Management Buyouts Can Be Too Cozy Some corporate decisions leave you wondering what the board might have been thinking at the time. That seems to be the case with the board of Venoco, a California oil company that is the subject of a proposed $770 million management buyout. On Jan. 16, the Venoco board of directors agreed to let the company be acquired by its chairman and chief executive, Timothy Marquez, for $12.50 a share. The deal came after Mr. Marquez, the owner of 50.32 percent of the company, and the board had announced that he had made a bid in August 2011 at the same price. Management buyouts are fraught with peril, and the reasons are fairly obvious. Management not only has superior information about the business, but studies have also found that managers can time their bid opportunistically to pay a lower price. Executives can also use their positions to push a board to favor their bid. Shareholders have to wonder why managers cannot make the same money for a public company that they are proposing to make by taking the company private. Creating value for shareholders is management's job, after all. The Venoco board was at a further disadvantage because Mr. Marquez was not only management but also a controlling shareholder. Under the law, he is not required to sell the company to anyone, even if he is the one making a bid. Other company buyouts have not worked out well for shareholders. In two cases - bids by Robert F.X. Sillerman for the entertainment firm CKx in 2007 and Tilman J. Fertitta's multiple bids for the restaurant operator Landry's - the chief executives were heavily criticized for taking advantage of their positions to push for a sale to them. I labeled both as "deals from hell" for these reasons. In the summer of 2011, the Venoco board did what a board was supposed to do when presented with a management bid - form a committee with special advisers to consider it. The board also contacted or had its bankers contact 42 other companies to see whether they were interested in bidding against Mr. Marquez. As often happens when a controlling shareholder makes a bid, no other bidders emerged. Why would another company step in to bid when the controlling shareholder can just say no? Even so, the board committee was empowered to turn down Mr. Marquez's bid and negotiate with him for a higher amount. This does happen. Recently, the special committee of the board of Exco, another oil and natural gas company, rejected a buyout proposal by its chief, Douglas Miller. The Venoco board not only failed at securing more money from Mr. Marquez, it also did not turn him down. Mr. Marquez made his bid, then lowered it and then raised it to the initial offer to secure a deal. This type of zigzag bidding is par for the course. The same thing happened when J. Crew's chief, Millard S. Drexler, and his co-bidders dropped their offer at the last minute to push the board into a deal. As in that case, the Venoco board did not call Mr. Marquez's bluff. Venoco officials did not respond to requests for comment. Even if this deal was justified, the transaction structure the board agreed to is highly unusual because it gave Mr. Marquez what amounted to a free option on the company. Mr. Marquez has this option because he has yet to arrange the estimated $385 million to $400 million of financing for the deal. Despite the lack of financing, the Venoco board agreed to a deal, and gave him the ability to walk at any time simply by paying Venoco's fees and expenses up to $4 million. The company initially agreed to require Mr. Marquez to have his financing in place by mid-May, but agreed to extend this deadline at his request through Oct. 16. The shareholder vote scheduled for June 5 will mean that investors are likely to approve the deal, but Mr. Martinez can wait until October and still walk away. This type of arrangement might be justifiable for a blow-out price. Mr. Marquez's bid in August was almost 40 percent higher than the company's stock price before the offer, though it was less than where the stock had been trading only a month before. In the days after the deal was announced in August, analysts at JPMorgan Chase expressed disbelief. They expected that Venoco "would reject the offer and allow the company to manage its way through the recent rough market." Such a decision would have allowed the company to wait until its drilling project in the Monterey shale came to fruition. Venoco's board could have bargained harder in other ways. To his advantage, Mr. Marquez negotiated a termination fee of up to $10 million if Venoco accepted a higher bid from another party. This is only about 1.3 percent of the deal's value, but it is not clear why Mr. Marquez should receive anything because as chief executive, he should be looking to maximize shareholder value. The board also agreed to give Mr. Marquez matching rights if another bid were made, something that would give him the opportunity to ensure that he could make the last bid. Given the head start he already has, why does he need this advantage? Venoco board did negotiate one thing to its benefit: a majority of Venoco's minority shareholders must approve the deal to sell to Mr. Marquez. But even here, the terms seem odd. The background to the transaction section of Venoco's proxy statement describes how the company bargained to accept $12.50 a share, only if Mr. Marquez accepted that the minority shareholders must vote in favor the deal. As any corporate lawyer knows, Mr. Marquez needed this condition to pass muster under Delaware law or else risk extended litigation. Earlier this week, Institutional Shareholder Services, the proxy advisory firm, recommended that shareholders vote against the deal. I.S.S. stated that "approving the transaction would transfer all the potential upside to the acquirer through a free option." The company's stock is about $9.25 a share, well below the offer price, meaning investors are not confident that shareholders will approve the deal.It also may be that the Venoco board has good reasons for agreeing to this deal. The board appeared to be well advised, and it followed governance rules. But the best conclusion that can be made is that the board is doing this transaction because it felt it had no choice but to accept these unusual arrangements, which unduly favor Mr. Marquez.