Take Privates: Court approves targeted stub equity structure that excluded retail shareholders

A common consideration for bidders looking at stub equity deals is the complexity and administrative burden of having a tail of small shareholders who elect to receive the stub and must be catered for in the shareholder arrangements post-acquisition.

The recent decision in Re Millennium Services Group Limited [2024] NSWSC 307 allowed stub equity to be offered on a basis that excluded retail shareholders from participating.

The court did not require there to be separate classes for those shareholders who were offered the stub equity option and those who were excluded, allowing all shareholders to vote together on the scheme in a single class. If this decision is followed, it would provide another way a bidder can manage the risk of having small shareholders take the stub equity option and becoming shareholders in the bidder or its holding company, without impacting on who can vote to approve the scheme.

However, the reasoning in the Millennium decision does not elaborate on the issue of class and no clear line was drawn on the issue. Accordingly, private equity bidders considering using a similar structure will need to review carefully the eligibility criteria based on the specific circumstances of the deal, including the composition of the target’s register.

In brief

• The court in the recent Millennium scheme approved a stub equity structure which targeted a distinct group of shareholders and excluded retail shareholders. Despite that, the court did not require there to be separate classes for the vote.
• If followed, the decision may open the door for stub equity transactions to be structured in such a way that a broader set of shareholders (including retail shareholders) can be excluded without creating separate classes.
• However, the reasoning in the Millennium decision does not elaborate on the issue of class and no clear line was drawn on the issue. Accordingly, anyone considering using a similar structure will need to carefully review the eligibility criteria based on the specific circumstances of the deal, including the composition of the target’s register.

Overview of stub equity

Stub equity is the term used to refer to unlisted shares issued in the bidder or the bidder’s holding company that are offered to target shareholders in public M&A transactions. It is typically offered as an alternative to cash consideration, and is particularly desirable for private equity bidders seeking to provide the opportunity for shareholders to roll-over into the private vehicle.

Stub equity is offered for two key reasons.

• It allows the bidder to maintain alignment with a founder or management who are shareholders in the target and important to the future success of the target.
• It allows target shareholders to retain economic exposure in the target business (by owning shares in the bidder or its holding company) and therefore benefit in the future upside of the target business.

Given stub equity is usually targeted at a specific set of shareholders (e.g. a founder or management), the take up of stub equity offers is often not high. The table below sets out recent stub equity transactions and the number of shareholders who participated in the stub equity offer (as well as the percentage of total shares in the target that participated in the offer).¹

* Minimum take up not achieved.

Class issues

Although stub equity offers are usually targeted at a specific set of shareholders, a stub equity offer is generally made to all shareholders. Usually, the only exceptions are foreign shareholders who reside in certain jurisdictions where issuing the shares is unlawful or unduly onerous.

The primary reason to offer stub equity to all shareholders is to avoid creating separate classes of shareholders. For a scheme to be approved, it must be approved by at least 75% of the votes cast on the scheme and by more than 50% of shareholders voting on the scheme. These approvals are required in each ‘class’ of shareholders.

A class of shareholders comprises those shareholders ‘whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest’.² Generally speaking, a different class of shareholder will be created where shareholders are receiving a different type of consideration. For example, if only a specific group of shareholders were entitled to take stub equity, rather than all shareholders, a separate class would likely be created.³

Having multiple classes can create material transaction risk as minority shareholders can have a larger say on the outcome and potentially cause the scheme to be voted down.

Small shareholders taking up stub equity

In addition to class issues, there is a risk in stub equity structures that some small shareholders elect the stub equity option and therefore become shareholders in the bidder or its holding company. These shareholders would sit outside the set of shareholders that the bidder was specifically targeting. Their presence on the register may cause further complexities for the company (including the complication of having more than 50 shareholders when trying to sell the company).

In some transactions, this risk has been managed by giving the bidder or its holding company a right in the shareholders agreement or constitution to compulsorily acquire small parcels. This right usually commences 12 months after implementation and applies to holdings of less than $10,000. This approach has been taken in most recent stub equity transactions, including the InvoCare, Healthia and BINGO Industries schemes, to name a few.

Millennium scheme

The Millennium scheme tackled the issue in a novel way. The bidder was able to offer stub equity to only a targeted group of shareholders without the court requiring separate classes for the vote.

Under the Millennium scheme, shareholders would receive cash consideration of $1.15 per share or, for ‘eligible shareholders’, an option to elect all or part stub equity. The stub equity was shares in the unlisted holding company established by the bidder, MXS Ventures Pte. Ltd. (Softbank Robotics HoldCo), which was a private company incorporated in Singapore.

Under the scheme, the stub equity offer was open to all ‘eligible shareholders’. This comprised all Millennium shareholders, except:

• shareholders outside Australia and New Zealand; and
• ‘small shareholders’, being shareholders who hold (i) less than 300,000 Millennium shares or (ii) more than 300,000 Millennium shares, but as a result of an election to receive cash/stub equity would receive less than 300,000 shares in the bidder’s holding company.

Although the stub equity option was open to all ‘eligible shareholders’, this was an extremely small group. Based on consideration of $1.15 per share, shareholders holding a parcel of $345,000 or less were excluded. This meant only approximately 30 out of more than 1,250 shareholders were eligible to take stub equity.

Millennium announced to the ASX on 12 April 2024 that only 4 shareholders (who were members of management) elected the stub equity option. The stub equity offer was presumably structured so that the bidder could specifically target these members of management and to keep them involved with the target business going forward.

At the first court hearing, Justice Black briefly considered whether the stub equity structure created a separate class,⁴ stating at [18]: ‘I accept… that [the stub equity option] does not require that separate classes be established’.

In support of this finding, Justice Black referred to two previous schemes, the Diverger Ltd scheme and Cirrus Networks Holdings Limited scheme.⁵ Interestingly, both of those schemes are quite different to the Millennium scheme. Neither involved stub equity. However, in each of those schemes, the scrip option was not open to shareholders who held (or would be entitled to receive on implementation) unmarketable parcels of $500 or less.

Counsel for Millennium at the first court hearing argued that the scheme booklet included full disclosure of the stub equity offer and also pointed to the fact that Millennium had an ‘unusually’ large number of small shareholders. Counsel stated that the stub equity structure therefore should not trouble the court. These points, presumably in addition to written submissions, gave the court comfort that the scheme did not require separate classes to be established for the vote.

Commentary

The stub equity structure in Millennium allowed the bidder to offer stub equity almost exclusively to founders and management, without the court requiring separate classes to be established for the vote. This enabled the bidder to manage the risk of having small shareholders taking stub equity, rather than waiting for a period after implementation to go through a compulsory acquisition process, as used in previous stub equity schemes.

The Millennium decision may suggest that Black J is open to excluding a large number of shareholders from a stub equity offer without being class-creating. This goes further than the previous decisions which excluded foreign shareholders or small shareholders who hold unmarketable parcels of $500 or less.

However, it is not clear where the line has been drawn on this issue. The reasoning in the court’s decision does not deal with these issues in any great detail. The specific register composition of Millennium and the assumed attractiveness of unlisted shares in a Singaporean private company appear to have been relevant to the court’s decision. It may therefore be wrong to simply assume that the case gives a green light to excluding shareholders who hold shares worth less than $345,000 in future stub equity arrangements. Accordingly, anyone considering using a similar structure will need to carefully review the eligibility criteria based on the specific circumstances of the deal, including the composition of the target’s register.

This article was originally published on 28 June 2024 and republished on 16 September 2024