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composed of KKR and Silver Lake, entered the bidding after Blackstone had been announced the winner in the auction. Selling to Although their late bid did not succeed, their entrance into the auction forced Blackstone to raise its winning bid by $1.6 billion, or almost 10 percent. Many proponents also note that club transactions enable sellers and the club their shareholders to ultimately receive the highest value for their assets. How a seller should negotiate a club deal By enabling bidders to pool funds and expertise in order to provide targets with ith the availability of from the suspicion that firms value maximizing bids that would otherwise significant levels of debt and formed clubs in order to decrease competition be impossible or implausible if done on an equity financing, the M&A amongst the bidders by colluding and rigging individual basis, clubs offer greater world has seen a resurgence bids. competition and higher value. Among the sinceW its downturn in 2001. Club Deals or In addition to the Department of Justice proponents of club transactions is Delaware consortium transactions – those that involve inquiry, a class action complaint was filed in Vice Chancellor Leo Strine, who wrote in the two or more buyers joining together to acquire the Southern District of New York against Toys “R” Us case that the formation of clubs a target company – have played a significant several prominent private equity firms to win auctions is “logical and is consistent role in recent M&A activity levels. These clubs alleging that they formed clubs that with an emerging practice among financial or consortiums are typically composed of at artificially deflated a target’s price by buyers...[and allows bidders] to make bids least one, and often several, private equity exchanging information about bid prices and that would be imprudent, if pursued in sponsors. agreeing upon which party would win the isolation.” The number of club deals and the values of auction. Actions like these are causing sell side these transactions have risen substantially companies and their advisors to consider ways over the past few years, peaking in 2006 with to preserve the integrity and value in the sale The buyer’s perspective the now closed $33 billion leveraged process. There are several reasons why bidders seek to of hospital-operator HCA by the consortium form clubs. Joining together allows bidders to of , Competitive vs anti-competitive share in the bid price, the risks related to the (KKR) and Lynch. This record is The formation and interactions of clubs in a investment, the work and costs associated with likely to be broken soon with the recently sale or auction have raised questions as to their due diligence, and the documentation involved announced $45 billion of anti competitive effects. Concerns include: (i) in submitting a bid, which is particularly Texas power producer TXU by KKR and that consortiums reduce the number of beneficial in the case of a bid that ultimately Texas Pacific Group. potential bidders in a process; (ii) that they fails. Consortiums also have the advantage of Based upon the amount of capital that monopolize financial institutions, thereby being able to utilize all of the members’ continues to flow into private equity and preventing other bidders from acquiring the influence with financial institutions, which, in hedge funds, as evidenced by ever increasing funding necessary to submit a fully-financed turn, enables clubs to leverage the institutions fund sizes, and the availability of significant bid; (iii) that clubs collude with each other and for large amounts of financing and favorable levels of cost-effective debt financing, there rig their offers by designating which bid will rates. are few companies that cannot be considered win and by setting a maximum price for the Aside from purely financial reasons, potential buyout targets by clubs. The idea of target; (iv) that consortiums agree not to bid forming a consortium gives bidders the a $100 billion leveraged buyout is no longer against each other; and (v) that they abide by a advantage of pooling the expertise of its inconceivable. collective understanding that once a firm has a sophisticated members, who have diverse Companies that wish to sell themselves or formal acquisition agreement with the target, knowledge bases, industry expertise, their assets are presently dealing with the no other club will make a competing bid. reputations, as well as practical experience in challenges of orchestrating a sale or auction Furthermore, with the use of equity the M&A market. Club deals also enable with consortium bidders. The typical seller’s bridges, opponents of club deals are quick to some bidders to penetrate into foreign auction of five years ago has changed with point out that consortiums are no longer markets, which might otherwise be closed to companies striving to ensure that their equity necessary, or certainly less necessary, to them due to foreign ownership restrictions or holders receive fair value in the transaction. consummate most large transactions. For limitations. By clubbing up, bidders are able The concern over fair value in club deals is example, due to the confluence of the to partner with local investors who meet these apparently not restricted to the selling availability of an equity bridge and a criteria and thus enter auctions formerly companies. significant amount of debt and equity closed to them. In October 2006, the Department of financing, At the same time, private equity bidders are Justice contacted several well-known private (Blackstone) was able to acquire Equity cautious about forming a club to acquire and equity firms inquiring about their practices Office Properties for over $39 billion without own an asset. By joining together, bidders and participation in consortiums in past sales having to form a club in order to finance the must share in the upside return of the and auctions. These inquiries likely stemmed acquisition. acquisition, which reduces the absolute return In contrast, proponents of consortium on the investment. Furthermore, consortiums deals argue that sales and auctions involving are effectively joint ventures that require clubs have been highly competitive – that cooperation among the members during all The idea of a $100 clubs, in fact, enhance competition – and that stages of the investment – acquisition, “ the fear of collusion is unfounded. These ownership and exit. billion leveraged same proponents also dismiss the notion that There is always the possibility that clubs participate in agreements to drive down members’ plans or philosophies for the target buyout is no longer prices or willingly abandon a potential will differ, resulting in deadlock and the transaction if another club or private equity inability to effectuate a mutually agreed upon inconceivable buyer has a formal agreement with the target. plan. In addition, although being able to ” The buyout is access the collective expertise and knowledge often cited as an example where a club, of the various club members is a distinct

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advantage in a sale or auction, private equity bidders are also weary of sharing such Sellers can preempt concerns regarding expertise with other private equity firms that “ could be their competitors in a future sale or auction. bid jumping by drafting the bid procedures

