Consortium Bids: An Overview

With consortium bids—or club bids as they are commonly called—becoming more prevalent, Rob Assal of Stikeman Elliott’s Toronto office looks at the business and legal factors that characterize these transactions.

Consortium bids involve two or more buyers, typically private equity firms, joining together to bid on potential corporate targets, often in the over US$1 billion range. The composition of a bidding group and the responsibilities of its members vary from deal to deal and are generally governed by negotiated agreements amongst the members. However, the popularity of consortium bids is driven by common factors.

Since 2001 there have been 60 or so club deals of more than US$1 billion involving a U.S. entity. The second and third-largest leveraged buyouts in history were completed in 2005 by way of consortium bids. SunGard Data Systems Inc. was sold to a consortium of seven private equity firms led by Silver Lake Partners for US$11.4 billion in August of 2005. Shortly thereafter, in September of 2005, Hertz Corp. announced its sale to a three-firm consortium led by Clayton, Dubilier & Rice, Inc. for US$15 billion.

The recent announcement of the definitive agreement by Albertson’s, Inc. to sell the entire company to a consortium of industrial strategic buyers and private equity firms (Supervalu Inc., CVS Corporation, and an investor group led by Cerberus that includes Kimco Realty, Schottenstein Realty, Lubert-Adler Partners and Klaff Realty, LP) for a total transaction value of approximately US$17.4 billion in cash, stock and assumed debt marks the largest consortium bid in the current rise of club deals.

The increased incidence of club transactions arises from a number of factors, including the competition for deal flow, growth in the availability of private equity capital and the popularity among sellers of controlled auctions. Other issues that drive the growing frequency of consortium bids include the following:

• Diversification and Risk-sharing – Club transactions permit firms to use their available equity to participate in a larger number of transactions and to spread the risk of a single transaction among members of the club, especially when the value of the transaction is significant.
• Ability to Raise Equity/Greater leverage with Financing Sources – The percentage of equity needed to complete transactions has increased to such a degree that in the largest transactions even large private equity firms cannot complete a transaction on account of the diversification limitations in their limited partnership (fund) agreements. As a result, club deals may be the only way to raise the required equity to finance a very large transaction.
• Benefiting from Expertise – Consortium members may benefit from the industry expertise or prior relationships of their fellow club members in complex transactions.
• Cost Effectiveness – Joining a club mitigates the competitive pressures of the auction process by allowing potential bidders to join forces to attain better pricing and share the due diligence costs and other costs of unsuccessful bids.
• Ability to Penetrate Foreign Markets – When investing outside of one’s home market, private equity firms may benefit from the expertise of local private equity firms, thereby reducing the risks and uncertainties of investing in a new geographic area.

Club transactions introduce an additional layer of considerations and issues for a private equity acquisition transaction, including confirming that club members share a common strategic vision for the business, a common philosophy to operate the business, and an agreed approach to bidding tactics and timing. Other issues firms should consider when joining a consortium include:

• Exclusivity – Members of the consortium should consider the terms of their relationship vis-à-vis other members. Specifically, they should consider whether, and for what duration, the members will be exclusively tied to each other, and who will have the authority to decide whether to admit new members.
• Bidding Strategy and Negotiating Control – Members of the consortium must determine which members will control the bidding process. A consortium may have a "lead" investor, who may be the member who is contributing the most equity, or who initiated the transaction, or who has the strongest relationship with management.
• Selecting Advisors – The consortium must decide whether traditional advisors of each of the members will be chosen, or whether a "neutral advisor" will be appointed so that each member of the group has the same degree of relationship with the advisor.
• Financing Structure – There must be agreement between the members of the consortium on the overall financial structure of the bid.
• Allocation of expenses and any break-up fees – The allocation of expenses and break-up fees must be determined in the event the transaction is not successful.
• Governance Rights – The allocation of governance rights among the consortium members will depend on their relative equity stakes in the target, their relative bargaining positions, and their expertise in the industry. Governance rights that must be allocated include board representation and committee membership, super majority voting rights and veto rights, anti-dilution protection, allocation of deal and management fees among the club members, and information and observation rights of minority investors that are unable to secure board membership.
• Exit Strategy – Members should determine whether they have similar time horizons and target rates of return on investment, and should consider what form of exit they prefer: initial public offering (equity or income securities) or a sale to third parties. Also, members should define events that allow a club member to leave the club and act independently, including, the extent to which a club member can compete separately (or with others) for a transaction once the member leaves the club.
• Limited Partner Reaction – Private equity firms should consider the potential reactions of the limited partners in its funds before participating in a club deal. Limited partners that are investors in two or more private equity funds that jointly acquire a business may be concerned that the transaction will have an anti-diversifying effect by increasing their risk exposure with respect to a single business.

