The use of a two-step tender offer/back-end merger structure has become increasingly common in large US leveraged buyouts (LBOs). While the single-step statutory merger remains the norm, the two-step structure was used in 38 percent of all-cash large ($500 million+) US LBOs of public companies in 2012, as compared to 18 percent in 2011 and 15 percent in 2010. Why the increasing popularity of this structure? Speed. The deal can close faster, which means more deal certainty for the target and less risk for the buyer of the deal getting jumped by a higher bidder.
Historically, private equity buyers were reluctant to use the two-step structure for two reasons: (i) the “all holders/best price” rule (Rule 14d-10 under the Securities Exchange Act of 1934), which requires the buyer to pay all stockholders the same price per share in the offer, created ambiguity as to whether arrangements with target management (e.g., a post-closing employment agreement) could result in the buyer having to pay a higher price per share to all stockholders than that originally agreed to with the target (on the basis that the target management would receive additional consideration through their post-closing employment arrangement) and (ii) the challenge of obtaining debt financing to pay for tendered shares when the buyer was not certain that the offer would deliver a 100 percent acquisition of the target and, therefore, was not certain to be able to use the target’s assets as collateral for the financing.
In recent years, two developments have addressed these concerns:
First, in 2006, the US Securities and Exchange Commission clarified that the “all holders/best price” rule does not apply to employment compensation, severance or other employee benefit arrangements that meet certain criteria.
[The two-step structure] allows deals to close twice as fast
Second, recent Delaware court decisions (e.g., Joanne Olson v. ev3, Inc. and In re Cogent, Inc. Shareholder Litigation) have approved a target’s issuance of a “top-up” option to a buyer, which, when certain conditions to the offer are met (including a minimum tender condition of at least 50.01 percent of the outstanding shares), allows the buyer to reach the statutory ownership threshold to complete a short-form merger to acquire all of the outstanding shares of target stock, and in turn enables the buyer to use the target’s assets as collateral for the debt financing.
With these impediments removed, the market has observed that the two-step structure, all things being equal, is better for both target and buyer because it allows deals to close twice as fast. In 2011, the mean number of days from signing a definitive agreement to closing the transaction (measured by the closing of the short form merger in tender offer transactions) was 44 days for tender offers vs. 92 days for one-step mergers. (Comparison data for 2012 is not available yet because none of the applicable one-step mergers has closed.) “Twice as fast” means less risk that an adverse event happens between signing and closing to the target’s business (which could give the buyer an “out” depending on how the buyer’s “material adverse change” clause is drafted) or that there are adverse changes to the financing market that could crater the deal (and possibly require the buyer to pay a reverse termination fee to the target, typically around 6 percent of the target’s equity value).
Tender offers also provide an advantage in dealing with stockholder opposition to a transaction. While delay of a stockholder meeting to solicit additional votes in the face of opposition is possible, it is more vulnerable to court challenge. In contrast, a tender offer can easily be extended repeatedly until the minimum tender offer condition is satisfied.
Going forward, the two-step structure should continue to be an attractive option – at least in transactions that do not involve significant regulatory or antitrust issues. We expect it to be used more in the future, to both target’s and buyer’s benefit.
John Pollack and David Rose are M&A partners, and Walker Brierre is an M&A associate, in the New York office of Schulte Roth & Zabel.