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An acquihire is an informal term for a type of transaction in which a buyer purchases a target company—or a substantial portion of its assets—primarily to obtain the services of the team of individuals working for the target company rather than for the purpose of acquiring the business of the target company.
The goal of the buyer is to bring on a team of talented individuals who are experienced at working together to assist in developing the buyer’s products or services. Because the business of the target company is not highly valued by the buyer, it is typically shut down or no longer actively pursued by the buyer.
An acquihire is usually structured such that a significant portion of the purchase price is used for retention and incentive compensation to keep the team in place for a period of time after closing. As a result, investors in the target company often receive minimal or even negative returns. The consideration to be paid to the team being acquired is typically dependent on meeting certain future conditions such as the team remaining employed by the buyer for a specified period of time or achieving product development or other goals determined by the buyer.
An acquihire is often the result of the target company being distressed, unable to raise necessary funding to continue operations, or otherwise being unable to realize any significant value for the products or services it is developing. Because an acquihire generally does not result in substantial consideration being paid to the target company’s stockholders, the target company’s directors must be especially careful to consider whether the transaction will be in the best interests of the stockholders, particularly where individual directors are “interested” in the transaction due to compensation they may receive as members of the team employed by the buyer following the closing (click here to learn more about director duties in the M&A context).
Additionally, the company should review its covenants with its lenders and other creditors to ensure that an acquihire is not prohibited or doesn’t otherwise require consent or a notice.
The buyer may purchase only a minimal amount of assets (or none at all), leaving the target company to deal with those assets and any liabilities such that it must go through a separate wind down and liquidation process, or potentially even file for Chapter 7 bankruptcy or seek other protection from creditors, after closing. We recommend that any company considering an acquihire transaction consult with legal counsel as early as possible in the process.
The stockholder approval required to sell a company generally depends on the structure of the transaction, the jurisdiction of the company’s incorporation and the requirements of the company’s governing documents. In the U.S., technology companies typically are not sold in direct share sales. Instead, transactions typically are structured as mergers (which is a state law process) or sales of assets, where the company survives the transaction.
If the company is being sold through a direct share sale, the approval of 100 percent of the stockholders will effectively be required, as each stockholder will need to sign the definitive agreement to sell their shares. Note, however, that once a buyer obtains 90 percent of the outstanding shares of each class, it can acquire the remainder of the shares of the company through a short-form merger, for which no stockholder approval is required, as long as the consideration and other terms offered to the remaining stockholders are identical to what was offered in the earlier transaction.
As noted above, direct share sales are burdensome as every stockholder has to negotiate and enter into an agreement, so they are uncommon among technology companies.
If the company is being sold through a merger:
- Under Delaware law, generally, the approval of holders of at least a majority of the outstanding shares will be required.
- Under California law, generally, the approval of holders of at least a majority of the outstanding shares of each class will be required. Note that California law on this point applies to companies incorporated in California as well as to companies incorporated in other jurisdictions if the number of their shareholders and the extent of their operations in California exceed certain thresholds (see FAQ: “Will a Delaware corporation doing business in California be subject to California corporate law?”).
- The certificate or articles of incorporation of the company might also contain protective provisions that require the additional approval of holders of at least a majority (or greater percentage) of certain classes or series of shares. Even if the certificate or articles of incorporation do not provide for a series or class vote, additional votes of a series or class of shares may be required if the transaction treats the series or class differently than is provided in the governing documents.
- It is relatively common for a buyer to request that a company obtain the approval of holders of an even greater percentage of shares (often around 90 percent) for a merger in order to limit the number of stockholders that may exercise appraisal or dissenters’ rights.
- It is also relatively common for a buyer to request that holders of a certain percentage of the shares of a private company expressly agree to be liable for the indemnification obligations set forth in the merger agreement.
If the company is being sold through an asset sale:
- Under Delaware law, generally, the approval of holders of a majority of the outstanding shares will be required.
- Under California law, generally, the approval of holders of a majority of the outstanding shares will be required.
- The certificate or articles of incorporation of the company might also contain protective provisions that require the additional approval of at least a majority (or greater percentage) of certain classes or series of shares.
- It is relatively common for a buyer to request that the holders of a certain percentage of the shares of a private company agree to be liable (either directly or as guarantors) for the indemnification obligations of the company set forth in the asset purchase agreement.
In the context of any structure of transaction, additional votes may be required if the company being sold is private to approve compensation being paid in connection with the transaction under Section 280G of the Internal Revenue Code, as amended. The voting requirement for a compensation vote under Section 280G is 75 percent of the disinterested stockholders. The consequences of failing to obtain the vote are that the person receiving the compensation is subject to significant excise taxes and that the company cannot deduct the compensation.
You should be aware that there are exceptions to the general rules stated above. A company contemplating a sale should seek the advice of its counsel regarding the optimal structure and required stockholder approval required for any particular transaction, ideally prior to the signing of a term sheet. Voting considerations are not the only factor to take into account. Other issues, such as taxation, are also important in determining transaction structure.
The duty of care is a duty to act with reasonable care and to make decisions on an informed, deliberative basis after giving due consideration to relevant information and advice.
