Friday, September 2, 2016

Talking Two-Step Tender Offer Transaction Techniques for Texas Targets

Are we living in the Golden Age of the two step tender offer acquisition technique?  Probably so - last year, the process got a whole lot easier for buyers seeking to acquire publicly traded M&A targets incorporated in Texas.

What is Two Step Tender Offer?

A buyer seeking to acquire all of a public company (a Target) may either:
(1) propose a one-step merger - which generally must be approved by the Target's shareholders; or
(2) propose a tender offer - in which case the buyer offers to buy at least a majority of the Target's shares (STEP 1); followed by a "squeeze-out" merger in which a successful vote of the Target shareholders is already assured (because that was the minimum number of shares purchased in the tender offer) (STEP 2).

Historic Second Step Merger Thresholds Requirements

Historically, both the Delaware corporate law (Section 253 of the Delaware General Corporation Law (DGCL)) and Texas corporate law (Section 10.006 of the Texas Business Organizations Code (TBOC)) required that the buyer acquire at lease 90% of the Target shares after the tender offer in order to enter into a short-form merger.  Qualifying for short-from merger treatment was important because the short-form merger did not require a vote of the Target shareholders. It was presumed that such a vote would be meaningless because 90% of the shareholders would doubtlessly vote to approve the merger.

Shareholder merger votes cost time and money because state corporate law and SEC proxy voting rules require the preparation or a detailed disclosure document, an SEC review, and distribution of the disclosure document to the Target's shareholders.  

New Second Step Merger Threshold Requirements

Eventually, Delaware realized that a merger vote by the Target's shareholders would be equally meaningless if the buyer acquired at least a majority of the Target shares (or whatever the minimum number of shares otherwise necessary to approve a long-form merger under the DGCL and the corporation's certificate of incorporation).  So in 2013, Delaware adopted a new subsection (h) to Section 251 of the DGCL which permits the buyer to merge with a publicly traded Target (or a Target with more than 2,000 shareholders) following a tender offer under certain conditions.

Effective September 1, 2015, the State of Texas adopted new sub-sections (c), (d) and (e) to Section 21.459 of the TBOC, thereby granting public companies formed in Texas the right to merge without a shareholder vote following a successful tender offer.  The (relatively) new Texas rule is substantially similar to Section 251(h) of the DGCL.

Why do buyers like Two Step Tender Offers?

Simply put, a two step tender offer is a whole lot faster and cheaper than an acquisition via a traditional one-step merger, especially when the buyer is paying cash (rather than stock) to the Target's shareholders. This is because the SEC review process is generally more limited and more expedited for a tender offer than it is for a one-step merger.

According to a recent a survey conducted by the M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of the Business Law Section of the American Bar Association (ABA), from the announcement of a public M&A deal until the closing of the deal, the average cash tender offer takes 49 days, the average stock tender offer takes 54 days, the average cash merger takes 129, and the average stock merger takes 199 days.  (Thanks to Richard E. Climan, Joel I. Greenberg, and Claudia K. Simon for providing the survey data in a recent webcast sponsored by the ABA).  

What are the requirements to use the Two Step Tender Offer?

In order for a buyer to take advantage of Section 21.459(c) of the TBOC to obtain a shareholder vote waiver following a tender offer, certain conditions must be met, including the following:
  1. The Target's certificate of formation cannot prohibit merger without a shareholder vote;
  2. The Target's shares must be listed on a national securities exchange or held of record by at least 2,000 shareholders;
  3. The plan of merger must expressly: (A)  permit or require the merger to be effected under Section 21.459(c) of the TBOC; and (B) provide that the merger be effected as soon as practicable following the consummation of the tender offer;
  4. The tender offer must be for all of the outstanding voting shares of the corporation on the same terms provided in the plan of merger, except that the offer may exclude shares owned by: (A)  the Target corporation; (B) the buyer; (C) any person who owns, directly or indirectly, all of the ownership interests in the buyer; or (D) any direct or indirect wholly owned subsidiary of any of the foregoing persons;
  5. The buyer must acquire in the tender offer (together with shares held prior to the tender offer) a number of shares of the Target equal at least the percentage of the shares that, absent Section 21.459(c), would be required to approve the plan of merger under both: (A) the TBOC (generally, two-thirds (2/3) of the shares); and (B) the certificate of formation of the Target;
  6. The buyer must merges with or into the Target pursuant to the plan of merger; and
  7. Each outstanding share of the Target not purchased in the tender offer must be converted or exchanged in the merger into the same consideration as those selling in the tender offer.

