Maximizing Shareholder Value: The Funco Experience


At midnight on June 13, 2000, Barnes & Noble, Inc. completed its tender offer for all of the outstanding shares of common stock of Funco, Inc., a publicly-held video game retailer with over 400 stores. More than 98% of the Funco shares were tendered into the tender offer. On June 16, 2000, the short form merger of Funco and a Barnes & Noble subsidiary was completed. As a result of the tender offer and the merger, all public shareholders of Funco received $24.75 per Funco share in cash; Funco became a wholly-owned indirect subsidiary of Barnes & Noble; and Barnes & Noble.s Babbage.s unit became the world.s largest video game and personal computer entertainment specialty retailer.

The total acquisition price, approximately $160 million, was relatively small for a public corporation. Nonetheless, the Funco acquisition was an extraordinary transaction. Consider:

  • Funco.s stock was trading at less than one-half of the final tender offer price immediately before Funco announced its agreement to sell the company;
  • The initial transaction announced publicly was not with Barnes & Noble . and was at a price approximately 40% below the ultimate price paid by Barnes & Noble;
  • Funco had already canvassed the market for prospective buyers before entering into the initial agreement.

The Funco experience is a lesson for those who believe that state statutes and court decisions relating to the acquisition of public corporations unnecessarily tie the hands of buyers and sellers. It is similarly a wake-up call for those who believe that corporations should be allowed to sign "no out" acquisition agreements prior to shareholder approval, as long as an auction has been conducted. And it is an eye-opener for those who believe that Boards of Directors do not generally attempt to maximize shareholder value.

In order to fully understand how the shareholders of Funco were able to sell their shares to Barnes & Noble at $24.75 per share after Funco entered into an agreement with another corporation at $17.50 per share, it is helpful to understand (1) the state statutes and case law applicable to the sale of publicly-held corporations, (2) Funco.s sale process and the terms of the $17.50 per share agreement negotiated by Funco and (3) the makeup of the management team of Funco, which may have strengthened the Board.s resolve to assure that shareholders were given every opportunity to sell at the highest possible price.

The Law


Almost any acquisition of 100% of a publicly-held corporation requires a statutory merger or similar structure. While a buyer can make a tender offer directly to shareholders, it almost never will acquire 100% of the corporation.s outstanding stock through the tender offer. As a result, even though a first-step tender offer often is used to expedite the acquisition of control, the offer almost always is followed by a second-step merger to eliminate the shareholders who do not tender.

While the business of a publicly-held corporation also can be acquired by purchasing substantially all of the corporation.s assets and distributing the proceeds to shareholders, this structure usually results in a double income tax, triggers additional third-party approvals and creates complications under state corporate dissolution statutes. Therefore, most acquisitions take the form either of a one-step statutory merger or a tender offer followed by a second-step statutory merger.

A statutory merger, whether or not preceded by a tender offer, normally requires approval first by the Board of Directors and then by the shareholders of the seller. However, if at least 90% of the outstanding shares of each class of stock is acquired in a first-step tender offer, most state statutes, including those of Minnesota and Delaware, permit the second-step merger to be completed without a shareholder vote. The fact that both director and shareholder approval are generally required to complete a merger creates most of the interesting legal problems inherent in the acquisition of a publicly-held corporation.

Fiduciary Standards for Board Approval

The fiduciary standards for a Board of Directors generally include two basic duties: the "duty of loyalty" and the "duty of care." The "duty of loyalty" is the Board.s duty to act in what is believed to be the best interests of the corporation, not in the interests of the officers and directors of the corporation. The "duty of care" is the duty to act in a careful and deliberative manner and to be fully informed before making a decision.

