A tale of two schemes: the novel structure for management roll in HMA International
Ahead of the Deal - Australian M&A briefing
Key insights
- Two schemes instead of two classes: a recent scheme involving HMA International, an unlisted public company, shows a novel streamlined approach for schemes where only management may roll equity, using two inter-conditional schemes instead of one scheme (applying to all ordinary shareholders) with two separate classes.
- A simpler approach: Brereton J noted that the approach recognises the differences between the two groups of shareholders who are treated differently under the proposed transaction and provides a simplified way to treat those groups. It will be interesting to see if this dual scheme structure starts to replace the dual class structure for deals involving an exclusive rollover opportunity.
- Trade-offs and options: more generally, securing the commitment of management via a rollover arrangement can often have the 'side effect' of potentially compromising deal certainty – while there are alternatives, each has its own compromises.
"The need to align and incentivise target management is key to delivering a sponsor's objectives. It can, however, result in difficult structuring decisions where deal certainty must be carefully balanced against management incentivisation and other considerations"
Introduction
In take privates, the need to align and incentivise target management is key to delivering a sponsor's objectives. It can, however, result in difficult structuring decisions where deal certainty must be carefully balanced against management incentivisation and other considerations.
The recent acquisition by Anchorage Capital Partners (ACP) of HMA International Ltd (HMA), an unlisted public company, shows a novel approach when offering only management an equity rollover option. This involves two schemes being used as opposed to the more traditional approach of one scheme (applying to all ordinary shares) with two classes of shareholders voting separately on that scheme to reflect the differential treatment of management or other continuing shareholders as compared with other ordinary shareholders.
A two scheme structure
The proposed acquisition involves two schemes, referred to as the Management Scheme and the Ordinary Scheme. The schemes are inter-conditional and together allow the ACP bidder to acquire 100% of the shares in HMA.
The Management Scheme is a proposed scheme between HMA and a fixed group of 55 persons who are ordinary shareholders and members of HMA management (Management Shareholders). Under the Management Scheme, the Management Shareholders will have the ability to elect between (1) cash consideration of $2,340 per share, (2) shares in the ACP bidder holdco equal in aggregate value to the cash consideration or (3) a combination of scrip and cash consideration.
The Ordinary Scheme is a proposed scheme between HMA and all HMA shareholders other than the Management Shareholders (the Ordinary Shareholders). Under the Ordinary Scheme, the Ordinary Shareholders will receive the cash consideration of $2,340 per share.
In both cases, the consideration may be reduced by any permitted dividend.
At the first Court hearing for the proposed scheme, Brereton J accepted that having separate schemes for persons who have the same underlying legal rights, but whose rights are proposed to be treated differently under a proposed control transaction was permissible. Brereton J noted that the approach recognises the differences between the two groups of shareholders who are treated differently under the proposed transaction and provides a simplified way to treat those groups. His Honour noted that this was consistent with existing authority that would otherwise deal with class issues and without the need to engage in a detailed analysis of class composition. As the outcome is the same as if the Management Shareholders and Ordinary Shareholders constituted two classes under the one scheme and each group has full visibility of the terms of the other scheme, there is no unfairness to either group.
While it is not clear from the judgment what motivated the two scheme structure, it will be interesting to see if other sponsor bidders adopt the same approach where scrip consideration is offered only to management.
Implications for a blocking stake
Securing the commitment of management via a rollover arrangement can often have the 'side effect' of potentially compromising deal certainty. It has long been accepted that a right to elect between cash and scrip consideration will generally be enough to place a shareholder in a different class to one who only has the right to receive cash consideration. The consequential placing of relevant management in a separate class – or in a separate scheme – means that when the typical voter participation is factored in, the threshold for a blocking stake is materially reduced. For example, if excluded management own 25% of the shares on issue and voter turn-out is 70% of shares on issue, the threshold for a blocking stake will be as low as around 13% – potentially making it easier for a rival bidder to block the transaction with a relatively small shareholding in the target.
Deal protection devices
The reduction in the threshold for a blocking stake arising from class separation (or scheme separation) often leads to the use of other deal protection devices by bidders when looking to limit the equity rollover opportunity to key management.
In PEP's initial bid for Zenith Energy in 2020, where almost one quarter of management was placed in a separate class for this reason, the founder and chairman of Zenith Energy (and other rolling shareholders) entered into an exclusivity deed pursuant to which they unconditionally agreed to vote all Zenith shares held or controlled by them in favour of the scheme, provided the deed remained on foot. Ultimately, the deal showed the limits of what may be achieved with a voting commitment in a dual class structure. In that deal, an OPTrust/ICG consortium acquired a blocking stake on market, facilitating its entry into the PEP bidding consortium under a revised deal.
In Ardonagh's acquisition of PSC Insurance in 2024, it was a condition of the amended implementation deed that five named target directors elected to receive scrip consideration for approximately 21% of their aggregate shareholdings. The exclusivity of the rollover again resulted in a dual class structure, with the rollover shareholders, who collectively held more than 39% of all shares on issue, excluded from voting at the general scheme meeting. In that deal, the bidder obtained call options from five of the target directors over a total of 19.99% of PSC shares.
Other alternatives
The alternatives for sponsors when structuring management lock-in each have their own compromises.
In a limited number of schemes, we have seen target management retain part of their shares in the target, commonly referred to as a retention scheme. This approach was used in 2022 when Woolworths acquired approximately 80% of the shares in the online marketplace, MyDeal, leaving approximately 20% held by the MyDeal founder and CEO and key management personnel. While these excluded shares were not able to be voted on the scheme, other shares held by such persons representing approximately 38% of shares (and for which they would receive cash) were able to be voted at the scheme meeting. Accordingly, while this structure still reduces the threshold required for a blocking stake, it does not do so to the same extent as the traditional dual class structure, as cash shares are still able to be voted.
This structure, however, means that an acquirer will not own 100% of the target, which is an outcome not generally compatible with sponsor holding structures and may result in adverse tax consequences post-implementation.
A further alternative is for a sponsor to obtain a pre-deal commitment from key management to reinvest some or all of their existing incentives into the bidder's holding structure on or shortly after implementation (e.g. using some or all of the consideration received from the cancellation of incentives or other bonus arrangements). As such arrangements are dealt with outside the scheme and are tied to a position of employment, ASIC and the Courts have generally accepted that this structure is not class-creating (at least where relatively small amounts are involved), though votes may need to be tagged so the Court can assess whether the requisite majorities would have been otherwise achieved. While this provides certainty for sponsors (as opposed to dealing with the issue post-implementation), it may not result in a desirable tax outcome for management given the lack of equity rollover.
Of course, offering the equity rollover option to all shareholders (and not just specified management) will remove the class issue and the risk of extensive retail take-up can sometimes be managed, though not removed, through limitations in the offer itself and restrictions in the post-implementation shareholders' agreement. The downside, however, is significantly greater complexity and cost. Further, the disclosure associated with a stub equity offer is unlikely to be acceptable in circumstances where a sponsor wishes to make the acquisition through a portfolio company.
Final observations
It will be interesting to see if the dual scheme structure starts to replace the dual class structure for deals involving an exclusive rollover opportunity. While there is no clear tactical advantage for a bidder, the simplicity of the structure, and the elimination of the need to engage in a detailed analysis of class composition, may potentially lead to it being used again.
