Originally published in the January 2011 edition of the M&A Lawyer
As the global private equity industry rebounds from the 2008-2009 recession, private investors have been increasingly receptive to making significant minority investments in public companies. The growth of these types of deals has been driven by, among other things, continued unfavorable financing terms for typical leveraged buyout transactions that marked the pre-financial crisis deal-making era — as well as acute memories of significant leverage buyout failures during the recession. At the same time, while many public companies continue to hold out for higher valuations for change of control transactions, they have found that minority investments can be an efficient and useful technique for raising capital.
In structuring and negotiating the terms of a significant minority investment (generally between 10 percent to 40 percent of the outstanding stock) in a public company, investors must unravel a number of interlocking issues that may not emerge in the typical change of control buyout transaction. Such issues may depend upon, among other things, the long-term investment strategy of the investor, the size of the investment as a percentage of the company's outstanding capital stock, the legal and regulatory regimes applicable to the company and the investment, and the amount of control and influence the investor seeks over the company.
This article highlights some of the issues that private investors should consider in planning for and negotiating such minority investments in public companies.
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Securities Exchange Restrictions on Private Placements. In a negotiated transaction between an investor and a public company listed on either NASDAQ or the NYSE, the parties will need to consider the applicable rules requiring shareholder approval prior to, among other things, issuing 20 percent or more of the issuer's outstanding common stock (or of securities convertible into or exercisable for common stock) or voting power. For commercial and other reasons, it would be impractical to delay many financing transactions until shareholder approval is obtained.
Many traditional private investments in public company transactions have addressed this limitation by permitting the initial issuance of 19.9 percent of the issuer's common stock, with additional shares being issuable only upon the receipt of shareholder approval. This traditional structure may not be attractive to an investor seeking a significant minority investment if an equity ownership cap of 19.9 percent following the failure to obtain shareholder is not an acceptable outcome.
One alternative transaction structure that may be more attractive to an investor contemplating a significant minority equity investment would be to initially acquire debt that, per its terms, would only become convertible into equity (or a security that could be convertible into equity) upon the receipt of shareholder approval. Under such a transaction structure, the minority investor could protect itself by negotiating an immediate "exit" right by providing for an event of default/acceleration trigger under the initial debt instrument if shareholder approval is not obtained within a certain period.1 Furthermore, the investor should consider whether automatic conversion to equity immediately following the receipt of shareholder approval is preferred, rather than negotiating for the option to remain in the debt instrument following shareholder approval, with subsequent conversion rights at the investor's option. The latter structure would be advantageous from the investor's perspective to, among other things, remain senior to the underlying equity in the capital structure, exercise significant rights through debt covenant protection and increase the option value of the convertible security.
Exit Provisions/Registration Rights. Unlike in a typical control acquisition, a minority investor may not have as much flexibility with respect to the timing of the exit of all or part of the investment. Most companies would be hesitant to allow a "put" right on an equity instrument (requiring the company to repurchase the equity instrument upon demand). Consequently, minority investors in public companies should negotiate for robust registration rights to provide for flexibility of a complete or partial exit through open market dispositions. Subject to certain limited exceptions, if a person or group is deemed to be an "affiliate" of an issuer under the US securities laws, such person or...