Going Private: Rule 13e-3 and Private Equity Buyouts - Part 2
In acquisitions of public companies, private equity sponsors often seek to retain members of the target’s management to run the day-to-day operations of the portfolio company after closing. Almost invariably, the sponsors will offer management shares in the surviving company in order to align the managers’ interests in improving the company’s profitability with those of the private equity fund. Sponsors may offer managers an equity interest in the surviving company in proportion to their existing equity interests in the target company (known as “roll over” equity). Alternatively, they may allow managers to invest their own funds to purchase equity in the surviving company alongside the private equity fund (a deal structure known as a “buy-in management buyout” or “bimbo”). When management is offered equity in the acquiring company without having to take out loan notes to finance their buy-in, their shares are known as “sweet equity.” Such equity interests may be offered either in addition to or in lieu of equity options that vest over time or upon meeting certain financial milestones (referred to as “promote equity”).
When private equity sponsors issue equity interests in the surviving company to a public target’s current management, the managers may be considered “affiliates” of the target company who are “engaged” in a transaction subject to the Securities Exchange Act’s Rule 13e-3 “going private” filing requirements. Although the Staff of the Division of Corporation Finance of the Securities Exchange Commission as a policy does not provide guidance on whether or not a particular party should be deemed an “affiliate” for purposes of this rule, Compliance and Disclosure Interpretations (C&DIs) released by the Staff on January 26, 2009 together with the Staff’s interpretive releases provide practitioners guidance on what types of deal structures may require Schedule 13E-3 filings. For an overview of Rule 13e-3’s definitions of a “going private” transaction and “affiliate,” please see Part 1 of this post.
Management as “Affiliates” in Private Equity Buyouts
The SEC has maintained that the determination of a person’s status as an affiliate is a factual question that only may be determined by considering all the relevant circumstances of a given transaction. Nevertheless, the Staff’s C&DIs provide some insight into the factors considered by the Staff to be determinative of a person’s affiliate status. Judging whether or not officers or directors of a publicly traded target company are affiliates of the company under Rule 13e-3 generally turns on whether or not they have the power to direct or cause the direction of the management and policies of the target company. According to the Staff’s interpretive releases and C&DIs, the continuity of management or directors of the target before and after the transaction in question likely indicates that the deal requires compliance with Rule 13e-3.
In the interpretive release adopting Rule 13e-3 (Release No. 34-16075), the Staff suggested that even if an unaffiliated private equity sponsor engages in arm’s-length negotiations regarding the acquisition of a target, yet intends to keep the target’s management in place after the purchase is completed, the parties engaged in the transaction may be required to file Schedule 13E-3. Among the factors the Staff takes into consideration are:
- an increase in consideration received by management;
- any alterations in management’s executive agreements that are favorable to management;
- equity participation of management in the acquiring or surviving entity; and
- the representation of management on the board of directors of the acquiring or surviving entity.
The Staff has consistently held that members of senior management of a public corporation that is “going private” are affiliates of the company. In deals where a transaction is accomplished by way of a merger, the Staff has concluded that senior managers are required to file Schedule 13E-3, even though:
- management’s involvement in the target’s negotiations with the buyer was limited to the terms of each manager’s future employment with or equity participation in the acquiring or surviving company; and
- the target’s board of directors appointed a special committee of outside directors to negotiate all other terms of the transaction except management’s role in the acquiring or surviving entity.
Measures taken by a public company’s board of directors to protect shareholders from the possibility that its officers or directors may collude with a buyer do not alone obviate the need for a Schedule 13E-3 filing. Factors considered by the Staff include: whether management would hold a material amount of the surviving company’s outstanding equity securities, occupy seats on the company’s board of directors in addition to having senior management positions, or would otherwise be in a position to “control” the surviving company.
Although the Staff has not defined what constitutes a “material” equity interest in a company, historically it has determined that a 10% ownership interest is sufficient to cross the materiality threshold. Nevertheless, this 10% figure should not be taken as a bright-line rule, as even a smaller equity interest in a public target may trigger Rule 13e-3 if other evidence of “control” is present.
Private Equity Funds as “Affiliates” of the Target and its Management
In one of the January 2009 CD&Is, the Staff specifically addressed the situation where a financial buyer, previously unaffiliated with the target, intended to enter into separate agreements with members of the target’s senior management resulting in management’s ownership of 20% of the surviving entity after the deal closed. Although the managers neither negotiated the merger agreement with the private equity sponsors nor executed any documents regarding their future equity participation, the Staff held that “where there exists a general understanding that a target’s senior management will receive equity in a surviving equity, whether derived from unexecuted documents or otherwise, Rule 13e-3 may apply.” The Staff reasoned that because senior management understood they would be equity holders in the surviving entity, the financial buyer in effect straddled both sides of the transaction (i.e. as both acquirer and target). Owing to the substantial equity participation in the transaction by senior management, each of whom would remain in a position to influence the policies of the target, the financial buyer could be in “control” of the target before the deal closed.
As the previous CD&I demonstrates, where management of the target company is effectively “on both sides” of the transaction, the private equity funds (and any acquisition vehicles formed for the deal) may also be deemed to be affiliates of the target company engaged in the transaction and thus be required to file Schedule 13E-3. In Release No. 34-16075, the Staff stated that “affiliates of the seller often become affiliates of the purchaser through means other than equity ownership, and thereby are in control of the seller’s business both before and after the transaction. In such cases the sale, in substance and effect, is being made to an affiliate of the issuer.”
A recent example of this scenario may be found in the July acquisition of Bankrate, Inc. by funds advised by Apax Partners in which the Apax funds, the holding companies set up by Apax to complete the deal, members of senior management, and Bankrate jointly filed a Schedule 13E-3.
Related Post: Going Private: Rule 13e-3 and the Acquisition of Public Companies – Part 1