If the corporation being sold is a Delaware corporation, the Delaware courts, beginning with the Revlon decision, have established that once the Board determines that a corporation is for sale, it generally has the duty to sell the company at the best price that it can reasonably obtain . regardless of the differing effects of competing acquisition proposals upon employees, customers or communities. However, the courts have created an exception if the transaction involves a sale in exchange for stock of the acquiring corporation or its parent (as long as the corporation issuing the stock is not controlled by a single shareholder following the transaction). The theory behind the exception is that in a stock for stock transaction, no "sale" has occurred. Instead, the two businesses have combined and can later be sold at a premium for the shareholders. Under this theory, the Board legally can accept a stock for stock business combination and reject a competing cash proposal, even if the cash purchase price is higher than the current market price of the shares issued in the stock transaction.

The courts have not determined whether the duty established in the Revlon case to reasonably attempt to obtain the highest price in the sale of a company applies to a Minnesota corporation. Minnesota, unlike Delaware, has a statute that expressly provides that a Board of a Minnesota corporation may take into consideration not only the short term interests of the corporation.s shareholders, but also the shareholders. long term interests and the interests of the corporation.s employees, creditors, suppliers and customers, community and economic interests and societal interests. However, it is very possible that a court would determine that shareholder interests in the sale of the corporation should predominate over interests of other constituencies. Nevertheless, because of the Minnesota statute, the Board may consider long term interests of shareholders in lieu of their short term interests. The Board may conclude, for example, that a stock for stock merger will create more value in the long run to the shareholders than a higher cash proposal that pays the shareholders now but eliminates their stake in the company.

Market Checks

The Delaware courts consistently have stated that there is no "blueprint" for attempting to obtain the best price. One possibility, of course, is to retain a financial advisor (usually an investment banker) to contact the most likely buyers on a confidential basis and conduct an "auction" with those parties that express an interest in purchasing the business. This auction process is common and may be the optimal means of maximizing the sale price in many transactions. However, the auction process is not without its pitfalls. First, contacting numerous parties increases the risk that news of the potential sale will be publicly leaked before any buyer signs a definitive agreement. Such a leak customarily increases the anxiety of employees, customers and suppliers and may therefore have adverse operational consequences, even if a sale does not occur. A leak also prevents the seller from controlling the timing and nature of the disclosure. Moreover, early disclosure often causes the seller.s stock to spike and, if a sale is not completed, to plummet even below its "pre-leak" trading price. Another disadvantage of an auction is that certain potential buyers simply refuse to participate.

At the opposite end of the scale from the "auction" process is the process of contacting, or being contacted by, a single potential buyer and negotiating with that buyer. Such a process decreases the risk of leaks and is usually less time-consuming than an auction. The disadvantage of such a process is that the seller normally cannot be confident, prior to signing an agreement with the buyer, that there are no other prospective buyers that might be willing to pay a higher purchase price or be willing to agree to more attractive terms.

If the "single buyer negotiation" results in a merger agreement providing for cash payments to the shareholders, Boards of Delaware corporations have a duty to allow other unsolicited bidders to make a proposal that the seller.s Board may recommend after the merger agreement is signed and before the shareholders vote to approve it. This is frequently referred to as a post-signing "market check." Without such a check, a court almost certainly would conclude that the Board of a Delaware corporation violated its duty to seek the maximum sale price by negotiating with a single buyer. It is very possible that a court would reach the same conclusion with respect to the Board of a Minnesota corporation. The court.s conclusion would be driven by the fact that likely buyers neither knew the company was for sale before the seller entered into a definitive agreement nor had the opportunity to buy the company after discovering it was for sale.

Until recently, the law concerning the necessity for a post-signing market check was less certain in two situations: (1) a merger in which the shareholders of the acquired corporation received stock and not cash (such that the Revlon duty to maximize price was not invoked) and (2) a merger in which an "auction" was conducted prior to signing the definitive agreement.