To fulfill the duty of care, directors should review all reasonably available, material information regarding a potential transaction and solicit input and advice from management and external advisors when appropriate. Directors should consider the benefits, risks and timing of any proposed sale and any alternative transactions and strategies, including the continuation of the company on a standalone basis. Directors should take sufficient time, to the extent practicable, to consider fully and evaluate a proposed transaction.
The duty of loyalty is a duty to act in good faith and in the honest belief that actions taken and decisions made are in the best interests of the company and its stockholders. To fulfill the duty of loyalty, directors should consider whether there are any conflicts of interest or biases in respect of a potential transaction and, if so, implement procedures to address them.
Conflicts of interest may include, for example, a director standing on both sides of a transaction or a director deriving a personal financial or other benefit from a transaction that is not shared with the stockholders generally, such as an employment arrangement post-merger, ownership of shares in the acquirer and so on.
In recent years, Delaware courts have become significantly more expansive in their views of what would cause a director to be conflicted, including long-standing social relationships between directors, whether a director is appointed by one or more investors to the boards of other companies, etc.
Therefore, a very detailed and candid discussion with counsel at the outset of a transaction about the nature of any such relationships is important to enable the board to follow a process that will reduce the risk of litigation. Transactions involving potential conflicts of interest should be disclosed by the conflicted director, and the other directors should consider appropriate procedures relating to the potential conflict. Such procedures may include the possible negotiation, review or approval of the transaction by the “independent” and “disinterested” directors and/or the approval of the transaction by the stockholders after being fully informed as to all material facts regarding the transaction and any such conflicts.
Under the business judgment rule, courts defer to board decisions made in good faith, on an informed basis and in the honest belief that such decisions are in the best interests of the company and its stockholders. If a court applies the business judgment rule, it will generally uphold board decisions so long as they are attributable to a rational business purpose, and it will not second guess board decisions even if they turn out to be “wrong” when viewed with the benefit of hindsight.
However, in a sale of control of a company, the Revlon standard applies. Under the Revlon standard, the purpose of the board’s duties shifts from long-term corporate planning to short-term value maximization for stockholders, and a court’s standard of review escalates from the deferential business judgment rule to a “reasonableness” standard. In a sale of control of a company, the focus of the board’s duties is to obtain the “best price reasonably obtainable.”
A court will examine the board’s process and deal terms for reasonableness to determine if they assisted the board in obtaining the best value reasonably obtainable. The board may consider factors such as value to stockholders, timing and the likelihood of closing a particular transaction.
Note that there is no single blueprint to satisfy the Revlon standard; the process can range from an auction to a pre-agreement market check or post-agreement market check with modest deal protections, depending on the facts. Board actions that have an anti-takeover effect are also subject to enhanced scrutiny (under Unocal) and will only be upheld if reasonable in relation to the threat posed and if the board’s process was reasonable.
Courts may evaluate the “entire fairness” of a proposed transaction under a much more exacting level of judicial review if the plaintiff can show that the directors breached their duty of care or duty of loyalty. If a court determines to review the “entire fairness” of a transaction, the court will evaluate two components of the transaction:
First, was the board process fair? To answer this question, courts will evaluate all aspects of the transaction process, including timing, negotiation process, disclosures, details of board review, etc.
Second, are the terms of the transaction fair? To answer this question, courts will evaluate all aspects of transaction price, value and terms – often with emphasis on the analyses performed by the company’s financial advisor.
It is important to note that Delaware courts take the view that the fiduciary duties of care and loyalty run primarily to the common stockholders, and that preferred stockholder rights are generally contractual in nature. Preferred stockholders do get the benefit of fiduciary duties when the interests of the preferred stockholders are aligned with the interests of the common stockholders and there are no preferred stock terms that address a specific issue.
This means that directors may at times be required to act in the best interests of the common stockholders (who are viewed by the courts as the residual owners of a company) when the directors have the discretion to do so, even when the common stockholders’ interests are in conflict with those of preferred stockholders. This is true even if a director is appointed by a particular stockholder or class or series of stock. For a summary and analysis of the Trados case, in which the court highlighted these points, please see the following article: https://www.wsgr.com/PDFSearch/survival-guide-2016.pdf.
To protect themselves from liability in connection with a sale of a company, directors should take care to comply with their duties of care and loyalty and to document their consideration of the transaction. In addition, directors should consider the following:
- confirming that the company’s charter contains a limitation of liability clause applicable to directors;
- entering into an indemnification agreement with the company; and
- ensuring that the company has appropriate D&O insurance coverage and purchases a D&O “tail” policy, which is a pre-purchased insurance policy that covers new claims made against directors and officers after the closing that relate to matters prior to closing.
In certain circumstances, it may also be prudent to take the following actions:
- having the transaction approved by an independent committee of directors and/or the stockholders;
- including a ‘fiduciary out” in the acquisition agreement so that the directors can consider a better offer received between signing and closing;
- engaging a banker to identify potential buyers for the company; and/or
- obtaining a fairness opinion from an independent banker.
The law regarding directors’ duties with respect to the sale of a company is complex and is only briefly summarized above. Further, the ideal sales process for any company will depend on that company’s particular circumstances and the details of the transaction being considered. A company contemplating a sale should seek the advice of legal counsel to ensure that the directors are taking appropriate steps to comply with their duties and to protect themselves from liability as they make decisions with respect to the transaction.