In early discussions with the target board or its Chairman, the potential bidder will usually be trying to gauge the price it needs to pay to get its offer recommended. Although a bidder can always go hostile, and appeal to shareholders over the heads of management, most would prefer to see management recommend a deal to shareholders. Any takeover is risky, but advantages of a recommended offer include:
- acceptances are more certain, as most shareholders will follow the board’s recommendation to accept, and there is no restriction on the percentage of target’s share capital that the bidder can tie up, before the offer is made, by means of irrevocable undertakings from shareholders to accept the offer. By contrast, a hostile bidder cannot usually obtain undertakings over more than 29.9%
- a scheme of arrangement could be used to save the bidder stamp duty and increase its chances of acquiring 100%
- the bidder will usually be given access to non-public information about the target to do limited due diligence
- petarget employees may be more willing to co-operate with a bidder who is not labelled ‘hostile’, and directors are more likely to stay on to help manage the business.
Quid pro quo for a recommendation
Bidders are therefore usually prepared to pay a higher price to obtain a recommendation. Apart from negotiating the price, the target board may also be in a position to influence the type of consideration and the terms offered to holders of convertibles and options. For example, where the target has lots of individual shareholders, they may want the bidder to provide a loan note alternative. In the recent Ferrovial/BAA deal, BAA shareholders were also offered the opportunity to take shares (as well as loan notes) in a specially-established AIM company with a minority interest in the merged company.
In return, the bidder may demand a period of exclusivity, a ‘break fee’ payable by target if the directors withdraw their recommendation (or in other circumstances) and/or a merger agreement governing how bidder and target will conduct the offer process.
To recommend or not?
All of these matters can raise difficult issues for target directors. Their obligation to act in the best interests of the target (broadly meaning those of its current shareholders) does not mean that they must recommend the highest bid, or indeed any offer, but they will need good reasons to reject an offer made at a fair price. In last year’s takeover of Manchester United by the Glazer family, having failed to obtain assurances from the bidder that the levels of debt to be borne by the club would not compromise investment in new players or drive up ticket prices, the club’s directors refused to recommend the final offer but had to acknowledge that the price was fair and that, given that the Glazers had already bought enough shares in the market to give them control, it would be financially prudent for shareholders to accept.
If a bidder is really unwelcome, the alternatives for target directors are limited. In the UK, it is generally felt that shareholders should be free to decide on the ownership of a company, and that boards should not deprive shareholders of the opportunity to consider the merits of an offer. Once the target board believes that a bona fide offer might be imminent, actions that might ‘frustrate’ a bid – such as issuing shares to friendly parties, selling key assets or entering into unusual, onerous contracts – cannot be taken without shareholder approval. Had Arcelor been a UK company attempting to ward off Mittal Steel’s bid by selling a large minority stake to the Russian company, Severstal, the sale would have required approval by a simple majority of all the ordinary shareholders. Where the UK differs from some continental jurisdictions and US states is in the difficulty of lawfully putting in place before any bid has materialised ‘poison pill’ and other ‘change of control’ provisions that are designed to deter a bidder or prevent control of the company passing to outsiders. Unless such an arrangement can be justified on other commercial grounds, a director who approves it could breach his duties to act in the best interests of the company and to exercise his powers for a proper purpose, and the arrangement itself may be void. For example, including a ‘golden parachute’ clause in a director’s service contract, giving him a substantial lump sum payment if the company is taken over, may not be proper unless it is genuinely needed to recruit, retain or motivate the director. It would also probably attract criticism from shareholders.
Market raids: a shift in the balance of power?
Political lobbying, involving regulators, and seeking a ‘white knight’ bidder are all common, but efforts in the UK are mostly focussed on good old-fashioned argument. However, with the abolition in May of the Substantial Acquisitions Rules, target directors and their shareholders will more often find themselves presented with a bidder who has already bought nearly 30% of the company. Argument and discussions over any recommendation can then be a mere formality.
This article first appeared in our Directors’ digest bulletin July 2006. To view this publication, please click here to open a new window.