Latham & Watkins: Delaware Merger Statute Facilitates Private Equity Tender Offers: New Section 251(h)
Private equity buyers will welcome new amendments to the Delaware General Corporation Law (DGCL), which became effective August 1, 2013, intended to streamline the tender offer structure for negotiated acquisitions of public companies. Tender offers historically have been challenging for private equity buyers due to the potential delay arising from the risk that stockholder approval of the second-step merger would be required after the tender offer. This potential delay necessitates “bridge” financing to fund the purchase of shares in the tender offer, which must be arranged without access to credit support from the target company or its assets until the merger. Due largely to the cost and risk associated with this bridge financing, private equity buyers typically have been unwilling to use a tender offer structure, absent certainty that the parties will achieve the 90% ownership threshold necessary to complete a short-form merger immediately after closing the tender offer.
New Section 251(h) of the DGCL reduces the threshold necessary to effect a short-form merger immediately after the closing of the tender offer (in most cases to a simple majority), eliminating the need for tender offer bridge financing, if all of the following conditions are met:
- The target is a Delaware corporation whose shares are listed on a national securities exchange or held of record by more than 2,000 holders.
- The merger agreement expressly provides that the merger will be governed by Section 251(h) and will be effected as soon as practicable after consummation of the tender offer.
- The buyer consummates a tender offer for any and all of the target’s outstanding shares that would otherwise be entitled to vote on the adoption of the merger agreement.
- Following consummation of the tender offer, the buyer owns at least the percentage of shares (typically, a majority) that otherwise would be required to adopt the merger agreement.
- At the time the target’s board approves the merger agreement, no other party to the merger agreement is an “interested stockholder” (as defined in Section 203(c) of the DGCL) of the target.
- The buyer entity consummating the offer merges with or into the target pursuant to the merger agreement.
- The outstanding shares of the target not purchased in the tender offer (or otherwise cancelled in the merger) are converted in the merger into the same amount and kind of consideration paid for shares accepted in the tender offer.
Section 251(h) is not the optimal structure for all transactions, however, and private equity buyers should be particularly cautious in the following two situations:
- A buyer owning 15% of the target company cannot use Section 251(h) because the buyer is an “interested stockholder”. In addition, a buyer may be deemed to be an “interested stockholder” if the buyer enters into customary support agreements related to the transaction with existing stockholders that together hold 15% of the target company. In this context, a private equity buyer may prefer to obtain support agreements for a higher percentage of the target company’s shares, as opposed to accepting an artificial 14.9% cap to permit the use of Section 251(h).
- Private equity buyers often require existing stockholders, particularly management, to “rollover” equity in connection with the transaction. These shares should not be tendered in the offer, but instead contributed to the buyer in exchange for buyer equity interests, immediately after the tender offer and prior to the second-step merger. Section 251(h) requires that buyers own at least the percentage of shares required to adopt the merger agreement “following consummation of the offer,” but does not specify whether shares acquired after the tender offer, such as rollover shares, may be counted. Accordingly, absent further clarification regarding the statute, prudent practice would recommend that private equity buyers exclude rollover shares for purposes of establishing the minimum threshold required under Section 251(h), resulting in a higher de facto minimum condition (on a percentage basis) than would otherwise be required.
Private equity buyers should recognize that tender offers are more complicated than long-form mergers. These complexities include the requirement that a private equity buyer’s fund entity sign the tender offer document, which may create direct liability by the fund entity to target stockholders and uncertainty as to whether private remedies in the merger agreement, such as sole recourse reverse termination fees, will be effective to limit liability to target stockholders, absent triggering a specific tender offer condition. Private equity sponsors should also understand the SEC’s position regarding financing proceeds conditions, which requires the satisfaction or waiver of the condition five business days prior to closing the tender offer. To comply with this requirement, buyers must either draw their debt financing into escrow prior to the expiration of the tender offer to satisfy the financing proceeds condition, or enter into definitive financing arrangements or obtain other appropriate assurances from their financing sources to be able to waive the financing proceeds condition.
Notwithstanding these additional complexities, we anticipate that private equity buyers increasingly will adopt the tender offer structure to take advantage of the demonstrable timing advantages, particularly for target companies with a diffuse stockholder base, and better compete against strategic acquirers of public companies.
