There may be legal advantages to a dual-track strategy in
the current Canadian marketplace
Over the past year, as Canadian capital markets have regained their
footing, Canadian private companies in search of greater liquidity
have generally had a wider range of strategic alternatives to
explore. One increasingly popular option is the
"dual-track" or "parallel-track" IPO/M&A
process, in which the company simultaneously pursues both an
initial public offering and a negotiated or controlled
auction sale process (or other specific sale process). Because
market and economic conditions have not generally favoured
dual-track processes in recent years, some boards and shareholders
may find the concept relatively unfamiliar. The purpose of this
article is to highlight, from a Canadian legal point of view, some
of the potential benefits of pursuing a dual-track strategy for
Canadian private issuers, Canadian portfolio companies of private
equity groups and Canadian subsidiaries of multinational
companies.
Factors to consider
Issuers considering a dual-track process must carefully compare
the costs and benefits of pursuing such a strategy. They will need
to consider and analyze not only the hard costs involved in
completing a transaction (i.e. legal, accounting and professional
advisors and related transaction expenses), but also the soft or
opportunity costs of taking time from management and other key
personnel of a business to participate in a transactional process
that can be burdensome, complex and which realistically may not
result in a transaction for the company.
Other significant considerations in a dual-track scenario are
similar to those that are typically considered when making an
"either-or" choice between an M&A sale process and an
IPO:
- Partial or total exit: One of the most important
things to determine is whether the desired liquidity transaction
would result in a total divesture of the business by shareholders
(perhaps leaving no ongoing management role for the existing
principals). The alternative is a partial sale or planned two-step
sale transaction (whether in an IPO or an M&A context) under
which the controlling shareholders will maintain a controlling
equity position (or at least a significant minority position) in
the company and some or all of the existing principals will remain
an integral part of management of the business.
- Liquidity issues: Another key consideration is whether
the proposed exit strategy will produce instantaneous liquidity
(total or partial) in the form of cash or freely tradable public
company securities. In an M&A transaction, privately held
illiquid securities can be exchanged for public company securities
of the purchaser (freely tradable or restricted securities) or for
securities of another private issuer (subject to resale
restrictions). Similarly, a cash payment can either be subject to
an escrow or holdback arrangement or fully paid at closing. In an
IPO transaction, private issuer securities be sold for cash as part
of a concurrent secondary offering, but the remaining securities
can also remain subject to standstill or "lock up"
arrangements or securities escrow provisions (whether imposed by
stock exchanges, applicable securities laws or contractually by
underwriters in accordance with market practice).
- Indemnity profile of sellers: The indemnity or
liability profile of an entity and its directors, officers and
shareholders depends on the process involved: a controlled auction
can differ significantly in this respect from a negotiated purchase
and sale agreement and each of these scenarios in turn differs from
a public offering (with respect to an underwriting agreement or as
a result of statutory liability under prospectus or registration
statement).
- Time constraints: The time constraints applying to a
sale process should be carefully compared to those that apply to an
IPO. A fully marketed public offering typically takes 3 to 6 months
to complete; a similar timetable would typically apply to a
traditional controlled-auction process with customary regulatory
approvals required to be obtained. Like a prospectus in a public
offering, a sale process would typically utilize a comprehensive
disclosure document on the issuer and its underlying business in
the form of an offering memorandum. The timetable for a bilateral
negotiated transaction could be significantly reduced without
significant conditionality. In either case, the level of complexity
increases (along with potential timing issues) to the extent that
an IPO or M&A process involves multiple parties or multiple
jurisdictions, including the existence of several regulatory
authorities, different financial standards and overlapping legal
regimes.
- Completion risk: The variables impacting the completion risk of an IPO are very different from those that tend to affect a negotiated sale transaction with one or more prospective purchasers. In each case these variables must be carefully monitored.
These points illustrate one of the main challenges of a dual-track
process, specifically that those participants involved in such a
process will generally have to be willing to accept any of a very
wide range of possible outcomes, particularly with respect to their
ongoing participation in the entity. Of course, this somewhat
naïvely supposes that a dual-track process is invariably
carried out with the intention of securing the best deal, no matter
which side of the IPO/M&A divide it comes from. Traditionally,
that has not always been the case: the IPO announcement has often
been used to force potential acquirors out of the woodwork with a
view to encouraging a negotiated sale. However, over the past year,
in a climate where the emphasis has been on finding investors of
any description, some commentators have observed that the
dual-track process is more frequently being employed with no
preconceptions about the outcome.1
Advantages of a dual-track approach
Dual-track processes are well-known in Europe and the U.S., with
particular prominence in certain industry sectors, such as
technology, that have been forced by the weak economic climate to
shift from what has traditionally been a more exclusive focus on
IPOs.2 Where a dual IPO/M&A sale process is a
practical alternative for a company in Canada seeking liquidity,
the case for pursuing it is equally compelling here. Among the more
significant underlying advantages are:
- Greater transaction certainty: Pursuing a dual-track
strategy provides greater transaction certainty in the event that
an issuer is not able to access the capital markets in a timely
manner, e.g. because of underwriters' objections or
unanticipated delays arising from regulatory processes of stock
exchanges or securities authorities;
- Better pricing and multiples: Pursuing both paths will
ideally create price tension that produces a more robust
competitive process in terms of the pricing of securities in an IPO
and/or enhancing negotiated multiples on the sale of a business -
