When an Executive Turns Buyout Advisor it Raises Concerns

executive buyout advisor
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You may think that you have an advantage in deal-making if you hire the former chief executive of the company you want to buy to advise you.  However, this could turn out to be a problem as was evidenced in recent litigation surrounding the $3.7 billion buyout of the industrial machinery maker, Gardner Denver.

In that deal, private equity firm Kohlberg Kravis Roberts & Company hired Barry Pennypacker, the target company’s former chief executive, as a buyout advisor shortly after his resignation.  Using a top executive creates the same type of concerns that a management-led buyout does. 

Pennypacker was chief executive of Gardner Denver for five years prior to his July 2012 resignation.  It appears that he resigned over disputes with the board.  When Pennypacker left the company, Gardner shares fell 8.6 percent the next day. 

Within two weeks, a preliminary proposal to acquire the company was submitted by SPX one of Gardner’s competitors.  Just a few days later, ValueAct Capital sent a letter to the company requesting a sale.  Shortly thereafter, another company also wanted to acquire Gardner.  The Board of Directors and Michael Larson, the company’s CEO started working with Goldman Sachs to explore the possibility of a sale.

This led to Pennypacker shopping his expertise to private equity firms.  Kohlberg Kravis and its industrial team hired Pennypacker.

This is a common practice, where private equity firms hire industry veterans as advisors for operating the companies in their portfolios and any potential acquisitions.  Since deals are scarce, these advisers have the potential to encourage private equity buyers to target their former employers.   

According to a person close to the deal, almost all of the private equity firms who participated in the bidding had hired former employees of Gardner or one of its competitors to advise them. 

Even though the practice isn’t that rare, hiring former executives raises concerns at target companies.  You can look at hiring a former executive to advise on a takeover bid as a type of management buyout, which includes all the potential conflicts and misuse of confidential information.

The reality is that hiring former executives can cause a real problem for the shareholders of the target company, since the information these managers have can give a bidder a big advantage.  However, similar to management-led buyouts, there are procedures that bidders and targets can use to prevent the conflicts of interests.

It appears that Kohlberg Kravis did follow these procedures.  The firm required Pennypacker to sign an agreement that he would not divulge confidential information about Gardner.  This is what started the trouble.

According to court filings, in October Pennypacker’s attorneys inadvertently sent a draft of this agreement to Pennypacker’s old email address at Gardner Denver.  This alerted Gardner of his involvement and the company began working on making sure he did not share any confidential information.

Then a shareholder class-action lawsuit challenging the acquisition was filed in a Delaware court.  In the beginning it appeared to be a case that would settle quickly.  But during discovery the plaintiff’s lawyers uncovered details of Pennypacker’s involvement.  The plaintiff’s claims that Pennypacker had provided confidential information to the private equity firm despite the safeguards.

Source: www.dealbook.nytimes.com

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