A series of cases decided by the Delaware courts in late 1999, however, clearly signaled that even in a stock for stock transaction, the seller.s Board cannot agree to deal protections following a "single buyer negotiation" that absolutely preclude the seller from considering a superior alternative proposal. Whether such provisions generally could be included in a merger agreement following an auction has not been clearly established. Although one of the Delaware courts recently suggested that preclusive deal protections might be permissible if an "auction" had occurred, the Funco experience, as discussed below, suggests that a selling corporation should not enter into a merger agreement that precludes a competing transaction even if a full-blown confidential "auction" is conducted beforehand.

It is reasonable to ask why a merger agreement could not preclude subsequent competing proposals if no duty exists to maximize the sale price (such as in most stock for stock transactions), or why the duty is not satisfied by conducting a full "auction" before the merger agreement is signed. After all, corporations may bind themselves in other transactions, including most sales of subsidiaries or business divisions, without the right to terminate contracts before they are completed. The difference is that mergers normally require an affirmative shareholder vote as a matter of law. By denying a seller.s Board the right to discuss alternative proposals (thus denying shareholders the right to know, prior to voting, whether more attractive transactions could have been negotiated), or by making it impossible or prohibitive as a practical matter for shareholders to vote against the proposal of the contracting buyer, the Board arguably deprives the shareholders of their legal voting rights.

Deal Protections

Denying a contracting buyer the right to lock up a merger transaction upon signing an agreement is, to some extent, unfair. The buyer has bound itself to complete the transaction and often has incurred significant expenses prior to signing, including the cost of performing due diligence, negotiating the contract and, in many cases, obtaining bank commitments and a fairness opinion from its financial advisor. The buyer also may have given up other acquisition or expansion opportunities on the assumption that it could complete the acquisition. Because the seller will insist upon public disclosure of the agreement at the time of signing for securities law reasons, the jilted buyer.s own stock may rise upon public announcement of the transaction and then decline if the deal falls through, and its public reputation may suffer. Understandably, the buyer wants assurances about the transaction and actually may walk away prior to signing if it does not receive such protection.

Nevertheless, a seller.s Board and advisors should resist preclusive deal protections if the seller.s shareholders will receive cash in the merger. The seller must attempt to obtain the best deal it reasonably can obtain for its shareholders under Delaware law (and perhaps under Minnesota law) and should be certain that its shareholders have the meaningful ability (to which they are entitled as a matter of law) to accept or reject the merger. Even in stock for stock transactions, the seller.s ability to agree to deal protections is not unlimited, based on the recent Delaware court decisions referred to above.

Sellers may be willing and even eager to bring closure to a sale when a merger agreement is signed. It is difficult for management of a company to consider a sale to an alternative buyer after it already has developed integration plans and possibly conditional employment or consulting contracts with the contracting buyer. It also is difficult for a Board to deal with a subsequent competing bid, particularly when the bid is non-binding. However, the Board and management are legally obligated not to ignore possible alternatives simply because the contract has been signed, even if it is more convenient to bring closure to the process.

The Board and the corporation.s officers may believe that the prospective buyer has made a preemptive bid that no one will top, but that the buyer will not sign the agreement without preclusive deal protections. This rationale, while appealing on its face, has a logical flaw: if the buyer is making an offer that no alternative buyer would top, there is no need for deal protection. It also has a legal flaw, because the shareholders, and not the Board, have the right by statute to make the final merger decision.

This is not to say that a seller.s Board cannot agree to certain deal protections in the merger agreement. It should do so, however, only if (1) the contracting buyer has insisted upon them before it will sign an agreement and (2) the protections, as a practical matter, do not preclude a competing bid.

Set forth below are deal protections frequently requested by prospective buyers and the legal and practical positions for the seller.s Board to consider in response:


Definitive merger agreements normally prohibit the seller from soliciting alternative bids after the merger agreement is signed. Such clauses are reasonable, because a seller should not sign a merger agreement unless it believes that it will complete the transaction, absent a superior unsolicited proposal. The courts should approve non-solicitation provisions, regardless of whether the merger is a cash or stock transaction.

