Appraisal Arbitrage
When large investors, typically hedge funds, purchase a company’s shares after the announcement of a merger, this is called an appraisal arbitrage. This is done to question the sufficiency of the value of the offer and potentially get more respect for their shares. According to Delaware’s legislation, any investor is entitled to evaluate those forms of merger transaction as long as they meet the statute’s procedural criteria that will be listed.
Appraisal Arbitrage In Detail
Over the past years, there has been a rise in the number of appraisal actions filed in the court, an amount close to 25% of all transactions where the appraisal is possible. And the rise of evaluation arbitrageurs continues to be a major factor.
A majority of shareholders, usually 51%, should provide their approval before a merger can be completed. Those who have not accepted are required to tender their shares to the controlling shareholders, also known as the minority shareholders. They are frozen out of their position, in other words.
Primary to the need to protect minority shareholders from majority abuse, especially in transactions involving a perceived conflict of interest or the potential for self-dealing, was to compensate stockholders for the loss of veto power and to give dissenters the right to exit the corporation and recover the cash value of their shares as the original purpose of appraisal.
A classic example of the type of merger in which concern for minority shareholders abounds and one of the types of mergers granted appraisal rights in Delaware’s appraisal statute is the short-form merger. A short form merger takes place when a subsidiary merges into a parent who already owns most of the stock of the subsidiary, typically about 90%. In such a scenario, there is a risk that the parent company will offer the subsidiary’s shareholders a price for their shares that is less than the fair value because the transaction does not require a shareholder vote meaning there is less incentive to pay a competitive price. The appraisal can serve as a defense in the sales process against sloth, incompetence, or unconscious bias.
Those who think that their shares are worth more than the terms of the merger are offering may go to a judge and ask them to decide what a fair price for the target company would be and make the acquirer pay for it. However, there is only a certain time to dissent and proper procedures to follow. The assessment legislation of Delaware gives rise to an absolute right to evaluate only certain forms of fusions, such fusions involving cash consideration, short term fusions and interesting transactions. Additionally, other enumerated conditions may be defined by companies that will trigger assessment rights in their charters.
The dissenting investors or the minority were asking the court to decide its interest for 120 days of judicial manner. Before the vote on the transaction, any investor seeking to seek an assessment must send a written request to the company. We should also remember that voting strictly against the merger does not protect one’s right of assessment.
Analysts may then use various valuation methods to determine the acquired company’s fair share price and value, including asset-based methods, sales or cash flow methods, and equivalent market data models and hybrid or equation methods. While most appraisal rights events are based on mergers or fusions, they may also refer to a situation where the company takes any unusual action that investors find detrimental to their interests.
The valuation fees are buyer’s post-closure duty and this mechanism has been followed as in investment strategy by certain hedge funds. Hedge funds that own shares are allowed by the appraisal system to pursue their higher value and get it on the original deal price less than the appraisal costs. The law allows the plaintiffs to receive interest in the amount they are ultimately rewarded.
It is rare for courts to determine a value less than the offer price, so it is likely that those seeking appraisal rights will get the offer price or more and then also interest on what they receive. The interest rate is set at 5% above the Federal Reserve’s discount rate and that can be attractive in a low-interest-rate environment because of attractive investment opportunities promising returns that typically outflanked the risk-adjusted returns of similar investments. Hedge funds are also allowed to purchase shares in the market after the deal announcement date, and also after the record date for voting on the offer, and up to the effective date of the deal.
There is an approach for arbitrators that they can employ where they can wait to buy shares and carry out assessment actions until information about the transaction is revealed that can provide a better understanding of both the target’s value and the risk of not closing an agreement, information that increases the likelihood of bringing about a profitable assessment actions.
There are many critiques of the arbitration of the assessment. Others claim that it exacerbates the risk already inherent in appraisal proceedings where judges fail famously to discern and decide between highly technical and divergent assessment opinions offered by dueling litigant-retained experts. It is indeed an uncomfortable topic because it assumes inefficient markets. The only reason one would seek an appraisal is that they think that the market got the wrong price for a company, but that a judge will get the right price, which, of course, is higher.
It is also seen as intended to protect the existing stockholders who are or will be forced to sell their shares in the merger. But the real puzzle is why assessment arbitration is lucrative since the purpose of an assessment agreement is to decide the fair price of the target securities using the same valuation methods used by financial professionals who advise the parties to such deals.
This solution has drawn many opponents mainly based on who is making such cases and buying them, saying that even non-appraisal arbitrators are no longer using the law for liquidity purposes.
