Target company M&A readiness for 2024

This article is part of our M&A outlook for 2024.

Despite challenging macroeconomic trends as we head into 2024, overall M&A activity in the Canadian market remains robust. For many public companies, in fact, the conditions may be ripe for unsolicited M&A proposals—undervalued public company share prices, shareholders pressuring companies for performance improvement and liquidity, and potentially less competition among buyers who may not have access (or the appetite) for financing in the current high-interest rate environment. Unsolicited M&A proposals come in a wide variety of forms: some will be preliminary while others will be ready to execute; some will be friendly, others may be hostile. Whatever the circumstances, companies will need to be prepared to consider, evaluate and potentially respond to any of these situations. In this article we discuss M&A preparedness for target public companies and steps they can take on receipt of an unsolicited M&A proposal.

M&A planning in advance of a proposal

When an M&A proposal is submitted, bidders typically exert significant pressure on the company to respond swiftly. Advance preparation allows for a more organized and effective response to an unanticipated proposal and enhances the company’s ability to control the process, on its own timeline, and achieve optimal outcomes for stakeholders.

Companies should consider taking the following steps in advance of any proposal being received:

1. Implement a market watch, including monitoring changes in shareholdings, share price and volume for unusual activity, and provide regular management and board briefings on market and analyst commentary.
2. Maintain active dialogue with investors and the investment community.
3. Anticipate likely bidders and strategic developments in the industry.
4. Maintain updated financial forecasts/models and a strategic plan.
5. Maintain an up-to-date data room.
6. Identify a proposed working group of key members of management and external advisors.
7. Consider which directors may serve as potential special committee members (and consider this as part of the ongoing board recruitment process).
8. Consider adopting an M&A response playbook, which will memorialize a number of the above points.

Taking immediate steps after receiving a proposal

There is no one-size-fits-all approach for how a company should respond to an unsolicited M&A proposal. Each response will be largely contextual, dependent on the attractiveness of the proposal, credibility of the bidder and state of the target company, among other factors.

If the company receives a bona fide proposal meriting active consideration, it should take the following steps before determining how to respond:

1. Promptly notify the Board of the proposal. While many proposals are submitted directly to the Chair of the Board, this is not always the case. The Board plays a key oversight role in any M&A process and it is critical that the Chair of the Board is advised promptly. Typically, the Chair will determine how best to inform the rest of Board.
2. Identify and consider potential conflicts, and consider establishing a special committee of independent directors to lead the review of and any response to the proposal.
3. Assemble a working group—including key management members and external advisors (financial and legal). In considering advisors, it will be important to confirm that they are not subject to conflicts,..
4. Get caught up on the financials. Identify and update any existing financial analyses, models and projections, as well as the company’s strategic plan. Consider performing new or supplementary analyses where necessary or advisable. These documents will be key to assessing the value of the company, and any assessment of the bid or any alternatives.
5. Together with the company’s external advisors, develop a strategy to ensure there is sufficient time to pursue alternatives and enhance value.
6. Consider any trading restrictions for anyone aware of the proposal and related company blackouts.
7. Consider the company’s disclosure obligations and external communications strategy. Leak risk is heightened in these contexts, so active monitoring of trading activity and media reports is important.

Assessing the proposal

The Board should always act promptly to consider a credible proposal, but take the necessary time to evaluate the proposal, seek input from advisors and formulate an appropriate response. That said, the Board is not obligated to engage with a bidder or start a sale process and a Board may decide that maintaining the status quo is in fact the best alternative for a company.

In considering a proposal and determining its response, here are some important questions for a Board to ask:

• How serious and credible is the bidder? Is this a known party with a reputable history? Is additional diligence required on the bidder to make this determination?
• How executable is the proposal? What are the conditions and are they reasonable? Will shareholders and other stakeholders of the company support the transaction?
• Is the price attractive? Is it pre-emptive? Is the Board prepared to discuss a potential transaction only with the bidder (on an exclusive basis or otherwise), or will it conduct some form of market check?
• How important is the deal to the company? Is the company in financial distress, or is the deal a strategic imperative?
• How is the company performing, and is it likely to be able to achieve its financial and operational goals over all relevant time frames in the absence of a sale transaction?

Role of management in responding to an M&A proposal

Management input is critical to an effective M&A response. Management knows the business and its prospects, and all of the company’s stakeholders—shareholders, employees, customers, suppliers—better than anyone. Management is responsible for executing on the company’s strategic plan and building the forecast that is key to assessing the company’s value.

Despite their importance to the success of any process, management is inherently conflicted in any M&A transaction. Any transaction will likely have a material impact on management roles, compensation and the company’s go-forward strategy.

Boards can manage these conflicts with strategies to preserve the independence of the process while facilitating the appropriate input of management. Typical techniques include:

• closely supervising and limiting management interaction with bidders about matters relating to transaction terms, and post-closing management and employee compensation;
• having the Board or special committee receive management’s input and views of the potential transaction at the beginning of their meetings, followed by an in camera session first with the CEO only and then without the CEO present;
• obtaining the support and advice of outside financial advisors who can test management-prepared forecasts and provide insight into broader market dynamics.

Addressing conflicts in related-party transactions

When two parties that have a preexisting material relationship enter into a transaction, conflicts of interest may arise. Typical conflicts of interest include: a bid made by a significant shareholder (whether or not it has a board representative); or a management buyout where the CEO and other members of management are either making the proposal or working jointly with a bidder.

Conflicts in related-party transactions can create major issues if they are not identified early and appropriately managed. Unmanaged conflicts can (i) impair the effectiveness of a company’s response and ability to achieve the optimal results for its stakeholders, (ii) leave the company exposed to challenge from other parties and shareholders, and (iii) result in reputational damage.

To address conflicts, conflicted directors should recuse themselves and the company should establish a special committee of disinterested directors with sufficient time and experience to devote to the M&A process.

Conflicts are growing as an area of focus for regulators and courts. As a threshold matter, the company must consider whether a proposal presents any conflicts of interest for directors and management. Special regulatory requirements, including minority shareholder approval and independent formal valuations, may be applicable for related-party transactions under Multilateral Instrument 61-101.

Responding to a hostile bid

Hostile bids that are unsolicited and unwelcome by a target board are relatively infrequent in Canada but do occur from time to time—particularly where a target company is vulnerable or likely to be sought after by multiple parties. Hostile bids are especially time-intensive for target Boards and management teams.

Companies have options available to them to defend against a hostile takeover bid. Most commonly, target companies will try to convince target shareholders to resist an offer, search for another buyer or deploy regulatory or political pressure.

However, defensive measures that constrain shareholder choice or lead to a coercive result in respect of a change-of-control transaction will be subject to regulatory scrutiny. In Canada, structural defences in constating documents or by-laws of a company (e.g., supermajority voting provisions, staggered board provisions, prohibitions on shareholders’ ability to call meetings, removal of directors only for cause) are extremely rare and are often either not permitted or ineffective under Canadian corporate law.

Ultimately, the best defence against a hostile bid is a clear and well-articulated strategic plan that is supported by shareholders, a strong management team focused on executing on that plan, and an active and open dialogue with shareholders.