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Taking a Company Privateor “Dark”
Transaction Options for Public Companies
Presented toNational Association of Corporate
DirectorsBy
Tom BriggsBreckenridge, Colorado(970) [email protected]
Matt HafterGrippo & Elden LLC(312) [email protected]
Greg [email protected]
Going Private – What Does It Mean?
• Public private– Transaction between issuer and affiliates
intended to cause securities to be held by less than 300 shareholders of record or delisting from exchange
• Going dark– Delisting from exchange and withdrawing from
public reporting; but no significant changes in ownership and stock can be traded on pink sheets
• Private more private– Private company can become “more
private” by taking out non-affiliated shareholders and concentrating ownership
Reasons to Go Private
• Greater focus and efficiency– Assets owned by those who value them
more highly– Greater control – Better measurements of performance
• Resolve differences among stockholder groups and other constituencies
• Costs of being public outweigh benefits
When Public Ownership No Longer Makes Sense
• SOX compliance• Costs of accounting, legal, PR, D&O
insurance, etc.• Demands on directors for greater expertise
and attention• Public markets are not exclusive source
of capital• Public markets may not offer liquidity• Executive talent does not require public
status• Disclosure of company information
Candidates forGoing Private or Dark
• Market capitalization under $250 million• Book value substantially exceeds market
value• Only a few analysts covering company• Low daily average volume (under 50,000
shares)• Substantial shareholder blocks with
differing agendas; or substantial inside ownership
How to Accomplish
• Tender offer– Odd lot holders (less than 100 shares)– All non-affiliated
• Cash out merger• Reverse stock split (followed by
forward split)• Negotiated block purchases• Private equity purchase
Legal Issues
• Conflict of interest between affiliates (inside group leading the buyout) and non-affiliates (stockholders being bought out)– Affiliates on both sides of deal as buyers and
sellers negotiating to buy company from themselves
– Risk that affiliates use superior knowledge and bargaining power to dictate terms and non-affiliated stockholders do not get best deal
• Careful deliberative process often ignored
Legal Issues (con’t)
• Sale of control– May invite/require competing offers or
market test of price– Lock up arrangements cannot be too
restrictive
• Fraudulent transfer– Leverage may leave company
insolvent
Director Responsibilities
• Business Judgment Rule – judicial deference based on presumption of proper decision making– Duty of care – thorough, informed, skeptical,
deliberative; process oriented– Duty of loyalty – protection of minority
interests; includes duty of full disclosure – Good faith – subjective belief that
transaction benefits company and stockholders
Entire Fairness Test
• Applied when traditional Business Judgment Rule presumption is not appropriate
• Standard of review – “de novo” examination of:– Fair dealing – procedure– Fair price – substantive terms
Ways to Mitigate Risk
• Independent committee– Authority to negotiate at arms’ length
with no constraints imposed by affiliates• Price• Negotiating process
– Advice of independent counsel, financial advisors and other resources of the full board
– Carefully evaluate pros and cons
Ways to Mitigate Risk (con’t)
• Price must be fair compared to benchmarks– Historical market price– Liquidation– Size of premium compared to pre-
announcement prices– Traditional valuation models – cash flow
analysis and market comparables
• Fairness opinion must confirm that price is fair to non-affiliated stockholders
Ways to Mitigate Risk (con’t)
• Bifurcated stockholder vote– Separate approval by majority of the non-
affiliated stockholders
• Fiduciary “out” enabling company to accept better offer
• Disclosure of all material information – If public company, SEC Schedule 13E-3– If private company, disclosure comparable
to Schedule 13E-3
Disclosure is Key to Process
• Part of the duty of loyalty• For public companies, typically
included with proxy or tender offer materials
• For private companies, more flexible but some tender offer disclosures apply
Basic SEC Disclosuresin Schedule 13E-3
• Offers by unaffiliated parties within prior 18 months
• History of negotiations• Alternative transactions that were
considered• Positions of outside directors
SEC Disclosures
• Fairness of transaction• Description of fairness opinion and
other reports• Other considerations
– Lock-up period– Break-up fees– Fiduciary out clause– Feasibility of financing – Probability of closing
Going “Dark” – An Alternative
• Delist from stock exchange• Deregister stock with SEC• Stock may continue to trade on Pink
Sheets– Must monitor shareholders of record – broker
“kick outs” or creeping over limit– Brokers need Rule 15c2-11 information to
trade
• More likely to be covered by Business Judgment Rule
Going Dark
• SEC Form 25 accomplishes delisting and deregistration
• Suspends all SEC reporting (including SOX compliance)
• Shareholders “of record” must be less than 300 (500 in some circumstances)– If greater than 300 (or 500), then must
file Schedule 13E-3 and formally go private
Life After Going Dark• “Near term” stock price drop after
announcement (10% est.)• Reduced trading liquidity on Pink Sheets• Negative perception from employees,
customers, vendors• Reliance on private equity and debt• Less effective employee benefits• But …..
– Significant cost savings ($500K - $1.5M)– Voluntary periodic disclosure
Issues for Directors• Use a Special Committee of independent
directors• Objectively evaluate pros and cons• No direct or indirect benefit to any officer
or director• Assure fairness to all shareholders• Independent counsel and financial advisor• Fairness opinion• Run a good process – keep detailed and
accurate records of all meetings and proceedings
Practical Problems
• Timing– Risk of putting company in play and
inviting competing bids– “Upside-down” process – requires PE
group to incur expense, conduct due diligence and arrange financing before deal is locked up
– Risk of SEC review
Practical Problems (con’t)
• Transaction emphasizes process but pressure to move quickly
• Turns colleagues on board into adversaries
• Large team of professionals to manage
• Difficult to explain to stockholders that being public is no longer desirable
• No clear metrics for safety
Relevance to Other Transactions
• Stockholder derivative litigation or other litigation where directors are defendants
• Change of control transactions– Structure and conduct of auction– Approval process
Mitigation techniques are relevant to many other situations confronting public and private companies
Other Transactions
• Transactions with interested parties– Between portfolio company and PE
group (especially if PE director)– Between operating company and real
estate partnership that owns plant – Loan to company with which director
is affiliated