In this article, we follow up on our overview of going private transactions (available here) by focusing on an important but often overlooked workstream in these deals. Companies are frequently privatized by a group of significant shareholders, outside investors and sometimes members of senior management, and in these "club" or "consortium" deals, the buyer group members must negotiate their rights in the privatized target company against the backdrop of the complicated take-private process. Below, we address key considerations for these negotiations, including the interplay of this process with the going private process and documentation.
A Private Company Investment
Members of a buyer group in a going private transaction are essentially making an investment into a private company. They just have to navigate a unique set of complexities in order to make their investment in the first place—that is, to privatize the public company. Understandably, much attention is given to the take-private process, with its many particularities including special board committees, heightened SEC disclosure requirements and the frequent threat of appraisal actions from "dissenting" shareholders.
Nonetheless, members of any buyer group must also focus on the same types of issues that concern investors into an already private company—especially governance and exit rights. There is no single template for these private company arrangements, and much will depend on the composition of the particular buyer group and its long-term plans for the privatized company. Still, there are several important guidelines for buyer group members.
Importance of the Shareholders Agreement: First of all, it is critical for members of a buyer group to reach formal agreement on their post-closing arrangements—typically in a Shareholders Agreement—because the default rules of corporate law will not deliver the rights and protections that most buyer group members will expect to have. This point is important to both smaller and larger shareholders. As an example, a 20% shareholder in a Delaware or Cayman Islands company will not have board rights, veto rights or rights to demand an exit transaction (individually or in concert with other shareholders), unless these terms are specifically negotiated. At the same time, controlling shareholders will typically want to impose various transfer restrictions and cooperation covenants on smaller shareholders. Accordingly, as a rule, all parties are better off with a well-drafted Shareholders Agreement that crystallizes the commercial understanding regarding their post-closing rights and obligations.
Prepare for Disagreements and Contingencies: Second, members of a buyer group should prepare for disagreement, even if the group appears to be fully aligned at the outset.
As in many private companies, the stakeholders in a buyer group often have different investment timelines and expectations. Simply because the stakeholders joined forces to take ownership of a public company does not mean that they will see eye to eye going forward. This potential for conflict is most apparent when the buyer group is composed of different types of stakeholders—significant shareholders, strategic investors, financial investors and members of senior management.
But even the same types of investors might want to pursue divergent strategies. For example, one private equity investor in the buyer group might push for the target company to be re-listed in a different market as soon as possible. Another financial investor might see a greater opportunity for value enhancement in selling off or restructuring the target's under-performing businesses before attempting to re-list the company. Meanwhile, a third financial investor might support an industry "roll-up" strategy, where the company will make a series of acquisitions before the investors achieve an exit through a dual-track sale and IPO process.
Further, buyer group members that start with a common goal still need to plan for contingencies. In take-privates of U.S.-listed Chinese companies, for instance, the plan is often to de-list from the U.S. market and re-list in Hong Kong, Shanghai or Shenzhen as soon as possible (we explored the background and outlook for these types of going private transactions in our article here). Yet market conditions, regulatory hurdles and business performance might dim the luster of an immediate re-listing. In that case, buyer group members may well disagree—some preferring the quick IPO on less attractive terms, others willing to wait out poor market conditions and still others pushing for significant changes in business strategy before attempting an exit.
Fortunately, the parties have a large toolkit to address these concerns and structure their post-closing arrangements. These tools include board representation rights; veto rights; super-majority voting requirements; deadlock provisions; transfer rights and restrictions; non-competes; drag-along rights; "force exit" provisions; put, redemption and buy-sell arrangements; and so on. We have addressed many of these terms in previous articles on private company deal terms (for example, please see here and here).
Interplay with the Going Private Process
For most members of a buyer group, it will be critical to negotiate the key terms of their post-closing arrangements before the buyer group formally agrees to the going private transaction with the target company. This is based on two practical considerations.
The first consideration, as discussed above, is that members of the buyer group will want a bespoke Shareholders Agreement setting out their post-closing rights instead of relying only on the basic rights available under corporate law. The second practical consideration is that most members of the buyer group will have maximum leverage to negotiate the terms of their Shareholders Agreement before they have made a binding commitment to invest. Their investment commitment will be subject to some limited conditions—for example, in many take-privates of U.S.-listed companies, the availability of debt financing—but buyer group members cannot expect a walk-away right if their Shareholders Agreement is not agreed.
