December 2006

Go-Shop Provisions: a New Trend?In the current market, more and more public company merger agreements contain a so-called “go-shop” provision that permits the tar-get company to continue to actively solicit a better deal after signing a definitive agreement with the initial buyer. The increased useof this provision suggests a trend that is fueled by an M&A environment dominated by financial buyers and increasing competition fordeals.

What’s a “Go-Shop?”A “go-shop” is a provision in a merger agreement that allows a target to solicit interest from potential buyers of the company for a lim-ited period of time (typically between 20-55 days) after signing a definitive agreement with an initial buyer. The right to solicit includesthe ability to exchange confidential information about the target with a potential buyer so long as the potential buyer signs a confiden-tiality agreement that is substantially on the same terms as the confidentiality agreement signed with the initial buyer. Any potentialbuyer expressing interest during the go-shop period is encouraged to submit an acquisition proposal to the target and is usually permit-ted to continue any ongoing discussions with the target after the go-shop period expires. Once the go-shop period ends, the target typ-ically is subject to the customary “no-shop” prohibitions against soliciting other bidders or engaging in due diligence or negotiationsexcept in response to an unsolicited offer that could reasonably be expected to lead to a superior transaction.

In virtually any public company merger agreement, if a superior offer emerges, the target company board is able to exercise a “fiduci-ary out” and terminate the merger agreement with the initial buyer subject to the payment of a break-up fee. However, merger agree-ments that contain a go-shop provision often have a two-tiered break-up fee that is approximately 1-2% of the equity value of the trans-action if the superior offer results from discussions arising during the go-shop period, and increases to between 2-4% of equity valueif arising after the go-shop period. Because there may not have been an auction prior to signing the agreement, the lower break-up feeduring the go-shop period is less of a hurdle for potential competing bidders.

From a seller’s standpoint, a go-shop provision is desirable for a number of reasons. The initial buyer serves as a stalking horse topotentially make the seller more attractive to other buyers, and its purchase price sets a floor for other potential buyers to top. A go-shop also preserves a board’s ability to fulfill its fiduciary responsibilities while not conducting a full-blown auction initially by pro-viding for an alternative process in which the target can solicit competing bids. A go-shop also allows a target to secure a deal priorto widely soliciting bids, unlike a typical auction situation where there is a risk that the target may conduct a highly visible public auc-tion only to be left with no buyer.

From a buyer’s point of view, agreeing to a go-shop might secure a deal with a target without the buyer having to participate in a lengthyauction, putting the initial buyer in the enviable first-place position as the preferred buyer. Although the target is able to shop the dealafter signing, that period may be shorter than a typical auction period. Upon signing the merger agreement, the initial buyer benefitsfrom the deal protection rights in the merger agreement, including potentially “last-look” or “match” rights upon the receipt by the sell-er of a superior proposal. Some recent agreements containing go-shops, however, have eliminated the initial buyer’s right to match asuperior bid made during the go-shop period, reducing the advantage. As previously discussed, the initial buyer typically receives abreak-up fee if the target terminates the merger agreement in favor of a better deal.

Despite these advantages, some critics have questioned the efficacy of go-shops, citing their limited ability to lure other bidders.Bidders are less likely to emerge after a deal has been signed due to the advantages conferred on the initial buyer in a merger agree-ment and the additional cost of paying a break-up fee. Bidders are, however, more likely to emerge if actively solicited, as is the caseduring a go-shop period, which some commentators believe offsets a potential bidder’s hesitancy to break up a pre-existing M&A deal.The number of bidders willing to jump a deal have also increased, suggesting a larger appetite in the market for hostile activity. (SeePhillip Mills and Mutya Harsch, “How to avoid the jump,” IFLR, December 2006).

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Market ExperienceGo-shops first occurred in non-shopped LBO deals led by founders and management, although they currently appear also in other typesof LBO deals. For example, there may be special circumstances that require the company to limit active shopping of a deal in orderto balance other interests, such as the interests in controlling leaks during an auction process, avoiding competitive issues in disclos-ing information to strategic buyers and minimizing distraction to management during an auction process.

Since January 1, 2004, 19 publicly announced M&A deals in the U.S. contained a go-shop provision.1 Of these deals, three resultedin the target’s closing on a superior transaction. In most cases, the parties did not conduct a market check prior to signing the defini-tive agreement but in some cases (See, e.g., West Corporation, Criimi Mae Inc., Ace Cash Express), pre-signing market checks wereconducted. The attached chart summarizes the transactions that have included go-shop rights.

Fiduciary Duty Issues to ConsiderUnder Delaware’s Revlon standard, a board has a fiduciary duty when selling the company to seek the highest price reasonably avail-able. It remains true today that Revlon does not require the target to conduct an auction so long as the no-shop, break-up fee and otherdeal protections do not preclude expressions of interest from other potential buyers. However, a target board that foregoes an auctionor other pre-signing market check should consider whether a go-shop provision may be appropriate in certain circumstances. If thetarget elects to include a go-shop provision, it can enhance the sale and thereby further buttress the argument that the board has satis-fied its Revlon duties by limiting, during the go-shop period, some of the rights by which the incumbent might otherwise expect to haveduring a no-shop period. For example, we have seen deals where the incumbent’s right to match a superior proposal is suspended dur-ing the go-shop period (See, e.g., OSI Restaurant Partners, Inc., Kerzner International) or during some part of the period (See, e.g.,Freescale Semiconductor, Inc.). As noted above, break-up fees are often lower during the go-shop period than in the no-shop period.And the requirements to inform the incumbent of the terms of any competing proposal are also typically more limited during the go-shop period.

Please call your Davis Polk contact, Paul Kingsley (212-450-4277) or Mutya Harsch (212-450-4289) if you have any questions regard-ing this newsletter. For a list of Davis Polk’s primary private equity lawyers, please click here.

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1 Source: Mergermetrics.com