In all economic cycles, engaged public company boards and management teams do their homework on the wide range of potential strategic opportunities. In the current market environment, however, we have observed that an increasing number of companies and their boards are actively progressing (or taking steps to formulate a plan for exploring) multiple alternatives at the same time. The goal? To maximize the speed and likelihood of executing a successful strategy all while maintaining optionality – and often working against liquidity constraints or other factors necessitating a tight timetable.
These strategic alternatives are varied – a potential sale of the company for cash to realize immediate value and de-risk future execution; a stock-for-stock merger with another company to create value from synergies; a strategic acquisition to accelerate revenue growth or product innovation; a debt or equity financing to raise capital; the sale of a business line to raise nondilutive capital and sharpen the company’s strategic focus; minority investments, collaborations or strategic partnerships to add additional capabilities, de-risk a development pathway or establish a toehold in promising new market segments; value-maximizing restructuring alternatives, including those utilizing the bankruptcy code; and more.
The parallel pursuit of multiple opportunities requires deep understanding and the balancing of separate business rationales, timelines, potential hurdles and fiduciary considerations for directors. Generic, one-size-fits-all advice on deal tactics and board duties will fall short in this multipronged scenario. Do you find yourself navigating a number of potential and simultaneous paths with an unknown ultimate destination? Directors and management teams of public companies listed in the U.S. should remain mindful of the following 13 principles.
1. A sophisticated understanding of your alternatives – even if you’re comparing apples and oranges – creates leverage with counterparties.
Challenges are presented when different types of available strategic alternatives would necessarily evolve on different execution timetables. Experienced advisers, especially if utilized early, can help companies manage timelines and processes to minimize situations where a decision needs to be made on one pathway before another potentially compelling pathway is ripe for consideration – and even create leverage by working to keep competing alternatives alive.
Transaction counterparties often try to use speed and a sense of urgency to drive outcomes (e.g., “accept my offer at a premium to your trading price now, or it’s off the table”). A board that proactively educates itself on a “clear day” regarding the company’s available strategic alternatives (and the time and key steps necessary to implement each) will be able to react more nimbly to unsolicited approaches, which can help mitigate the first mover advantage for the party making the unsolicited approach.
2. In order to evaluate any strategic alternative, the board must first understand the value delivered by the status quo – the company’s standalone strategic plan.
In practice, this means that management should maintain a set of long-term forecasts (in addition to, but based upon, the standalone operating budget approved by the board each year) that is periodically reviewed with the board. A word of caution, though: In many circumstances (including the sale of a company), management’s standalone long-term forecasts may be strategically provided to counterparties, utilized by the board’s financial advisers in their fairness analysis and publicly disclosed in filings with securities regulators. Further, plaintiff’s firms increasingly use management forecasts – particularly in cases where the board or counterparties received multiple, conflicting sets of forecasts – as the basis for post-closing damages claims against companies and their directors.
Given the level of scrutiny on these numbers, it is critical to coordinate with experienced legal and financial advisers regarding the timing, scope and use of projections in any strategic process. When a company pursues multiple potential alternatives, careful planning will be required to ensure that a consistent set of forecasts is provided to the board and all counterparties. In the event that more than one set of forecasts is necessary or appropriate, the assumptions and use case for each set must be made clear, so that information intended for use in one setting is not misconstrued in another.
3. A board’s decision to evaluate strategic alternatives generally does not require public disclosure.
In fact, the vast majority of these strategic reviews (assuming they do not result in a transaction) are concluded by boards in private without the broader public being any the wiser. Of course, a board may choose to voluntarily disclose that it is evaluating strategic alternatives – including to create leverage and force a sense of urgency from potential counterparties, to quell market rumors, in response to a public unsolicited proposal, as part of a settlement with a shareholder activist, or in an effort to reach a broader set of potential counterparties and get more direct feedback from existing stockholders while complying with Regulation FD.
That said, the possibility of publicly disclosing a strategic review must be balanced against the significant potential downsides to that disclosure – including disruption to core business operations and key stakeholder relationships, the potential to attract shareholder activism and the creation of a significant bias toward action, even if the status quo is ultimately determined to be the best outcome. Boards should remain mindful of the public disclosure requirements that could apply to certain advanced (but not yet finalized) discussions regarding material transactions, in the event the company first pursues a debt or equity offering or files a related registration statement.
