Every so often the Delaware legislature adopts a change to the Delaware General Corporation Law (DGCL) that has far-reaching consequences in the practice of mergers and acquisitions. Everyone in the deal community, and especially those in the private equity world, should be tracking an anticipated amendment to the DGCL that will make acquisitions structured as tender offers more inviting. The amendment will greatly simplify the deal process once a bidder acquires more than 50% of the outstanding shares of the target by permitting the use of a short-form, squeeze-out merger to acquire the remaining shares, without a stockholder vote. Under current law, a bidder must reach a 90% threshold in order to consummate this type of squeeze-out merger. Last year, less than 40% of large ($500 million +) U.S. LBOs of public companies were effected via tender offer. We expect this number to increase significantly upon adoption of the amendment.
The Benefits of Two-Step Tender Offers
As is commonly known, a tender offer followed by a back-end merger provides acquirers of public companies with several advantages as compared to one-step, long-form mergers, accelerated timing being chief among them. The primary reason for the timing advantage is that a bidder does not need to file the disclosure documents with the SEC prior to launch of a tender offer, whereas the acquirer in a one-step merger must pre-file a proxy statement, often wait 30 days or more for SEC comments, then provide responses and sometimes rinse and repeat several times. Once the review process is over, a merger proxy must be mailed to stockholders at least one month in advance of the stockholder meeting. By comparison, once launched, a tender offer is required to remain open for just twenty business days, and the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, which is generally thirty days, is shortened to only 15 days. Thus, a successful bidder in a tender offer can usually acquire control of a target in a little over a month, whereas a typical one-step merger can take three or four months, during which time the pending transaction is exposed to competing bidders who can disrupt or derail the deal. Other risks, such as those associated with financing and MAE, can be eliminated in the two-step structure if the back-end merger can be closed at the same time as the tender offer.
Another benefit of the tender offer structure is that the disclosure documents are generally less burdensome to prepare than a proxy statement. For instance, full audited financial statements of the target are required in a proxy statement, but are not typically required in a tender offer where the consideration is all cash. Not surprisingly, this faster and more streamlined process also tends to result in lower transaction costs.
So What’s the Rub?
You may now be asking yourself why anyone would ever choose the one-step merger structure. Well, the answer is that, historically, there was a real stumbling block with the tender offer approach, which was the need to acquire at least 90% of the outstanding shares in order to effect a second-step, short-form merger to squeeze out the remaining stockholders of the target. This can be a difficult threshold to reach even in a deal with broad stockholder support due to the fact that it is often hard to get the attention of retail stockholders, never mind that achieving such a high threshold can be quite challenging where there is any stockholder ambivalence about the deal. If a bidder does not reach the 90% threshold, it then has to proceed with all of the steps that would have been needed to effect a long-form merger, including filing a full proxy statement and calling a stockholder vote, which of course results in an even longer transaction timeline than if the parties had simply begun with a long-form merger. And it is all somewhat meaningless because the bidder will have already obtained control of the target (and thus the stockholder vote) through the tender offer, so the outcome of the second-step merger is a foregone conclusion.
Despite the benefits of speed and lower costs, private equity buyers, unlike strategic acquirers, have often been reluctant to pursue two-step financed acquisitions of public companies due to concerns relating to the federal margin rules, which prohibit loans to a shell acquisition vehicle if directly or indirectly secured by margin stock with a value in excess of 50% of the amount of the loan. If the sponsor was able to close the back-end merger simultaneously with the closing of the tender offer by reaching the 90% threshold, the loan would not be deemed secured by margin stock, but rather by the assets of the surviving company. But if it did not reach the 90% threshold, and thus had to pursue a long-form back-end merger, the sponsor would run a real risk of violating the margin rules, because the margin stock would be the only available collateral for the loan. Although some workarounds have been developed over time, they present a number of complications and are not available in all circumstances.