No-Talk Provisions

Although non-solicitation clauses clearly are permissible, the law until recently was unsettled regarding a contracting buyer.s ability to prohibit a seller from negotiating with, or providing non-public information to, an unsolicited alternative purchaser after an agreement is signed. Most practitioners believed that such "no-talk" clauses were impermissible in a cash merger. Therefore, most cash merger agreements provided that a seller could enter into discussions and negotiations with, or supply non-public information to, an unsolicited alternative purchaser in limited situations. Some agreements permitted such action if the Board of Directors of the seller determined, in the exercise of its fiduciary duties, that it was necessary to do so. Other agreements permitted such action if the Board determined that the competing proposal was superior to the agreement with the contracting buyer.

Many merger agreements in stock for stock transactions, however, absolutely prohibited such communications with prospective alternative purchasers. The rationale, of course, was that if there was no Board duty to maximize price, the Board could reasonably agree not to have discussions or negotiations with others that contacted the Board on an unsolicited basis.

But the Delaware court decisions in 1999 regarding stock for stock mergers appear to establish that a Board cannot absolutely prohibit itself from talking with an unsolicited prospective buyer, because doing so would be the equivalent of "willful blindness" that may constitute a breach of the Board.s duty of care. The courts did not impose an absolute duty to have discussions or negotiations, but signaled that a Board could not contractually deprive itself in advance of the ability to do so. While these cases were in the context of stock for stock transactions, they would have been reasoned in the same manner in a cash merger context. One of the 1999 Delaware cases, however, suggested that a no-talk provision in a stock for stock merger might be acceptable if the market had been canvassed through an "auction" before the merger agreement was signed, or if no voting agreements with substantial shareholders limited the shareholders. right to vote against the merger.

Board Withdrawal of Recommendation

Although case law has not established whether a Board can contractually agree not to withdraw its recommendation of a merger, the reasoning behind the "no-talk" cases in Delaware suggests that a Board must allow itself the ability to withdraw a recommendation of a merger before the shareholders vote, if it concludes in the exercise of its fiduciary duties that it is necessary to do so. The consequences of such a withdrawal present more interesting legal issues.

Recent changes to the statutes of both Minnesota and Delaware clarify that the parties to a merger agreement may contract to submit the merger agreement to a final shareholder vote even if the seller.s Board withdraws its previous approval of the merger. The theory is that the corporation may contract to let the shareholders decide. If a competing buyer makes a proposal that causes the Board to withdraw its initial recommendation, of course, it is likely that the shareholders will vote against the transaction with the contracting buyer.

There are two problems with this theory, however. First, if a majority or controlling block of stock binds itself at the time the merger agreement is signed to vote in favor of the transaction, the withdrawal of a recommendation by the Board will not affect the requisite shareholder vote. Therefore, notwithstanding the Minnesota and Delaware statutes, the seller should use all reasonable efforts to negotiate the right to terminate a merger agreement (and to allow its significant shareholders to terminate their voting agreements) following withdrawal of the Board.s recommendation, at least if the bound shareholders have less than 50% of the total shareholder voting power. If the bound shareholders hold a majority of the voting power, they arguably have the authority to pre-determine the shareholder vote when the merger agreement is signed, regardless of whether the Board later withdraws its recommendation. A Minnesota corporation, unlike a Delaware corporation, is not likely to be trapped by a controlling block of shares that binds itself at the time the merger agreement is signed. This is because a Minnesota statute prohibits a person that acquires shares, or the right to vote shares, of other shareholders from voting more than 20% of the outstanding shares without a disinterested shareholder vote, subject to limited exceptions.

The second problem with requiring a shareholder meeting to be held despite the Board.s withdrawal of its recommendation is that this process may delay the inevitable termination of the agreement by several weeks. A prospective alternative buyer may be unwilling to buy the company if the purchase is delayed because a shareholder vote is required on the first agreement.

