Emergence of the “Go-Shop”
By Mark W. Peters, Mark A. Metz, Douglas S. Parker and Priya M. Doornbos

The term “go-shop” is a relatively new addition to the rich and ever expanding lexicon of M&A transactions. “Go-shop” refers to a provision in a purchase agreement that permits a target company’s board of directors to not only respond to certain unsolicited competing offers but to actively solicit such offers for a limited period of time. Just a couple of years ago, this provision was rare and hardly deserving of its own name. Recently, however, go-shop provisions have become more common and now hardly a week goes by without a deal that warrants mention in the mainstream press being described as including a provision allowing the target to solicit better offers for several weeks after the agreement has been signed.

Fiduciary Outs and the Go-Shop

Go-shop provisions are the latest in a long line of deal provisions that have arisen as a result of the natural tension between a prospective purchaser’s desire to close a deal and obtain the benefit of its due diligence and negotiation efforts and expense, and the obligation of the target’s directors to discharge their fiduciary duties and obtain for its shareholders the best transaction reasonably available. The courts have refereed this ongoing dual for over twenty years. Since the Delaware Supreme Court decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. in 1986, it is well-settled that once a board of directors has decided to sell a company, its directors are expected to take steps to obtain the best transaction reasonably available for the shareholders. The question faced by directors who find themselves in this position relates to the process they should follow in order to satisfy themselves that they have conducted an adequate check of the market to ensure that a proposed transaction is indeed the best one reasonably available.

The most desirable method of ensuring a target is receiving the best deal in the sale of the company may be for the target’s board to hire the requisite professionals and conduct a full-blown auction. Once a robust auction process is complete, the target can, with a high degree of comfort, enter into a purchase agreement with the bidder who makes the best offer. This form of pre-agreement selling effort has the benefit of permitting the board to orchestrate an orderly process that should result in the best reasonably available price for the stockholders. However, an auction may not be the best course of action for a target company in certain situations. For example, the uncertainties raised by a possible takeover may lead members of management and other key employees to leave the target or may cause the target’s customers to move their business to a competitor which is viewed as more stable. There may also be concerns about commencing an auction process and not receiving an offer the target views as adequate, resulting in the target being viewed as somehow tainted. Even if not engaged in an auction, a target board may be faced with a situation in which, although it has no intention to sell, it is approached by an unsolicited bidder who makes an offer that the board is compelled to consider. In response to these or other factors, a target company may determine that it is prudent to enter into a purchase agreement with a suitor before performing an adequate check of the market.

Virtually all purchase agreements limit the ability of the target to consider competing offers. These “no-shop” clauses are almost universally tempered with a provision that recognizes the fiduciary duties owed by a board of directors to the target’s shareholders by permitting the target’s board to consider and accept an unsolicited superior proposal should one arise. Although the target almost certainly must preserve its board’s ability to accept a better deal, such a provision is not necessarily sufficient to withstand judicial scrutiny where there has been no pre-signing market check. As a result, targets have successfully over the years included provisions in acquisition agreements that expand the board’s ability to provide confidential information to, and negotiate with, potential bidders after signing. These “window-shop” provisions have been upheld by courts as sufficient market checks where they are not otherwise encumbered with oppressive deal protection measures, such as unreasonable termination fees, that make the market check minimally effective, or of no effect at all.

Despite the acceptance of post-agreement market checks facilitated by a window-shop process, a significant number of purchase agreements have recently been negotiated to add a go-shop process, permitting a target’s board to not only consider unsolicited offers but to actually solicit bids for the target for a limited period of time. A go-shop provision essentially permits a target to use a deal with an initial bidder as a stalking horse and the terms of that deal as a floor for possible better offers. Interestingly, as opposed to other evolutions of fiduciary duty-related provisions, the appearance and recent rise of go-shops has not been driven by court action. The following discusses some of the likely reasons for the increased use of go-shops and why buyers have been somewhat accepting of them.

Overview of “Go-Shop” Provisions

Go-shop provisions are most often encountered in agreements related to going private transactions in which management has teamed up with a private equity buyer to acquire the target. In all likelihood, the use of the go-shop arises from the directors’ additional exposure to liability in these situations and their concerns that the transaction will be closely scrutinized. In this era of ever-increasing shareholder activism, boards are becoming more proactive in addressing perceived challenges to their actions, and directors may be using their negotiating leverage in the current seller’s market to ask for, and receive, the protections offered by the go-shop provision. In addition to the protection that may be offered to directors through the go-shop provision’s more effective post-agreement market check, the device may also lead to the initial bid being higher than it might otherwise have been to try and guard against the go-shop auction process resulting in a competing offer.

Initial bidders may be willing to permit the inclusion of a go-shop provision for various reasons. While the go-shop is more risky to an initial bidder than the traditional window-shop or no-shop, it is still preferable to postponing a signing to allow a full pre-agreement auction. The post-signing go-shop process allows the transaction to move forward during the market check, as most purchase agreements with go-shop provisions still require that proxy statements be prepared as soon as practicable and mailed promptly after SEC clearance. In addition, a post-agreement market check provides an initial bidder whose transaction is terminated in favor of a higher bid with a termination fee consolation prize. An initial bidder also has certain advantages in a post-agreement market check that it does not have in a pre-agreement auction. In order to successfully trump a deal, competing bidders will have to offer a price that is not only higher than the initial bid but also must absorb the cost of the termination fee and related expenses. Furthermore, the competing bidder will likely have much less time than the initial bidder to evaluate the target and determine a price. These challenges may explain the fact that only a few acquisition agreements with go-shops have been terminated in favor of agreements with competing bidders.