While tools such as top-up options and dual track structures have been developed to mitigate some of the issues presented by the tender offer approach, they are clunky and imperfect. A top-up option allows the bidder to buy shares directly from the target in an effort to “top up” the bidder’s post-tender offer ownership to 90%. However, because of the way the math works, the target may not have enough shares authorized under its charter to move the needle significantly. For example, if a bidder in a tender offer obtains 70% of the outstanding shares at the completion of the offer, the target would need to issue to the bidder twice as many shares as the total outstanding in order for the bidder to reach the 90% threshold. See “The Tender Offer Returns: What Does It Mean for Private Equity” in our Winter/Spring 2007 issue and “Speed is King: Pointers and Pitfalls on Sponsor-Led Tender Offers” in the Spring 2011 issue for background on the use of tender offers by sponsors.
In a so-called dual track structure, the bidder runs a tender offer and a one-step merger process in parallel, so that if the 90% threshold is not reached, it can drop the tender offer in favor of a one-step merger process that is already well along. However, there are, of course, incremental costs to this approach, and it is not clear that the SEC is fully comfortable with it. Moreover, this structure will obviously not allow the bidder to gain control of a target as quickly as a tender offer followed by a short-form merger in the event that the 90% threshold is not reached.
Section 251(h) to the Rescue
Many of these issues would be swept away by proposed Section 251(h) of the Delaware General Corporation Law, which is expected to be adopted and made effective as of August 1st of this year. If adopted, a bidder for a public Delaware corporation would be able to consummate a short-form merger without a stockholder vote if the following criteria are met:
- the bidder completes a tender offer for any and all outstanding stock, and following completion, holds at least the number of shares required to approve a merger (a majority of the outstanding shares, unless the target’s charter specifies a higher threshold);
- the merger agreement expressly provides that the merger will be governed by the new rule and that the back-end merger will be effected as soon as practicable following the completion of the tender offer; and
- the bidder is not an “interested stockholder” under Delaware law, which generally means that the bidder does not already own 15% or more of the target’s stock.
Thus, Section 251(h) would allow a sponsor to launch a financed tender offer conditioned on valid tenders of only a majority of the target’s stock without worrying that the margin rules would prevent it from closing the offer if it cannot reach the 90% threshold. The new rule would therefore help level the playing field for sponsors competing for assets with strategic buyers and make tender offers a more attractive acquisition structure generally.
Have We Seen the Last of One-Step Mergers?
Adoption of the new rule does not mean, however, that tender offers will all of a sudden become the weapon of choice for sponsors in all circumstances. For one thing, by its terms, Section 251(h) would not be available to buyers who own, together with their affiliates, 15% or more of the target. This limitation could have consequences in particular in the context of a management buyout where management and the bidder together hold more than 15% of the target’s stock. In addition, where lengthy periods of time may be required to obtain regulatory approvals, tender offers do not provide much, if any, benefit to the bidder, since the deal cannot close within the twenty business-day period in any event.
Indeed, in a deal where a long period between signing and closing is expected (either due to regulatory reasons, holiday financing blackouts or otherwise), a one-step merger may be preferable to a tender offer. A tender offer would need to be extended again and again until regulatory approval was finally obtained permitting the bidder to close the offer. During that extended period, stockholders who tender would continue to have the right to withdraw their shares at any time, allowing more time for interlopers or activists to appear. By contrast, there is no such need to wait to conduct a stockholder vote, which, if successful, would effectively cut off any further opportunity for a third party to upset the deal or for the stockholders to change their minds, as the “fiduciary out” would fall away at that point. The deal could then close as soon as regulatory approval is obtained.
Another timing concern relates to the acquisition financing itself. It may simply not be feasible to complete the contemplated financing process within the twenty business-day period that the tender offer remains open, particularly where the financing is marketed. However, it may well be possible to complete the process within a period that is shorter than the 2-3 months required for a one-step merger process. In this case, the parties might pursue a tender offer, but negotiate the circumstances under which the offer is automatically or voluntarily extended to accommodate the financing. While an abbreviated transaction timeline may limit the buyer’s ability to manage entry into the financing markets, even with a long-form merger there is often a limited window in which to conclude the marketing period (unless the financing is closed into escrow, which presents its own complications and costs).
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Ultimately, Section 251(h) will go a long way in making tender offers a more attractive deal structure for private equity buyers of public Delaware companies. However, sponsors should not discard long-form mergers from the toolkit altogether as regulatory approvals and financing considerations may make that old standby preferable in certain cases