Notice or First Refusal Option

Many agreements may be terminated by the seller only after notice is given to the contracting party and the contracting party is given several days to make a higher proposal. While such a notice requirement is probably enforceable, it can discourage a competing bidder that does not want several days to elapse before it can enter into a new agreement with the seller. Such a provision was in the Funco merger agreement discussed below, however, and in Funco.s case may have been beneficial to the seller.

Termination Fees

As discussed earlier, a contracting buyer generally incurs substantial out-of-pocket expenses and lost opportunity costs. It also generally has performed a valuable service for the seller by acting as a "stalking horse" for a third party. The Delaware courts have now established that the contracting buyer can legally contract for a fee equal to at least 2% to 3% of the total acquisition price to compensate itself for lost opportunity costs and for being a stalking horse. It also is likely that reimbursement by a terminating seller of a limited amount of the contracting buyer.s out-of-pocket expenses may be agreed to in the merger agreement. On the other hand, a Delaware court has recently determined that a 6.3% termination fee in a stock for stock transaction "probably stretches the definition [of reasonableness] beyond its breaking point." The key determinant of the reasonableness of a termination fee appears to be whether its size is likely to preclude a third party from making a substantially higher offer. If so, the courts probably will not enforce the payment of the termination fee.

In addition to determining the size of the termination fee, the contracting parties will negotiate the events that trigger payment of the fee. Withdrawal of the recommendation of a merger or entry into a competing sale agreement almost always triggers a termination fee and should be upheld by the courts if the fee is reasonable. A contracting buyer also may try to negotiate such a fee if the shareholders vote down a merger agreement or if less than a majority of the shares is tendered in a tender offer. While the enforceability of such triggering events has not been established by the courts, those triggering events arguably create possible legal concerns on the theory that they penalize shareholders for voting against a merger even though their vote is required by law. Agreeing to pay a termination fee if the seller breaches a representation or covenant in a merger agreement also may present legal concerns, because the termination fee may exceed the actual damages resulting from such a breach. It is more likely that termination fees in the event of a negative shareholder vote or a breach of the agreement by the seller will be upheld if such vote or breach follows a publicly-announced competing proposal (on grounds that the proposal was the reason for the negative shareholder vote or the impetus for the seller to breach) and/or if a transaction with an alternative buyer is agreed to or completed following termination of the original agreement.


Buyers frequently try to require management, the controlling shareholders or the seller itself to grant them options for stock of the company that may be exercised if the agreement terminates. Options granted by a corporation on 20% or more of a corporation.s outstanding shares are not permitted under applicable New York Stock Exchange rules or Nasdaq National Market System regulations without shareholder approval. Moreover, a buyer granted options from shareholders of Minnesota corporations cannot vote more than 20% of the outstanding stock, even if it exercises options for more than 20% of the stock, unless the disinterested shareholders vote to afford full voting rights to the acquiring buyer. For these reasons, options generally are limited to 19.9% of the outstanding stock. Such options customarily are granted at an exercise price equal either to the per share merger price or the last closing price of the shares before the agreement is signed.

If uncapped options are granted in addition to a substantial termination fee, the courts probably will invalidate the options, the termination fee, or both, on grounds that they effectively preclude a competing transaction. To increase the likelihood that an option will be sustained by the courts, many agreements cap the profits from the option so that such profits, together with any termination fees, do not exceed an amount equal to the amount of total termination fees that the courts would deem to be reasonable if there were no option. While capping the profit on an option seemingly renders it superfluous if the agreement provides for a full termination fee, the purpose of such a capped option (unlike a termination fee) is to destroy the ability of another potential purchaser to account for a stock for stock acquisition as a "pooling" (in which goodwill does not have to be amortized). As such, it will preclude acquisitions that a competing purchaser would complete only if it could "pool" the transaction. While using an option to destroy pooling has been challenged in the courts, no court has decided the issue to date. Since it is likely that "pooling" treatment will not be permitted after calendar year 2000 under revised accounting rules, such options may become outdated after the end of this year.

