FOREIGN WATERS, PAPER CURRENCY

Increasingly, U.S. public companies are venturing into foreign waters seeking acquisition targets. For many of these companies, using equity as the currency for foreign acquisitions is becoming vogue. For shareholders of foreign targets, accepting equity as consideration can optimize the value ultimately received. The use of U.S. equity, however, carries certain obstacles that both parties must fully comprehend. The transferability of shares in U.S. trading markets and the U.S. securities registration process are two hurdles that practitioners need to appreciate. Both acquirers and targets should understand the implications of what they are giving -- and getting.

A typical acquisition structure will involve a U.S. acquirer using its shares to “acquire” a foreign target’s shares pursuant to a purchase agreement signed by the buyer, the target and its shareholders. Unless the buyer’s shares issued in the transaction are registered with the U.S. Securities and Exchange Commission (SEC), they are considered “restricted securities” under U.S. securities laws. As “restricted securities,” these shares cannot be freely traded for at least one year, and even then sales will be subject to trading volume limitations. In contemplating the receipt of foreign “paper,” shareholders of foreign targets should demand registered securities from U.S. buyers. This solution can be accomplished by either filing a registration statement on Form S-4 and issuing registered shares at the closing, or issuing unregistered shares at the closing and then registering the shares for resale on a Form S-3 registration statement.

Registration Using Form S-4

Whether to use a Form S-4 registration will largely depend on whether the U.S. buyer is required to obtain approval from its shareholders for the transaction, as well as the number of target shareholders involved. In addition to registering securities, the Form S-4 is frequently used as a proxy statement for the U.S. buyer to solicit proxies from its shareholders to approve the transaction. Utilizing a Form S-4 to register the acquisition consideration, however, can be more expensive and time consuming than other alternatives simply because of the amount of information required for disclosure.

Under this Form S-4 registration process, the parties would execute an acquisition agreement and the closing of the transaction would not occur until the Form S-4 was declared effective by the SEC. Target shareholders would not receive any of their consideration until the closing (once the SEC approves the registration), at which time they would receive registered shares of the buyer’s stock that they could freely sell in the U.S. public market.

Given the amount of information required to be included in the Form S-4, it could require 4 months from the time a stock purchase agreement is signed to the eventual closing of the transaction. The Form S-4 could not be filed until approximately 45-60 days after the execution of the stock purchase agreement. Preparing the Form S-4 is a time-consuming and expensive process because the Form S-4 is a complex document that requires a detailed description of both the buyer and the target, the details of the proposed transaction, financial statements of both parties, and consents from the parties’ auditor and legal counsel. If a foreign target’s financial statements were not prepared using U.S. accounting principles (GAAP), it is very likely that those financial statements would have to be converted to these GAAP principles, a process which can consume two months.

Once the Form S-4 is filed with the SEC, the SEC typically takes two weeks to determine whether it will review the document. If the SEC determines not to review the filing, the registration statement may be declared effective within 48 hours and would then be mailed to the buyer’s shareholders for approval of the transaction. However, if the SEC reviews the registration statement, it might require 30 days to receive the first set of comments and then several weeks to respond to the SEC’s comments. Given the complexity of and the amount of information in a typical Form S-4, it is normal to expect resolving and responding to SEC comments to consume approximately 60 days. This review process could cost the buyer as much as $300,000, which, in many cases, would cause a buyer to consider an “adjustment” to the transaction price to compensate for this extraordinary expense and delay. In summary, the process of utilizing a Form S-4, even if not reviewed by the SEC, can significantly delay the closing of an acquisition and introduces additional costs, complexity and deal risk to the transaction.

Registration Using Form S-3

Compared to pursuing the Form S-4 registration process, both buyers and targets find that utilizing a registration statement on Form S-3 is typically fast and inexpensive, and entails less risk for a failed closing. However, it is often difficult to convince shareholders of foreign targets to accept “restricted securities,” which are not immediately tradable, as closing consideration.

Under the Form S-3 process, the parties typically execute a stock purchase agreement and close on the same day, with the target shareholders receiving all transaction consideration at the closing. The buyer’s shares issued in the transaction are not registered with the SEC, meaning that target shareholders cannot freely sell these shares in the U.S. public market until the Form S-3 is filed and declared effective by the SEC. Accomplished as a “private placement,” the parties also often execute a Registration Rights Agreement requiring the buyer to file a Form S-3 and to use its best efforts to obtain SEC approval of the registration.

Registering shares on a Form S-3 can take as few as four weeks and, in the case of an SEC review of the filing, might take approximately eight to ten weeks from the closing of the acquisition. Moreover, with the Securities Offering Reform (effective December 1, 2005), those buyers that have non-affiliate market values of $700 million or more (“Well-Known Seasoned Issuers,” or WKSIs) can file a Form S-3 and have it declared immediately effective by the SEC, with no risk of SEC review whatsoever. For WKSIs, this development essentially eliminates any illiquidity discount that would otherwise depress the value of their equity given as currency in these transactions.

Non-WKSI buyers will normally agree to file a registration statement on Form S-3 within fifteen days following the closing. The Form S-3 is relatively easy to prepare because it requires little disclosure, which includes risk factors of investing in the buyer, a list of the selling securityholders, a section that outlines the manner in which the securities are to be distributed, a section listing the buyer’s SEC filings, and consents from the buyer’s auditor and legal counsel. Under this process, other than a brief description of the acquisition, no information regarding the target would be required in the Form S-3.

After filing, the SEC typically takes two weeks to determine whether it will review the registration statement. If the filing is not reviewed, it can be declared effective within 48 hours and target shareholders can immediately sell their shares. If the SEC determines to review the registration statement, the entire process of receiving and responding to comments will typically take six additional weeks (the SEC usually provides fewer comments on these so-called “short-form” filings).

Once the Form S-3 is effective, the buyer will use its best efforts to keep the registration statement “currently updated” until all of the shares have been sold (or may be freely sold in the public market pursuant to Rule 144).

Conclusion

In summary, for most acquisitions of non-U.S. companies that do not require the approval of the buyer’s shareholders, the Form S-3 approach is preferable to the Form S-4 process for rapidly registering the shares in an acquisition. Certainly for WKSIs, utilizing an immediately effective Form S-3 can provide registered shares within days of a closing. For non-WKSI buyers, although target shareholders must wait several weeks to have their shares registered, utilizing a “short-form” Form S-3 registration process is more efficient, less expensive and less time consuming than adopting a Form S-4 process.

Written By: John Hession and Marc Recht

John Hession and Marc Recht are partners in the law firm of McDermott Will & Emery LLP.