Private equity funds are increasing the use of tactics traditionally employed by hedge funds as part of their value maximization strategies. Private equity funds now are incorporating "toehold" accumulation strategies into their investment model. As highlighted in an October 2016 Wall Street Journal article, accumulation strategies have been used by traditional private equity funds such as KKR, Vista Equity Partners, Golden Gate and Sycamore Partners in a number of situations.
In a memorandum, Cadwalader attorneys Joshua Apfelroth, Richard Brand, Jason Halper, William Mills and Amy Ray outline the advantages, disadvantages, and legal considerations involved in the shift toward toehold accumulations.
Commentary / Joshua Apfelroth
One reason for this shift is a reduced incentive on the part of private equity funds to be viewed as the most "management-friendly" sponsor. Traditionally, private equity funds relied on strong relationships with a target's management team and a pro-management reputation to source and close acquisitions. The accumulation on the open market of a stake in a target company is often viewed as an "anti-management," hostile tactic. Private equity firms have therefore historically been hesitant to employ this approach as an alternative, or incremental, step to a whole company acquisition.
However, the ability of management to influence a sales process has largely been neutralized by the Delaware Chancery Court's focus in recent years on conflicts of interest in going private transactions. Cases such as In re J.Crew Shareholder Litigation, 6043-CS (Del. Ch.), where the Court found that management had steered transactions to preferred bidders, have led to the increased prevalence of pre-signing market checks and post-signing "go-shop" periods, which open transactions to a range of bidders beyond any preferred private equity sponsor. In turn, private equity funds have become less focused on being viewed as management-friendly and more willing to consider strategies utilized by their hedge fund counterparts, such as acquiring a toehold position in a target company, to create leverage and hedge costs as they pursue investment targets.
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