ATTORNEY: OFER GANOT
Pomerantz Monitor, January/February 2014
In a previous issue of the Monitor, we discussed potential problems the combination of certain “deal protection devices” may cause for shareholders wanting to receive the most they can get for their stock when their corporation receives an acquisition offer.
In most merger transactions, the party making the offer wants to lock up the transaction as tightly as possible. The offeror, after all, has just finished negotiating the deal, usually after a long and expensive process of due diligence, and does not want its offer to be just the opening of an all-out bidding war with competing bidders. Offerors therefore typically condition their offer on the target agreeing to limit its ability to consider other offers.
On the other side of the table sits the target company’s board of directors, which has fiduciary duties to the target company and its public shareholders. Among those is the duty to maximize shareholder value if the company is sold, and, to that end, to keep itself as free as possible to consider (or even to seek out) superior offers, should they be made (through what are known as “fiduciary out” provisions).
This conflict is usually resolved through the adoption of multiple deal protection devices which are incorporated into the merger agreement between the target company and buyer. These devices can include, among other things, “no solicitation” provisions which restrict the target’s board of directors from soliciting and negotiating potentially superior offers; “matching rights” which essentially give the buyer a leg-up over any potential bidder, allowing it to match any superior offer made for the target company; and termination fees which require the target company to pay a significant amount (usually ranging between 3% and 4% of the total value of the transaction) to the buyer in the event the target’s board decides to pursue a superior offer.
Sometimes the target’s board will negotiate what is known as a “go-shop period,” which is a period of time, usually between 30-45 days, during which the target’s board of directors is allowed to actively solicit superior offers from potential bidders without breaching the “no solicitation” mechanism.
But there is an inherent flaw in this mechanism, which in most cases does not turn up any superior bids. More often than not, go-shop provisions are negotiated in lieu of a pre-signing market check. This usually happens when the buyer pressures the target’s board to accept its bid in a short period of time. The board, afraid that any delay may thwart this opportunity, may choose to skip a market check – a process that takes time – and instead enter into a merger agreement with the buyer, leaving itself the theoretical possibility of potentially securing a better offer after the deal with the buyer is already agreed upon and publicly announced.
However, at that point, the target’s board has already approved the deal with the buyer, including the consideration to be paid for the target’s common stock. This acceptance by the target’s board sometimes leads to a number of insiders (including board members) entering into voting and support agreements pursuant to which they agree to vote their shares in favor of the deal with the buyer, and against any other deal.
Moreover, the go-shop mechanism doesn’t necessarily neutralize the other deal protection devices in place including, without limitation, the termination fees and matching rights. This means that any potential bidder who is now interested in making an offer for the target company must assume significant time and expense just to be able to make a superior offer, knowing that the buyer can always simply match the bidder’s offer. Such potential bidder will also have to work harder to secure a majority supporting its offer, in light of any voting or support agreements entered into by target insiders. Even if the buyer chooses not to match, the new bidder must, directly or indirectly, incur the termination fees, thereby increasing even further the cost of such a transaction.
It is no surprise, then, that the go-shop process usually produces zero competitive bids for the company. The hoops potential bidders must jump through are usually just too many, and they usually go on to search other opportunities, potentially leaving money on the table instead of in the target’s shareholders’ pockets. As a result, go-shop provisions are often dismissed as “too little, too late.”
It should therefore be shareholders’ preference that a company undergo a significant and meaningful pre-signing market check, or outright auction, rather than negotiate a post-signing go-shop. Bidders are far more likely to materialize if the target hasn’t already signed a deal with someone else. Target boards have to weigh the risk that the offeror will walk away, with the risk that they will be foregoing possibly better offers. In other words, directors have to decide whether a bird in the hand is really better than two in the bush.