The primary purpose of anti-dilution provisions is to protect investors from the adverse impact experienced when a company issues new securities (whether it be shares of preference stock, common stock or securities convertible, exercisable or exchangeable for shares of preferred or common stock) at a price that is lower than that paid by such investors. Anti-dilution protection and the liquidation preference are two important provisions that distinguish preferred stock from common stock.
There are two principle formulae to grant protection against anti-dilution: full ratchet and weighted average formulae. In each case, the anti-dilution protection can be effected by an adjustment to the conversion ratio of the investor’s share of preferred stock into shares of common stock (or sometime by the issuance of additional shares of capital stock to the investors).
The full ratchet formula is a more aggressive form of anti-dilution protection than weighted average formula and provides the most protection to the investors, but has the greatest adverse impact on the company, founders and management. The purpose of a full ratchet formula is simple – to place the investor in the same position it would have been had it originally invested in the company at the lower price per share being paid by the new investors in the subsequent round of financing, that is, the new conversion price for converting the investor’s share of preferred stock into shares of common stock would equal the lower price per share being paid by the new investors.
Weighted average formula is considered more equitable and takes into account the number of shares already issued plus the number of new shares being issued at the lower price. The weighted average formula determines the adjustment to be made to an existing investor’s stockholding based on the size of new offering and the lower price at which the new shares are to be issued to the new investors. Under the weighted average formula, the new conversion price of the investor’s share of preferred stock into shares of common stock can be calculated using the following formula:
new conversion Price = old conversion price x common stock equivalents prior to issuance + old conversion price (new consideration)/ common stock equivalents prior to issuance + new common stock equivalents
There are two main variations of the weighted average formula, namely, broad based and narrow based. Broad based weighted average includes a wider range of shares and other securities (such as warrants, options and other convertible securities) in the calculation and therefore the adjustment required to the existing investors’ stockholding is lower. Accordingly, it is less onerous on the company and not as dilutive on the founders, management and existing investors. Narrow based weighted average formula, includes a less number of shares and securities (generally may not include warrants, options and other convertible securities) in the calculation and therefore the adjustment required to the existing investors stockholding is higher and is therefore more burdensome on the company, founders and management.
Monday, April 27, 2009
Sunday, January 25, 2009
M&A- Relevance of Legal Structures
The number of overseas mergers and acquisitions pursued by India Inc. has grown remarkably in the recent years and is likely to further grow in the future. The current global meltdown in the world economy has considerably brought down the valuation of various reputable and viable companies around the globe, thereby facilitating and incentivising the companies with reserves to make expansions. However, it is imperative to structure a transaction in a way that yields and caters to the objective of the Company which is dispensing away with its reserves during these hard times.
There are a number of legal structures that can be pursued to consummate a transaction, wherein the Indian Company (sometime referred to herein as “Acquiror”) acquires a publicly listed corporation (the “Target”) in the US. For the purposes of this writing, I have focused on three alternative structures for the acquisition of the Target by the Acquiror in the US, which are noted below:
a. Tender Offer- In a tender offer, an Acquiror makes an offer directly to the Target’s shareholders to sell their shares to the Acquiror at a specified price, which is generally at a premium to the existing share price quoted on a stock exchange of the Target shares.
b. Statutory Merger- In a statutory merger, the foreign Acquiror would form a wholly owned subsidiary for the purposes of consummating the merger and depending on the structure of the merger either the Target would be merged with the newly formed acquisition subsidiary with the newly formed subsidiary surviving the merger or the newly formed subsidiary would be merged with and into the Target with the Target surviving the merger. The shareholders of the Target would receive the merger consideration for their shares. After the closing of the merger, the Target would be a wholly owned subsidiary of the Acquiror.
c. Asset Purchase- Depending on the intent of the Acquiror and the assets it intends to acquire in the acquisition, the transaction can be structured as an asset purchase.
The above mentioned structures are described briefly below:
A. TENDER OFFERS
The term "tender offer" is not defined in the Exchange Act or any of the rules promulgated there under, but it has been described generally as: publicly made invitation, usually announced in a newspaper advertisement, to all stockholders of a corporation, to tender their shares for sale at a specified price. To induce the stockholders to sell, the price usually includes a premium over the current market price of the Target company's shares. Cash or other securities may be offered to the stockholders as consideration. An offer is made for a limited period of time only. The Acquiror may offer to buy all tendered shares, or it may offer to buy only a stated number. In general, the Acquiror also sets a minimum number of shares that must be tendered before the Acquiror will buy any shares. The rules and regulation promulgated under the Securities Exchange Act of 1934, as amended, contained detailed provisions relating to tender offers.
