M&A Trends by Private Equity

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GF Data Resources issues a quarterly report on deal terms for Private Equity acquisitions which is a gold-mine of market information.  Trends noted in the Q-2 2021 report:

PE firms are using warranty and representation insurance almost 60% of the time, a recovery from a dip in 2020.

Strong target firms that can obtain robust insurance command a valuation premium, which is not surprising based on company strength and insurance reducing acquirer risk.

Consistent with the impact of the foregoing, in the fist half of 2021 the size of payment holdbacks (payments held in escrow to satisfy claims of erroneous representations) has fallen to the lowest level in several years in most categories of transactions (measured by size of transactions) and the period of time during which funds are held back similarly has declined; targets with insurance of course enjoy smaller and briefer hold-backs.

Finally, indemnification caps (the limitation on the percentage of deal price to which target companies expose themselves by way of liability for misstatements or errors in representations) remains consistent with 2020 for smaller deals but has increased for deals in the larger categories, a development that seems inconsistent with the the trend for insurance (although perhaps this increase is consistent with the very existence of insurance and reflects confidence on the part of insurers and target companies).

IPO Lock-ups

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When a company goes public with an Initial Public Offering, it has long been the practice that underwriters require major (sometimes all) prior shareholders to agree not to trade their shares into the public marketplace for 180 days.  This “lock-up” period permits the underwriters and market-makers to stabilize the price of the stock, and to protect the offering price against a sell-off of a large number of shares.

But, things are changing.  Starting in late 2020, many high-profile IPO companies have reduced the lock-up period.  This suggests a change in thinking about the IPO markets, or alternately hubris on the part of high-flyers that their companies are so strong that the sale of a chunk of shares will not work to deflate market price.

Companies that have reduced the 180-day lock-up include: Robinhood Markets, AppLoving Corp., SentinelOne, DoorDash, Airbnb and most recently, filings by Dutch Brothers, Inc. and ForgeRock Inc.

Developments in the securities markets can be credited with some of the impetus, as alternate methods of reaching public markets do not typically involve lock-ups: “direct listings” by companies placing shares on an exchange without underwriters, and using the SPAC acquisition model.

ForgeRock, which just went public, tied release of prior shares for public sale to the market pricing of its shares at  25% or more above the IPO price, a hedge against the IPO price getting walloped.  How common reduced lock-ups will become, and whether the ForgeRock approach will become common, cannot be predicted; IPO marketplaces can turn on a dime and smaller companies or companies coming out when IPOs are not “hot” could lead to a retrenchment.

Mergers Subject to Greater Scrutiny under Biden

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On July 9, the President by executive order directed government agencies to bolster competition through stricter analysis under the anti-trust laws.  On the 15th of September, the FTC, by 3-2 party vote, rescinded vertical merger guidelines adopted under the Trump administration (although such action left no formal guidance on the books).  That same day, the DOJ announced it was reviewing both its vertical and horizontal guidelines.

The rescinded Trump era guidance permitted vertical mergers if they created efficiencies or had some procompetitive effects; such provisions were declared unacceptable.

Separately on the same day, the FTc by 3-2 vote issued a policy statement holding health apps to the FTC rules requiring such apps to comply with the sweeping rules requiring consumer notification in the event of health data breaches.

\It is not a surprise that a Democratic administration would land on the side of greater governmental regulation of business; nor do I suggest such a result is necessarily a negative.  However, as to vertical integration mergers I do note that such deals might be a partial solution to the supply chain issues which hamper the supply side of our economy during and coming out of COVID.

SEC SPAC Attack Intensifies

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SEC Rules are expected this Spring to affect SPAC offerings; last week the SEC’s Investor Advisory Committee provided the Commission with a list of recommendations for consideration.

These recommendations focus primarily on enhanced disclosures: use of financial projections (generally omitted in regular IPOs); disclosure of profits for promoters regardless of share performance by SPAC founders; receipt of sizable equity in the target by founders regardless of how the target performs; plain English explanations of founder comp; disclosure of risks in finding a good targets; how the SPAC determines public readiness of a target, including accounting factors.

Commentary in the lawyer publishing service Law360 quotes one SEC Advisory Committee member as follows: “many target companies seem to prefer the more certain pricing and timing that comes with a blank-check [SPAC] merger compared with a traditional IPO;” and no doubt the robust compensation of promoters (and the generation of related professional service fees) support the prevalence of SPACs and the hundreds which today are funded and in the marketplace seeking acquisition targets, so it is not at all likely that SPACs will be mortally wounded by new regulation; and query if enhanced disclosure will matter much to the retail investor if the market generally remains “hot.”

Insider Trading Update: SEC Rules Coming

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The SEC is expected this fall to issue Rules restricting the use of so-called Rule 10b5-1 “Plans,” which are used as trading safe harbors by executives and directors of public companies to permit trading even while they may possess material inside information.

Briefly, a Plan provides a program for permitted trades, buy or sell, based on pre-determined metrics: date, number of shares, price or other triggering events.  The theory is that the Plan runs automatically and thus the trader is not by definition using inside information.

The SEC effort is being informed by the SEC’s Investor Advisory Committee, which Committee has just made recommendations to the Commission.  These include a cooling off period of four months before trading can begin under a Plan, and a ban on multiple Plans for one person.

It is not clear whether the SEC will attack the ability to de facto alter a Plan by aborting its operation in certain defined circumstances; such alteration can render a Plan subject to inside information manipulation.  Plans are on the SEC’s own list of rulemaking priorities, driven by the 3-2 Democratic majority.

DEI in Corporate America–Perspectives

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Corporate America treats DEI as a problem to be fixed, and often relies on DEI training as part of the process.  This approach was roundly criticised last week by a panel of corporate experts convened by the New England Chapter of the National Association of Corporate Directors, which posited that DEI rather should be framed as a “search for excellence.”

Directors should ask themselves: “what result do we want” rather than “how do we fix” what DEI addresses. How can a corporation create equity “at scale?”  Equity is not a zero sum game, where the winners’ existence must imply that there are losers also.  These recommended concepts must be invented in the marketplace as they have not been taught in business schools.

What does “diversity” mean?  Companies should not try to define it, as these lists inevitably center on one or more cohorts: race, sex, economics, color, country of origin, gender, etc.  Diversity should be approached holistically: it means human beings and how do we advance all of them as a group?

DEI is a cultural effort, not a response to “events.”  Reputational risk to enterprises is of great and of  growing importance.  Institutional investors are driving home this point. There is a delta between promises and progress today– why?  Should not DEI be placed into the purview of a “Risk Committee” along with all other potential pitfalls?

SPAC Attack

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SPACs are under attack in litigation file in New York Federal Court, claiming these entities should be closely regulated as investment companies under the ’40 Act.  SPACs typically invest their funds in market securities during they year or more they seek a company to acquire.

Not surprisingly, about sixty law firms (many of great size, all with SPAC business) have fought back, asserting that these investments are incidental and transitory and that the ’40 Act was not designed for the SPAC model (no doubt true as eighty years ago there were no SPACs).   SPACs seem to be relying on an implicit “grace period” which is nowhere specified in law or regulation.

If a SPAC is an investment company then the “promote” kept by the founders (typically 20% of the deal) would be illegal as to amount and form under the law; indeed, one plaintiff in current litigation so alleges.

It seems unlikely that these suits will prevail, particularly as the SEC has failed to object to SPACs conceptually for many years, and since there are today hundreds of funded SPACs on the hunt for an acquisition.

Parenthetically, the Singapore Stock Exchange just last week adopted rules that will permit SPACs to be traded, subject to mandatory quality standards which echo better US practice.

SEC Hits Brokers and Advisers on Cyber

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The SEC supervises brokers and investment advisers and people in those professions know that periodic compliance visits can get very granular.  We all also know that the SEC is deeply interested in protecting the investing public.

Latest SEC move: at end of August, the Commission levied hundreds of thousands of dollars of fines against brokerages and advisory firms based on failure to maintain cyber security over customer data. Client emails were hacked though on the cloud.  The Commission also has complained against at least one firm where there was no hack but a failure to maintain robust data security.

Although rules covering cyber for brokers and advisers are old and general, they do require written policies (SEC) and periodic review (Advisers Act).  Clearly the SEC has broad general supervisory powers, so it is clear that they do not think there is a need for more rule-making as part of its enforcement tool kit.

Anti-Trust Regulation: Change in the Rules

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Assuming the parties to a deal are of sufficient size prior to the deal itself, the FTC requires filing and clearance of all M&A deals above a certain size under the infamous Hart-Scott-Rodino Act.  That size of deal trigger is now $92M (it is updated regularly, which means it is increased).

It has long been established that the size of a deal can be reduced as follows: from the deal consideration in an acquisition of equity, if any debt of the target to third parties is paid at closing then the amount of that payment is deducted from the deal size.

Last week, advice from the FTC website has reversed this practice if the selling equity holders will benefit from the retirement of that debt.   While one can appreciate a certain symmetry to cash deals (where assumption of target debt always was counted in determining deal size), parties to equity M&A transactions now will need to calculate FTC reporting requirements utilizing this new metric.

Harvard Study: Failure of Corporations to Benefit Stakeholders

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On the second anniversary of the signing by many major corporations of the Business Roundtable Statement calling on business to operate for the benefit of all stakeholders, the Harvard Governance Program accuses corporate America of, in effect, intending to con the American public.

The Roundtable Statement admonishes companies to work to benefit not only shareholders but also customers, employees, suppliers and communities.  After a survey of over 130 signatory companies, the Harvard Program concludes that “signatory companies did not intend or expect their endorsement to be followed by changes in how they treat stakeholders.”  Details of study results follow.

Signatory CEOs did not bring the signing to their boards, evidence of lack of serious intent.

Almost 100 signatories updated their governance guidelines and failed to elevate status of stakeholders other than shareholders.

Forty shareholder proxy proposals were presented to various companies based on the Statement and every one of them was opposed by managements.

Corporate by-laws continue to emphasize shareholder return.

About 85% of proxy statements do not even mention joining the Statement.

Director compensation remains tied to shareholder return and typically is paid in company stock.  No comp program links director compensation with other stakeholder interests.

The Program’s report ascribes all sorts of cynical motives to what it seemingly considers to be management duplicity.  Putting aside the accuracy of such accusations, it is hard to parse the results of the Program’s report with the professed growing corporate focus on ESG, DEI, climate change, etc.  The Harvard study was headed by Professor Lucien Bebchuk, long a sharp critic of corporate management, who expressed suspicion at the beginning of the favorable press surrounding the Roundtable pronouncement based in part on lack of Board involvement.