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Mergers and Acquisitions
Delaware Passes Amendments to Delaware’s Corporate Law to Override Judicial Precedents and Simplify Corporate Governance in M&A Transactions.
Changes to the Delaware General Corporation Law (“DGCL”) were signed into law last week by Governor John Carney. SB313 will now take effect on August 1, 2024, and will apply retroactively to all agreements (including merger agreements) made by a Delaware corporation and all agreements and instruments approved by the board of directors of a Delaware corporation, except for the agreements and board action in pending litigation on or prior to August 1, 2024. These changes were in response to several Delaware Chancery Court (“Court”) rulings affecting stockholder agreements, merger agreements and corporate governance requirements applicable to merger transactions. The amendments propose a legislative override over recent decisions to implement changes that allow for greater freedom of contract for stockholder and merger agreements and the elimination of technical, seemingly non-material governance requirements applicable to merger transactions. A new DGCL § 122(18) permits corporations to convey the rights to consent and approval of corporate action to persons through stockholder agreements unless such conveyance is specifically prohibited by the corporation’s certificate of incorporation. This amendment nullifies the recent decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. where the Court found a stockholder agreement requiring the majority stockholder’s approval for certain corporate actions “an impermissible internal governance restriction” in violation of DGCL § 141. Addressing the Court’s finding of a violation of DGCL § 251(b) when the board approved a draft version of the merger agreement in Sjunde Ap-Fonden v. Activision Blizzard, Inc., the new DGCL § 147, eliminates the requirement for board approval of the ‘final form’ of agreement if, at the time of approval, all of the material terms are determinable through information and materials presented to or known by the board, and second, the new DGCL § 268(b) clarifies that disclosure schedules and the like are not required to be a part of the merger agreement for board approval pursuant to DGCL § 251(b). Doubling up on the results of Activision, in response to the Court’s finding of a violation of DGCL § 251(c) where the corporation had included a brief summary of the merger agreement in the proxy statement sent with a separate notice to the stockholders that did not include a brief summary of the merger agreement, a new DGCL § 232(g) allows a corporation to satisfy the stockholder notice requirement for a merger agreement when such agreements and brief summaries are “enclosed with the stockholder notice or annexed or appended to the notice.” A third byproduct of the Activision decision, a new DGCL § 268(a) allows a board to approve and file a certificate of incorporation of the surviving corporation of a merger following the effectiveness of the merger if the surviving entity will be wholly-owned and controlled by the buyer and all of the shares of capital stock of the constituent corporation issued and outstanding immediately before the effective time of the merger are converted into or exchanged for cash, property, rights or securities (other than stock of the surviving corporation). In Crispo v. Musk, the Court denied a stockholder plaintiff’s claim for lack of standing where the plaintiff sued for ‘lost stockholder premium’ damages despite a provision in the merger agreement that specified that the buyer would be liable for ‘lost stockholder premium’ in the event buyer breached the merger agreement. DGCL § 261(a)(1) specifically allow parties to a merger agreement to include provisions requiring the payment of penalties and ‘lost stockholder premiums’ in the event the merger is not consummated and allow parties to enforce these payment provisions. New DGCL § 261(a)(2) confirms that the stockholders of a constituent party to a merger agreement may irrevocably appoint one or more persons to serve as a representative of all stockholders and delegate to such person the exclusive authority to enforce the rights of all stockholders under such agreement, after consummation of the transaction as an agent of the stockholders of the constituent corporation whose shares are canceled and converted in the merger into the right to receive cash or other property, and to enter into a binding settlement on behalf of all shareholders, a principal of corporate law. Seemingly, this amendment codifies stockholder representative authority articulated by the Court in Aveta Inc. v. Cavallieri, where the Court found that the stockholders were bound to the results of a post-closing adjustment and subsequent arbitration decision when the stockholders appointed a stockholder representative to represent the stockholders and the representative utilized facts ascertainable outside the merger agreement to derive post-closing adjustments on behalf of all stockholders using a calculation method clearly and expressly set forth in the merger agreement and subsequently pursued the final determination through the use of a neutral arbitrator.