Kudos to the Texas Legislature for following Delaware's lead in modernizing the two step tender offer rules for Texas Targets.

Friday, August 26, 2016

Crowdfunding Offers New Ways for Companies to Access Capital

Effective May 16, 2016, the United States Securities and Exchange Commission (SEC) has adopted rules permitting private companies to offer and sell shares of their stock and other securities via crowdfunding. The SEC’s new rules, named “Regulation Crowdfunding,” permit companies to raise up to one million dollars per year through crowdfunding.

Crowdfunding means raising capital in small amounts from a large number of investors, typically over the internet. The concept has been around for years, with companies using websites like Kickstarter, Indiegogo, or GoFundMe to raise funds for all sorts of projects, such as new technologies, movies, music, or any other sort of project one might imagine. Proponents of crowdfunding cite the “wisdom of crowds” to support the notion that if a large number enough number of people were willing to financially support a project through crowdfunding, it was likely that there would be support for the finished product of the project as well. Investors in such projects historically received some sort of reward for participating in the crowdfunding effort, such as a t-shirt, or a role in the movie being produced, a free copy of the finished product, or at least a discount on its purchase price of the finished product.

Prior to the adoption of Regulation Crowdfunding, however, a company generally could not legally offer stock to crowdfunding investors because to do so would be conducting an unregistered public offering of securities, which was prohibited by state and federal securities laws. Conducting a registered offering of securities is expensive and time consuming, and therefore is not a practical solution for smaller projects seeking crowdfunding support.

Companies considering raising capital through crowdfunding should be aware of the following rules under Regulation Crowdfunding:
  • Annual company limit. A company may raise up to $1,000,000 via crowdfunding in any 12-month period.
  • Annual investor limit. The aggregate amount of crowdfunding investments that any one investor may make in any 12-month period across in all companies conducting crowdfunding offerings is limited as follows:
    • If the investor has either an annual income or a net worth of less than $100,00, then the investor’s annual investment limit is equal to the greater of (i) $2,000, or (ii) 5% of the lesser of the investor’s annual income or the investor’s net worth; and
    • If the investor has both an annual income and a net worth of $100,000 or more, then the investor’s annual investment limit is equal to 10% of the lesser of the investor’s annual income or the investor’s net worth.
  • Crowdfunding platform required. A company must conduct crowdfunding offerings only through a single intermediary that maintains a crowdfunding platform registered with the SEC.
  • Offering disclosure requirements. A company conducting a crowdfunding offering must file a new form adopted by the SEC called a Form C.  The Form C is required to provide potential investors and the SEC with information about the company, the company’s officers, directors and promotors, the company’s financial performance, the securities offered, and the offering itself. The disclosure must include the minimum and maximum dollar amount of securities offered via crowdfunding and risks involved in making the investment.
  • Ongoing reporting requirements. After completing a crowdfunding offering, a company is required to file an annual report with the SEC which includes financial statements. If the company has had its financial statements reviewed or audited by a CPA, it must file those reviewed or audited financial statements.  
  • Advertising limited. A company is not permitted to advertise its crowdfunding offering, but the company is permitted to advertise a simple notice of the offering directing investors to the company’s crowdfunding platform. The notice must be limited to factual information about the company and the crowdfunding offering and may include a brief description of the company’s business.
  • Promotor compensation. A company is permitted to compensate promotors of the crowdfunding offering, but any such compensation must be disclosed to potential investors in connection with the promotion of the offering.
  • Resale restrictions. Securities purchased in a crowdfunding offering generally may not be re-sold or otherwise transferred by investors during the first 12 months after their investment.
  • Bad actor disqualifications. A company is generally not permitted to conduct crowdfunding offerings if the company or any of its officers, directors, substantial shareholders, promotors or affiliates have been involved in any disqualifying events, such as regulatory bans from participation in the banking or securities industries or felony convictions related to past securities industry activities.
  • Crowdfunding platform mechanics. A company must file its Form C with the SEC and make it available to potential investors through their crowdfunding platform at least 21 days before selling any securities and at all times during the offering. The crowdfunding platform must provide a communication channel which permits potential investors to communicate with each other and with the company. The crowdfunding platform must be operated by a registered broker-dealer or it must maintain an escrow account for investor funds with a broker-dealer, bank or credit union. The company must identify a deadline for cancelling an investment in its offering materials and grant investors the right to cancel their investment. The cancellation right generally expires 48 hours prior to the deadline unless there is a material change to the offering.  If the company does meet receive the minimum amount of investments by the deadline or the offering otherwise is not completed, the platform must return any investor funds received.   
The SEC hopes that Regulation Crowdfunding will open up new opportunities for small business to access capital. Time will tell if companies and investors determine the new regulations meet their capital and investment needs.

