On February 28, 2024, Dentons and MPA Morrison Park Advisors Inc. were pleased to release the first instalment in our M&A Fireside Chat Series, hosting a webinar on partial rollover transactions in public M&A deals. The webinar was moderated by Andrea Johnson of Dentons and included Jason Saltzman, Co-Head of the National M&A Group at Dentons, as well as Brent Walker (Co-Founder and Managing Director) and Sandy Mackay (Managing Director) of Morrison Park. The topics that were discussed, and which are summarized below, include:

• What is a rollover?
• How much is rolled?
• Key considerations in planning rollovers
• What has led to an increase in rollovers?
• Fairness issues, including application MI 61-101
• Tricky issues for special committees

What is a rollover?

For purposes of this discussion, a “rollover transaction” refers to a partial rollover transaction in public M&A. This is an arrangement in which one or more (but not all) target shareholders (the Rolling Shareholders) exchange (roll) all or part of their shareholding in the target for a shareholding in the buyer (or an entity controlled by the buyer) (the Buyer). This share-for-share exchange can typically be accomplished on a tax-deferred basis. The form of consideration paid to the Rolling Shareholders is typically a combination of cash and shares. The non-Rolling Shareholders generally receive cash consideration for their shares and have no part in the post-closing entity.

In most rollover transactions, the Rolling Shareholders consist of management shareholders that Buyer wants/needs to retain to assist in the management of the post-closing entity. While uncommon, depending on Buyer’s access to financing, it may, however, wish to have select non-management shareholders included in the Rolling Shareholder group as well. The most common type of Buyer that requires a management rollover is a private equity buyer who wants the management team (or certain key individuals) to remain to run the company. In a survey of 13 recent rollover transactions (the Survey), over half of the buyers were private equity firms, the vast majority of whom were US-based.

Recent rollover transactions include the Magnet Forensics transaction, in which Magnet was acquired in March 2023 for approximately US$1.8 billion by US private equity group Thoma Bravo. In the transaction, the two founders (as well as the Chairperson of the board) rolled a significant portion of their equity. Similarly, in the first quarter of 2024, the CEO and certain large, non-management shareholders of Q4 Inc. rolled shares in the acquisition of Q4 Inc. by US private equity buyer Sumeru Equity Partners.

How much is rolled?

Buyer generally wants the Rolling Shareholders to roll some of their equity rather than to be cashed out in order to align incentives upon closing.

The amount that Rollover Shareholders roll can, of course, vary depending on deal specifics and is subject to negotiation between Buyer and the Rolling Shareholders. Buyer will generally want the Rolling Shareholders to roll a “substantial” amount of their equity to ensure that such shareholders are incentivized on a go-forward basis – or as some refer to it, to ensure that the Rolling Shareholders have “continued skin in the game.” The Survey showed that, on average, the consideration paid to Rolling Shareholders was 86% shares and 14% cash. 

The amount that is rolled is generally not determined by legal considerations: once the parties are involved in a rollover transaction involving management, Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions (MI 61-101) will typically come into play and require a valuation and a minority vote, subject to some exemptions.

Key considerations

The first consideration for the various parties is whether they want (or are willing to have) a roll at all. For Buyer, the benefit is that the management team has “skin in the game”; but the downside means having minority shareholders (and the minority protections they are typically afforded) going forward, thus giving up some degree of post-closing control. For target companies, the benefit may be a deal that may not otherwise be available. The downside includes potential issues of fairness: only a select group of shareholders are offered the roll, which puts some negotiating power into the hands of the Rolling Shareholders. Finally, for the Rolling Shareholders, this means receiving less cash up front while balancing the benefits and risks of retaining equity in the post-closing entity. The desire to roll, and the amount that a shareholder may want to roll, will depend on the specific circumstances of the individual and the deal.  For example, does the shareholder believe that there is upside in the combined entity? In addition, what is the cash position of the shareholder? In one transaction we worked on, one Rollover Shareholder had significant wealth outside of the target, and preferred a significant roll as they had little need for cash, whereas for other Rolling Shareholders, this was their first significant (life changing) liquidity event, so they wanted to cash out a larger portion of their shares.

What has led to an increase in rollovers?

A few things have contributed to an increase in the prevalence of rollover transactions. First, the IPO market in Canada was hot a few years ago, both in terms of volume and valuation. That increased the available pool of founder-controlled public companies, who are the ideal candidates for the rollover transactions. There are also huge pools of capital in the US looking for deals and opportunities to partner with good management teams. When you combine these two dynamics, you end up with buyers and sellers seeking to engage in rollover transactions.