The applicable provisions of the regulations provide that it is unlawful for a person to make a tender offer for an Exchange Act-registered equity security if, after consummation of the offer, the Acquiror would beneficially own more than 5% of a class of securities unless, at the time such offer is first published or given to stockholders, certain required filings are made with the Securities and Exchange Commission (SEC), including a Tender Offer Statement on Schedule TO. A tender offer may not only be conditioned on the receipt of a minimum number of securities, but may also place a cap on the number of securities that the Acquiror desires to purchase. There exist detailed regulations and provisions which have to be complied with prior to as well as during the tender offer process, such as Pre-Commencement Communications, Commencement of Tender Offer, Filing Schedule TO, Dissemination of Tender Offer Materials, Withdrawal Rights, Pro Rata Purchase, Pricing and Best Price Requirement, Recommendation of Target Company, Tender Offer Period, Filings with SEC, etc.
One of the features that makes tender offer more lucrative over a merger is speed of closing. In a statutory merger, the Acquiror can not circulate the materials to the shareholders of the Target unless and until the SEC has completed its review of or has decided not to review the initial material to be circulated. However, the SEC does review the material circulated to the shareholders during the pendency of the offer, which allows the tender offers to close several weeks earlier than a statutory merger transaction. Also, the target is more protected from market risk, material adverse change risk and the risk of a third party matching a bid due to quicker speed of Tender Offer over a statutory merger.
Another fact that needs to be weighed in is that in a cash tender offer, the initial antitrust review is quicker as the waiting period under the Hart-Scott-Rodino Act for a cash tender offer is 15 days whereas in a merger, it is 30 days. Furthermore, there are some securities laws benefits in a Tender Offer as the Company that is not in compliance with its financial reporting obligations can initiate a tender offer by circulating the proxy material, whereas in a merger transaction such a company cannot issue a merger proxy and thus, cannot hold a proper shareholder vote on the merger.
B. STATUTORY MERGER
As noted above, in a statutory merger, the Acquiror would form a wholly owned subsidiary for the purposes of consummating the merger and depending on the structure of the merger either the Target would be merged with and into the newly formed acquisition subsidiary with the newly formed subsidiary surviving the merger or the newly formed subsidiary would be merged with and into the Target with the Target surviving the merger. The existing shareholders of the Target would receive the merger consideration for their shares. After the merger, the Target would be a wholly owned subsidiary of the Acquiror.
In a merger, the Acquiror and the Target would negotiate and execute a merger agreement. Among other conditions to closing, one of the conditions would be that the requisite number of stockholders of the Target approved the merger. To obtain the stockholder consent the Target company sends its stockholders a proxy statement soliciting votes on the merger. Assuming the Board of the Target is in favor of the merger, the Board would recommend to the stockholder of the Target to vote in favor of the merger. Delaware General Corporation Law provides that, unless otherwise set forth in the charter documents of the Target company, the consent of stockholders holding at least a majority of the shares of capital stock is necessary to approve a merger. If all conditions to the merger are satisfied as set forth in the merger agreement (including obtaining the necessary stockholder consent), the parties would file the certificate of merger with the relevant states, and the Target would be merged with the newly formed acquisition subsidiary formed by the Acquiror and the Target would become a wholly owned subsidiary of the Acquiror on the closing of the merger. Section 262 of the Delaware General Corporation Law provides for appraisal rights to stockholder who disapprove of the merger. However, the stockholders of the Target would not be entitled to appraisal rights. Pursuant to Section 262 (b) (1) of the Delaware General Corporation Law, no appraisal rights are available to the stockholders of a company whose shares are listed on a national stock exchange.
Target’s Board of Directors Responsibility and Special Committees: The board of directors of the Target must carefully consider their fiduciary duties while approving or disapproving the acquisition transaction. The Board of the Target will frequently form a special committee of disinterested independent directors to consider the merger transaction. To be disinterested, a director must not be an affiliate or designee of the controlling shareholder or the acquiring management team or otherwise be "related" to the proposed acquirer. To be independent, a director must not be "beholden" to the controlling shareholder. This committee must have real bargaining and negotiating power on an arms length basis. The committee also has the duty to approve transactions only if it finds the transactions to be in the best interests of the shareholders. The use of a special committee of disinterested and independent directors will not be conclusive that the transaction is fair, but courts will view it as strong evidence of fairness. It is still highly recommended that the Target’s Board form a special committee composed entirely of independent, disinterested directors to consider the proposed acquisition transaction. It is also necessary to obtain a fairness opinion from an investment bank in connection with the merger.
