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DealThink: Doing the Two-Step (Or the One-Step): A Look at One-Step and Two-Step Mergers
Jennifer T. Wisinski
You are the general counsel of a public company. The CEO walks into your office one day and says that the board of directors has identified a merger target for the company, a public company incorporated in Delaware, but time is of the essence. The CEO asks you what the differences are between one-step and two-step mergers.
In a one-step merger, the target, the acquiror and usually a subsidiary of the acquiror, enter into a merger agreement which provides that, upon satisfaction or waiver of the conditions to the agreement, the acquiror subsidiary will merge with the target (usually with the target surviving the merger), and the target will become a wholly owned subsidiary of the acquiror. Generally, a one-step merger where the acquiror is paying cash can be completed within a few months from execution of the agreement, depending on the length of SEC review.
Under state corporate law, the target will be required to obtain stockholder approval of the merger, and under federal securities laws, will be required to comply with the proxy regulations in connection with the solicitation of proxies in order to obtain stockholder approval. Merger proxy statements must be filed in preliminary form with the SEC, and the SEC will have 10 days to determine if it will review the proxy statement before it is mailed to stockholders. If the SEC determines to review the proxy materials, and it typically does, the target may not mail definitive proxy materials or begin the solicitation process until the SEC clears the proxy materials. Generally, the solicitation period is around 30 days but the exact time required will depend on state corporate law, among others. Once stockholder approval is obtained, the merger is usually consummated promptly, perhaps the same day or the next day, subject to the satisfaction or waiver of other conditions.
If the merger consideration for a transaction includes securities, the one-step process is similar but becomes longer and more complicated due to the registration of the acquiror’s securities to be issued. After executing the merger agreement, the parties prepare a Form S-4 Registration Statement that will include a proxy statement/prospectus, which includes, among other things, a description of the acquiror’s securities being offered as consideration. The parties submit the Form S-4 to the SEC for review and comment, which can take a few months in the event of a full SEC review. The acquiror may also be required to obtain stockholder approval in certain circumstances. Once the SEC clears the proxy materials and declares the Form S-4 effective, the solicitation process begins.
The goal of a two-step merger is the same as that of a one-step merger: the target will become a wholly owned subsidiary of the acquiror. However, the merger agreement in a two-step merger requires the acquiror’s subsidiary to commence a tender offer for all of the target’s shares within a few days of signing the merger agreement. The primary timing advantage of the two-step transaction is that the acquiror may commence the tender offer without prior SEC review. A two-step merger with all cash consideration may be completed in as little as 30-40 days if the acquiror is able to effect a “short-form” back-end merger.
Although it is common for the SEC to review tender offer materials, the review process for tender offers is generally done on an expedited basis. The tender offer must remain open for at least 20 business days and is usually subject to a number of conditions, including the tender of the minimum number of shares necessary to ensure that the acquiror will own, following the offer, a number of shares sufficient to complete the “back-end merger” (generally, a majority of shares on a fully diluted basis absent a higher threshold). This is known as the “minimum tender” condition.
When the tender offer closes, the acquiror purchases all the tendered shares and becomes a majority stockholder of the target. If the acquiror owns more than 90 percent of the target’s shares, the acquiror will within a day or two complete a “short form” merger that does not require approval of the minority stockholders. If the tender offer is completed but the 90 percent ownership level was not reached as a result of the tender offer and the merger agreement included a “top-up option,” the acquiror may purchase newly issued shares from the target to increase its ownership to be able to complete a short-form merger.
If the acquiror was not able to complete a short-form merger, the back-end merger, which will “squeeze out” the stockholders who have not tendered their shares into the tender offer, may take up to two months to complete. Although the acquiror will have the requisite vote to approve the merger, the acquiror will either have to approve the merger by written consent, if permitted, and deliver an information statement on Schedule 14C to the stockholders or prepare proxy materials and hold a stockholders meeting to approve the merger. The information statement is subject to the SEC review and comment process described above and the merger may not be effected until 20 days after the mailing of the information statement. In the event that the acquiror cannot act by written consent to approve the merger, the target will have to file a preliminary proxy statement, which will be subject to the SEC review process for proxy statements as discussed above, and take all the other necessary steps in order to hold a stockholders meeting to approve the merger.
If the two-step merger consideration includes securities, the process generally is longer. SEC review of share exchange offer documents, where the merger consideration is shares of the acquiror, generally takes a greater amount of time than a review of cash tender offer documents. Following amendments to the tender offer rules in 1999, bidders may commence a registered exchange offer on the filing of the Form S-4 rather than upon its effectiveness, but the completion could not occur until after the effectiveness of the Form S-4. As a result, the timing advantage of the two-step merger generally applies to all cash transactions.
Pros and Cons
In the last few years, following an SEC amendment to the “best price” tender offer rule, two-step mergers have become more common when the acquiror is paying all cash. This is due to the fact that control and, if, as is often the case, the 90 percent short-form merger threshold is reached, 100 percent ownership can be accomplished much more quickly than a one-step transaction and without prior SEC review. A bidder may acquire control in a two-step transaction in about a month following execution of the merger agreement. This compares to the longer period, depending on SEC review, that a one-step transaction might require, though the timeline in each case does not account for delays for Hart-Scott-Rodino (which requires a 15-day waiting period for cash tender offers) or other regulatory review. This preference for a two-step merger also reflects a general view that the risk of non-consummation of the back-end merger is not substantial. In addition, even if the back-end merger takes some time to complete, the acquiror controls the target from the time it completes its tender offer.
However, a one-step merger is often the more favored transaction structure when there are regulatory or other approvals that cannot be satisfied quickly. Further, one-step mergers are often utilized for mergers where the acquiror is financing the transaction with loans and the lenders do not wish to provide bridge financing for the purchase of shares in a first-step tender offer. Also, in a transaction where the merger consideration consists wholly or partially of shares of the acquiror, the timing advantages of a two-step merger are less pronounced and the acquiror may choose the simpler, one-step process.
An additional consideration concerns whether the target has outstanding debt or other obligations that will be accelerated upon a change of control. Although the acquiror will control the target upon the completion of the tender offer, if the target has debt or other obligations that will become due upon the change of control, the acquiror must be prepared to refinance or pay the obligations in full. It will be more difficult for the acquiror to refinance the target’s debt because it does not own 100 percent of the target. Under such circumstances, unless a negotiated solution can be reached by the parties prior to entering into the tender offer, the acquiror should consider a one-step merger.
In closing, you should tell the CEO:
- If the acquiror is paying all cash, the two-step merger can be completed quickly and without prior SEC review. However, if the target has significant obligations that will be triggered upon the change of control that will occur at the closing of the tender offer, the acquiror must be able to satisfy those obligations without having access to all of the target’s assets. This can be an issue for financing parties of the acquiror.
- If the acquiror is using securities as consideration, the one-step merger may be the best approach.
- If the acquiror cannot acquire control until other regulatory approvals are obtained (e.g., banking approvals, FCC), the acquiror will likely need to structure the transaction as a one-step merger.
If you have any questions, please contact one of the following attorneys: