While going public is a sought-after milestone for many growing companies, an increasing number are instead opting for growth through alternative sources of private financing. Remaining private for longer — in some cases indefinitely — is a desirable alternative that affords companies the opportunity to tap into the abundance of available private capital and the ability to select investors while avoiding public compliance costs and disclosure requirements.
It is becoming more common for growing companies to raise multiple investment rounds, which has resulted in a rising number of private companies having broad shareholder bases. This is especially common in the technology sector, with shareholders including founders, friends and families, employees, consultants, venture funds and private equity investors. The health-care sector is another space that has seen a growing number of widely held private companies or “roll-up” platforms, into which multiple health-care practices are aggregated to form larger consolidated entities that are held by the healthcare practitioners that “rolled” into the aggregated structures alongside the private-equity sponsors of the platforms.
What happens when these widely held private companies are put up for sale? It creates an intersection of private and public M&A.
1. Public Transaction Elements
Plans of Arrangement
Most negotiated Canadian public company acquisitions are nowadays completed by plan of arrangement, a flexible, statutory process that is particularly well suited for acquisitions of widely held companies. A plan of arrangement allows a buyer to acquire the securities of a target company without having to negotiate an acquisition agreement with every selling shareholder. In addition, a plan of arrangement allows for great flexibility to implement complex transactions.
An arrangement agreement is negotiated between the buyer and the target’s board of directors which contains not only customary acquisition terms and conditions (including in respect of structure, purchase price, representation and warranties, closing conditions and interim period covenants), but also those relating to the arrangement and shareholder approval process itself (such as covenants to seek the required court orders and to call the meeting of the target’s shareholders to approve the transaction).
After the arrangement agreement is signed, the implementation of the plan requires two court appearances and a meeting of the target’s shareholders, which takes approximately 45–60 days in total. At the initial court hearing, interim court approval is sought regarding the management proxy circular delivered to the target’s shareholders, the mechanics of the shareholders’ meeting and the votes required from the target’s shareholders to approve the transaction (typically, two-thirds of shares voted). Once the interim court order is obtained, the circular and notice of the target’s shareholders’ meeting are delivered, with the target shareholders’ meeting held approximately three to four weeks later.
Once the target’s shareholders’ approval is obtained, a final order court hearing is held to seek approval of the arrangement. At that hearing, the court determines, among other things, if the arrangement is fair and reasonable. Target shareholders that oppose the transaction are able to appear and object at this hearing. While the court will consider such objections, it will typically approve the transaction if the meeting process provided for in the interim order has been complied with, the requisite shareholder approval has been obtained and the interests of all relevant stakeholders have been adequately considered. Subject to other closing conditions being satisfied, the transaction can close after the final court approval is obtained.
Role of the Target Board of Directors
While the acquisition of a private company typically involves direct negotiation between the buyer and the selling equity holders, the negotiation of a plan of arrangement involves the buyer negotiating with the board of directors of the target company. In negotiating the transaction, the target’s directors must act according to their two principal duties under corporate and common law: fiduciary duty (requiring directors to act honestly and in good faith with a view to the best interests of the corporation) and duty of care (requiring they exercise the diligence and skill that a reasonably prudent person would exercise in comparable circumstances).
As part of the target’s board process to determine whether to recommend the arrangement to the target’s shareholders, it invariably obtains an opinion from an independent financial advisor as to the fairness of the transaction, from a financial perspective, to target shareholders.
In exercising its fiduciary duties, the target’s board will also typically negotiate the right to accept an unsolicited superior proposal for the target from a third party as part of the arrangement agreement. This right is typically contingent upon the buyer being afforded the right to match the third party’s offer or to receive a termination or break fee if the superior proposal is accepted.
The circular provided by the board to the target’s shareholders must describe the transaction in sufficient detail to enable them to make an informed decision about the transaction. Prospectus-level disclosure is required if securities of the buyer are offered as consideration, and the additional disclosure requirements of Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions apply if the transaction involves conflicts or related party elements.
2. Private Transaction Elements
In addition to the public transaction elements, a private company plan of arrangement transaction typically reflects a number of hallmarks of private M&A transactions, which are rare or non-existent in the public context, including those described below.
Representation and Warranties and Indemnities
In public M&A transactions, the buyer typically does not benefit from robust risk protection mechanisms and related indemnity provisions because it is uncommon to claim recourse from a large group of disparate public shareholders post-closing. Therefore, in public acquisitions, representations and warranties typically terminate upon closing. In a private company plan of arrangement, the arrangement agreement contemplates representations and warranties and post-closing indemnities, providing the buyer with risk protection that is commonplace in private M&A transactions.