The third piece to the puzzle in Canada is that we have a legislative framework that works well for these types of transactions. In particular, MI 61-101 was designed to ensure fairness to minority shareholders in related party transactions. This involves requiring enhanced disclosure as well as a valuation and a minority vote, subject to some exemptions. While this framework imposes requirements on parties to rollover transactions, it also creates a bit of a roadmap in which the transactions can be completed. In addition, regulators and courts have addressed transactions involving insiders and further set out what parties should/should not do in such cases. Two of the most notable cases are the 1998 Ontario Court of Appeal’s decision in Pente Investment Management Inc. v. Schneider (Schnieder) and the OSC’s 2010 decision with respect to the collapse of Magna International, Inc.’s dual class structure (Magna). These decisions further provide boards and special committees with an acceptable roadmap in which to complete rollover transactions

Fairness issues

Despite the safeguards provided by MI 61-101, relevant case law and market practice, some target shareholders and market participants believe that some rollover transactions may not be fair. Non-Rolling Shareholders may feel that even if the cash offer made by Buyer is reasonable, if they believe the Rolling Shareholders are getting a “sweetheart deal,” they may still be unhappy. In both Magnet and Q4, the dissident shareholders argued that the Rollover Shareholders were getting more value than the cash offer to the general shareholder base. 

This raises two questions: (i) does it matter what the Rolling Shareholders are getting or should the non-Rolling Shareholders vote based on the fairness of what they are receiving, particularly given that they can vote the deal down through the minority vote?, and (ii) if the answer to (i) is yes, is there adequate disclosure regarding what the Rolling Shareholders are getting to determine the value of the roll?

The answer to the first question, at least in the view of some non-Rolling Shareholders appears to be that it is not enough to be able to vote the deal down – they want the ability to participate in the roll as well. The Survey showed that nearly one quarter of the deals were formally contested by one or more shareholders. Further, it is reasonable to assume that there were other situations where shareholders were not happy not being able to roll but chose to accept the deal as proposed in any event. 

On the second question, targets are required to mail management information circulars to shareholders and such circulars must not contain any misrepresentations (which includes omissions of material facts).  Notwithstanding this requirement, it is standard for circulars to contain a very brief description regarding the existence, but not necessarily the substance of, a rollover agreement. The relevant disclosure is often one to two sentences and merely states something to the effect that the parties entered into a rollover agreement pursuant to which the value of the consideration to the Rollover Shareholders is not greater than that paid to the other shareholders; but rather the difference is only in the form of consideration. There is typically little or no description of the combined entity going forward, nor any analysis that would assist in determining the value of the consideration to the Rolling Shareholders. This is particularly true in cases where the Rolling Shareholders receive shares of an operating company controlled by the Buyer. Given that this style of disclosure has consistently been used, it suggests that it meets disclosure standards even if non-Rolling Shareholders feel it is inadequate. 

Special committee approach

Rollover transactions can raise some tricky issues for a special committee, and they are well advised to be very mindful of process. Special committee members should be familiar with the application of MI 61-101 as well as the guidance coming from relevant decisions such as Schnieder and Magna. Above all, special committees should be very mindful of the process that they follow so that if challenged, they can rely on the business judgment rule. A few steps that a special committee can take include the following:

• Ensuring that the special committee is comprised of directors that are independent, not just under securities laws, but with regards to the transaction.
• Engage their own independent financial advisors and legal counsel.
• Consider their activities through the lens of an activist shareholder later questioning the transaction.
• Demonstrate an ongoing record of tough negotiations and seeking to maximize value for shareholders (having regard, of course, to the particular circumstances).
• Understand the shareholder base, identify potential non-Rolling Shareholders that could influence the outcome of the transaction, and develop a strategy for engaging with them (either before or after a transaction is announced, depending upon the circumstances).
• Consider creative approaches to balance the interests of Rolling and non-Rolling Shareholders, including bifurcated consideration and contingent value rights.
• Conduct a market-check or other process to solicit offers, or consider if a go-shop may be appropriate.
• Do not limit the scope of offers considered to those brought, or desired/supported, by the Rolling Shareholders.
• Be mindful of the participation by the Rolling Shareholders in discussions with Buyer and other potential bidders.
• Perform appropriate due diligence on the Buyer, including assessing the value of the post-closing entity.
• Do not permit Rolling Shareholders to enter into “hard” lock-ups that result in the Rolling Shareholders not being able to support a superior proposal even if the special committee is able to do so under the arrangement agreement.
• It is interesting to note that while based on a broad study of public deals, only 3% have hard lock-ups, 4 of the 13 reviewed in the Survey included hard lock-ups.
• Negotiate with both the Buyer and potentially the Rolling Shareholders. If necessary or appropriate, try to extract value from the Rolling Shareholders through a bifurcated offer. For example, in Magnet, the Non-Rolling Shareholders received $44.25 in cash for their shares whereas the Rolling Shareholders received $39.00 per share, paid partly in cash and partly in shares of Buyer.
• Consider special terms in the arrangement agreement – for example, in the Magnet Forensics transaction, provisions were added to the concept of a superior proposal that permitted the special committee to confirm whether the Rolling Shareholders would accept an acquisition proposal before determining whether it was in fact a superior proposal.

For more information on this topic, please contact the authors, Andrea Johnson and Jason Saltzman.

For further information about Dentons’ and Morrison Park’s Mergers and Acquisitions teams, visit Dentons Mergers and Acquisitions and Morrison Park Advisors.