The Funco Experience

The Auction Process

The process of selling Funco was undertaken against the backdrop of the law discussed above, as well as common sense considerations about maximizing shareholder value. As reported in Funco.s tender offer recommendation disseminated to its shareholders, thirty-five prospective buyers were contacted by Funco.s financial advisor in the spring of 1999. That auction process, as is customarily the case, was not publicly announced. As discussed above, such processes generally are designed to remain confidential, so that if no deal emerges, the seller.s business will not be adversely affected by news of an aborted sale. Fifteen of the contacted parties (including Electronics Boutique Holdings Corp., a publicly-held corporation, and Babbage.s Etc. LLC, a competitor of Funco and Electronics Boutique) decided that they had enough interest to receive information concerning Funco. Babbage.s at that time was an independent company, but now is a subsidiary of Barnes & Noble, Inc., a publicly-held corporation.

Five of the fifteen companies then submitted written expressions of interest in buying Funco, according to procedures established by Funco.s financial advisors. Electronics Boutique submitted an expression of interest. Babbage.s did not. The three companies that submitted expressions of interest at the highest prices were invited to meet with Funco.s management and conduct more extensive due diligence. Electronics Boutique was one of the three. Another was a prospective "financial" buyer that did not have operations in the video game retail industry, but that bought businesses in a variety of industries based upon the likely levels of their future returns.

Following the meetings and due diligence, the financial buyer was the only one of the three "finalists" to make a proposal to buy the company. Its proposed price was $24 per share in cash, but its proposal was very contingent. The financial buyer stated that it would make the purchase only if it could obtain financing and only if management would invest in the buyer at a significant level that management found unacceptable. It also proposed a purchase agreement that differed markedly from Funco.s proposed agreement. While Funco was willing to pursue a possible transaction with the prospective financial buyer if it could limit the conditions and negotiate a mutually acceptable agreement, negotiations between Funco and the financial buyer ended in June 1999.

The Electronics Boutique Merger Agreement

In December 1999, Funco publicly reported that its earnings for the quarter and fiscal year would be significantly lower than Wall Street expectations, for reasons set forth in its press release. The market price of its shares plummeted from $18.50 to $11.375 in the day following the announcement. Prior to and after that announcement, Electronics Boutique was confidentially discussing a possible acquisition of Funco.

After a series of negotiations between Electronics Boutique and Funco, Electronics Boutique in late February 2000 proposed a cash purchase price for Funco of $17.50 per share and requested a two-month exclusivity period to negotiate the remaining terms of the agreement. Funco.s Board, in consultation with its financial advisor, reviewed the proposal, but determined that Funco would not sign the exclusivity agreement without again canvassing the market to determine whether there was an interest by the most likely purchasers in acquiring Funco at a higher price.

The financial buyer that had made its highly-conditional proposal several months before Funco.s changed financial circumstances said it was not interested in receiving updated information concerning Funco or in pursuing a possible transaction. The other contacted companies, including Babbage.s (which by then was a subsidiary of Barnes & Noble), requested, and were provided with, updated information. Of the canvassed companies, only Babbage.s made a preliminary proposal. However, Babbage.s proposed price was only $80-90 million or $13.00 to $14.50 per share of Funco. The Board of Funco therefore agreed to a one-month exclusivity agreement with Electronics Boutique and proceeded to negotiate a merger agreement with Electronics Boutique at a cash acquisition price of $17.50 per share.

Some would argue that at this point Funco could have agreed to a merger agreement with a "no discussion, no negotiation" (i.e., a "no-talk") provision without exceptions, with high termination fees and with preclusive options. There had been, after all, a full auction process, an updated canvassing of the market and no other interest in buying Funco except by Babbage.s at a price that was significantly inferior to the price proposed by Electronics Boutique. The Board of Funco, however, recognized that interested buyers often are willing to commit themselves to buy a seller at maximum prices only if they know that a competitor has committed to buy that seller. In an auction process, a financial advisor either ethically or contractually is reluctant to identify the front-runner or specify the amount bid by the front-runner. When a definitive agreement is signed, however, both are disclosed.

