Overview Of Going PrivateTransactions
Many small to mid-size public companies whose stock prices have declined or who otherwise have low market capitalization are hesitant to consider going private because of stringent regulatory requirements, increased regulatory scrutiny by the Securities and Exchange Commission (SEC) and the high cost associated with going private. Although these are legitimate considerations in connection with going private, companies looking to effect a going private transaction should not be deterred from doing so by the legal regimen surrounding such transactions. Instead, a company should weigh the short term costs and regulatory burdens of going private transactions as well as the potential long term benefits of going private, against the long term costs and public disclosure and compliance requirements of remaining a public company. Public companies should consider several factors before deciding that going private is not beneficial to their company.
"Going private" means different things to different people. For purposes of this article, we will use the term to describe a transaction in which a company reduces the number of its shareholders to less than 300, thereby permitting the company to deregister under Section 15(d) of the Exchange Act. These transactions typically will involve a controlling shareholder, an executive management group or an outsider acquiring all of the company's outside public shares.
Generally, companies consider going private transactions for many reasons that benefit the company in the long term, including eliminating the time and expenses associated with being public; managing the business with a long term outlook and not being subject to the short term focus of Wall Street; providing a defense mechanism against a hostile takeover attempt; operating the business with minimal exposure to liability under SEC statutes and regulations; capitalizing on an opportunity in distressed market conditions to acquire the equity of the company; and managing the business in a more private way.
SEC Filings
Many companies are discouraged from going private because going private transactions trigger the SEC's going private rules. Such transactions are governed by Rule 13e-3 of the Securities Exchange Act. This Rule requires detailed and expanded disclosures regarding the transaction, including the purposes of, reasons for and alternatives to the transaction; whether the related parties believe the transaction is fair to the unaffiliated stockholders and how they reached that conclusion; whether the company or the related parties have received any reports or appraisals regarding the transaction; a statement of plans or proposals regarding the company's structure or business, including asset sales, post-transaction; if material, pro forma information for the company going forward; whether and why any of the company's directors disagreed with the transaction or abstained from voting on the transaction; and whether a majority of independent directors approved the transaction. The preparation of this disclosure can be an arduous task requiring management's collaboration. The SEC reviews all going private transactions rigorously and comments vigorously. In addition to the Rule 13e-3 filing and disclosure requirements, the transaction may be subject to other filing and disclosure requirements pursuant to other statutory provisions or rules of the SEC, such as those governing a third party tender offer or merger.
Director Fiduciary Duties
A going private transaction will also likely trigger heightened duties under applicable state corporate laws, typically leading the board to form an independent special committee of the board, with separate advisers, to consider the transaction and determine the fairness of the transaction to stockholders. Independent directors and committees are responsible for ensuring the fairness of the transactions and negotiating a higher price than offered, if necessary. To protect stockholders, some states have adopted corporate takeover provisions that entitle stockholders to dissenters' rights. Compliance with applicable state laws imposes on companies the cost of engaging legal counsel as well as independent investment bankers for valuation, stockholder dissenters' rights and possible stockholder derivative suits against the board and its committees. Moreover, the independent directors and committees typically retain their own separate counsel and engage their own independent financial adviser to issue a fairness opinion regarding the transaction.
The concern raised by going private transactions, under SEC rules and any applicable state laws, is that management, with its inside information and insight into the company, will attempt to buy the company from the public stockholders at a bargain price. The SEC addresses this issue by requiring additional disclosure. Applicable state laws address the issue by imposing stricter scrutiny on the board's discharge of its fiduciary obligations.
Litigation Risks
It is true that going private transactions, regardless of the structure used, are among the more frequently litigated corporate transactions, spawning claims of alleged breach of fiduciary duty, self-dealing by affiliates, inadequate consideration, deficient process to protect the minority and various other grounds. It should be noted, however, that public companies and their directors and officers are frequently sued based upon claims of alleged insider trading violations, breach of fiduciary obligations, self-dealing and excessive compensation or other benefits, to name a few. The basis for such claims and the associated litigation risks would be eliminated by a going private transaction and, if properly structured, the transaction itself should survive scrutiny and should not invite meritorious litigation. Therefore, although the litigation risks incident to a going private transaction are greater than those that would exist in the absence of such a transaction, these risks are not materially greater than the litigation risks incident to remaining a public company. Most importantly, the threat that going private litigation risks present are of finite duration and can be managed with the proper advice.