for example, where IPO investors are encouraged to pay a premium
price because private equity has shown an interest in the company
that suggests a possible future bid;
- Lower valuation uncertainty: Academic studies have
pointed to the reduction in valuation uncertainty resulting from
IPO filings as a major reason for the higher acquisition premiums
typically attained through dual-tracking, noting that private
targets with higher valuation uncertainty, such as
low-profitability companies in research-intensive industries, are
traditionally among the major users of the dual-track
process;3
- Less impact on timetable: Moving forward
simultaneously with an IPO and a sale process ensures alternative
liquidity options without negatively impacting the transaction
timetable in the event that one strategic alternative ceases to be
available to an issuer;
- Complementary strategy: The legal requirements of an
IPO process and the preparation of a comprehensive disclosure
document with the requisite financial information assists with, and
can be complementary to, the M&A process. The two processes are
not mutually exclusive. Due diligence investigations can also be
streamlined without incurring additional transaction
expenses;
- Protection of stakeholders: Pursuing a parallel
process allows the issuer flexibility in ensuring that the desired
treatment for employees, customers, suppliers and other key
stakeholders is achieved;
- Efficiency: Being engaged in both processes imposes
competitive and time discipline on the participants in each of an
IPO and a M&A negotiated or controlled auction sale process;
and
- Flexibility for unexpected events: A dual-track approach gives issuers the flexibility to switch to another course of action should any of a range of unexpected extraordinary events occur (e.g. CEO termination, inability to obtain an auditor's report or to complete the requisite audited financial statements, deficiency in an expert report, inadequate funds to meet working capital requirements, etc.). Pursuing both an IPO and a sale process as part of an issuer's exit strategy ensures that fewer issuers will be subjected to unilateral determinations not to proceed with a transaction in the late stages of a controlled auction process by a prospective bidder or an IPO transaction by a financing syndicate member.
In addition, even in the "worst case" scenario - i.e.
where the IPO does not go ahead and no buyer materializes - the IPO
process may act as a profile-builder for the company, putting it on
the radar of potential acquirors who may keep it in mind for
further consideration when economic conditions have improved.
Minimizing cost duplication
While the cost of pursuing a dual-track strategy may at first
instance appear to be "double", potential economies and
efficiencies can be exploited to ensure that the increased
incremental costs of a dual-track strategy are only marginally
higher than a single-track strategy. For example, costs can be
minimized for a dual-track strategy by
- Retaining experienced transactional, financial, accounting and
legal advisors to assist in leading the processes;
- Using key dedicated and experienced personnel of the issuer to
establish and manage the processes;
- Creating, populating and maintaining a fully integrated and
robust global electronic data site for completion of transactional
due diligence by underwriters, lenders, prospective purchasers and
their advisors; and
- Cross-utilization of work product (e.g. disclosure documents) for both processes.
In all cases, the key to minimizing cost duplication lies in
planning the process carefully in advance.
Situations in which a dual-track process may not be feasible
In many instances, it may turn out that one of the alternatives
(IPO or an M&A sale process) is simply not available to an
issuer as a result of:
- The nature of the industry in which the issuer operates or the
underlying business not being suitable to prospective purchasers or
a capital markets transaction;
- The jurisdiction in which the business operates being in a
state of conflict or unrest;
- The existence of past legal or regulatory compliance issues, or
other similar extenuating circumstances, with respect to one or
more key stakeholders;
- The added burden of a dual-track process in situations where
management is already preoccupied with other significant
"core" business related issues;
- Inadequate financial records or the risk of restatement of the
financial statements of the business; or
- Other significant risk factors such as expected changes in applicable law or accounting practices.
In addition, in most distress transaction scenarios, participation
in an IPO process will generally not be available, yet in such
scenarios the complexities of a M&A transaction can be
significantly increased due to the involvement of a statutory
bankruptcy and insolvency regime with court supervision of the sale
process or as a result of the utilization of alternative less
customary sale processes such as stalking horse bid processes or
live auctions. Conversely, in a down market such as we experienced
in 2008, earnings deterioration, lower multiples for certain
targets and/or industries and limited or reduced credit
availability made effecting a sale transaction on the desired
commercial terms very challenging. Under such conditions, a poor
response to an IPO could potentially deflate the enthusiasm (and
offers) of potential acquirors.
Conclusion
Following the economic uncertainty in late 2008 and in early
2009, several multinational companies seeking liquidity utilized
this strategy in Canada for their Canadian subsidiaries as part of
the implementation of various strategic alternatives. At the end of
the day, each issuer will need to consider its own unique
objectives, together with the objectives of its key stakeholders,
the environment in which its business operates and its ability to
realistically pursue both avenues given its existing resources,
management team, board of directors, the existing state of its
business and other key situation-specific
variables.4
Footnotes
1 See, e.g., Liam Vaughan, "'Dual track' IPOs return", The Wall Street Journal, October 26, 2009, p. C5.
2 See Steve Schaefer, "Mergers Re-emerging", Forbes.com, January 5, 2010 and Amanda Lyle, "Keys to Success: Experts Offer Tips for All Stages of Partnering", BioWorld Today, October 14, 2008.
3 Qin Lian and Qiming Wang, "The Dual Tracking Puzzle: When IPO Plans Turn into Mergers", unpublished working paper (March 2007 version), pp. 5-6. In their study of a sample of 132 firms that withdrew IPOs in favour of acquisition by public bidders from 1984 to 2004, Lian and Wang found that the dual-tracking targets commanded a 58% acquisition premium over targets that did not dual-track. (p. 26)
4 I would like to acknowledge the contributions to this article by Andrew Cunningham of Stikeman Elliott LLP.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.