2013 Bus. L. Today 1 (2013)
Side-Stepping Fiduciary Issues in Negotiating Exit Strategies for Preferred Stock Investments after Trados

handle is hein.journals/busiltom2013 and id is 248 raw text is: Side-Stepping Fiduciary Issues in Negotiating Exit
Strategies for Preferred Stock Investments after
By LisaR Stark

In In re Trados Inc. Shareholders Litig.,
C.A. No. 1512-VCL (Del. Ch. Aug. 16,
2013), the Delaware Court of Chancery
held that a venture-backed board's ap-
proval of a merger in which the company's
common stockholders received nothing
was entirely fair despite the merger having
been approved as part of an unfair process
in which the interests of the company's pre-
ferred stockholders were favored over the
interests of the common stockholders. The
court reluctantly reached the conclusion
that the board's actions survived scrutiny
under the exacting entire fairness standard
of review after finding that: (1) the value of
the common stock was nothing at the time
of the merger, and (2) the entire fairness
standard is not a bifurcated test as between
fair price and fair process, the two compo-
nents of an entire fairness analysis. Thus,
in the court's view, it could find that the
board's approval of the merger was entirely
fair even if the VC-backed board's pro-
cess was unfair. In principle, the Delaware
courts have consistently held that the entire
fairness test is not a bifurcated analysis.
However, in practice, the Delaware courts
have consistently found against defendants
in cases reviewed under the entire fairness
standard where there has been unfair deal-

ing because an unfair process usually re-
sults in an unfair price. Although the court
found the directors committed no breach
of fiduciary duty under the entire fairness
standard, the court noted, in dicta, that the
company's venture capital investors could
have averted or mitigated fiduciary issues
in connection with a merger in which the
interests of the common and preferred were
not aligned.
This action arose from the July 2005 acqui-
sition of TRADOS Inc. (Trados) by SDL
plc (SDL) for $60 million in cash and stock.
The preferred stockholders received $52.2
million as partial payment of their liquida-
tion preference, which was triggered by
the merger, and management received $7.8
million as part of a management incentive
plan (the MIP). The common stockholders
did not receive any merger consideration.
Without the MIP, the common stockhold-
ers would have received $2.1 million in the
merger. The merger constituted the cul-
mination of a process initiated in 2004 by
four venture capital firms, which held Tra-
dos preferred stock and designated five of
seven members of the Trados board. Trados
had initially obtained venture capital fund-

ing in 2000, from Wachovia Capital Part-
ners (Wachovia) and Hg Capital LLP (Hg),
and Wachovia and Hg each obtained the
right to designate a director. Subsequent
preferred stock investors included Sequoia
Capital (Sequoia), which designated two
directors, and Invision AG (Invision and,
collectively, with Wachovia, Sequoia and
HG, the VC Investors), which also des-
ignated a director.
Although Trados increased revenue
year-over-year, the company struggled fi-
nancially. By 2004, the VC Investors were
no longer willing to fund Trados and be-
gan to demand an exit strategy. To this end,
the Trados board approved the MIP, which
compensated management for achieving a
sale even if the transaction yielded nothing
for the common stock. As the company's fi-
nancial picture improved, Trados manage-
ment actively solicited offers for the com-
pany. SDL emerged from the sales process
as the only merger partner offering the pos-
sibility of a near-term exit for the VC Inves-
tors. On June 15, 2006, the Trados board
approved a merger with SDL which trig-
gered the preferred stockholders' contrac-
tual liquidation preference and provided
no value to the holders of Trados common
stock. At the time of the board's approval


Published in Business Law Today, September 2013. @2013 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any
portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written
consent of the American Bar Association.


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