C. ASSET PURCHASE
Another alternative is structuring the transaction as an asset purchase. If the Acquiror is interested in acquiring only certain, all or substantially all the assets of the Target, then the transaction could be structured as an asset purchase transaction. However, one of the disadvantages of an asset purchase transaction is that all assets, contracts, intellectual property, etc. need to be individually assigned to the Acquiror. Other considerations include the possible transfer of the corporate name, and the rehiring of employees by the Acquiror entity.
The Target may be less inclined to structure the transaction as an asset purchase often because of negative tax consequences to the Target and its stockholders – essentially the purchase price for the assets is paid to the Target, which would trigger an income to the Target attracting corporate taxes and then when the Target makes a distribution of the purchase consideration to its stockholders the stockholder would again be subject to income taxes. However, depending on the financials of the Target (i.e., Target having past losses) the tax consequences may not be adverse to the Target and its stockholders. From an accounting perspective, the Acquiror records the assets and liabilities at the fair market value assigned to them as part of the transaction. This may increase or decrease the carrying value and/or amount of annual depreciation with respect to individual assets and liabilities.
There are a number of legal structures that can be pursued to consummate a transaction, wherein the Indian Company (sometime referred to herein as “Acquiror”) acquires a publicly listed corporation (the “Target”) in the US. For the purposes of this writing, I have focused on three alternative structures for the acquisition of the Target by the Acquiror in the US, which are noted below:
a. Tender Offer- In a tender offer, an Acquiror makes an offer directly to the Target’s shareholders to sell their shares to the Acquiror at a specified price, which is generally at a premium to the existing share price quoted on a stock exchange of the Target shares.
b. Statutory Merger- In a statutory merger, the foreign Acquiror would form a wholly owned subsidiary for the purposes of consummating the merger and depending on the structure of the merger either the Target would be merged with the newly formed acquisition subsidiary with the newly formed subsidiary surviving the merger or the newly formed subsidiary would be merged with and into the Target with the Target surviving the merger. The shareholders of the Target would receive the merger consideration for their shares. After the closing of the merger, the Target would be a wholly owned subsidiary of the Acquiror.
c. Asset Purchase- Depending on the intent of the Acquiror and the assets it intends to acquire in the acquisition, the transaction can be structured as an asset purchase.
The above mentioned structures are described briefly below:
A. TENDER OFFERS
The term "tender offer" is not defined in the Exchange Act or any of the rules promulgated there under, but it has been described generally as: publicly made invitation, usually announced in a newspaper advertisement, to all stockholders of a corporation, to tender their shares for sale at a specified price. To induce the stockholders to sell, the price usually includes a premium over the current market price of the Target company's shares. Cash or other securities may be offered to the stockholders as consideration. An offer is made for a limited period of time only. The Acquiror may offer to buy all tendered shares, or it may offer to buy only a stated number. In general, the Acquiror also sets a minimum number of shares that must be tendered before the Acquiror will buy any shares. The rules and regulation promulgated under the Securities Exchange Act of 1934, as amended, contained detailed provisions relating to tender offers.
The applicable provisions of the regulations provide that it is unlawful for a person to make a tender offer for an Exchange Act-registered equity security if, after consummation of the offer, the Acquiror would beneficially own more than 5% of a class of securities unless, at the time such offer is first published or given to stockholders, certain required filings are made with the Securities and Exchange Commission (SEC), including a Tender Offer Statement on Schedule TO. A tender offer may not only be conditioned on the receipt of a minimum number of securities, but may also place a cap on the number of securities that the Acquiror desires to purchase. There exist detailed regulations and provisions which have to be complied with prior to as well as during the tender offer process, such as Pre-Commencement Communications, Commencement of Tender Offer, Filing Schedule TO, Dissemination of Tender Offer Materials, Withdrawal Rights, Pro Rata Purchase, Pricing and Best Price Requirement, Recommendation of Target Company, Tender Offer Period, Filings with SEC, etc.
One of the features that makes tender offer more lucrative over a merger is speed of closing. In a statutory merger, the Acquiror can not circulate the materials to the shareholders of the Target unless and until the SEC has completed its review of or has decided not to review the initial material to be circulated. However, the SEC does review the material circulated to the shareholders during the pendency of the offer, which allows the tender offers to close several weeks earlier than a statutory merger transaction. Also, the target is more protected from market risk, material adverse change risk and the risk of a third party matching a bid due to quicker speed of Tender Offer over a statutory merger.