And that is what happened in the Funco process. The definitive agreement with Electronics Boutique was signed on the evening of Friday, March 31, and was publicly announced before the market opened on Monday, April 3. Within hours after that announcement, Babbage.s contacted Funco and its financial advisor. Despite having made a significantly inferior bid just five weeks before and never again contacting Funco prior to the public announcement of Funco.s agreement with Electronics Boutique, Babbage.s on April 3 signaled that it was interested in making a competing bid for Funco. Two days later, it did.

The Babbage.s Bid

The Babbage.s bid arrived in the form of an unsolicited non-binding letter faxed to the Chief Executive Officer of Funco. It stated that Babbage.s was prepared to offer $135 million for Funco (or approximately $21.00 per share, compared to Electronics Boutique.s agreement to acquire Funco for $17.50 per share). Babbage.s stated that it was prepared to pay such amount in cash or, at Funco.s option, in a combination of Barnes & Noble stock and cash. Funco publicly announced the Babbage.s proposal by press release before the market opened the next day.

On April 6, 2000, the day of the press release, Funco.s Board met to consider the Babbage.s proposal. While there was a non-solicitation provision in the Electronics Boutique merger agreement, the restrictions on discussions, negotiations and provision of non-public information to an unsolicited alternative purchaser did not apply if the Board, following consultation with Funco.s counsel and financial advisor, determined that (1) it was required to enter into such discussions and negotiations and supply such information in order to comply with its fiduciary duties to the shareholders under the applicable law, (2) the alternative proposal, if completed, was more favorable than the existing agreement and (3) the alternative proposal was reasonably capable of being completed. The Board made those determinations and its counsel entered into discussions with Babbage.s counsel the next day regarding a cash merger.

On April 12, five days after the first discussions between counsel to Funco and Babbage.s, Barnes & Noble sent a binding commitment letter to Funco agreeing to enter into a merger agreement with Funco on essentially the same terms as the Electronics Boutique merger agreement . except that the price was increased from $17.50 per share to $21.00 per share. This commitment was conditioned upon the termination by Funco of its merger agreement with Electronics Boutique and upon Funco.s Chief Executive Officer entering into a shareholder agreement with Barnes & Noble that was substantially identical to his previous agreement with Electronics Boutique. The CEO.s shareholder agreement with Electronics Boutique required him to tender 19.9% of Funco.s outstanding stock into the Electronics Boutique tender offer (the first step of a two-step merger). The percentage was set at 19.9% because of the limitations of the Minnesota statute described above, even though the CEO owned approximately 23.5% of Funco.s outstanding stock assuming the exercise of his options. However, the shareholder agreement by its terms terminated if the Electronics Boutique merger agreement terminated.

The terms of the Electronics Boutique merger agreement provided that Funco would pay Electronics Boutique $3,000,000 (less than 3% of the $17.50 per share acquisition price) and up to $500,000 of Electronics Boutique.s expenses if Funco.s Board withdrew its recommendation of that merger agreement or entered into an acquisition agreement with a competing buyer. Barnes & Noble.s commitment letter included a commitment by Barnes & Noble to pay Funco an amount equal to that termination fee and expenses to enable Funco to pay such amount to Electronics Boutique if Funco entered into the merger agreement with Barnes & Noble.