Whatever the reasons, the use of go-shop provisions is on the rise. While there were less than twenty agreements with a go-shop prior to this year, there have been at least half that number already in the first quarter of 2007, with many in high profile deals.

Common Elements of Go-Shop Provisions

The most visible — as well as one of the most significant — elements of a go-shop provision is its duration. In two examples of early go-shop provisions in the latter part of 2004 (the deals involving Hollywood Entertainment and Chalone Wine Group) the go-shop period lasted until the vote of the target’s shareholders. Although in both cases superior competing bids resulted, it is not clear that the extended go-shop period played a significant role in causing that outcome in either transaction. Since the middle of 2006, having a defined go-shop period is the rule, with the length of the periods ranging between approximately 20 to 50 days. In the last few months, this range has narrowed somewhat, with the low end rising to 35 days and most go-shop periods falling somewhere in the range of 40 to 50 days.

Go-shop provisions almost always supplement the more traditional “fiduciary-out” provisions of the acquisition agreement. In other words, target boards are permitted to discharge their fiduciary duties and consider superior proposals generally up to the time that the shareholders vote on the purchase agreement, even though the go-shop solicitation period has ended, and to terminate the initial agreement in favor of a superior bid upon payment of a termination fee.

One developing practice is to bifurcate the termination fee payable by the target to the initial bidder, with a lower amount payable if the termination is due to the target finding a superior offer during the go-shop period. The effect is to channel competing bids into the go-shop period by making a higher bid less expensive. The difference between the two fees varies widely. In the first quarter of 2007, the amount of the go-shop termination fee has ranged from as low as 17% of the termination fee up to as high as 86%. Excluding these outliers, the range generally falls between 38% and 67%, with a mean, even including the extremes, of just around 50%.

A less settled element of purchase agreements with go-shop provisions is the circumstances under which a target may take advantage of the lower fee where the termination fee is bifurcated. All of the purchase agreements with bifurcated fees provide that the lower fee is payable to the initial bidder if the purchase agreement is terminated before the end of the go-shop period in favor of a competing superior proposal. More recently, however, the majority of these agreements also provide that the lower fee is payable if the target enters into an alternative agreement after the end of the go-shop period with a party that was identified during the go-shop period. Within this subset of agreements there are two additional variables. First, some agreements require that the competing bidder actually submit a bid that is deemed to be superior before the end of the go-shop period, while others only require that the target be in negotiations with the competing bidder, so long as the target board has determined that such negotiations may reasonably lead to a superior offer. The other variable is whether there is a deadline by which the purchase agreement must be terminated in favor of an agreement with one of the competing bidders who was identified during the go-shop period. Some agreements permit termination under these circumstances until the date that the target’s shareholders vote on the transaction, while others set an earlier deadline stated in terms of a certain number of days after the end of the go-shop period.

Effectiveness and Criticisms

From a target’s perspective, the purpose of a go-shop provision in a purchase agreement is to provide a mechanism for testing the market to help ensure that the price being received for the company’s shares is the best reasonably available. Just how effective these provisions are in achieving this goal is difficult to determine. Some commentators have criticized go-shop provisions as simple window dressing that will seldom result in better offers. To date, most transactions with go-shop provisions ultimately close. The few exceptions generally occurred earlier in the life of go-shop provisions and, as previously mentioned, two of those involved indefinite go-shop periods and, in the case of Hollywood Entertainment, no termination fee. Even a go-shop period in the range of 40 to 50 days may leave little time for prospective purchasers to perform adequate diligence and present a competing superior proposal. There may, however, be some evidence of increased activity during go-shop periods. In March of this year, for example, a purchase agreement involving the sale of Triad Hospitals, Inc., which provided for a 40-day go-shop period, was terminated in favor of a competing superior offer. The original purchase agreement was terminated within days after the end of the go-shop period. Under the terms of the original agreement, Triad Hospitals is obligated to pay a termination fee of $20.0 million if that agreement was terminated in order to enter into an agreement with a bidder who started negotiations during the go-shop period, compared to a termination fee of $120.0 million that would be otherwise due. Ultimately, the benefit to shareholders provided by a go-shop provision may come down to how aggressively the target exercises its rights under the provision.

Another expected benefit of a go-shop is for the target’s directors to have an additional defense against a shareholder challenge to a transaction. Although there has yet to be a case decided that involves a go-shop, one can only assume that including such a provision in the purchase agreement would be beneficial to directors arguing that they adequately discharged their fiduciary duties using a post-agreement market check. As courts have upheld the practice of performing a post-agreement market check through the use of a window-shop provision or, in some circumstances, a simple fiduciary out provision, the additional information afforded to a board by a go-shop should be viewed favorably. It is conceivable, however, that a go-shop provision may be detrimental to directors if it were obtained in exchange for concessions regarding core elements, such as price, or other deal protection measures that, in the aggregate, a court believed offset the perceived benefits of the go-shop.

Conclusion

Every transaction is unique and purchase agreements will always be negotiated in light of the circumstances of the target and the potential acquiror; however, despite their lack of judicial impetus, it is likely that go-shop provisions will continue to be an increasingly frequent part of the negotiation process. With continued use, the more quantifiable terms of the go-shop will likely become fairly standard. While this “standardization” of terms within a range is already occurring, certain elements, like the conditions triggering a lower termination fee, continue to evolve. Although some skepticism continues regarding the value of go-shop provisions, they may provide a suitable element of a post-signing market check process under certain circumstances, and a device that will increasingly be demanded by directors seeking evidence that they explored all available avenues

About the Authors

Mark Peters and Mark Metz are Corporate Finance Members, and Douglas Parker and Priya Doornbos are Corporate Finance Associates, in the Michigan offices of the law firm Dykema. Contact: mwpeters@dykema.com or mmetz@dykema.com.