Introduction: Blurring Lines
Among the most fascinating developments in corporate practice over the past decade has been the incremental and reciprocal convergence of private equity and shareholder activism. The phenomenon has been discussed in various quarters, including the Harvard Law School Forum on Corporate Governance, and demands the attention of both clients and counsel.
What exactly has been occurring? Amid ever-tightening competition for value generation opportunities, as well as ample amounts of capital to deploy, each has begun learning from and adopting the strategies and tactics of the other.
Private equity in its most classic form is the leveraged buyout (LBO). The fund acquires its target outright to add industry expertise and implement a new business plan. The traditional activist, by contrast, acquires a minority holding as a means to influence change, prototypically via a proxy contest and the replacement of board members.
Both the private equity fund and the activist fund seek to create or unlock value in the target. But the former typically prefers private discussions leading to a friendly transaction. The latter is prepared for and accustomed to a highly public and hostile campaign to advance its agenda.
These lines are blurring, with numerous notable legal implications. The U.S. is at the forefront of this evolution. However, as with certain other market trends, it may only be a matter of time before Canada follows.
Convergence and Collaboration in the U.S.
Competition-prompted convergence sees each of U.S. private equity and U.S. shareholder activists wading into the other’s waters, and sometimes to significant depths.
U.S. private equity has become increasingly inclined to acquire minority stakes in companies. Similar to an activist, this investment can be made to force dialogue regarding operational or management change. Also similar to activism, this investment can serve as a means of leverage to compel an eventual sale of the company, perhaps to the private equity fund itself. Finally, while less common, but much in the vein of an activist, the private equity fund can position for an entirely hostile relationship and public campaign. These are material pivots. Public persuasion and media relations require much different resources than private engagement. The possibility of public rejection is also generally new to private equity.
On the other hand, U.S. activists have become increasing comfortable acquiring larger stakes in their targets. Similar to private equity, the goal may be more comprehensive control of the target than is obtained by a handful of board seats. Along the same lines, activists are increasingly agreeable to the longer term investment horizons needed to realize more fundamental progress. Indeed, activists increasingly use their initial toeholds to pursue an outright target acquisition. And once again, the shift in operations and required resources is substantial. Traditional activism focuses on high-level corporate redirection and the appointment of the best stewards toward that end. Outright ownership in the private equity mold requires far deeper management teams and related bench strength.
So too has collaboration among private equity and activists become more common, at least in the United States. Examples from the U.S. include private equity funds – having acquired a minority holding but unsuccessful in securing their desired changes from this vantage alone – partnering with activist funds to push harder on the target board. Another U.S. example is activists and private equity approaching the target in tandem: the activist signals the offensive at hand but offers a sale to the fund as the board’s opportunity to both avoid proxy warfare and retain their roles, including within private equity’s appealing incentive-based compensation model. A third U.S. example is private equity coordinating IPO exits with activists. The former benefits from a buyer for an additional block alongside the offering. The latter receives a significant holding acquired free of the premium that typically accompanies activist interest. Whether collaborative tactics such as these migrate to Canada will be particularly interesting to watch.
Lessons for Clients and Counsel in Canada
What are some takeaways from this convergence for clients and counsel in Canada?
Most important is to appreciate that this evolution is occurring, and could become more common in Canada going forward. Change presents both opportunity and risk. Foresight, planning and prudence will be required to take advantage of the former and mitigate the latter.
The activist establishing a private equity arm must be careful to avoid the structural impediments to dissident-type tactics typically included in classic private equity limited partnership agreements. So too must the activist be mindful of governance issues raised by diversified but partially overlapping strategies, including drafting for – and navigating – related party transactions and potential conflicts of interest. Regarding making their more substantial investments, activists must be prepared for the gauntlet of competitive auctions as well as scheme for their eventual exit. They must also be attuned to the greater regulatory scrutiny private equity has recently been attracting.
The private equity fund new to activist strategies must appreciate the full spectrum of applicable securities law concerns, including regarding stake-building, trading on material non-public information and “joint actor” status. Related issues include weighing the advantages, disadvantages and desirability of the different available means of communication with other shareholders, including quiet solicitation, public broadcast and dissident circular. The private equity fund must also prepare for the typical defense tactics employed by incumbent boards, whether aggressive reliance on advance notice bylaws, opposing meeting requisitions or tactical private placements. In all, a new blend of corporate law and precedent will be in play, as will proxy advisory firms and their policies.
Lessons for target companies are also manifest. The most immediate takeaway is being aware of these hybrid actors and the more complex dynamics their interest may bring, and to organize accordingly. For example, if an unwelcome advance is a cooperative private equity and activist effort, opportunities to exploit division may arise. First, these suitors will suffer from a lack of true centralized control. Second, they will likely ultimately originate from dissimilar philosophical roots: as has been observed, private equity and activists derive from “very different conceptions” of the utility of markets, traditional activists seeking to unlock value in the public realm, while the LBO was borne from the notion that value is best generated by going private. Alternatively, where an unwanted private equity suitor is going activist on its own, a company may seek to drive a wedge between the sponsor and its investors: while activism has lost much of its stigma, some limited partners may remain sensitive generally or at least to the particular public brawl at hand.
On the other hand, the cross-over of private equity and activism could well present opportunity for a company. The increased attractiveness of minority ownership positions to private equity represents a corresponding increase in the pool of potential “white squires” where an embattled board seeks to issue a decisive block of shares to an allied third party. Another possibility, including outside a hostile context, is partnering with a “management-friendly” private equity fund. Rather than buyout or confrontation, this recent breed of fund looks to take minority positions solely as a door to lending and leveraging its in-house expertise, operational support and industry contacts.
Finally, and perhaps most importantly, both client and counsel must recognize that once relatively disparate practice areas are growing increasingly complimentary. This added complexity requires ever-more sophisticated legal advice and industry awareness, as well as heightened alertness. Even before first contact, all strategic options, alternate tactics and potential partners should be mapped and weighed. On the one hand, any inadvertent handicapping of one’s own cause – whether by overly restrictive confidentiality undertakings, a premature standstill or otherwise – should be avoided. On the other hand, as is so often the case in contested transactions, speed may be key and room to maneuver tightly. Truly integrated teams will excel by better capturing opportunity while also better managing risk. Outdated or siloed thinking will do neither nearly as well.
 For related insights, see Fasken’s Annual Canadian PIPE Deal Point Study (June 2022).
 For further insights regarding shareholder activism, see Fasken’s “Directors’ Handbook: Shareholder Activism” and Fasken’s “Shareholder Activism in Canada: The Legal Framework” (forthcoming).
 Bruce Goldfarb, “Companies Need to Plan for the Convergence of Private Equity and Shareholder Activism”, Hedge Funds & Private Equity (Sept. 16, 2020).
See Stephen B. Amdur, Chuck Dohrenwend and Patrick Tucker, “Wake up the Raiders: Considerations for Private Equity Going Activist”, Harvard Law School Forum on Corporate Governance (March 28, 2019); Aneliya S. Crawford and Matthew J. Gruenberg, “Friend or Foe? The Convergence of Private Equity and Shareholder Activism”, Harvard Law School Forum on Corporate Governance (March 281, 2020); George Casey, Scott Petepiece, and Lara Aryani, “Recent Shareholder Activism Trends”, Harvard Law School Forum on Corporate Governance (November 29, 2021).