4. If a change of control transaction is a potential outcome of a strategic review, the board will need to be prepared to demonstrate that its process was reasonably designed to obtain the highest value reasonably available (even if it ultimately chooses non-change of control transaction that will receive business judgment rule deference).
Courts will generally apply enhanced scrutiny when reviewing legal challenges to a change of control transaction, including the sale of a company for cash (or mostly cash) or a strategic merger or majority financing that would result in a controlling stockholder for the post-transaction company. In these transactions, the board’s fiduciary duties require directors to employ a process reasonably designed to obtain the highest value reasonably available for stockholders. While no single blueprint is required – and these so-called Revlon duties do not require an auction process – advance planning is key to fulfilling the board’s duties. When pursuing potential Revlon and non-Revlon alternatives (such as a stock-for-stock merger with a noncontrolled company, a minority financing, or an acquisition or divestiture), a board cannot wait to see if a change of control transaction is selected to ensure it adopts a reasonable process, particularly in light of recent judicial opinions that have closely examined board and management actions in the very early stages of discussions.
5. Careful observance of corporate formalities is critical to withstanding challenges to a strategic process.
Directors have a duty to exercise due care in making decisions by informing themselves of all reasonably available material information, acting following informed deliberation and establishing a proper record of their process. In doing so, they are entitled to reasonably rely on advice from management and qualified and conflict-free expert advisers. But no matter how effective and detailed a board’s deliberations may have been, if they are not properly documented in board-approved minutes from duly convened board meetings, the board’s actions may be subject to challenge, and plaintiff’s firms may be successful in obtaining broad discovery of director emails and text messages even at preliminary stages of litigation or through books and records demands.
6. Directors always have a duty of loyalty to act in good faith and put the best interests of the company and its stockholders before any personal interests in making decisions and evaluating opportunities.
As plans change and new alternatives arise, directors and officers should remain constantly vigilant about disclosing any potential conflicts of interest with any transaction or counterparty under consideration, as well as consulting with experienced counsel regarding any protective procedures that may be necessary to mitigate the conflict. Conflicts should be disclosed to the board in a clear manner with appropriate detail as soon as the conflict becomes known, in advance of any action being taken. The board should then determine how to proceed. A conflicted director or officer may need to recuse themselves from the process, or the board could set up a special committee of disinterested directors to review and approve the transaction.
7. Board committees may be used for convenience or to manage conflicts in a strategic process, but boards must thoughtfully assess the purpose and scope of authority of a committee at the time of its creation in order to ensure the committee fulfills its objectives and does not introduce risk into an otherwise well-managed process.
In cases where a special committee is formed to obtain the benefits of judicially created safe harbors for a conflict transaction, appropriate steps must be taken at the outset of the deal process to achieve the intended cleansing effect. This frequently comes up in transactions involving controlling stockholders or “take private” scenarios – each of which have become increasingly popular amid today’s challenging public market conditions. Even in the absence of a conflict transaction, a board may form a transaction committee for convenience to lead a review of strategic alternatives or manage a transaction process, with the full board typically retaining the sole discretion to approve or reject the ultimate transaction. While the use of such a transaction committee can streamline a transaction process and allow the board to be more nimble in responding to changing circumstances, it is critical that the full board be properly kept abreast of developments and participate in key decisions to ensure that all directors (other than any recused directors) discharge their fiduciary duties for the transaction.
8. It is critical to understand requirements for stockholder approval and any risk of stockholder challenge.
When comparing multiple alternatives, it is critical to understand whether some will require stockholder approval and others will not. A sale of a company will require the approval of its stockholders, as will certain private placements of public equity, equity financings (or certain financings utilizing an instrument convertible into equity) conducted less than the market price or other transactions that result in a change of control of the issuer (generally 20% or more of the issuer’s pre-transaction outstanding equity under stock exchange rules). The sale of a business line or assets generally will only require stockholder approval if the disposed business or assets constitutes “substantially all” of the seller’s assets, while an acquisition of another company will generally require approval of the acquirer’s stockholders only if the merger consideration is stock or a mix of stock and cash and the acquiror would be issuing shares in excess of 20% its outstanding shares in the deal.
