Public company mergers of equals aren’t uncommon, but since the stock of private companies isn’t liquid, an MOE involving private companies has been a relatively unusual deal structure. However, they say that necessity is the mother of invention, and a recent Gunderson memo notes that the difficult funding environment has resulted in more companies and investors considering MOE deals for private companies to accelerate growth and to pool financial and operational resources.
The memo provides a primer on these transactions, including an overview of their risks and benefits, alternative transaction structures, approaches to valuation, post-closing risk allocation, governance considerations and employee retention and right-sizing issues. This excerpt addresses some of the valuation allocation issues that private companies may face:
Liquidation Preferences: Typically in an MOE the liquidation preferences of each of the parties’ preferred stock investors will be preserved in some fashion in the combined entity’s capitalization. However, how those preferences “stack up” with each other (e.g., all pari passu or ranked seniority) will depend on the specific transaction and the existing rights (including whether some of the preferred stock in the legacy companies is “participating preferred”). In some MOEs, however, the parties elect to eliminate preferences in a bid for “cleaner” capitalization for the go-forward company.
Note: In a non-MOE private company stock consideration deal, buyers will often propose that selling stockholders receive buyer’s common stock, but with the business understanding that such common stock should be evaluated as if valued at the valuation used in the buyer’s last private preferred financing round (rather than on the basis of a “409A” valuation of the common stock). How such proposals are evaluated by selling stockholders is highly transaction-specific. Because of the instinct for mutuality in MOEs, by contrast, the negotiations around whether the preferred stock in the constituent companies is converted into preferred stock of the combined company are typically less fraught.
Wiping Out Common: Depending on the valuation assigned to each constituent company, it is possible that such valuation would not clear the collective liquidation preferences of one or both companies. If that is the case, while often the existence of the common stock is preserved (especially if liquidation preferences are likewise preserved), the parties sometimes consider cancelling the common stock for no consideration. However, as fiduciaries for common stockholder interests, parties should be extremely focused on fulfilling their fiduciary duties in this scenario, and should consult closely with counsel to construct a decision-making process that can withstand review.
– John Jenkins, DealLawyers.com, March 2, 2023