1. Chapter 11 M&A Deal Structuring Process: Payment & Legal Considerations (Closely linked to Chapters 12 and 13)

2. Deal Structuring Process
Deal structuring involves identifying
The primary goals of the parties involved in the transaction (Strategic versus financial?);
Alternatives to achieve these goals; and
How to share risks.
The appropriate deal structure is that which
Satisfies as many of the primary objectives of the parties involved as necessary to reach agreement
Subject to an acceptable level of risk

3. Ethical/Legal Issues – BOD and Buyers ¹
Delaware courts – what buyers and BOD can and should do in sale context. Losing Business? Forum & substantive law issues
October 1, 2012, ruling in Shocking Technologies, Inc. v. Michael,² Delaware Court of Chancery held dissident director breached fiduciary duty of loyalty by sharing confidential information with third party and trying to discourage third party from investing in company.
VC Noble significant opinions on 9/30/11
Deal structure – OPENLANE
BOD & majority stockholder both enter into competing deals. No good.
Escrow arrangement w/o stockholder consent OK if fairly disclosed to shareholders.
¹ See Chapter 11 materials on website. For case details check The Harvard Laws School Forum on Corporate Governance and Financial Regulation website,
² See posting Discussion Board.

4. Ethical/Legal Issues – BOD and Buyers ¹
BOD Conflict – see infoGroup & OPENLANE
infoGroup – director, Vinod Gupta, received same share consideration as others and had no affiliation or arrangement with buyer HOWEVER $ 100M & need for liquidity = disabling conflict.
Directors may lose independence by “domination through force or will” by conflicted party (Gupta).
Pattern of threats, unreasonable, erratic behavior.
s-”dump company and run due to pain, trauma and everything else”
Gupta wore them down stripping them of independence.

5. Ethical/Legal Issues – BOD and Buyers ¹
OPENLANE – not a conflict
Acceleration of director stock options is not alone evidence of a conflict.
Agreement of target director to remain with new firm as an executive is not itself a disabling conflict .
Fact that a director is “interested”, absent domination of other members of BOD, not alone sufficient to attack objectivity of fill BOD. (Contrast to Gupta in infoGroup).
Banker “pitch books” containing valuation does not constitute financial advice that must be disclosed to shareholders in proxy. Viewed as bank’s “self marketing” efforts and not impartial.

6. Ethical/Legal Issues – BOD and Buyers ¹
Sales process
infoGroup – where BOD conflicted, decision favoring one bidder over another, where both are financial bidders subject to close scrutiny.
ONELANE – where BOD is “very well informed”, possessing “impeccable knowledge of the company’s business”, the court may give additional deference to its process and decision making.
Decision not to hire a financial advisor or to obtain “fairness opinion”, was OK.
Decision not to seek financial buyers and to favor strategic buyers. Two BOD were affiliated with PE firms.

7. Conflicts in Buyout Financing - Barclays
LBO financed PE acquisition of Del Monte¹
BOD received “conflicted” advice from its financial advisor Barclays = breach fiduciary duty.
Buyout firm may have “aided and abetted.
Case settled October 2011 for $89.4M² against buyer and Barclays.
Acting as seller’s advisor and financier for buyer creates conflict.
¹ In Re Del Monte Foods Co. S’holders Litig., C.A. No.6027-VCL (Del.Ch Feb. 14, 2011)
2. /2011/1-/21/del-monte-settlement-highlights risk of conflicts-in-buyout-financing/

8. Conflicts in Buyout Financing - Barclays
DE courts recognize, in some contexts, stapled financing by sell side advisors.
Permissible if may induce prospective, competitive bidders and ….
Good reasons and close oversight by BOD.
Original trial found neither in Del Monte.
No need or benefit from target banker's participation and
Target BOD learned of its banker’s interest in providing buy-side financing after the prospective buyers did.
BOD, particularly with private equity buyers, need to pay close attention to sales process and oversee its advisor.

9. Responsibilities of Controlling Stockholders¹
DE court awarded $1.2 B breach fiduciary duty.
SPCC received proposal from majority stockholder, GM to buy its 99.15% in MM, a non public Mexican company for $3.1B.
SPCC formed Special Committee (SC) disinterested shareholders own advisors.
DCF, contribution, sum of parts and relative valuation analysis ≤ $1.7B.
SC caved, based on advisor’s fairness opinion.
¹In Re Southern Peru Copper Corp. Shareholder Derivative Litig., CA No. 961-CS, October 14, 2011

10. Responsibilities of Controlling Stockholders¹
Chancellor Strine:
Fairness Standard not met.
SC must avoid operating in controlled mindset
Review not rationalize controlling stockholder deal.
SC – Broad mandate, explore all alternatives
SC continuously evaluate deal even post signing but pre closing. SPCC stock value ↑
SC should be aligned with minority not majority interests.
Massachusetts – majority is “fiduciary”

