Stalking-Horse Bid

What is a Stalking-Horse Bid?

A stalking horse bid is an initial bid that is made on the assets of a bankrupt company. This sets a lower bar such that the other bidders cannot underbid. In other words, it is the highest initial bid amongst the prospective buyers, so others will have to bid a higher amount. 

While going into bankruptcy, a company usually chooses a bidder from an initial pool of bidders to make the first bid, who is the one who makes the first bid and thus sets the tone for the entire bidding process. 

As mentioned above, the primary purpose of such a bid is to set up a lower bar or a floor price, which acts as an incentive for other bidders to bid more and participate in the bidding process. 

As an incentive for making the first bid, such a bidder usually gets a lot of benefits in the form of breakup fees, expense reimbursement, and much more. This helps justify the higher initial bid. 

This also benefits the company as a higher initial bid can help the company realize a more elevated amount from its set of assets, which eventually may help the debtors learn more value from their outstanding debts and get a more favorable deal.

How a Stalking Horse Bid Works

According to everyday vocabulary, stalking horse is a term used to hide a person’s true intentions. It originates from the hunters who used to hide behind their horses to conceal themselves from their prey.

Thus, this bid is the first bid that usually sets the lower bar or the floor price in the event of the sale of a company's assets during bankruptcy. 

Such bids allow companies on the verge of bankruptcy to receive competitive offers and remove the chances of underbidding. 

Thus, the company going into bankruptcy can earn higher profits by ensuring its assets are not sold at a meager value. This is because all bids after the stalking horse must be more than that. 

After the company has gone into bankruptcy, the first interested buyer is called the stalking horse bidder, with whom the company agrees. The price set is called the floor price. 

Even if there are higher bids in the auction, the first buyer will get a favorable deal as they are provided with a breakup fee to compensate for the bidding expenses, ranging from 1-3% of the purchase price. 

Bidding Procedure for a Stalking-Horse Bid

Before bidding begins, the company that will be selling its assets will have to get consent to go into bankruptcy from the court. Only after this consent can they enter into contracts with the stalking horse bidders.

These bidders have advantages over other bidders during the bidding procedure. As a result, they influence many components in the bidding procedure, which they may use to their advantage. 

For example, these bidders can negotiate terms that prevent rival bidders from submitting lower bids than what has already been submitted to the debtor during the bidding process. 

Additionally, the stalking bidder could have an impact on several factors, including

• Lowest overbid sums
• Creating bid lots out of assets
• Timing of the bidding procedure
• When a bid is accepted for discussion or is disqualified
• Whether the auction will be an open auction or a silent auction
• Whether or if the stalking horse bidder is informed of any other bids

Additionally, after the stalking horse bidder makes their bids, the first bidder will always have the opportunity to do their due diligence on the assets and the company to ensure that the deal is favorable for them. 

Incentives given to Stalking Horse Bidders

Many companies or investors may be reluctant to be the initial bidder. This may be because they must spend more resources to do the due diligence and set a floor price. Thus, many investors may prefer to wait for the auction to begin. 

Thus, to compensate for these added efforts, these bidders get a lot of additional incentives and advantages in the form of breakup fees, reimbursements, exclusivity arrangements, and favorable bidding procedures. 

Expense Reimbursement

Repayment of negotiation-related costs is one of the most typical rewards provided to such horse bidders. In addition, reimbursement is possible for expenses incurred in relation to legal and financial advisers, due diligence, and other reasonable costs associated with the deal. 

The costs, however, have a maximum cap relative to a certain percentage of the transaction amount. In addition, the reimbursement must receive bankruptcy court approval. 

Typically, the bidder becomes entitled to such reimbursement when the company accepts a "higher and better offer."

Breakup Fees

The breakup fee is an additional incentive given to the stalking horse to persuade it to place the opening bid and create a foundation for future bids. The breakup fee is one of the incentives provided to influence the stalking horse to set a higher "floor." 

If the breakup fee is too high, it can be thought to be suppressing potential bids. Thus, the combined breakup fees and expense reimbursement shouldn’t exceed 3% of the deal amount. If it does, it may garner a lot of scrutiny from authorities. 

Bidding Procedures

Negotiating advantageous bidding procedures is one of the most significant potential sources of leverage. In addition, having pre-approved bidding procedures in place helps deter stalking horses from trying to change them and use them as an unfair advantage. 

This is because any attempted changes will probably be viewed as attempts to chill the bidding process and deter other bidders from participating in the auction process.

Exclusivity Arrangements

The buyer will frequently desire to engage in an exclusivity agreement with the seller in transactions outside of bankruptcy. However, such an arrangement might conflict with the debtor's need to get the most money possible for their assets. 

However, it is common for a prospective buyer to discuss brief periods of exclusive dealing with the debtor as it works to reach a stalking horse purchase agreement. 

To increase the likelihood of reaching a purchase agreement, the debtor may publicly or informally commit to such exclusivity.

Advantages of a Stalking Horse Bid

Pros are:

• This bidder is the first bidder and gets an opportunity to negotiate the terms of the sale, choose which assets they want to acquire, etc.
• The first bidder gets an opportunity to conduct due diligence before any of the other bidders. They can review the financial records, talk to the management and engage with creditors and vendors to ensure they approve the offer. 
• The bidder gets protection from being overbid in the form of expense reimbursements and breakup fees incurred in the legal and financial costs. 

Disadvantages of a Stalking Horse Bid

Cons are:

• The stalking-horse bidder pledges to buy the debtor's assets by setting the floor price, even if the assets' value decreases below the purchase price throughout the auction. 
• The stalking horse agreement is enforceable against all parties as long as the bankruptcy court approves it, and it will be challenging to renegotiate or withdraw from the deal.
• In an auction, the stalking horse establishes the starting bid for other bidders. But the original offer can be surpassed by rival bids, and the stalking horse might lose out on the purchase. However, subject to the bankruptcy court's approval, the stalking horse will still be reimbursed for the fees incurred during the procedure.

Example of a Stalking Horse

In the example of SCO, a US-based tech company, a buyer would acquire "essentially all assets used by the Company in connection with its SCO UNIX business and any related claims in litigation," according to the agreement proposed by it in its bankruptcy petition filed in Oct 2007. 

The contract included a "stalking horse" clause that required SCO to pay York Capital Management a $780,000 breakup fee and repay it for expenses up to $300,000 if York Capital Management were to be identified as a stalking horse in later bids for SCO's assets. 

In this method, York would cover costs plus $780,000 by serving as the stalking horse and discouraging lowball proposals from other bidders.

Similarly, in the case of Dendreon, a biotech company on the verge of bankruptcy, Valeant Pharmaceuticals International placed a stalking horse bid on its assets. While the offer was $296 million, it rose to $400 million due to requests within a week.

The court determined that Valeant, in this case, was a stalking horse bidder and, thus, was entitled to compensation in the form of breakup fees and reimbursement for their expenses even if the bid didn’t end up being successful. 

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