Use of Escrows
Further in line with private M&A transactions, the buyer often benefits from the use of escrows, whether for post-closing financial adjustments such as working capital or for indemnity protection. Escrows in private plans of arrangement are often documented pursuant to separate escrow agreements between the buyer, a representative of the target’s shareholders, and the escrow agent. A portion of the cash consideration is deposited in escrow for indemnity claims (providing the buyer with security against breaches of the target company’s representation and warranties and indemnities) and post-closing purchase price adjustments (most often to the cash consideration paid following the final determinations of the target’s net working capital and indebtedness).
Representations and warranties insurance has now become a mainstream feature in private M&A transactions. As a result, not surprisingly, participants engaging in private plans of arrangement leverage this transaction tool as part of the risk allocation exercise to further bolster the buyer’s post-closing protection in combination with the target’s indemnities.
Rollover Equity for Holders of Equity and Incentive Awards
Private equity investors view the continued involvement of key shareholders as an integral element of the transaction. A common method to achieve this is through “rollover equity,” whereby certain if not all target equity holders, such as founders or critical management-team members, receive a portion of their transaction consideration in the form of equity in the buyer. Rollover equity benefits both the buyer and the selling equity holders. For the buyer, rollover equity reduces the upfront cash consideration paid in the transaction and is a powerful tool for aligning the incentives of the target management team with those of the post-closing shareholders. Rollover equity holders also benefit as they are able to receive some cash consideration for their shares while still participating in the growth of the new entity.
As high-growth private companies continue to seek expansion capital through private markets, we can expect to see more of these entities with widely held and complex shareholder bases. As a result, potential buyers or investors in such companies should anticipate continued and evolving applications of this quasi-public private M&A transaction model in the future.
Kurt Sarno is a Partner at Blake, Cassels & Graydon LLP in Toronto. He specializes in mergers and acquisitions, private equity and joint ventures. He advises buyers, sellers and targets on domestic and cross-border mergers and acquisitions; private equity investors and sponsors on buy-outs, investments and exits; and businesses across various industries on complex joint ventures and strategic corporate and commercial matters.
Kurt is the Co-Leader of the Firm's Private Equity group and the co-author of the Firm’s Canadian Private Equity Deal Study.
Before becoming a Partner at Blakes, Kurt practised at a pre-eminent law firm in New York, concentrating on mergers and acquisitions and private equity.
Rory ffrench is a Partner at Blake, Cassels & Graydon LLP in Toronto. He is primarily focused on mergers and acquisitions, investments, strategic transactions and reorganizations, with particular expertise in cross-border and multijurisdictional matters. As part of his practice, he also provides strategic advice to clients on all aspects of corporate and commercial law, including strategic alliances, joint ventures, partnerships, the establishment and structuring of Canadian operations, and other day-to-day legal matters.
Rory’s experience collaborating with and advising strategic, private equity and other financial sponsor clients spans a broad set of industries, including agribusiness, food and beverage, financial services, manufacturing, infrastructure, sports, media and entertainment, and technology.
Rory’s corporate and M&A experience has been enhanced by his time as a visiting associate in the Amsterdam office of a major international law firm and as a legal secondee to a foreign investment bank. Prior to joining Blakes, Rory also spent a number of years working in the financial advisory group of one of the big four accounting firms where he earned his chartered accountant designation.
Joanna Myszka is a Partner at Blake, Cassels & Graydon LLP in Montréal. She focuses primarily on domestic and cross-border mergers and acquisitions, share and asset sale transactions, and general corporate matters. She takes part in several aspects of managing the M&A process, from due diligence to transaction closing, including drafting and negotiating the purchase agreement and other transaction documents.
In addition, Joanna advises companies on a wide range of commercial transactions involving information technology and intellectual property, including relating to the acquisition, licensing, development and disposition of intellectual property assets. She assists companies in the drafting and negotiating of license agreements, development agreements, implementation agreements and other technology-related agreements.
Joanna also has an active life sciences practice and has worked for some of the world's largest pharmaceutical companies on a wide array of operational matters, including the drafting and negotiation of clinical trial agreements, product listing agreements and consulting and advisory board agreements as well as the establishment of patient support programs, among others.
Joanna is fluent in French and English.