Careful planning and attention to these considerations are vital to avoiding the pitfalls and reducing the potential conflicts raised by an investment in a club transaction.

The members of a club will usually negotiate a consortium agreement to govern their legal and business relationship. It will reflect the agreement of the club members on the issues discussed above, such as whether the members will be exclusively tied to each other, how bidding decisions will be made, how fees and expenses will be allocated and which members will negotiate and execute contracts. A target company or its bankers will also typically require club members to enter into confidentiality agreements that restrict members from discussing due diligence documents with parties outside of the consortium.

Some of the trickier legal issues that arise from consortium arrangements include the non-compete and confidentiality obligations contained in consortium agreements, the application of standard confidentiality agreement provisions to the consortium context, and whether fiduciary duties may apply to the relationship between consortium members.

• Consortium Agreements – If there is a breakdown in the relationship between a member firm and the other club members, the non-compete restrictions within the consortium agreement will limit, if not eliminate, the firm’s ability to pursue the bid individually or with another consortium. Firms should ensure that they are comfortable with the club dynamics before committing themselves to the consortium.
• Confidentiality Agreements – Companies put in place confidentiality agreements not only to protect commercially sensitive information, but also to encourage competing bids. Confidentiality agreements with respect to company due diligence materials could restrict the formation of large consortiums, as investors will not be able to discuss the company particulars with other potential investors. Companies will often retain the right under a confidentiality agreement to consent to the creation of consortiums, overriding the confidentiality clause. In this way, companies and their bankers can seek to control the number and structure of potential bidders. If the company waives the confidentiality agreement with respect to dealings between consortium members, the consortium agreement will then govern how the due diligence will be shared between the members.
• Fiduciary Duties – In Canada, courts have looked to three specific factors in determining if a fiduciary relationship exists outside the standard categories of agent, trustee, partner or director. If a fiduciary has scope for the exercise of some discretion or power, can unilaterally exercise that power or discretion so as to affect the beneficiary's legal or practical interests, and the beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion or power, then a fiduciary relationship would exist in the Canadian context. It is foreseeable that a club member may someday frame an argument complaining of the actions of a fellow club member in fiduciary terms. There is limited case law bearing on the issue of fiduciary duties between consortium members. The best approach to deal with this issue is to provide clearly in the consortium agreement that there is no fiduciary relationship created among the club members.

The acquisition of Toys "R" Us is an illustration of the benefits and opportunities club bids create. In July 2005, Toys ‘R’ Us, Inc. (Toys) was acquired by a consortium of three private equity firms for US$6.6 billion. Originally, Toys was looking to sell only part of its business – primarily its global toy operations – and to spin off its better-performing Babies "R" Us unit. The original field of bidders included Bain Capital Partners LLC (Bain), Kohlberg Kravis Roberts & Co. (KKR), Vornado Realty Trust (Vornado) and groups led by Apollo Advisors LP and Cerberus Capital Management LP (Cerberus). When the target of the bidding changed from the global toys business to the entire company, including Babies "R" Us, Bain, KKR and Vornado teamed up to make the successful US$6.6 billion bid, beating out the other bidders. It was by joining in a club and pooling their resources (as well as sharing the risk) that Bain, KKR and Vornado were able to put forth the winning offer and take part in the transaction.

The Toys "R" Us transaction provided the courts with an opportunity to recognize the commercial relevance of consortium bids. The Delaware Court of Chancery heard a motion by the shareholders of Toys for a preliminary injunction to halt the sale of Toys to the Bain/KKR/Vornado club. In dismissing the motion, the court observed that it was not unreasonable for Credit Suisse First Boston, Toys’ investment banker, to consent to KKR and Vornado/Bain’s request to present a joint bid. The court noted that the consortium’s rationale for joining together, namely to share the risk of a multi-billion dollar retail acquisition, was "logical and consistent with an emerging practice among financial buyers" and created a strong competing bid to the Cerberus consortium. The court’s decision in Toys should be regarded as recognition of the commercial practice of consortium bids; courts will not cast a suspicious eye at consortiums insofar as consortiums conduct themselves in a fair manner and do not behave collusively.

The consortium bid model is growing in popularity because it offers investors the opportunity to embark on sizable transactions they could not otherwise afford on account of the sheer cost and risk associated with "going at it alone." However, consortium bids pose challenges for all parties involved, as there is an increased need for consensus and cooperation from a business and legal perspective. Evaluating the risks and benefits before entering into a consortium and seeking professional expertise in the area are advisable.

Stikeman Elliott has been involved in a number of club deals as Canadian counsel, including acting for Bain, KKR and Vornado in their acquisition of Toys "R" Us and acting for the lenders in the Hertz acquisition.

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.