Going Private: More Public Companies Begin Life Anew as Private Companies

Do the advantages of being a public company outweigh the disadvantages, including the expenses and potential liabilities? For an increasing number of public companies, the answer to that question may be no. Recent market conditions combined with the current regulatory environment have resulted in a large number of public companies trading at values below the amount of cash on their balance sheets. At the same time, these companies face increasing reporting and corporate governance requirements. Many of the benefits of being a public company are also largely unavailable since it is currently difficult to access public capital markets and many employee options are "underwater." For public companies, a going private transaction may provide a way to eliminate the disadvantages of being a public company and allow a company to focus on long-term strategy instead of quarterly results. For private equity investors, a going private transaction may provide an opportunity to invest capital at a favorable price in a company that is at a later stage of maturity than many private companies seeking equity financing.

An increasing number of going private transactions are occurring. A public company can "go private" if it completes a transaction that results in its publicly traded securities being held by fewer than 300 persons. Candidates to go private often have one or more of the following characteristics: a large cash position relative to market capitalization; limited Wall Street research and attention; and a need to restructure to achieve profitability. Potential impediments to these transactions include the need to obtain financing, the need for stockholder approval and the uncertain prospects for a profitable liquidity event for investors in the resulting private company.

Going Private Transactions. Going private transactions take a variety of forms. These transactions may be structured as either a buyout led by a group that includes existing management or as a reverse stock split. The need for outside financing, the composition of the stockholder base and the likelihood of a competing bid for the company are all factors that influence the choice of structure. Potential funding sources for the transaction include the existing cash on the public company’s balance sheet and financing from buyout or venture capital funds.

Buyouts are generally negotiated transactions between the buyout group and the public company and typically take the form of a merger or tender offer. If the buyout is structured as a merger, a proxy statement soliciting approval of the merger is sent to the public company’s stockholders once an agreement has been reached between the buyout group and the company’s board. If the stockholders approve the merger, a newly-formed private company owned by the buyout group is merged with the public company and cash is exchanged for the shares of the public company as part of the merger.

If the buyout is structured as a tender offer, a cash tender offer for outstanding shares of the public company is commenced by an entity owned by the buyout group once an agreement has been reached with the company. The buyer may choose to close the tender offer once the buyer owns a majority of the outstanding shares. The buyer would then undertake a merger that requires the approval of stockholders (which the buyer would control as a result of the shares acquired in the tender offer) and a related proxy statement. Alternatively, the buyer may attempt to purchase 90% or more of the outstanding shares and then close a short-form merger. Under Delaware corporate law, a company that owns 90% or more of another company can merge the two companies without stockholder or director approval at the target level.

A reverse stock split is achieved through a charter amendment that combines a large number of shares into a single share. The goal is to "cash out" enough smaller holders who end up with less than one share so that the stockholder base is reduced to less than 300. The requirements for a reverse stock split are primarily dictated by the laws of the jurisdiction of incorporation of the company and the charter of the company. The amendment typically requires a proxy statement soliciting approval by the stockholders.

Fiduciary Duty Issues. A conflict of interest exists if existing management will retain an interest in the resulting private company. As a result, under Delaware law, going private transactions are generally subject to the "entire fairness" standard, which requires both a fair price and fair dealing, rather than the more typical business judgment rule which applies to most board actions. The fair price prong focuses on the value received by the public stockholders and the probability of the deal being completed, while the fair dealing prong focuses on the fairness of the process to all participants and potential buyers.

The conflict of interest between management and other stakeholders in the company requires steps to be taken to protect against possible litigation. Strike-suits that allege a breach of fiduciary duty and/or a duty of disclosure are common following the announcement of a going private transaction. It is possible to shift the burden of proof to the plaintiffs with a properly constituted and functioning special committee of independent directors who will not be part of the company after the transaction. The role of the special committee is to negotiate the best deal for the public stockholders. It is also advisable to "shop" the company prior to any going private transaction and for the special committee to retain its own financial and legal advisors and obtain a fairness opinion. There should be a clear, written record of the steps taken by the special committee in this regard. The special committee process should not be tainted by actions of insiders to assert influence on the committee.

Disclosure Requirements. Proxy solicitations and tender offers are subject to the disclosure rules of the Securities Exchange Act of 1934. In addition, the disclosure requirements of Rule 13e-3 under the Securities Exchange Act apply when management, directors or other affiliates of the public company will retain an interest in the resulting private company. Rule 13e-3 and the related Schedule 13e-3 require disclosure of information in addition to the background and structure of the transaction required to be disclosed by the proxy and tender offer rules, including information about the fairness of the transaction. Copies of all valuation materials and reports used to demonstrate the fairness of the transaction must be filed with the SEC. The effects of the transaction on the company and its unaffiliated stockholders must also be included in the filing.

Conclusion. A going private transaction may be an attractive alternative for existing management and investors where the benefits of being a public company are outweighed by the costs and burdens of the public markets. By going private, a company may benefit from restructuring and focusing on a long-term strategy designed to result in long-term equity upside for investors in the resulting private company. In addition, a going private transaction may be an attractive investment opportunity for private equity investors.