Member Article

You are the general counsel of a public company and expect M&A activity to increase in the United States during 2012. Do you know if your company looks like a good target to potential acquirors? It is important to understand whether you could be a target before getting that first overture from an acquiror. The following list can help you examine your company’s current vulnerability, which could influence whether you should be considering any of the anti-takeover measures described in order to help control the company’s future.

Characteristics of an Acquisition Target

Although neither exhaustive nor determinative, if your company has the following characteristics, you may be considered a potential target:

• Valuation. Is your company’s stock price trading at historical lows or below its cash balances or liquidation value?
• Cash and Liabilities. Does your company have an unreasonably large cash balance and/or relatively low liabilities? In addition to shoring up the acquiror’s balance sheet, existing cash balances may be used to help pay off or pay down acquisition related financing and expenses. Similarly, companies with limited liabilities (e.g., low debt levels, minimal litigation exposure) can often be prime candidates for acquisitions, as potential acquirors may value an opportunity with minimal exposure to uncertain risks and liabilities.
• Size. Are you a small to mid-cap company? They are frequently the targets of much larger competitors. However, as we have seen lately (e.g., AT&T’s failed acquisition of T-Mobile and BHP’s acquisition of Petrohawk), size is not always the determinative factor.
• Distressed. Is your company having difficulty meeting its liquidity needs? If so, a third party may feel that your company’s assets are valuable and could be utilized under a different business structure or with new leadership.
• Business. Does your company have a unique business or operate in a service niche that would complement a competitor’s product line? Often this takes the form of intellectual property (e.g., attractive patents) or an attractive asset base.
• Ownership. Does your company have an active base of one or more large stockholders? You should check filings with the Securities and Exchange Commission regularly, because groups comprising five percent stockholders are required to file Schedule 13Gs (or Schedule 13Ds).
• Performance. Does the investing community feel your stock has underperformed recently? A third party may feel that your company’s performance could be improved through new guidance and perhaps cost-cutting measures. Alternatively, if your company has been performing well, a third party may feel that your management team would be an attractive addition to help manage the third party’s existing assets or improve the third party’s financial condition and operating results.

Acquisition Defenses

Regardless of whether you view your company as a potential acquisition candidate, below are several anti-takeover devices and defenses that you should consider to potentially thwart unwanted acquisition threats or to, at the minimum, give you the leverage to be able to negotiate the best friendly deal possible for your stockholders. Note, however, that the implementation of certain of these measures may result in a negative reaction from the market and could adversely impact the company’s stock price. Additionally, you should consider the impact that the adoption of certain of these devices will have upon recommendations by stockholder advisory firms such as ISS and Glass Lewis at future stockholder meetings. It is important that any measures ultimately implemented are deemed to be a reasonable response to the potential threat or danger of an unwanted takeover.

• Stockholders Rights Plans (“Poison Pills”). The purpose of a stockholder rights plan, or poison pill, is to protect stockholders from a coercive takeover. Poison pills function by causing shares acquired by an unwanted acquiror (once the acquiror reaches a prescribed ownership threshold, typically 15 to 20 percent) to be diluted by allowing existing stockholders (other than the unwanted acquiror) to exercise rights to purchase a large percentage of the target’s shares at a substantial discount to the then-prevailing market price. With respect to management proposals to ratify a poison pill, ISS makes recommendations on a case-by-case basis, focusing on the features of the stockholder rights plan. However, many of ISS’ guidelines are more restrictive than the provisions found in a typical rights plan. A poison pill can be adopted by the board, but would be required to be approved by the stockholders, and if an amendment to the charter is required to provide for the additional shares required, stockholder approval would be necessary.
• Staggered Board of Directors. Generally, all members of a company’s board of directors are elected annually at a stockholders meeting. In contrast, a staggered board of directors allows the individual directors to be elected for multi-year terms, typically classifying the board into three equal groups, with one group elected each year. Such a provision makes it more difficult for a hostile acquiror to take immediate control of a board. In order to establish a classified board, the company’s charter would have to be amended and approved by the stockholders.
• Advance Notice Bylaw Provisions. Companies are increasingly adopting provisions to their bylaws to provide advance notice requirements for stockholder proposals/nominations and to ensure that activist stockholders disclose all of their holdings, including those in derivative form. In recent years, Delaware courts have taken a very narrow approach to their interpretation of advance notice bylaw provisions. Therefore, companies should take great care to ensure that these provisions are carefully and narrowly drafted to eliminate potential challenges to such provisions. ISS makes recommendation on a case-by-case basis on advance notice requirements for stockholder proposals/nominations, giving support to those proposals which allow stockholders to submit proposals/nominations as close to the meeting date as reasonably possible and within the broadest window possible, recognizing the need to allow sufficient notice for company, regulatory and stockholder review. Generally, an amendment to the company’s bylaws to provide for advance notice can be achieved with board approval.
• Supermajority Voting Requirements. It is generally possible to amend your governing documents with stockholder approval to require the approval of a “supermajority” of your common stockholders (typically between 66-2/3 percent and 80 percent) for certain extraordinary transactions, such as a merger. ISS recommends a vote “against” proposals to require a supermajority stockholder vote. However, for companies with stockholders who have significant ownership levels, ISS recommends a vote on a case-by-case basis, taking into account ownership structure, quorum requirements and vote requirements. Amending the voting requirements would require an amendment to the company’s charter and stockholder approval.
• State Anti-Takeover Statutes. Many states have enacted anti-takeover statutes, which consist primarily of business combination statutes and control share acquisition statutes. In contrast to a poison pill, most state business combination statutes simply prevent a stockholder from engaging in certain transactions once they reach a specified ownership level without prior board approval. The statute itself does not prevent ownership of a large stake in the company. ISS recommends a vote on a case-by-case basis on proposals to opt in or out of state takeover statutes (including fair price provisions, stakeholder laws, poison pill endorsements, severance pay and labor contract provisions, and anti-greenmail provisions). Because most statutes have to be either specifically included or excluded, as the case may be, from the company’s charter, this would require stockholder approval.
• Net Operating Loss (“NOL”) Protections. NOL protective provisions may be included as part of a poison pill or on a stand-alone basis as part of a company’s organizational documents. ISS recommends a vote “against” proposals to adopt a protective amendment to the company’s charter for the stated purpose of protecting a company’s NOLs if the effective term of the protective amendment would exceed the shorter of three years and the exhaustion of the NOL. ISS recommends votes on a case-by-case basis, considering various factors, for management proposals to adopt an NOL protective amendment that would remain in effect for the shorter of three years (or less) and the exhaustion of the NOL. As with a Poison Pill, stockholder approval or ratification would be required.
• Acquisitions. Making an acquisition can have the intended (or unintended) effect of causing an existing stockholder’s ownership percentage to become diluted if the company’s stock is used to pay the purchase price and also increasing the potential purchase price for a third party acquiror. Generally, an acquisition may be completed without stockholder approval, unless the issuance of stock consideration in the transaction requires such approval.

Regardless of any anti-takeover defenses your company considers adopting, your investor relations department should be in frequent contact and keep an open dialogue with your significant stockholders. Additionally, we suggest that either you or your outside counsel review your corporate documents to determinate what potential anti-takeover defenses your company may already have in place, as that will influence what additional defenses are appropriate and reasonable.

If you have any questions, please contact one of the following attorneys: