Many private and ESOP-owned companies are adopting one of private equity’s core strategies, namely, growing through acquisitions. As I wrote in my previous blog,[1] this makes sense: To be successful, ESOP-owned and private businesses must continue to offer career opportunities for their talent, increase revenue faster than inflationary costs, and de-risk their operations, especially to meet the challenges posed by today’s accelerated pace of change.
But there’s a flip-side to this strategy: How to stay private in today’s robust M&A market. Growth-hungry businesses, especially those owned by private equity firms, are seeking attractive acquisition targets, making private and ESOP-owned companies more vulnerable to unsolicited offers. Consequently, how to respond to an unsolicited acquisition offer has become one of the most vexing questions facing a company’s board.
Until recently, this issue rarely confronted an ESOP company. Over decades advising hundreds of private and family business transitions, I found that simply being an ESOP almost always deterred “unwanted expressions of corporate affection.” That’s because advisors were generally unfamiliar with ESOP structures and unsure how to navigate them, which generated an unfounded perception that ESOPs were reluctant to respond to attractive offers.
But times have changed! We now see unprecedented interest in evaluating and potentially acquiring ESOPs, especially from PE firms. They are more familiar with ESOPs and employee ownership, and global investment giant KKR’s initiative to make employee ownership part of every investment is a notable example. Another factor is PE firms’ trillions[2] of dollars in “dry powder,” that is, funds earmarked for acquisitions. And a third is the success of the many now well-established ESOPs that compete with PE firms’ portfolio companies, which has made them attractive acquisition candidates.
To be successful, ESOP-owned and private businesses must continue to offer career opportunities for ... [+]
ESOP boards should consider two fundamental points when determining how to respond to an unsolicited offer. (Please recognize that what follows isn’t legal advice).
First, when an unsolicited offer emerges, the target’s board needn’t respond “yes” automatically. That’s because an unsolicited offer will almost always be deemed not bona fide, enabling the company’s response to vary widely.
While there is no black-letter law – those well-established legal rules no longer subject to reasonable dispute – several critical factors elevate an offer’s seriousness. These include:
· Specific consideration that is, on its face, adequate.
· Proposed deal terms that are fair, reasonable, and treat all shareholders equitably.
· The prospective buyer possesses the financial ability to pay the proposed purchase price and has a track record of completing transactions.
· The prospective buyer has completed sufficient due diligence and offered a sound acquisition rationale.
Because these considerations are so exacting, it is practically impossible for an over-the-transom buyer to possess sufficient information and diligence to meet the requirements of a bona fide offer.
The second fundamental point is that because so many elements are relevant, a target company’s board must follow a logical, well-documented process to evaluate offers. To be sure, many unsolicited offers can be dismissed immediately; think of it like the junk mail in our email inboxes, most of which is filtered-out and goes into our trash folder.
However, if the offer is attractive on its face and perhaps solves some company gaps – in capital, leadership, scale, talent, or governance – the board may opt to engage the suitor. This is where it becomes interesting — with many potential options. This is also where you hire the legal and financial advisors who can take a board through such evaluations – and not before.
A meticulous process, including employing independent advisors, will help satisfy the so-called “business judgment rule” in most states. This legal principle protects corporate directors from liability for their decisions provided they have acted in good faith.
The ESOPs’ legal and financial advisors will walk the board through the pros and cons of various factors, including when and how to assess the value of a given offer. This could include everything from getting an informal read of value from a financial advisor, to a limited market test with a few potential buyers, a formal valuation from an expert third-party, or even a full auction process.
If the board receives data from experts or the market that the ESOP can attain the perceived level of its value on its own by following its current strategy, the board retains the option to say “no” to the suitor and keep the company independent. Advisors will help the board navigate the type of data about the company’s market value they need to satisfy their duty of care and the business judgment rule.
When it comes to informing their trustee of a suitor, ESOP directors in general may wait until they determine they want to engage in discussions with the suitor, complete a market test or auction process, or evaluate whether greater value can be obtained by remaining independent. This will enable the trustee to determine contemporaneously that the potential outcome is fair to ESOP shareholders and, if a sale occurs, it will generate sufficient proceeds to repurchase the shares of all ESOP participants.
ESOP directors should be aware that auction dynamics sometimes generate sharply higher estimates of worth than indicated by the most recent annual valuation. Further, they will be asked to balance diverse roles that encompass serving as:
· A member of the management team, with a fiduciary obligation to select the outcome in the ESOP’s best interest.
· An employee, who may be anxious about ongoing job security for the company’s workforce.
· An individual with ESOP shares and stock appreciation rights, from which they may benefit.
This is an exciting time for ESOP directors, who may receive offers for their company far beyond what they had imagined just a few years before. By understanding what’s required of them to respond to an offer, they are poised to generate meaningful shareholder value provided they act in good faith, acquaint themselves with independent assessments of their company’s value, and evaluate the range of alternatives carefully and deliberately.
[1] Key Trends For ESOPS And Family Businesses Considering Acquisitions (forbes.com)[2] Private equity firms face pressure as dry powder hits record $2.59 trillion | S&P Global Market Intelligence (spglobal.com)