The terms of the Electronics Boutique merger agreement permitted Funco.s Board to withdraw its recommendation of the Electronics Boutique merger, terminate the Electronics Boutique merger agreement and enter into a new merger agreement with an alternative buyer if the Board, after consultation with its counsel, determined that it was necessary to do so in the exercise of its fiduciary duties. However, the merger agreement could not be terminated under these circumstances unless Funco gave Electronics Boutique advance notice of its intent to do so five business days before termination, in order to give Electronics Boutique an opportunity to propose an adjustment of the terms of its merger agreement. For that reason, Funco could not terminate the Electronics Boutique merger agreement or enter into the proposed Barnes & Noble merger agreement on April 12. But it could, and did, give the requisite notice to Electronics Boutique on April 12 of its intent to terminate the existing agreement and enter into a new agreement with Barnes & Noble in five business days.

Electronics Boutique.s Revised Proposal

On April 19, the last business day of the notice period, Electronics Boutique advised Funco that it would amend its merger agreement to increase the tender offer and merger price to $21 per share, matching the offer by Barnes & Noble on April 12. On April 20, Funco agreed to that amendment.

Barnes & Noble.s Winning Bid

On April 25, however, Barnes & Noble informed Funco that it would commit to increase its cash acquisition price from $21.00 per share to $24.75 per share, and on April 26 it did so. Funco gave the requisite five business days. notice to Electronics Boutique of its intent to enter into the $24.75 transaction with Barnes & Noble, and on May 2, Electronics Boutique advised Funco that it would not amend its merger agreement further.

The author was not privy to the thought process that resulted in the magnitude of the increased purchase price commitment by Barnes & Noble (jumping from $21.00 to $24.75 per share). However, buyers frequently desire to complete the purchase expeditiously to integrate the two companies as soon as possible. Because of the five business day advance notice required by the Electronics Boutique merger agreement, Barnes & Noble would have invested considerable time if it wished to offer a series of modest price increases. While Barnes & Noble might ultimately have prevailed at a lower price, such a strategy may have extended the process considerably. It is therefore possible that the five-business day requirement actually benefited the Funco shareholders in this situation.

Pursuant to its rights under the Electronics Boutique merger agreement, Funco terminated that agreement and entered into the Barnes & Noble merger agreement on May 4. Barnes & Noble commenced its tender offer at $24.75 per share on May 16 and completed it twenty business days later, the minimum period required by Federal law.

Composition of Management of Funco

The author believes that most Boards in connection with the sale of public corporations would seek to maximize shareholder value regardless of legal obligations. However, well intentioned Boards may occasionally be impeded by the sheer size of the Board or by its makeup. Large Boards sometimes are difficult to pull together on short notice and there may be a tendency not to burden numerous directors with numerous meetings. This may be particularly true if those Boards are composed primarily of key executives of major corporations. While such executives have tremendous insights, ability and experience, they also are extremely busy. Moreover, Boards are occasionally dominated by one or more inside executives who have limited stock interests in the selling corporation and would receive more benefit, financial or non-financial, from a long-term relationship with the company than from a somewhat higher stock price.

From the standpoint of maximizing proceeds from the sale of the company, the make-up of the Funco Board was advantageous. It consisted of only four members, two of whom were outsiders. While the outsiders had substantial expertise, they also had time to meet frequently and upon short notice, and the Board met on numerous occasions not only to take action but also to receive updates and consider strategy.

The CEO and the president of Funco constituted the other two members of the Board. Together they held nearly 27.5% of the corporation.s outstanding stock, presuming the exercise of their options. Their obvious concern, for both the public shareholders as a whole and themselves personally, was to maximize the purchase price for the stock. The advantage to public shareholders of substantial ownership of stock by directors, and particularly by inside directors, of a public corporation cannot be overstated.


The law that has been established in connection with the sale of public corporations focuses on process and emphasizes the duty of Boards of Directors to be informed and deliberative and to perform "market checks," at least in cash transactions, in an attempt to obtain the best price that can reasonably be obtained. Boards that focus on a deliberative process, that do not preclude competing transactions prior to a shareholder vote and that give shareholders their legally mandated right to make the final merger decision perform a tremendous service to their shareholders. This is indeed the lesson from the Funco experience.