Situating these considerations within the timeline for a going private deal, the ideal time for members of the buyer group to agree on post-closing arrangements is at the signing of the overall transaction. On this date, a number of agreements will be executed, including (1) the buyer vehicle's merger agreement with the target company; (2) the investors' equity commitment letters pursuant to which they agree to fund their investment into the buyer at the closing; (3) debt commitment letters (or even full credit facilities), if a portion of the purchase price will be funded with debt; (4) guarantees pursuant to which the investors agree to backstop certain obligations of the buyer vehicle; and (5) an agreement among the buyer group members regarding their intra-group rights and obligations.
This last agreement, often referred to as an Interim Investors Agreement or Consortium Agreement, is the natural place for buyer group members to agree on post-closing arrangements. Yet in practice, parties are rarely prepared to agree on the terms of a full-length Shareholders Agreement upon the signing of the going private transaction.
The Interim Compromise
In the absence of a full Shareholders Agreement, the members of the buyer group will typically include a "stop-gap" provision in the Interim Investors Agreement.
This compromise position has three main features. First, certain key terms of the buyer group's post-closing arrangements will be agreed on in the Interim Investors Agreement itself—usually at a "term sheet" level of detail. Second, the parties undertake to negotiate a full-length Shareholders Agreement before the closing of the going private transaction. Third, if the full-length Shareholders Agreement is not finalized by closing, then the post-closing terms included in the Interim Investors Agreement will become binding on the parties—effectively, as a short-form Shareholders Agreement. Often the parties will still have an obligation to negotiate toward a full-length Shareholders Agreement.
As a matter of documentation, the term sheet of post-closing terms is usually a schedule or exhibit to the Interim Investors Agreement. Incidentally, this schedule or exhibit is typically omitted from the publicly filed version of the Interim Investors Agreement. Further, the proxy statement sent to target company shareholders will usually summarize several aspects of the Interim Investors Agreement, but not the buyer group's post-closing arrangements.
This stop-gap solution has been widely adopted by private equity investors in particular, both in going private transactions and in other types of club deals. Nonetheless, this approach requires careful consideration in any given deal. After all, there is a reason why parties typically commit to complicated business transactions on the basis of fully negotiated documents, rather than term sheets.
Just as there is no single template for a Shareholders Agreement, there is no single template for the post-closing terms to be included in the Interim Investors Agreement. Buyer group members can push to include as much detail as they think is needed. As a general rule, less detailed terms might suffice in club deals led by several private equity firms with relatively equal shareholdings, while more detailed terms should be helpful to all parties in more diverse buyer groups. Buyer group members should also negotiate these terms in light of the risk, however remote, that a full Shareholders Agreement may never be agreed.
Buyer group members should also be wary of the remarkable number of variations among different Shareholders Agreements, even on terms considered to be standard. Cursory references in the Interim Investors Agreement can give rise to disputes. To give just one example, a shareholder's proposed transfer of shares to a third party is often subject to a right of first offer, or ROFO, in favor of the non-selling shareholders. Yet there are a few common variations in ROFOs. Reference in an Interim Investors Agreement to a "customary ROFO" may lead to disagreement on at least two important terms: does the selling shareholder name its price and make a binding offer to the other shareholders, or is it the other shareholders who must make an offer to the seller if they wish to buy? And if the other shareholders are willing to buy only half the stake that the seller proposes to transfer, can the seller reject these partial transfers and sell the full stake to a third party?
In short, any potentially binding term sheet in the Interim Investors Agreement deserves more attention than the typical non-binding term sheet used at the outset of many transactions, where the parties are often happy to defer important (and sometimes contentious) details until they begin negotiating definitive agreements.
Overall, as we have described above, establishing an appropriate package of rights in a privatized company requires careful consideration and often much negotiation, both for "interim" arrangements and in the definitive Shareholders Agreement. Accordingly, this process should not be an afterthought as the parties navigate the more headline-grabbing aspects of the going private process.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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