11. Fairness Opinions ¹ Formal written form of valuation analysis
Often used in M&A, particularly closely held to:
Assist conflicted BOD
Objectively consider other options
Establish a record sustainable in court
Value acquired company or new entity
Not a substitute for fiduciary judgment
Not evaluation of rationale, insurance policy or recommendation to proceed
1. For a concise discussion of Fairness Opinions see Fairness Opinions Summary Guide,

12. Major Components of Deal Structuring Process
Acquisition vehicle – Entity type
Post-closing organization - integrate ?
Form of payment – to tax or not
Form of acquisition – type consideration
Legal form of selling entity – convert?
Accounting Issues – GAAP/CPA issues
Tax considerations- both seller & buyer

13. Factors Affecting Alternative Forms of Legal Entities
Control by owners
Management autonomy
Continuity of ownership
Duration or life of entity
Ease of transferring ownership
Limitation on ownership liability
Ease of raising capital
Tax Status – flow through or not,taxable?

14. Acquisition Vehicle Acquirer’s Objective (s) Potential Organization
Maximizing control
Facilitating postclosing
integration
Corporate (C or S); LLC or
divisional structure
Minimizing or sharing risk
LLC, Partnership; joint venture
Holding company
Gaining control while limiting investment
Transferring ownership
interest to employees
Employee stock ownership
plan

15. Post-Closing Organization
Acquirer’s Objective (s)
Potential Organization
Integrate target immediately
Centralize control in parent
Facilitate future funding
Corporate or divisional structure
Implement earn-out
Preserve target’s culture
Exit business in 5-7 years
Assume minority position
Holding company
Minimize risk
Minimize taxes
Pass through losses
Partnerships
Limited liability companies

16. Form of Payment
Cash (Simple but creates immediate seller tax liability)
Non-cash forms of payment
Common equity (Possible EPS dilution but defers tax liability)
Preferred equity (Lower shareholder risk in liquidation)
Convertible preferred stock (Incl. attributes of common & pref.)
Debt (secured and unsecured) (Lower risk in liquidation)
Real property (May be tax advantaged through 1031 exchange)
Some combination (Meets needs of multiple constituencies)
Closing the gap on price
Balance sheet adjustments (Ignores off-balance sheet value)
Earn-outs or contingent payments (May shift risk to seller)
Rights, royalties, and fees (May create competitor & seller tax liability). CVRs etc.

17. Sanofi/Genzyme materials – Chapter 1 website

18. Form of Acquisition: Buyer’s Perspective
Cash purchase of assets (Permits “cherry picking,” asset write-up; limits liabilities, & no minority owners; but lose tax attributes and assets not specified in contract and incur transfer taxes)
Cash purchase of stock (Assets transfer automatically but responsible for all liabilities and minority shareholders; avoids shareholder approval (buying from target shareholders); contracts and licenses may require consent to assignment)
Mergers (More flexible payment terms, assets transfer automatically, no minority shareholders (potential “cramdown”) or transfer taxes but responsible for all liabilities and subject to shareholder approval)
Alternatives to mergers – may be tax free
Stock for stock (By operating as subsidiary avoid need for contract & license consent as continuity of ownership maintained; avoids target shareholder approval; possible EPS dilution)
Stock for assets (Similar to cash purchase of assets)
Staged transactions (Provides greater strategic flexibility but postpones synergy realization) – Creeping acquisition – Icahn raider & Genzyme

19. Legal Form of Selling Entity
A seller’s concern about the form of acquisition (i.e., sale of assets or stock) may depend on its own legal structure.
C-corporations are subject to double taxation, while subchapter S, limited liability companies, and partnerships are not.
C corporation shareholders generally prefer a stock for stock transaction to defer their tax liability. IRC § 368
Subchapter S, limited liability companies, and partnership investors may be indifferent to a sale of assets or stock.

20. Accounting Considerations
Contingent payouts valued at acquisition date (closing) and revalued as new data becomes available
Deals valued at closing rather than announcement date
Goodwill periodically reviewed for impairment. Should be done prior to deal being finalized on the Seller’s dime.
Implications
Potential increase in earnings volatility may make earn-outs less attractive as form of payment - Genzyme
Value of equity-financed deals can change significantly between announcement and closing
Threat of major write-downs may discourage overpayment for targets

21. Tax Considerations: Impact on Seller Shareholders
Business combinations may be
Tax free
Partially taxable
Wholly taxable
Non-taxable transactions occur when mostly acquirer stock is used to buy substantially all of the target’s stock or assets.
Taxable transactions occur when the acquirer uses
Something other than its own stock. i.e. cash or boot
Buys an insufficient amount of the target’s stock or assets.

22. Tax Considerations: Impact on Combined Businesses’ Shareholders
Avoiding double (i.e., by firm and shareholder) or triple taxation (i.e., by firm; shareholder on sale proceeds & possible liquidating dividend)
Allocating losses to owners