Taking a Company Private (#84)
/In this podcast episode, we discuss the mechanics of taking a company private. Key points made are noted below.
When to Go Private
Sometimes, a public company finds that the cost of being public outweighs its benefits. There’re a couple of situations where this is the case: First, trading volume is so low that investors can’t easily buy or sell shares, so they don’t care if the company goes private.
The second scenario is when the company can’t raise money by selling its stock to investors. This usually happens when the stock price is so low that the company would have to issue an awful lot of stock in order to raise any kind of serious money.
In these cases, management starts to look at the cost of being public, which I’ve seen reported as low as $50,000, but is generally closer to $1/2 million. Now keep in mind that this expense range applies to really small public companies, which are the ones most likely to go private. Larger firms can more easily raise money and have decent trading volumes, so they won’t go private.
Methods for Going Private
So, management looks at the costs and benefits, and decides to go private. There are two ways to do this. The first is going straight to a Form 15 filing. This is an incredibly simple one-page form. You file it, and you’re done. Technically, you’re supposed to keep up your filing obligations with the SEC for another 90 days, but most companies stop reporting right away. This sounds easy, and it is, except for one thing. You must have less than 300 investors of record when you file the Form 15. If you have more than 300 investors, then you cannot go private. There is a variation that increases the 300-shareholder limit to 500 shareholders, but it’s going to be 300 for most everyone.
Here’s the problem with that first option – it assumes that you’ve done no stock buybacks in order to go under the 300 shareholder limit. In other words, the company doesn’t have many investors to begin with, so it files a Form 15 and it goes private.
So, what if you have more than 300 investors, and you want to go private?
This brings us to option two, and it gets a bit more complicated. It requires filing a Schedule 13e-3. In this Schedule, you explain to the SEC how you plan to reduce the number of shareholders. There’re two main methods for doing this. The first is a reverse stock split. In this case, the company is trying to eliminate its small shareholders. So, for example, let’s say that you have a large number of small-lot shareholders, which are those shareholders having 100 shares or less. If you did a 101 to 1 reverse stock split, then everyone having 100 shares or less would end up with a fractional share, which the company then pays for in cash. This flushes out all of the small-lot shareholders, which in most cases leaves you with far fewer shareholders. Also, the total amount of cash paid out for these shares is typically very small, so it’s a good option.
The other way to reduce shareholders is to conduct a general solicitation to buy back shares, which is typically targeted at all shareholders – which makes it a fair site more expensive.
Both scenarios require a shareholder vote, so you have to create a preliminary proxy statement that gets filed along with the Schedule 13e-3. The SEC has 10 days to comment on the proxy, after which you can proceed with the vote. You should figure on taking about two months to conduct the vote, because you’re required to give brokers 20 days notice to figure out how many of your shares they’re holding on behalf of their clients, plus another month for the voting period.
Assuming the shareholders vote in favor of either option, you can then reduce the number of shareholders, and then file a Form 15 to officially go private.
So, in short, you have to file a Form 15 no matter what – it’s just that you also need to file a Schedule 13e-3 beforehand if you’re also taking steps to reduce the number of shareholders first.
Other Issues with Going Private
But there are some other issues to be aware of. First, I mentioned earlier that there have to be less than 300 shareholders of record. This is really important, because if your shareholders have placed their shares with a broker, then the broker counts as just one shareholder, even if it’s holding the shares of dozens of shareholders. This means that you don’t necessarily have to buy back shares.
An alternative is just to encourage your shareholders to take their stock certificates out of their safes and give them to a broker.
But, unfortunately, that also brings us to the second issue, which is the broker kick-out. When a broker finds out that the company has gone private, it has the option to send any stock certificates that it’s been holding back to the shareholders. This means that each shareholder that was with a broker now counts as a shareholder of record. And if too many broker kick-outs occur, you may very well find yourself back over 300 shareholders. And if that happens, then you need to start reporting to the SEC again.
The Risk of Shareholder Lawsuits
Now, before you think this is a relatively mechanical process, there is a risk of shareholder lawsuits. If a company goes private, it becomes much more difficult for them to dispose of their shares. If you want to reduce the risk of the company losing these lawsuits, it really helps to create a special committee of the board that evaluates the going private decision. This committee should be comprised entirely of independent directors, so that means the CEO is not invited. Also, the committee should document its investigation extensively, with things like a compilation of the cost of being public, and maybe even hiring a third party to review their numbers. And in addition, the committee should document how going private is good for the unaffiliated shareholders. This means that a shareholder who is not a director or officer or large shareholder will be better off if the company goes private than if it continues with its SEC reporting.
Parting Thoughts
And finally, going private makes it very difficult to issue shares to employees as compensation. If you do that, the shares won’t be registered, so the employees can’t sell any shares to pay for the income taxes on the shares. And yes, even if you’ve already issued an S-8 registration statement, where shares issued to employees are automatically registered, this is no longer valid as soon as the company goes private.
There’s also an issue of terminology. What I’ve been talking about is sometimes called going private, and sometimes called going dark. Going private is reducing the number shareholders so that you’re in a position to stop your SEC filings, which is essentially what the 13e-3 is all about. Going dark is the Form 15 filing, where you essentially flip a switch and turn out the lights on your public filing obligation.
In short, going dark makes a lot of sense for smaller public companies, since the resulting cost reduction can be quite remarkable. But there are some downsides, so the board needs to very carefully consider the ramifications of doing so, and document its discussion in detail.