•In order to ensure that arbitrators can continue to bring meritorious claims, the legislature must refrain from implementing additional legislative restrictions, particularly those relating to the record date and holding requirements.
Type of Merger: Short-Form Merger
A short-form merger may take place in situations in which the stockholder approval process is not necessary. As a continuation of the previous article, we will discuss short-form mergers and how they are structured. We have previously established that there are different types of entity deals such as a stock deal or a merger.
In the previous article (Deal Structure: Asset Versus Entity Deals), we have discussed the difference between selling company assets and selling the company as a whole entity. Each of those options has its own pros and cons, which we have also discussed.
Mergers are often used by a large public company with a large and widely distributed shareholder base. In a merger deal, the company or corporation who survives the deal succeeds to all the liabilities of the company or corporation who did not survive.
Additionally, mergers can only happen if the majority of the shareholders agree to the deal. Voting approval needs between shareholders need to happen first.
Most giant companies use merger deals instead of asset deals. This is because a merger is much more beneficial to a seller in comparison to asset deals. You might have heard of giant companies merging with a similar company, this is done when a company or corporation is on the brink of bankruptcy. They merge with a similar company who will adapt all of their assets (including the liabilities), the surviving company will now own all of the non-surviving company.
There are different phases when it comes to mergers and acquisitions. It is also important to understand that there are different types of merger deals. First, there is what’s called the Forward Merger where the target merges directly into the purchaser corporation. In these types of deals, the target disappears while the purchaser survives. This is also known as a statutory merger sometimes.
Then we have the Forward Subsidiary Merger also known as a forward triangular merger. In this type of merger deal, the purchaser creates a merger subsidiary and the target merges directly into the subsidiary instead of the target merging directly into the purchaser.
Another type of merger deal is the Reverse Subsidiary Merger. This is also referred to as reverse triangular mergers sometimes. In these types of merger deals, acquirer subsidiary pays the target’s shareholders and receives the shares in the target exchange. This type of merger improves upon the forward subsidiary merger by reversing the direction of the merger.
Now that we have those three covered, it is time to focus on the Short Form Mergers.
This means that the stockholder approval may be bypassed when the corporation’s stock is concentrated in the hands of a small group. The said the small group could be the management who are advocating the merger.
However, all of that still depends on the state where the company is located. There are some state laws that may allow this “small group” to approve the transaction on its own without soliciting the approval of the other stockholders. Then, the board of directors simply approves the merger by a resolution. This law varies from state to state.
Furthermore, a short-form merger may also happen only when the stockholdings of insiders are beyond a certain threshold stipulated in the prevailing state corporation laws. Again, there are different state laws for this type of deal, so the percentage varies depending on the state in which the company is incorporated.
For instance, under Delaware state law, the short-form merger percentage is 90%. However, it could be different in other states. The 90% is the relevant percentage for most states with the exception of a few states such as Alabama, Florida, and Montana in which these states have an 80% threshold.
It is also important to mention that a short-term merger may follow a tender offer as a second-step transaction. This is where shareholders who did not tender their shares to a bidder who acquired substantially all of the target’s shares may be frozen out their positions. To know more details about tender offers, read our article about Tender Offers vs. Long-Term Mergers.
You might realize that the word “law” popped up quite a few times in this article. This is why it is important to have some great attorneys and law firms by your company’s side during merger deals and any type of deals. Look for law firms who specialize in mergers and acquisitions.
Once the short-form merger is approved by the company’s board of directors and they decide to take that route, it is typical that the board will also create a plan with a detailed definition of how the merger will proceed. This merger plan will also state the effects that the board of directors anticipates the transaction will have on the company.
Next, the plan will be distributed to the shareholders to allow them to determine whether or not they want to proceed with the transaction. Once the majority of shareholders approve of the short-form merger, the legal proceedings begin. The company will combine everything – including financial statements, business operations and legal rights with the parent company.
Should there be any shareholders who disapprove, the parent company will try to buy their shares out. There are also cases where shareholders disapprove of the short-form merger simply because they are not interested in the transaction. Either way, the parent company will have full control of the subsidiary.
As previously mentioned, there are a lot of options when it comes to the types of mergers. The type of merger deal you should take depends on the state of your company or corporation, and the agreement between shareholders. Again, a law firm who specializes in these cases is crucial for you and your company.
There you have it, a quick overview of short-form mergers and how it happens. In the next article, we will discuss more mergers and merger waves. To learn more about mergers and acquisitions, explore our website. We offer free articles regarding mergers and acquisitions as well as detailed guides on corporate restructurings.