The seller’s perspective letters and agreements to bar any losing Although concerned by the formation of clubs, sellers understand that consortiums present bidder from joining a winning bidder’s club substantial benefits to a sale process. The ” seller’s ultimate goal is to receive the highest club to be part of the winning bid or the approval from the seller. Through this and best value for the asset, and since clubs subsequent syndication of the equity. method, a seller can also ensure that the have multiple sources of funding and deep Sellers are also concerned about the number of bidders in an auction does not experience, they are often able to provide fair availability of adequate financing for the decrease too low or that the real pillars among value. Clubs also often enable sellers to increase transaction. The formation of powerful clubs, the bidders do not join together. the bidding pool by allowing certain bidders to with members whose clout and influence However, this method is fairly aggressive, enter the sale that otherwise could not, allows them to lock-up advisers and debt and many bidders will resist the seller whether due to the transaction size, lack of providers, limits the ability of other bidders to dictating who their partner ultimately will be. adequate funding, need for a strategic partner finance a bid and enter the auction. This has Therefore, in practice, a toned down version or desire to share the risk. occurred in past auctions, where the seller and of this approach is what works best for all Despite these benefits, sellers have many its advisors have had to request that banks constituents involved. This approach was concerns regarding the formation of make themselves available to other bidders. recently employed by in the consortiums. In running a sell side auction, the Similarly, sellers are concerned by the Albertson’s auction and by General Electric in seller and its advisors attempt to ensure that the potential of clubs to monopolize strategic the recent sale of its plastics division. process is highly competitive in order to bidders or local partners. Often times, a seller Sellers will also want to prevent clubs from provide the company’s equity holders with a full requires a local partner for strategic or legal locking up financial advisers and financing and fair price for the company or its assets. The reasons (for example, when the bidder is a providers. If a seller retains the ability to mere formation of a club, in and of itself, could foreign-based fund in relation to the target). decide or manage the makeup of a club, it can negatively affect the ultimate price paid for the Bidders that lock up all of these potential ensure that each bidder group has access to target. Specifically, if several bidders decide to partners inhibit competition by preventing separate financing sources, thereby providing join together rather than compete against each other bidders from delivering qualifying bids. that no single group has an exclusive right to other in the auction by continually raising the A final concern revolves around the these sources. Alternatively, a seller can price of the target, they can eliminate the relationships that develop between private establish that in order to participate in the competition among themselves. equity firms that form a consortium. Firms may sale or auction, bidders or groups cannot Sellers are also concerned by the fact that be unwilling to bid against an opposing club for create exclusive arrangements with bankers or bidders may violate a seller’s non-disclosure fear of not being invited to join members of that lenders, and if an exclusive arrangement and confidentiality restrictions when they consortium in a future deal. Related to that is already exists, then for the purposes of the form consortiums without the consent of the the concern that firms operate according to an transaction, other bidders will be allowed to company. A seller non-disclosure agreement unwritten agreement which provides that a use those bankers or lenders. Similarly, sellers must be signed before a bidder is allowed private equity firm or club will not enter a bid can require that a consortium not lock up all access to the business and legal due diligence once another sponsor or consortium enters into strategic or local investors, enabling more information of the company. A typical a formal agreement with the seller. bidders to join and bid in the process. agreement prohibits a bidder from sharing Finally, sellers can preempt concerns information about the target or the proposed Managing deals for the seller regarding bid jumping by drafting the bid transaction with another party, including Despite the concerns that may be raised by the procedures letters and agreements to bar any other bidders, without prior consent. formation of clubs in an auction context, there losing bidder from joining a winning bidder’s These restrictive provisions enable a seller to are certain precautions that a seller can take in club. This would discourage bidders from control who has access to the proprietary order to mitigate some of the risks. To guard having any tacit agreements to withdraw from information of the company and who to exclude against consortiums stifling rather than an auction or purposely underbid in the from the auction process, such as rivals who may fostering competition in an auction, a seller expectation of being allowed to later join the only wish to view the seller’s confidential can limit or manage the ability of bidders to winner’s consortium. information or bidders who are not perceived as form clubs. This is usually implemented being serious participants in the auction process. through agreements that limit bidders’ ability Ensuring a successful auction Thus, when forming clubs, it is possible for to talk to each other, namely, cross-talk The ultimate goal of any seller is to receive the bidders to intentionally or inadvertently violate restrictions. These provisions prevent bidders highest and best value for its assets. Although these non-disclosure requirements and invite from discussing any information with other this goal is sometimes harder to achieve when participants into the sale process that the seller potential bidders regarding the company or the dealing with club buyers, implementing specific had no intention of including. transaction. provisions can help protect the sale or auction Another concern of sellers is the prevalence of To ensure bidders’ compliance, sellers can from potential anti-competitive behavior and, so called bid jumping by club members, which provide for the payment of monetary damages in fact, foster competition. Ultimately, price and occurs when the losing bidders in an auction as well as equitable relief if the bidder fairness of the terms offered, whether by a single jump onto the winning club after the bidding breaches. Sellers may also remove bidders bidder or a consortium, will dictate whether a closes. This raises the possibility that the bid from the auction process upon a breach of transaction will proceed. However, by following jumpers struck a deal with the winning these restrictions. These remedies may not these suggestions, a seller will be in a much consortium by agreeing to underbid and lose the always prevent bidders from breaching these better position to negotiate with clubs and auction in exchange for being allowed to agreements, but they should dissuade bidders ensure that the sale process will be as participate in the deal after the winning club from engaging in these actions. competitive as possible. determines the price. A similar concern arises A seller can also limit the ability of a bidder when clubs withdraw from the auction to form a consortium by retaining the sole By John D Franchini, partner, and Elad completely, and in return for dropping out, the right to structure clubs. In other words, Roisman, associate, private equity group, winning consortium allows the withdrawing bidders wishing to form clubs must first seek Milbank Tweed Hadley & McCloy LLP www.iflr.com IFLR/April 2007 73