Investors are more engaged and less deferential to boards and management teams—a trend that is increasingly being felt in M&A. Companies considering strategic transactions have to be aware of the risks of dealing with investors who are critically evaluating strategies developed by management, in some cases going as far as proposing their own competing strategies. This dynamic is creating challenges for companies in pursuing strategic transactions.
Laying the Groundwork
Recognizing that investor support is fundamental to successful M&A execution, management teams are more proactively disclosing to investors the role they see for M&A in their overall strategy, sometimes being fairly specific about sectors, geography or specific assets. Boards are increasingly pressing management teams to bring their analyses of potential opportunities to the board so that they can be more engaged in this element of the company’s strategy. Boards are also showing more transparency, including by speaking directly with investors. Direct communication with select investors always carries the risk of selective disclosure. Discussing M&A strategy publicly provides more latitude to management in investor meetings. It continues to be rare to see specific discussion of M&A strategy and goals in a company’s MD&A or other disclosure documents; it is more common for companies to discuss these matters in investor presentations or media interviews. While the Canadian regime does impose liability for misrepresentations in public statements, Canada lags behind the U.S. in requiring such communications to be incorporated into a company’s formal disclosure record.
Approaching Investors Pre-announcement
Companies frequently consider approaching larger shareholders prior to announcement to gauge how the market will react. This raises “tipping” concerns. The general principle in Canada is that whenever a company wishes to impart confidential information prior to announcement, it has to be comfortable that the communication is in the necessary course of business. Where a transaction does not require shareholder approval, it can be difficult to meet that test. A further complication is that when making the disclosure, the company should impose confidentiality and trading restrictions. Investors are leery of being restricted without knowing more specifics, including how long the restrictions will apply, which may or may not be clear. In addition, hedge fund and other event-driven investors, while always happy to receive information, do not generally accept limitations on their ability to trade. Against this backdrop, companies are often forced to rely on their own judgment, informed by expert advice, regarding the likely market reaction. Companies that understand investors’ perspectives on their growth initiatives and overall strategy going into a negotiation are better positioned to make those judgments.
Shareholder Approval Considerations
A key point for companies considering a significant transaction is whether shareholder approval will be required. TSX rules require listed companies to obtain shareholder approval for an acquisition involving the issuance of more than 25% of the company’s outstanding shares. For an acquiror, a shareholder vote can introduce significant complexity and risk. Shareholders typically are not receiving any consideration and the vote dynamics are therefore different than in a sale where shareholders are receiving a premium price to entice them to vote in favour. In a buy-side vote, the fact that shareholders have to make a decision and vote on the merits of the deal provides an opportunity for shareholders to express a view on the company’s strategy, and its execution to date, without selling their shares. It also gives parties waiting in the wings an opportunity to propose alternatives at a time when both the board and the shareholders will be forced to respond. Acquirors must consider whether they should negotiate for a “fiduciary out” in the event that they themselves become a target in the midst of the deal. This most often arises where an acquisition is sufficiently large to necessitate a buy-side shareholder vote or where the deal is portrayed as a merger. In those cases, parties tend to negotiate for reciprocal deal protections. In addition, boards of acquirors, concerned about the risk of being put “in play,” sometimes see advantage in having a fiduciary out because an interloper will be required to pay a break fee, making a competing deal more expensive.
Disclosure in the Spotlight
Companies are holding themselves to a higher standard in the disclosures they provide when significant strategic transactions are announced. More and more, investors want to see and understand for themselves the analysis on which the company relied. For example, even where not required, companies are providing details on their plans for an acquired business. Companies selling a business face increased pressure to be specific about their plans for sales proceeds. In many transactions, agreeing on an estimate of synergies is essential to settling the financial terms. Investors expect information about the estimated synergies to assist them with their analysis. However, companies are reluctant to provide specifics around the quantum, categories and timing because the numbers used for negotiating purposes will invariably be refined once the transaction has been announced and integration planning begins in earnest. The rules for disclosure of forward-looking information protect companies in disclosing synergies estimates but require them to be specific in disclosing their key assumptions and risks and, in some cases, require actual results to be reconciled to the estimates. This can be challenging for management because the synergies are based on very high-level information.
Compensation issues are receiving more attention from investors in the context of M&A. Retention or termination arrangements are often negotiated or modified as a transaction is being negotiated. Even though these arrangements are of keen interest to investors, the tendency in Canada is to provide disclosure only when and to the extent required. Investors have taken notice. In the U.S., new rules require companies to provide enhanced disclosure of “golden parachute” compensation arrangements and to hold a separate shareholder advisory vote in the context of a merger transaction.
Alternatives to M&A
Companies have to weigh M&A opportunities against alternatives that investors may find more attractive. In the current environment, investors seem increasingly prepared to accept relatively low returns in exchange for more certainty. That makes strategic M&A more challenging because the returns sought are less certain and depend on management’s execution over a longer period. With substantial cash accumulating on balance sheets as the economic environment improves, companies are opting to return record amounts of capital to shareholders though increased dividends and share buybacks. Spin-offs also continue to be popular with investors. From a company’s perspective, spin-offs can provide a means of disposing of a noncore business without the complexities of negotiating with a third party and the risk that investors will be disappointed by the financial terms. For shareholders, spinoffs are a tax-efficient means of returning capital because shareholders can decide either to hold the spun-off shares or sell them into the market. Although it can be debated whether companies are serving their long-term best interests in favouring immediate value-creation alternatives over long-term growth strategies, it is unlikely that directors face any practical risk or legal challenge in doing so.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2021 by Torys LLP.
All rights reserved.