A recently robust period for technology mergers and acquisition has involved a series of high-premium deals for venture-backed companies: Google’s acquisition of Nest Labs and Deep Mind Technologies, Facebook’s purchase of WhatsApp and Oculus and Maker Studios’ sale to The Walt Disney Company.
In all these circumstances, a new trend is emerging: Venture capital investors are engaging their own counsel to represent their interests and act as a partner to company counsel. And, often a consortium of institutional investors will hire one counsel to best leverage the bargaining power of the group and share costs.
Goodwin Procter has represented a number of such investor consortiums in the past few years, including in recent transactions involving Maker Studios, Nest Labs and Oculus. Goodwin partner Larry Chu, a member of the firm’s Technology Companies, M&A/Corporate Governance and Private Equity Practices, addresses this growing trend and the reasons behind it:
Q: What is behind this recent trend of investor consortiums bringing counsel to the table? Is it purely economic, strategic or prophylactic – or a combination of all three?
A: It’s a combination of the three, but principally strategic. Institutional investors have become quite savvy in a number of ways.
First, as deal-making has become more sophisticated and complicated, investors have brought on board people with differing skill sets to serve various needs – operating partners, chief operating officers, and, most importantly in this context, general counsels. GCs bring a different perspective to the deal team – they bring with them an attention to the legal details and a sense for what’s within the parameters of “market.” But they often want experienced deal counsel at their side looking after their interests or the interests of a consortium of investors.
Second, given the large number of portfolio companies and boards that general partners of venture capital firms are involved with, GPs are often not able to be intimately involved in each phase of a transaction. Timing is extremely important in deals, and to get the right results, it is very helpful to have separate investor counsel that is working lockstep with company counsel so all points are addressed real-time.
Q: What are the pitfalls that can arise when representing a consortium on such matters and how do you overcome them?
A: Two of the biggest challenges are (1) balance — being able to both advise a group of clients with potentially differing viewpoints on the issues and to bring consensus to the group, and (2) coordination — being able to digest, interpret, and give perspectives and constructive suggestions to our clients, and then effectively liaising with company counsel without stepping on toes or holding up the process.
I think there are some clear requirements for any good investor-side counsel to be in a position to overcome these challenges: we need to grasp the buyer’s strategic rationale for the deal and quickly come to understand the company and its risk profile; we need to clearly understand the relative bargaining power between buyer and seller; and we need to understand the motivations of both our clients (the investor syndicate) and management.
Once we know what makes the deal, and the people involved, tick, we can shape our advice, timing and prioritization of issues accordingly.
Q: Are there potential conflicts of interest?
A: There can be — both real and perceived — and separate counsel is often a necessity to properly navigate through all of the issues that may arise. For example, in both acqui-hires and high premium deals, there may be a tug-of-war between consideration falling into the “deal price” bucket and the “retention and incentive” bucket. From a buyer’s perspective there is a finite number to go around. What may be good for management going forward, may be coming out of the equity holders’ pockets.
When negotiating these “splits” and the provisions related to them, real conflicts may arise. Sometimes conflicts arise in softer forms – like management’s desire to “find the right home” vs. investors’ desire to maximize price. In an environment where “talent” can be an integral part of a deal, sometimes you cannot achieve the latter without management buy-in on the former.
In distressed deals, there can be a multitude of conflicting concerns to deal with, like directors, with their fiduciary hat on, making decisions while taking into account potentially different outcomes for the preferred vs. the common stock.
Q: What are the advantages to retaining experienced counsel on these matters?
A: Experienced and strategic counsel can pack a big punch in a very cost-effective manner. Being able to spot issues quickly, give advice based on the context of the deal and various parties' objectives, and deploy alternative solutions in high-pressure situations is critical. Most importantly, though, having the right team will help establish instant credibility and a good rapport with the buyer and its counsel. Separate counsel is also valuable in instances where there is a clear imbalance of power between buyer and target.
It should be emphasized that strong relationships often have a lot to do with driving the right outcomes; and strategically minded advisors will get to a balanced result much faster, without missing critical issues.
Q: Conversely, what challenges await those who opt not to retain counsel?
A: There are a number of downsides, but to list a few:
(i) investors can miss their window to raise points or to take a stand on critical issues if there is no one monitoring the evolution of the transaction and keeping an eye on their interests;
(ii) investors, as fiduciaries of their limited partners’ capital, have unique concerns and demands that others may not address – the impact of indemnification caps, exposure for fraud, intentional misrepresentation, reporting and confidentiality restrictions, etc.;
(iii) the loss of leverage that separate counsel brings to a tough negotiation; and
(iv) a lack of an advisor there to ensure consistency of terms (as far as is possible) across exits.
Q: What about Goodwin specifically has made the firm a key player in this arena?
A: As a firm with a top-tier, nationally recognized technology and life sciences practice, we see a very high volume of deal flow in the space and understand what terms are typical and atypical, as well as what new technologies are being deployed in deal structuring and other provisions in the industry.
In addition, we have a good mix of company-side and investor-side clients, so we understand the concerns and motivations from both perspectives. But most importantly, we are commercial and strategic in our approach to giving advice; we are collaborators; and we are well networked to bring the right touch points to the folks around the deal table.
I think clients really feel a difference in how we execute and negotiate transactions. We do it smartly and thoughtfully, and we’re always sensitive to the context of a deal — and that makes a huge difference when there’s a lot at stake.