estoppel:
  • In some cases, this will nullify a need to sign a final document, and mere failure to sign will not be enough to end contract
  • Requires:
  • 1.