July 25, 2024
Business
Compensation of Target Management Teams in Private Equity M&A
The typical private equity-sponsored buy-out includes the seller’s investment in the future growth of the target company’s valuation, a bargain for the participant’s active participation in the target company and buy-in for success. The customary approach for private equity buyers is to convey equity participation through equity-based incentive plans. There is a lot of appeal for both buyers and sellers to entertain deal structures with an equity-based compensation component to satisfy cash flow requirements, participant commitment and the creation of a common goal in the success of the target company. Both parties should be aware of the complexities associated with equity compensation which can present some disadvantages that are not discovered until after closing. Common forms of modern equity compensation include stock, stock options or warrants, profit participation and stock appreciation rights (and the limited liability company equivalents thereof). Each type of equity compensation has its own unique advantages to buyers and participants as well as potential negative consequences for both. Many of these structures are chosen over other structures for their total cost considerations and legal features that meet the operative requirements of the buyer. Both buyers and target management should factor these cost considerations and legal features in their offer and acceptance of this compensation. At a high level, here are a few of the considerations applicable to most all equity-based compensation schemes: With few exceptions, all equity-based compensation schemes have restrictions and conditions imposed on their receipt, retention, exercise and disposition. These limitations serve to align compensation with the long-term company performance requirements with the ability to mitigate against short-term behaviors. The most common restriction is a restriction on a participant’s resale of the equity-based compensation, making the opportunity unique only to the participant. A follow-on close-second restriction is the issuer’s right to ‘claw back’ or repurchase the equity compensation at the same or lesser value than its original valuation, a mechanism that aligns equity ownership with a participant’s active engagement. The common ‘management rights’ conveyed to institutional investors are commonly omitted in private equity-backed equity-compensation plans, including transactions for roll-over equity, to limit participant involvement and visibility of management discussions and information utilized by the company. Statutory rights are the minimum threshold and commonly the norm. Economic participation can come in the form of quarterly payments, annual payments, one-time payouts upon sale and the allocation of profit and loss. For private-equity sponsored plans, economic participation can have a minimum valuation threshold that the target must achieve and with exception to allocations, they are most-commonly limited until the target company’s liquidity event, which can be years later. Liquidity events include IPOs, sales and sometimes recapitalizations. Tax implications of equity-based incentives can vary between the types of equity-compensation conveyed. Synthetic forms of equity-compensation are typically taxed as income whereas traditional forms of equity ownership have capital gains treatment upon disposition. These tax consequences can occur at the time of conveyance, at vesting or disposition. For tax purposes, company and participant interests are not always aligned. Private equity buyers intend to provide value with the implementation of equity compensation plans. Each type of equity compensation has its own features, making it advantageous in some circumstances and not so in others. Firms frequently roll out an enterprise equity compensation plan that utilizes the same type of equity compensation plan throughout their portfolio to allow for a familiar and efficient form of management. Plans can vary greatly between different firms and participants can find distinctive and meaningful differences between plans although much of these distinctions remain unknown to would-be participants and are not discernable during the due diligence phase of a transaction.
July 3, 2024
Business
A Look at the U.S. Private Equity Middle-Market
There is some good news to report in the Private Equity (PE) world. PitchBook has released its US PE Middle Market Report, showing continued YoY growth for middle-market dealmaking in Q1 of this year. PitchBook cites recovery of deal multiples, an improvement in borrowing costs and a focus on selling the best assets as key features in publicized transactions. Here are some of the key findings from the report: Deal Values Are Up, Deal Count is Flat: PE middle-market dealmaking hit an all-time high in 2021 of $502.5 billion. It is no surprise that number was down last year by 36.8%, but PitchBook data shows a stabilization trend in recent quarters that started with the burst of activity we saw in Q4 2023 and continued into Q1 of this year. The Q1 numbers are not as strong as Q4, but they are ahead of Q1 2023 in terms of deal value. Deal count, however, remains flat. A Lack of Sellers: The report notes that a lack of PE sellers is impacting recovery in the volume of M&A transactions. PE sellers are focusing on bringing only their most attractive assets to the table and holding off on the rest. PitchBook notes that in order for dry powder to be deployed more quickly, the volume of sellers in the market needs to increase, especially in the middle-market. Decline in Buyouts: Overall, Pitchbook notes that buyouts were hit hard in 2023, but middle-market buyouts fared better, with only an 18.9% decline in deal value and a 4.0% increase in deal count. For Q1 2024, PitchBook notes that in Q1, buyouts across the board were relatively unchanged in value and slightly higher in volume YoY. Borrowing Costs Coming Down: PE borrowers are seeing some positive movement in terms of lending, with PitchBook pointing out competition between private credit lenders and bank-led syndicates as driving a decrease in borrowing costs. Their data shows that overall spreads were down by 54 basis points in Q1. Firming Trend on Multiples: Data also shows a “firming trend” for the middle market in terms of multiples. The report states, “The median EV/revenue multiple on middle-market PE deals for the TTM ending Q1 2024 rose to 2.2x, up from 2.0x as of Q4 2024. The median EV/EBITDA multiple recorded an even stronger bounce to 12.7x from 11.0x for the TTM ending Q1 2024 and Q4 2023, respectively.” These are just some of the key findings from this report, but they give us an overall idea of the health of the middle-market today. It will be interesting to see if an increase in sellers increases the deployment of dry powder. The report’s authors think this is the key to a rally in activity, so it is certainly something everyone will be watching closely.
