Dealing with Financial Sponsors

Transcription

1 Dealing with Financial Sponsors Practising Law Institute Acquiring or Selling the Privately Held Company 2016 June 13, 2016 Matthew P. Salerno Cleary Gottlieb Steen & Hamilton LLP clearygottlieb.com What We ll Cover Financial Sponsors What Are They? Considerations in Selling to a Financial Sponsor Contracting with a special purpose vehicle Debt Financing a Deal Debt and Equity Commitment Letters Co-investment and Multiple Sponsors as Investment Partners Financing Condition/Remedies Marketing Period/Closing Conditions Reverse Termination Fee / Limited Guaranty Regulatory Commitments Dealing with Management 2 Financial Sponsors Private Equity Funds Private investment funds structured as limited partnerships Examples: Warburg Pincus, KKR, TPG, Blackstone, Carlyle Typical investment period of 4-5 years; total fund life of 10 years Seek investment returns of 15%-30% per year Carried interest/promote; management, deal and monitoring fees Sovereign Wealth and Pension Funds Investment funds established by governments Examples: China Investment Corporation, Temasek Holdings, ADIA Hedge Funds More typically associated with investments in publicly traded securities Examples: Fortress, Paulson & Co. 3 1

2 Shell Game Most financial sponsors do not permit their investment funds to enter into purchase agreements Don t want responsibility for debt piece of purchase price financing Establish special purpose acquisition vehicles ( SPV ) for this purpose SPVs have limited assets; so they need financing to pay for the deal 4 Financing the Deal Financing a Deal Debt financing = 50-70% of purchase price, including high yield bonds Leverage enables financial buyers to generate outsized returns on equity investment, but also creates greater risk Debt Commitment Letters Written commitment of banks to provide debt financing on specified terms Subject to enumerated conditions and definitive documentation Longer commitments have become available, enabling firms to pursue deals in regulated industries that require longer closing times; but rocky financing markets in early 2016 Comes with a price: ticking fees, pricing flex and structure flex Equity Commitment Letters Specific performance remedy requires buyer to have equity funding sufficient to close Written commitment of investment fund to fund specified equity amount No conditions other than (i) closing conditions in purchase agreement and (ii) debt financing has been or is about to be funded If debt financing is not available, equity commitment letter does not apply 5 Multiple Sponsors as Investment Partners Shareholder Agreements Board composition Veto rights Exit Rights/Restrictions Lock-ups Tag along rights Drag along rights Rights of first offer/refusal Registration Rights Agreements Demand registration rights Piggyback registration rights Management/Monitoring Fee Allocation 6 2

3 What if the Banks Don t Show Up? Ancient times: financing condition in purchase agreement Seller relied upon risk of reputational damage to sponsor if it abused condition Debt financing failures were rare The SunGard Model (2005) No financing condition If debt financing fails, buyer pays reverse termination fee Fee serves as liquidated damages/liability cap Problems with the SunGard Model Reverse termination fees were viewed as inadequate by sellers Functioned as a cheap option Sellers fared best where alternative remedies were available 7 The New Paradigm Specific Performance Where debt financing is available, seller can ask court to force buyer to close Seller can also specifically enforce agreement to use efforts to obtain financing from the banks or to seek new financing (Huntsman) Two-Tiered Reverse Termination Fee Lower fee applicable if debt financing not available Higher fee serves as liquidated damages if buyer fails to close for any other reason (other than the failure of closing conditions to be satisfied) Time to call a spade a spade? 8 Marketing Period/Closing Conditions In order to assume debt financing risk, buyer wants certainty from banks Debt commitment letters contain specific conditions to funding, including: Provision of audited financial statements and other information necessary to prepare marketing materials Passage of agreed marketing period in which to syndicate debt (typically 20 business days) No material adverse change in target company having occurred Financial sponsor will seek to ensure that purchase agreement covenants and conditions match corresponding provisions in debt commitments 9 3

4 Reverse Termination Fee / Limited Guaranty Reverse termination fees have been on the rise as a percentage of deal value Low High Mean Median Reverse termination fee is funded by a limited guaranty from the investment fund, capped at fee amount Limited guaranty may also cover reimbursement of certain expenses, such as financing, antitrust and enforcement expenses 10 Co-Investment Allows sponsors to do bigger deals while maintaining control Structure determined on a deal-by-deal basis, depending on investment size and number of coinvestors Direct Co-investment Permits co-investors to have a direct interest in the portfolio or holding company Greater upside and greater exposure to risk No/reduced management fee Reimbursement of sponsor expenses Two Exit Approaches Joined at the hip Tag & drag 11 Regulatory Commitments Purchase agreements typically contain covenants to use reasonable best efforts to obtain regulatory approvals Common regulatory approvals/clearances: Antitrust, FCC, Banking Issue: solving regulatory issues raised by affiliated companies SPV cannot compel sponsor parent to act (ADS v. Blackstone) Parent Fund has fiduciary duties that prevent it from committing in advance to agree to remedies or divestitures Solution: Shell company agrees to hell or high water covenant with respect to target company s business and assets only 12 4

5 Dealing with Management Where the buyer is a financial sponsor, target company management typically is retained to manage the business Sponsor wants a management team capable of public company-style financial reporting and adaptable to sponsor culture Financial sponsors typically offer management the opportunity to co-invest in the deal, as well as performance-based options with respect to 10% or more of the target company s equity Structured to be aligned with financial sponsor s economic incentives to avoid management calling in rich This can place management in an awkward position Tasked with putting the best face on target Duty to seek the best terms possible for seller Future partner of buyer Self-interest in not setting the bar too high for future equity/bonus compensation 13 Sponsor as Seller Contractual Issues Limited recourse Once sale proceeds are received, they are distributed to investors Selling funds are often in winding-up mode Large or lengthy escrows/holdbacks generally unacceptable sponsors often willing to accept lower price in exchange for a cleaner contract Recourse, if any, limited to escrow funds Public company style sale agreements No surviving representations, warranties or pre-closing covenants Closing condition bring-down standard failure of reps or covenants to be complied with must amount to material adverse effect in order for conditions to fail Representation & warranty insurance In 2015, AIG reviewed 8 times as many submissions for representation and warranty insurance as compared to 2012 Policy costs typically range between 2.5% 4% of the indemnification cap, with a deductible between 1% 3% of the transaction value Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. Throughout this presentation, Cleary Gottlieb and the firm refer to Cleary Gottlieb Steen & Hamilton LLP and its affiliated entities in certain jurisdictions, and the term offices includes offices of those affiliated entities. 5