Thursday, July 14, 2016

The Wit and Wisdom of Commissioner Gallagher

I doubt that comments from SEC Commissioners are often dubbed "witty," but Commissioner Daniel M. Gallagher had a real zinger in connection with the SEC's adoption of pay ratio rules last year.

As a bit of background, among the many half-baked ideas in the Dodd-Frank Act of 2010 was the requirement that the SEC adopt rules requiring public companies to disclose the median annual compensation of all employees of the company (excluding the Chief Executive Officer) as well as the ratio of the median salary to the total compensation of the CEO.

Of course, this disclosure would be virtually meaningless to any rational investor.  The sole goal of this new disclosure requirement was to try to embarrass CEOs by making their compensation appear unreasonably high when compared to rank-and-file employees.  Did you think the goal of the SEC disclosure regime was to inform shareholders so that they can make rational investment decisions? So did I, but apparently the 111th Congress of the United States, which passed the Dodd-Frank Act, disagreed.

Anyway, the SEC was tasked with coming up with regulations to implement Dodd-Frank's disclosure requirement.  The task of determining the median annual compensation of employees was not as easy as it might initially seem. What about part-time workers? Seasonal workers? Non-U.S. based workers?  What about employees with different cost-of-living circumstances? Etc.

Ultimately, the SEC passed a controversial set of rules by a 3-2 vote, which included part-time and foreign workers in the median compensation calculation. At the meeting in which the vote was taken, Commissioner Gallagher objected to the adoption of the rule, noting that the disclosure was outside the SEC's core mission, and explaining that since the SEC was required to adopt the rule, he would have at least used the SEC's definitional and interpretive authority to limit the phrase "all employees" in the Dodd-Frank Act to full-time, U.S. based workers.

And here's the part I really like.  Commissioner Gallagher described his proposed disclosure rule as "marginally less useless" than the rule the SEC ultimately adopted. Classic.

I had the honor of introducing Commissioner Gallagher at the 2015 UT-CLE Conference on Securities Regulation and Business Law, and I can confirm that his prepared remarks were as thoughtful as his comment of pay ratio rules was witty.

Thursday, June 23, 2016

Reward-Based Crowdfunding Forum

Earlier this week, I was in the audience for a terrific roundtable discussion on reward-based crowdfunding at IDEA Works FW.  The discussion was led by Hayden Blackburn, the Director of IDEA Works FW, and included an interview with Stephen and Carrie Fitzwater, the founders of Modern Lantern, a designer and retailer of battery-operated cordless lamps (here is their website). Modern Lantern have raised over $15,000 in crowdfunding on Kickstarter to help bring their lamps to life.  

I learned a lot about rewards-based crowdfunding at the event.  For those that don't know, crowdfunding involves seeking funding for a project through small contributions from a large number of people, typically over the internet using websites such as Kickstarter.  Importantly, rewards-based crowdfunding does not involve an investment in securities, such as stock of a company (that's called "equity crowdfunding"). Contributors to a reward-based crowdfunding effort typically expect to receive something in return for their contribution, however, such as a discounted purchase price for a product under development, an extra role in a movie under development, a t-shirt or other swag from the company, and certainly some psychic benefit of knowing you have helped get a young company or project off the ground.

Below are a few take-aways  from the discussion, in no particular order:

  • DON'T EXPECT TO RAISE BIG BUCKS. Reward-based crowdfunding is generally not a way to raise a lot of funds. According to Kickstarter's statistics (available here), although their site has raised of $2.4 billion for over 100,000 projects, about 70% of the projects that successfully used the website for fundraising raised less than $10,000. Less than 0.2% of all successful Kickstarter projects raised $1 million or more.   
  • CHOOSE THE RIGHT PLATFORM. There are more than 190 websites that offer crowdfunding platforms, with more being added all of the time. Some of the more well-known crowdfunding platforms are Kickstarter, Indiegogo and GoFundMe. Different platforms focus on different types of crowdfunding projects (tech, movies, music, medical expenses, etc.), so a company seeking crowdfunding will want to make sure its project fits into the general focus of the crowdfunding platform it chooses to use.
  • MAKE A GREAT VIDEO ABOUT YOUR PROJECT. Kickstarter permits (and strongly encourages) you to prepare a video (perhaps 1-3 minutes long) describing your project. This is where potential crowdfunding contributors are likely to go first to learn about you, your project, your funding needs, and why they should care, so putting together a compelling video is an important part of the crowdfunding process.  It should tell your story in a way that makes the viewer care about and get invested in your success.
  • DRIVE TRAFFIC TO YOUR PROJECT PAGE. Do not expect Kickstarter to do any advertising for you. Getting a project accepted by Kickstarter (yes, they must approve your project before you can use their platform - other platform (such as Indiegogo) have a less rigorous admission process) is only part of the battle for funding.  You should plan to have a robust campaign to drive traffic of potential contributors to your Kickstarter project page.  E-mail blasts and social media "likes" to a broad range of potentially interested contributors is critical to a successful crowdfunding campaign. Media contacts who might help you promote your project and/or a coordinated series of press releases can also enhance your visibility. 
  • FOLLOW UP TO BUILD SUPPORT AND LOYAL CUSTOMERS. Perhaps more important than the funds that can be raised through crowdfunding, is the core of customers, supporters and fans of your product or service that can be grown and cultivated through an effective crowdfunding campaign and thoughtful interaction and follow-up throughout and after the crowdfunding campaign. An earlier contributor to your project is likely to feel invested in your success (literally and figuratively!) much more than a traditional customer.
  • COOL SUCCESS STORY. One interesting reward-based crowdfunding success story is Rocketbook, which has raised over $500,000 on Kickstarter for its cloud-connected, microwavable notebook.  The product allows you to take notes, store your notes on the cloud, then erase your notes in the microwave and re-use the notebook!  You can read more about it here.
Thanks to Hayden and his team for putting on a very interesting and informative event.      

Wednesday, June 1, 2016

German Efficiency?

If you have ever wondered why it is necessary to sign so many sheets of paper when buying or selling a house in the United States, just know that entering into a contract could be worse in other parts of the world.

I've been enjoying reading "Working with Contracts - What Law School Doesn't Teach You," by Charles M. Fox.  The book provides a really good summary of what we corporate lawyers do every day.  It also includes some interesting tidbits, such as this nugget on contractual formalities on page 159:

"[M]any German agreements must be read aloud from beginning to end (including schedules) by a notary, and some must be bound by a ribbon which is affixed to both the cover page and the back page with a waxed seal."

Apparently, the efficiency famously exhibited by German engineers is not shared by German lawyers!

Monday, May 23, 2016

Regulation Crowdfunding Investment Limit

The SEC's Regulation Crowdfunding sets forth the rules pursuant to which companies may raise capital through the SEC's equity crowdfunding exemption.  One of those rules sets limits on the amount of crowdfunding investments by any one investor in crowdfunding offerings (by all companies conducting crowdfunding offerings) in any 12-month period.

Specifically,  Rule 100(a)(2) of Regulation Crowdfunding provides:

"The aggregate amount of securities sold to any investor across all issuers in reliance on [the equity crowdfunding exemption] during the 12-month period preceding the date of such transaction, including the securities sold to such investor in such transaction, shall not exceed: 

(i) The greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net
worth if either the investor’s annual income or net worth is less than $100,000; or

(ii) 10 percent of the lesser of the investor’s annual income or net worth, not to exceed an
amount sold of $100,000, if both the investor’s annual income and net worth are equal to or more
than $100,000."

The investment limit (for all crowdfunding investments) for a crowdfunding investor always results in a number:

  • between $2,000 and $5,000; or 
  • between $10,000 and $100,000. 
Put another way, the investment limit for a crowdfunding investor can never be:

  • less than $2,000;
  • more than $5,000 but less than $10,000; or 
  • more than $100,00.
I have developed a handy calculator for determining the investment amount limit for a particular equity crowdfunding investor based upon their income, net worth, and prior crowdfunding investments in the past 12-months. Feel free to contact me if you'd like a copy of the investment limit calculator.

Tuesday, May 17, 2016

Equity Crowdfunding under Federal Law has Arrived!

It's finally here.  Four years after the JOBS Act of 2012 was signed into law which required the SEC to adopt rules permitting equity crowdfunding, the SEC's final rules titled "Regulation Crowdfunding" have gone effective.

Effective May 16, 2016, U.S. companies may now offer and sell shares of stock and other securities via crowdfunding and qualify for an exemption from securities registration requirements under Section 4(a)(6) of the Securities Act of 1933, as amended.

I'm still wading through the SEC's 685-page final rule release adopting Regulation Crowdfunding, which is available here.  I plan to blog about this matter further in the coming days, but in the meantime, you can read "Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers" written by the SEC, which is available here.