Despite the obstacles to going private, smaller public companies should not dismiss the alternative of going private without first identifying and weighing all the long term benefits and burdens described above against the benefits and burdens of remaining public. The high cost of disclosure and compliance of remaining a public company has recently been exacerbated by the Sarbanes-Oxley Act of 2002 (the Act), as well as recent rules proposed by the New York Stock Exchange and Nasdaq. The Act imposes additional and perhaps unintended burdens on smaller public companies.
For example, the Act requires chief executive officers and chief financial officers of public companies to certify that their company's periodic reports are not misleading within the meaning of Rule 10b-5 under the Securities and Exchange Act, as amended (the Exchange Act), and that the financial information included in periodic reports "fairly presents" the financial condition of the company. Knowing violations may result in fines of up to $1 million and imprisonment of up to 10 years. Willful violations may result in fines of up to $5 million and imprisonment of up to 20 years. Because executives are now personally liable for the accounting practices of their companies, the cost of director and officer (D&O) liability insurance has increased substantially.
The Act also requires a company's audit committee to consist entirely of independent, unaffiliated directors who may not accept any compensation from the company other than compensation for being on the committee. Faced with these new requirements for board members and audit committees, smaller public companies are having to engage executive search firms to find new directors and financial experts for their boards and audit committees.
In addition, the Act has shortened the deadlines for officers, directors and principal stockholders to report changes of beneficial ownership in reports required to be filed under Section 16(a) of the Exchange Act from as many as 40 days down to two business days following the day on which the change occurs. The SEC has also shortened substantially the deadlines for filing periodic reports on Forms 10-K, 10-Q and 8-K.
There is no doubt that public companies face higher compliance costs as a result of the Act. At present, the SEC has declined to exempt small businesses from any of the Act's requirements, although certain accommodations are under consideration. The Act's increased level of regulation will cause smaller public companies without the compliance infrastructure of a large company to incur increased administrative, legal and accounting fees to keep up with the new rules.
Going Private Transaction Structures
A public company can be taken private through a number of different transaction structures. The two most frequently used structures for public companies are the cash-out mergerand the tender offer . The determination of which structure is best for a particular company depends on the relevant facts. Such a determination is usually made following discussion and analysis among the acquiring entity's lawyers and bankers.
In the cash-out merger, an acquiring group forms and funds a new corporation that is merged with the existing public company. At the closing of the merger, the shareholders of the existing public company receive cash and the new private corporation ends up owning, directly or indirectly, all of the stock of the existing public company.
In the tender offer structure, the acquiring entity makes a public offer to buy all of the shares of the existing public company for a fixed amount of cash, which is the same for all shareholders. If less than all of the public company's shareholders agree to sell their shares to the acquiring entity, the tender offer is followed by either a merger or, if enough shareholders have opted to sell their shares to the acquiring entity, a short-form merger. In either case, the merger or short-form merger allows the acquiring entity to cash out all of the remaining shareholders, with the benefit of the short-form merger being that no shareholder vote is required.
Key Transaction Milestones
The following are the key going private transaction milestones along with a typical timetable to achieve the milestones. Note that some of the time periods overlap.
Milestone Timing
Acquiring entity engages bankers and counsel; Presents offer to public shareholders; Files Schedule 13D
Target company forms special board committee; Engages bankers and counsel; Responds to the offer
Conduct due diligence and negotiate definitive agreement
File SEC documents and respond to SEC comment letters
Hold shareholder meeting and closing
Total: 4 to 6 months
Other Considerations
In addition to the litigation risks, there are a number of other issues that should be considered in evaluating whether to proceed with a going private transaction.
- Nearly all information relating to the going private offer will be required to be filed with the SEC.
- The acquiring entity should be cautious during its consideration of whether to make the offer to the existing public company shareholders. Disclosure materials must be filed with the SEC immediately after the transaction commences. What is considered to be the "first step" in the transaction is often not a bright line. Thus, legal counsel should be consulted as early in the process as possible so as to avoid inadvertently running afoul of applicable securities laws.
- Once the transaction is announced, the existing public company is "in play." The company's special committee will be required to disclose the offer and pursue other bids in order to ensure that the maximum price is obtained for shareholders.
- The SEC rules take an expansive view of who is a "filing person," including officers, directors, subsidiaries, affiliates and other persons. The impact of this is that fairly exhaustive information regarding all of these persons is required to be filed with the SEC and will be available to the public.
Although going private is an expensive process involving extensive filings with and increased scrutiny from federal regulators, and a potential for stockholder suits, once accomplished, it can result in significant savings and benefits to the company, especially in light of the recent requirements of the Sarbanes-Oxley Act. When these burdens are balanced against the ongoing burdens and costs of remaining public, going private may be the right alternative for a public company, a fair deal for the public and a compelling value for the new owners.
Published May 1, 2005.