Another fact that needs to be weighed in is that in a cash tender offer, the initial antitrust review is quicker as the waiting period under the Hart-Scott-Rodino Act for a cash tender offer is 15 days whereas in a merger, it is 30 days. Furthermore, there are some securities laws benefits in a Tender Offer as the Company that is not in compliance with its financial reporting obligations can initiate a tender offer by circulating the proxy material, whereas in a merger transaction such a company cannot issue a merger proxy and thus, cannot hold a proper shareholder vote on the merger.
B. STATUTORY MERGER
As noted above, in a statutory merger, the Acquiror would form a wholly owned subsidiary for the purposes of consummating the merger and depending on the structure of the merger either the Target would be merged with and into the newly formed acquisition subsidiary with the newly formed subsidiary surviving the merger or the newly formed subsidiary would be merged with and into the Target with the Target surviving the merger. The existing shareholders of the Target would receive the merger consideration for their shares. After the merger, the Target would be a wholly owned subsidiary of the Acquiror.
In a merger, the Acquiror and the Target would negotiate and execute a merger agreement. Among other conditions to closing, one of the conditions would be that the requisite number of stockholders of the Target approved the merger. To obtain the stockholder consent the Target company sends its stockholders a proxy statement soliciting votes on the merger. Assuming the Board of the Target is in favor of the merger, the Board would recommend to the stockholder of the Target to vote in favor of the merger. Delaware General Corporation Law provides that, unless otherwise set forth in the charter documents of the Target company, the consent of stockholders holding at least a majority of the shares of capital stock is necessary to approve a merger. If all conditions to the merger are satisfied as set forth in the merger agreement (including obtaining the necessary stockholder consent), the parties would file the certificate of merger with the relevant states, and the Target would be merged with the newly formed acquisition subsidiary formed by the Acquiror and the Target would become a wholly owned subsidiary of the Acquiror on the closing of the merger. Section 262 of the Delaware General Corporation Law provides for appraisal rights to stockholder who disapprove of the merger. However, the stockholders of the Target would not be entitled to appraisal rights. Pursuant to Section 262 (b) (1) of the Delaware General Corporation Law, no appraisal rights are available to the stockholders of a company whose shares are listed on a national stock exchange.
Target’s Board of Directors Responsibility and Special Committees: The board of directors of the Target must carefully consider their fiduciary duties while approving or disapproving the acquisition transaction. The Board of the Target will frequently form a special committee of disinterested independent directors to consider the merger transaction. To be disinterested, a director must not be an affiliate or designee of the controlling shareholder or the acquiring management team or otherwise be "related" to the proposed acquirer. To be independent, a director must not be "beholden" to the controlling shareholder. This committee must have real bargaining and negotiating power on an arms length basis. The committee also has the duty to approve transactions only if it finds the transactions to be in the best interests of the shareholders. The use of a special committee of disinterested and independent directors will not be conclusive that the transaction is fair, but courts will view it as strong evidence of fairness. It is still highly recommended that the Target’s Board form a special committee composed entirely of independent, disinterested directors to consider the proposed acquisition transaction. It is also necessary to obtain a fairness opinion from an investment bank in connection with the merger.
C. ASSET PURCHASE
Another alternative is structuring the transaction as an asset purchase. If the Acquiror is interested in acquiring only certain, all or substantially all the assets of the Target, then the transaction could be structured as an asset purchase transaction. However, one of the disadvantages of an asset purchase transaction is that all assets, contracts, intellectual property, etc. need to be individually assigned to the Acquiror. Other considerations include the possible transfer of the corporate name, and the rehiring of employees by the Acquiror entity.
The Target may be less inclined to structure the transaction as an asset purchase often because of negative tax consequences to the Target and its stockholders – essentially the purchase price for the assets is paid to the Target, which would trigger an income to the Target attracting corporate taxes and then when the Target makes a distribution of the purchase consideration to its stockholders the stockholder would again be subject to income taxes. However, depending on the financials of the Target (i.e., Target having past losses) the tax consequences may not be adverse to the Target and its stockholders. From an accounting perspective, the Acquiror records the assets and liabilities at the fair market value assigned to them as part of the transaction. This may increase or decrease the carrying value and/or amount of annual depreciation with respect to individual assets and liabilities.
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