June 26, 2024
Business
New Legislation to Override Judicial Precedents and Simplify Corporate Governance in M&A
Changes to the Delaware General Corporation Law (“DGCL”) were recently introduced to the Delaware General Assembly in response to several Delaware Chancery Court rulings affecting stockholder agreements, merger agreements and corporate governance requirements applicable to merger transactions. Introduced last month, SB313 imposes a legislative override over recent decisions to implement changes that allow for greater freedom of contract for stockholder and merger agreements and the elimination of technical, seemingly non-material governance requirements applicable to merger transactions. A new DGCL § 122(18) would permit corporations to convey the rights to consent and approval of corporate action to persons through stockholder agreements unless such conveyance is specifically prohibited by the corporation’s certificate of incorporation. This amendment nullifies the recent decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. where the Court found a stockholder agreement requiring the majority stockholder’s approval for certain corporate actions “an impermissible internal governance restriction” in violation of DGCL § 141. Addressing the Court’s finding of a violation of DGCL § 251(b) when the board approved a draft version of the merger agreement in Sjunde Ap-Fonden v. Activision Blizzard, Inc., a new DGCL § 147, would eliminate the requirement for board approval of the ‘final form’ of agreement if, at the time of approval, all of the material terms are determinable through information and materials presented to or known by the board, and second, a new DGCL § 268(b) would clarify that disclosure schedules and the like are not required to be a part of the merger agreement for board approval pursuant to DGCL § 251(b). Doubling up on the results of Activision, in response to the Court’s finding of a violation of DGCL § 251(c) where the corporation had included a brief summary of the merger agreement in the proxy statement sent with a separate notice to the stockholders that did not include a brief summary of the merger agreement, a proposed DGCL § 232(g) would allow a corporation to satisfy the stockholder notice requirement for a merger agreement when such agreements and brief summaries are “enclosed with the stockholder notice or annexed or appended to the notice.” A third byproduct of the Activision decision, a proposed DGCL § 268(a) allows a board to approve and file a certificate of incorporation of the surviving corporation of a merger following the effectiveness of the merger if the surviving entity will be wholly-owned and controlled by the buyer and all of the shares of capital stock of the constituent corporation issued and outstanding immediately before the effective time of the merger are converted into or exchanged for cash, property, rights or securities (other than stock of the surviving corporation). In Crispo v. Musk, the Court denied a stockholder plaintiff’s claim for lack of standing where the plaintiff sued for ‘lost stockholder premium’ damages despite a provision in the merger agreement that specified that the buyer would be liable for ‘lost stockholder premium’ in the event buyer breached the merger agreement. A newly proposed DGCL § 261(a)(1) would specifically allow parties to a merger agreement to include provisions requiring the payment of penalties and ‘lost stockholder premiums’ in the event the merger is not consummated and allow parties to enforce these payment provisions. New DGCL § 261(a)(2) confirms that the stockholders of a constituent party to a merger agreement may irrevocably appoint one or more persons to serve as a representative of all stockholders and delegate to such person the exclusive authority to enforce the rights of all stockholders under such agreement, after consummation of the transaction as an agent of the stockholders of the constituent corporation whose shares are canceled and converted in the merger into the right to receive cash or other property, and to enter into a binding settlement on behalf of all shareholders, a principal of corporate law. Seemingly, this amendment codified stockholder representative authority articulated by the Court in Aveta Inc. v. Cavallieri, where the Court found that the stockholders were bound to the results of a post-closing adjustment and subsequent arbitration decision when the stockholders appointed a stockholder representative to represent the stockholders and the representative utilized facts ascertainable outside the merger agreement to derive post-closing adjustments on behalf of all stockholders using a calculation method clearly and expressly set forth in the merger agreement and subsequently pursued the final determination through the use of a neutral arbitrator. This Act requires the affirmative vote of two-thirds of the members elected to each house of the General Assembly. If passed, these changes will become effective on August 1, 2024, and retroactively applied except for any civil action completed or pending on or before such date.
June 20, 2024
