Asking the Right Question: The Mixed Consideration Denominator Problem
By: Laura Bower Braunsberg
Delaware law has been unsettled for the last two decades as to what level of scrutiny to apply when a stockholder challenges a transaction in which an acquirer purchases the target’s stock for a mix of cash and stock. When stockholders are paid for their stock with shares in a diversely held and uncontrolled entity, Delaware law treats the transaction as a strategic combination and affords the directors business judgment deference. When stockholders receive cash, Delaware courts scrutinize the transaction more closely under Revlon as an end-stage transaction. The uncertainty in the law stems from the inherent difficulty in determining whether a mixed cash-stock transaction more closely resembles a strategic combination or a cash-out merger. Delaware courts have used a ratio in which the per-share merger consideration is the denominator and the market value of the acquirer’s stock is the numerator. When this ratio is about half or less, Delaware courts have applied heightened scrutiny to the transaction as though it is an endstage transaction. This Article illustrates that this test over-values the investment being surrendered by including the premium paid by the acquirer, and creates adverse incentives for directors in negotiations. Instead, the question of whether there is a long-run for stockholders is better answered using a ratio of the market value of the amount of stock in the combined entity to be received over the pre-announcement market value of the stock to be surrendered.