Wahab & Medenica-Taking Public Companies Private

Taking a Public Company Private: A Primer

The time and expense of complying with the Sarbanes-Oxley regulations and other corporate governance reforms are causing an increasing number of public companies, particularly small and mid size firms, to consider going private (the “reverse IPO”). The transaction(s) involved in taking a public company private can take many forms, each with its own implications for disclosure, timing, and cost, including:

A cash merger, where the subject company merges with a company controlled by the majority stockholder or group of them;
A tender offer by an affiliated entity;
A tender offer by the issuer;
A reverse stock split - increasingly common with smaller companies - where the majority stockholder or group of stockholders remaining after the transaction remain invested, while minority shareholders are cashed out.

If the transaction is ever challenged, the legal standard of review can differ depending on the form of the transaction itself. Any transaction that is subject to a shareholder vote requires filing a proxy or information statement as well as other 'going private' forms with the U.S. Securities and Exchange Commission (SEC). Those filings will undergo a preliminary review, and a fairly extensive comment period is the norm.

This type of filing also requires a good deal of disclosure, covering such matters as the purpose of the transaction, expenses incurred in the transaction, the alternatives considered and why they were rejected, reasons for the timing, and why the issuer or affiliate believes the transaction is fair. A tender offer is not subject to such a review, so it can be accomplished much more quickly. Typically, the shorter the time period, the less costly the transaction becomes. Most companies do not have the liquidity or available capital to compensate minority shareholders, so these transactions often require additional financing.

Reasons to Go Private:

Small to mid size companies have increasingly determined that the value associated with the ability to raise capital in the public market is outweighed by the costs involved in complying with corporate and securities law requirements. These costs include:

Legal and accounting costs;
Management time and attention to SEC filing rules and SOX provisions;
Maintenance of an investor relations department, annual meetings, and reports;
Fielding calls from securities analysts;
Rising insurance premiums for directors and officers ("D&O")
Some estimate that the compliance cost for small-cap companies since Sarbanes-Oxley, which was enacted in 2002, has increased by approximately 130%. By delisting, small companies can save up to $2 million annually. While private companies are not required to comply with all SOX provisions, the whistleblower and document retention protections are extended to them.

Other Benefits of Taking a Company Private:

Along with avoiding the myriad disclosure requirements, a private company may be in a better competitive position in regard to other private enterprises. The following are some additional advantages of doing business as a private entity:

First and foremost: allowing management to focus on long-term goals, rather than managing quarter to quarter to meet earnings expectations, as is often the case with public companies;
Freeing majority owners from SOX restrictions relating to the prohibition on related-party transactions;
Providing the company with greater freedom in structuring their boards and committees;
Providing liquidity to minority shareholders without brokerage fees and commissions, and at capital-gain tax rates;
Affording greater flexibility in estate planning;
Giving management a better knowledge of and control over their shareholder base;
Reducing the potential for director and officer liability.

Reasons to Remain Public:

Financial constraints: Going private is often not an option because the capital structure of the company in question does not allow the issuance of sufficient debt capital to buy-out control and continue to fund operations. Typically, the debt taken on by bringing a company private limits the company's flexibility to make acquisitions and other capital expenditures. This is because the lending institutions involved in taking a company private have the right to control the company’s ability such make such expenditures. This inflexibility can limit how a company compensates its executives, especially equity incentives, thereby making in difficult to attract executives.

Time involved in a going-private transaction: In addition to the cash outlays for legal, accounting and lending services, which would generally run in the range of $2 million, the time involved in completing the going private transaction for SEC review can be considerable.
Loss of prestige: Being a public company carried a certain cachet, although that may be changing in light of the spate of recent corporate scandals.
Considerations to be weighed when deciding whether to go private:

Is the company taking advantage of its public status? Stock can be used as incentive compensation or acquisition currency, and public companies can frequently access the debt markets;
Is the company prepared for the effect that financing the transaction will have on the balance sheet?;
Is a shareholder lawsuit likely? It could be, particularly if major shareholders are institutional investors;
Is the company prepared for intense scrutiny by the SEC and the time involved? This process can take four to six months and includes collecting and filing all metrics used in determining price, negotiation history, and the independence of the directors and committee members;
Is the company's D&O liability coverage adequate?

By: Simon Riveles

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