Private Equity

  • Date:01 Oct 2007
  • Type:CompanyDirectorMagazine

Justin Harris and Tracey Renshaw provide some tips on what to do if a private equity player wants to run its ruler over your company’s books.

Letting the barbarians through the gate

There has been much recent media comment about the role and rise of private equity participation in merger and acquisition activity involving listed companies. Importantly, the analysis has focused on examining both the deals themselves and certain issues that confront a target board as a result, including when management is seeking to participate.

Whether or not there is management involvement, the pattern almost always involves an initial approach coupled with a request for a right to conduct due diligence (that is a right of access to ‘inside’ information). While such a request is not unique to the world of private equity (Wesfarmers was as keen as KKR to run its fingers over Coles’ books), it is virtually an essential pre-requisite for a private equity player. This is not surprising given that private equity participants in large high profile transactions do not only play with their own money – a private equity deal is leveraged with debt from a syndicate of financiers. The involvement of financiers dictates that stringent ‘investment’ conditions need to be satisfied before the debt will be advanced.

This means that private equity players want to:

  • Run the ruler over a target’s book and records before they (and their financiers) will commit;
  • Almost never acquire a pre-bid stake; and
  • Want the certainty of an all or nothing deal (hence, the preference for schemes of arrangement over takeover bids) so that target assets can be offered as security.

It is worth noting that there is no absolute obligation on a target board to provide access to its books and records to any third party. The duty is a more nebulous one to ensure that directors act in the best interests of the company, which usually means shareholders collectively. However, where the consideration offered or spoken of seems temptingly high, this is usually enough to convince a target board that it is in the interests of its shareholders to at least explore the matter a little further.

That being the case, and if a decision is made to provide access, what should a target board consider at this time? The following pointers apply whether or not there is management involvement, and, in varying degrees, whether or not the deal involves private equity.

1. Equal access

If there are, or could be, more than one interested acquirer, will the target directors need to give each of those parties the same information, or the same time and conditions to consider it? Although there is currently no general requirement that a target must provide equal information to rival bidders, the Takeovers Panel has re-iterated in a recent draft Guidance Note, titled: Insider Participation in Control Transactions, that it would normally expect that, in circumstances where target directors have not provided equal access, they would have sound reasons for their decision. In the same Note, the panel also indicated that, if participating insiders – that is, management – are given more information, the panel would be likely to scrutinise very closely the circumstances and reasons given by target directors.

2. Preliminary steps

What are the usual or necessary pre-requisites to allow a third party access to the target’s inside information?

A confidentiality agreement is essential. This will provide contractual rights in the event that an acquirer does not maintain the secrecy of information disclosed to it (and will facilitate obtaining discretionary remedies such as injunctions). The restrictions in a confidentiality agreement should extend to the acquirer’s officers, employees and advisors. Indeed, in appropriate circumstances, each of these individuals should be asked to sign their own individual undertaking. The agreement should also, at a minimum, contain obligations that require the acquirer to hand back (or destroy) the confidential information revealed if the transaction comes to nothing.

Confidentiality agreements are often increasingly sophisticated, and may well contain other provisions to protect a target. These may include:

  • A ‘standstill’ – which is a contractual undertaking on the part of the acquirer not to buy target shares for a stated period (or until a relevant event occurs);
  • A break fee – which may require the payment of an amount to compensate the target for wasted time and effort if the transaction does not proceed (rules have been developed which govern the maximum financial amounts that are permitted and the circumstances in which they can be payable). Beware that acquirers themselves are keen on break fees in their favour; and
  • Exclusivity arrangements – these often take the form of a ‘no shop’ (which prohibits the target actively seeking alternative offers) and ‘no talk’ (which goes further and prohibits the target from even talking to another interested party). The latter will usually be subject to a fiduciary carve-out to enable the target board to respond if approached by a third party with a particularly attractive offer (thus enabling the directors to fulfil their duty to shareholders in getting the best offer available).

3. A managed process

Having dealt with the preliminaries, the target board will then allow access to the relevant information. For reasons of public secrecy (and so as not to cause alarm to unsuspecting employees) this usually takes place as part of a carefully managed process. The relevant information is first collected, indexed and preferably independently screened. It is then made available in either a physical or ‘virtual’ (internet based) data room. There will usually be restrictions on the period of access and on the copying of information provided. There is often also a process so that specific questions can be raised and responses provided.

It is not unusual for disclosure to be part of a staged process whereby the more generic information is provided first and the more sensitive information is withheld until the acquirer has, more convincingly, been able to demonstrate its interest and financial clout.

It may even be that a target wishes to conduct the process. In this case, the target would have its own legal and financial representatives conduct a due diligence on itself. The resultant due diligence report would be given to (and could be relied upon by) interested third parties. The benefit of this to the target is that it owns the report – it can use it to shop around and tempt a range of potential acquirers, therefore hopefully facilitating a controlled auction. This contrasts with the position where an acquirer does its own due diligence – in which case the acquirer owns and keeps the report or destroys it when it walks away.

Ancillary issues

There can be consequences flowing from the above. Some relevant ones may include:

  • While signing a confidentiality agreement should help to preserve the confidentiality limb of the carve-out to ASX Listing Rule 3.1A (which relates to the disclosure of price sensitive information), the involvement of multiple parties may increase the risk of a leak, or at least market speculation about the possibility of a transaction. The ASX (and ASIC) take a very firm view of a target’s obligation to make fulsome disclosure to the market in these circumstances.
  • Irrespective of any standstill having been entered into, it is quite possible that as part of its due diligence investigations, an acquirer will discover price sensitive inside information concerning the target which would prevent it from being able to acquire target shares – without committing the insider trading offence. While this may apply in relation to the acquisition of a pre-bid stake, it may not prevent the making of an unwelcome takeover bid. An acquirer could potentially cure this state of affairs by disclosing the relevant information in any public bidder’s statement it issues.

When any interested acquirer (and particularly a private equity player) comes knocking at the door, there will be many matters for a target board to consider. Ensuring that the issues outlined above are among them should save time, uncertainty and embarrassment further down the track.

Justin Harris and Tracey Renshaw are partners at Cochrane Lishman.