(Article from Registered Funds Alert, February 2018)
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As M&A activity in the asset management space continues to grow and evolve, so too does the concern that third-party interlopers will make a play for the funds involved in a deal after a definitive agreement has been agreed to and announced, but before the transaction can be completed. While this so-called “deal jumping” is a concern in M&A transactions generally, it is of particular concern with respect to control and majority stake transactions involving asset managers because the regulatory requirements discussed above necessitate the approval or consent of advisory clients. The nature of the adviser-fund relationship creates a unique opportunity for interlopers and heightened risk for the selling adviser because an interloper can approach the board of a registered fund directly with an alternate proposal (e.g., they will manage the fund for a lower advisory fee) and could cause litigation or cut out the parties to the M&A deal entirely.
In a prior Alert, we provided a detailed breakdown of an M&A deal gone awry when the adviser to TICC Capital Corp., a publicly traded BDC, announced that it had reached a deal to be acquired by Benefit Street Partners (BSP), and two other parties attempted to jump the deal. First, NexPoint Advisors (NexPoint) submitted a rival management proposal to the board of TICC, offering to reduce the BDC’s current base management fee for the next three years. Although NexPoint’s offer was rejected by TICC, BSP lowered its proposed management fee to be comparable to what NexPoint had offered. Shortly after the NexPoint proposal, another interested party, TPG Specialty Lending (TSLX), offered to buy TICC in a stock-for-stock transaction at a 20% premium and offering similar reductions in management fees going forward. TICC rejected that deal as well.
Ultimately, when the BSP agreement was put to a shareholder vote at a special meeting, despite having the full support of management and the BDC’s largest shareholder, the agreement did not receive the requisite approval required by the 1940 Act and thus BSP’s acquisition of the TICC adviser was never consummated. Since the TICC deal, several other M&A transactions have involved deal jumping attempts, and negotiating protections against interlopers has become an increasingly important point in negotiation of M&A transactions.
So how can the parties to an M&A transaction limit the impact of deal jumpers? As with other types of acquisitions, the acquirer can negotiate the inclusion of certain protections in the merger documents, which are specifically included to deter competing bidders and/or make it costly for the target to walk away from the original deal. While this fundamental component of M&A practice is too nuanced and complex to completely survey in this article, some common deal protections include:
- some variation of “no-shop” provisions, which may grant the buyer the right to be notified of superior proposals that the seller receives and the ability to make a matching offer;
- break-up fee provisions, which provide for a payment to a buyer should the agreed upon transaction fail;
- voting agreements with significant owners of the target adviser (or fund shareholders who will vote on advisory contract approvals that would be triggered by the transaction), although the amount of stock subject to the voting agreement may be limited to an amount that does not prevent another suitor from winning; and
- carefully structuring a registered fund’s proxy so that the proposal shareholders vote on is contingent upon the M&A deal closing.
Another way to avoid deal jumpers involves structuring transactions in such ways that they do not immediately trigger an assignment under the 1940 Act and the associated shareholder votes. A buyer looking to acquire control of an investment adviser eventually, for example, may structure its initial investment such that it is acquiring only a minority non-controlling (i.e., less than 25%) share of the target’s outstanding voting securities, together with the right to receive a higher proportion of the profits from the seller’s investment advisory business. If structured properly, such a transaction would not be subject to approval by the seller’s advisory clients and sponsored registered funds, and thus would be not be vulnerable to deal jumping. Later, the buyer can move to take a controlling stake in the adviser when conditions are more favorable.