“Dual Track” Process: Maintaining Transaction Flexibility to Optimize Value

The ups and downs of the M&A and financing markets over the past few years, particularly in the emerging companies (EC) and venture capital (VC) sector, have demonstrated the importance of emerging companies and their stakeholders maintaining flexibility when pursuing liquidity transactions. Running a “dual track” process, or the parallel pursuit of both an M&A transaction and a financing transaction, such as an initial public offering (IPO), can be an effective strategy to maximize transaction certainty and optimize valuations.

M&A Exit vs IPO: What’s the Better Option?

At the outset of a dual track process, key stakeholders may have genuine disagreement on the preferred path forward for the company.

Certain key stakeholders, such as venture capital and private equity investors who are facing pressure to return funds to their own investors, may, at least initially, prefer an M&A exit on the basis that it is more likely to provide a full and immediate realization of their investment. However, this conventional viewpoint has been somewhat challenged in recent years as, in the face of higher interest rates, more and more acquirers have insisted upon some portion of the target’s existing equity being “rolled over” in connection with an M&A transaction. Moreover, since the frenzied deal-making of the COVID years, buyers have increasingly required more significant indemnities, therefore limiting the ability for selling shareholders to make a clean exit from their investment.

On the other hand, those stakeholders that have a longer-term view of the prospects of the company may prefer the liquidity and ability to realize returns on their investment gradually over an extended period of time (and the potential upside in doing so) that is afforded by an IPO. However, these perceived benefits of an IPO have also been challenged in recent years due to the growth of the number of companies staying private for longer, often at significant valuations that are uncertain to be realized in the public markets, and the growth of the secondaries market that has provided investors, including founders and management, to achieve liquidity prior to an IPO.

Ultimately, what is best for a particular company will depend on its particular circumstances and, as discussed further below, a dual track process can be a meaningful way to discover the best alternatives available.

Key Benefits to a Dual Track Process

Any significant transaction, whether it be a full or partial exit transaction or a significant equity raise, carries with it inherent execution risk as well as the need to balance the interests of various stakeholders. A “dual track” process can help address these considerations, with certain of the key advantages generally believed to be:

• Greater Transaction Certainty: By pursuing a “dual track” process, companies are able to mitigate against unforeseen and unknown risks that may threaten a particular transaction alternative. For example, as the many emerging companies that unfortunately missed their opportunity to complete an initial public offering (IPO) during the Canadian IPO market boom of 2021 are aware, market dynamics can shift quickly and be unforgiving to the hard work and underlying business fundamentals of a company. By pursuing both strategies concurrently, companies maintain the flexibility to switch to another transaction alternative without negatively impacting the transaction timetable and with a more precise appreciation of the relevant trade-offs between the available alternatives.
• Better Price Discovery: By running an “auction” sale process in parallel with a financing, a “dual track” process is generally believed to generate price tension, resulting in the company realizing its optimal valuation in either transaction scenario. For example, in a sale process where one bidder has emerged as the clear frontrunner, the competitive pricing tension continues to persist in a “dual track” process given the potential for the company to expeditiously pivot and carry out a financing if available on more attractive terms. Discovering the best terms available in either scenario can also help encourage key stakeholder “buy-in” for a particular transaction and prevent second-guessing of strategic alternatives. With the extension of the lifecycle of private companies with multiple rounds of pre-IPO financing, this can be of significant importance given the potential for divergent viewpoints among key stakeholders.
• Potential for Increased Efficiencies: While the perceived disadvantages to a “dual track” process, such as increased complexity, cost and strain on management’s resources, should not be wholly discounted, a well-managed “dual track” process is nonetheless able to take advantage of various efficiencies to ensure the incremental costs associated with the process do not outweigh the benefits. For example, as both prospective buyers and investors will require similar information to make their investment decision, there can be significant synergies realized in preparing diligence materials for both transactions at the same time. Cost duplication can also be minimized by retaining experienced legal, financial, tax and other advisors to assist with the process and leverage the work product (e.g., investor presentation, list of third-party consents implicated by the proposed transactions) produced by such advisors for both transactions. While such materials will need to be specifically tailored for their specific end-audience, there are economies of scale that can be realized in a properly managed “dual track” process, particularly as compared to two “single track” processes, that are often able to easily justify the incremental costs.

Whether a “dual track” process is the right approach for a company looking to execute a significant transaction will ultimately depend on the particular facts, including the industry in which the company operates, where the company stands in its business cycle and the demands of its key investors. However, pursuing a “dual track” process can be an effective tool to maintain transaction flexibility and optimize valuations.