When comparing alternatives that may require stockholder approval, in addition to timing implications, it is important to consider nonconsummation risk. In particular, some recent stock deals requiring acquirer stockholder approval have been challenged by stockholders and activists, requiring renegotiation, extending timelines and introducing post-signing uncertainty. In some circumstances, creative transaction structures can mitigate risks. For example, we have been able to structure certain reverse mergers between a smaller public company and a larger private company (common in the life sciences space) to sign and close simultaneously in advance of the public company’s stockholder approval.
9. Companies should evaluate every significant strategic transaction for the likelihood that it could draw scrutiny from shareholder activists.
Any announcement, or leak of a significant strategic transaction or consideration of strategic alternatives, may generate shareholder activism, sometimes from dedicated, well-known shareholder activist investors, but also increasingly from existing stockholders that adopt the activist playbook to attempt to scuttle a transaction they view as unfavorable. Transactions that are high on the activist radar include:
- Sale transactions that did not involve a pre-signing market check or that are priced below the cost basis of a significant portion of the stockholder base.
- Acquisitions with unfavorable financial characteristics for the acquirer, such as high dilution to existing stockholders, dilution to earnings per share, reduction in the dividend or a significant increase in leverage.
- Transactions that represent a departure from the company’s core business and strategy as understood by the market.
- Transactions where an activist investor is already a stockholder of one or more of the parties.
Advance preparation for an activist challenge to a transaction is key, especially since the prevalence of information leaks means deal announcements are not always on the company’s terms. This preparation can include:
- Tailoring announcement messaging to affirmatively address the most likely investor questions and concerns.
- Proactively setting up meetings with key investors immediately following announcement to address questions they may have regarding the transaction, to the extent practicable under the circumstances.
- Getting the support of major active stockholders prior to announcement via binding voting and support agreements.
- Understanding the company’s governance profile, defenses/vulnerabilities and upcoming director nomination windows.
10. Prioritize evaluating antitrust and other regulatory risks and required approvals early in any process.
In the current regulatory environment, antitrust and other regulatory approvals can significantly extend deal timelines or even result in transactions being abandoned. Companies should involve regulatory counsel early in any process to ensure that the regulatory timetable and risks are properly factored into the evaluation of a given transaction, particularly since, in some cases, the regulatory risk-adjusted value of a given transaction may be lower than an alternative, even if the transaction on its face would deliver higher value.
11. When financial distress is approaching, don’t wait until all else has failed to consider restructuring alternatives.
With careful advance planning, it is possible to turn lemons into lemonade – including by evaluating restructuring alternatives that may preserve value and allow the company to live to fight another day. Frequently considered transactions include out-of-court restructuring solutions, as well as in-court options such as Section 363 sales that allow a company to sell certain assets through an auction process free and clear of liens and claims – thus paving the way for an emergence from a Chapter 11 reorganization proceeding with a stronger financial profile. Unfortunately, many companies wait too long to consider the value-maximizing potential of these alternatives – which become significantly more challenging to execute once a company is in financial distress. Should an in-court option be pursued, it is important to remember that Chapter 11 proceedings come with funding requirements for the business during the process that must be met with new financing or company liquidity. These requirements and associated timeline implications should be taken into account when setting timelines for other non-bankruptcy alternatives under consideration. Otherwise, a Chapter 7 liquidation proceeding may be on the table.
12. Strategic transactions impact employees and attract their attention, so care must be taken to ensure they are properly retained and incentivized.
It is especially important for boards to remember that different types of transactions will create different outcomes for employees – including future roles within the organization and treatment of equity and incentive awards. Communications to employees should be carefully managed not only for securities law and confidentiality reasons, but also with a keen eye on employee morale. Whipsawing employees with a cascade of different potential alternatives can cause distraction and potential attrition, which can in turn lead to significant operational and execution issues. Of course, bringing an increasing number of employees “under the tent” as a transaction progresses can be critical for successful execution, so companies must be mindful to strike the right balance.
13. Avoid sour grapes.
In today’s dynamic climate, many transactions that come off the table (for any number of credible reasons) can quickly become relevant again. Many companies watch deals that seemed impossible or low priority reinvent themselves for the ultimate win-win scenario. Before locking into any particular transaction or strategic path, it is worth analyzing whether any other alternatives should be revisited – and whether a transaction should be structured to preserve the ability to pursue another alternative that remains under consideration on a nonexclusive pathway. If nothing else, taking one “last look” at other alternatives on the shelf can bolster the board’s rationale for its ultimate selection.