Do the advantages of being a public company outweigh the disadvantages? For an increasing number of public companies, the answer to that question may be no. The benefit of no longer having to invest the time or to incur the expense of complying with the Sarbanes-Oxley Act (SOX) and other public company disclosure and corporate governance regulations may make it worthwhile for small and mid-size public companies to consider going private.
Recent market conditions combined with the current regulatory environment have resulted in a significant number of public companies that do not benefit from being a publicly-traded company. Moreover, these companies face increasing reporting and corporate governance requirements that consume both management time and company cash. Since accessing public capital markets is currently difficult and many employee options are “underwater,” many of the advantages of being a public company are largely unavailable at this time. While being a public company carries a certain cachet, for some companies going private may provide a way to eliminate the significant costs of being a public company and allow them to focus on long-term strategy instead of quarterly results.
Reasons to Go Private
Small to mid-size companies should consider whether 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 associated with annual and periodic securities filings.
- Management time and attention to SEC filing rules and SOX requirements.
- Maintenance of an investor relations department or retention of an outside IR firm.
- Pressure from stockholders to maintain stock liquidity and/or increase share price.
- Higher insurance premiums for directors and officers.
Without doubt, the compliance costs for small-cap companies since the passage of SOX in 2002 have increased tremendously. By delisting, small companies may recognize significant annual savings by no longer having to comply with all SOX provisions nor with the myriad SEC reporting and disclosure requirements.
In addition, going private may:
- Allow management to focus on long-term goals, rather than ensuring SOX compliance or managing short-term results to meet earnings expectations.
- Free majority owners and directors from SOX restrictions relating to related-party transactions.
- Provide the company with greater freedom in structuring its boards and committees and allow for additional corporate governance flexibility.
- Enable the company to regain a measure of confidentiality because the company no longer has to disclose compensation and financial details to the public; reduce or eliminate the obligation to disclose competitive business and other sensitive information; and allow the company to restructure out of the glare of the public eye.
- Reduce the potential for shareholder lawsuits. Without public shareholders, companies may reduce their litigation risk. Given today’s fault-finding environment, companies that go from public to private could avoid unnecessary time and expense spent on litigation.
How to Go Private
The transactions involved in taking a public company private can take several different forms, each with its own implications for disclosure, timing, and cost:
- A cash merger where the public company merges with a private company controlled by the majority stockholder or a management-controlled entity.
- A self-tender offer by the company or a tender offer by an affiliated entity.
A reverse stock split where the majority stockholder or group of stockholders remaining after the transaction remain invested, while minority shareholders are cashed out.
A merger entails the filing of a merger proxy statement with the SEC and a vote of shareholders. A tender offer usually requires the filling of a “Schedule TO,” which includes the offer to purchase and a letter of transmittal. These transactions often require additional third party financing since most companies do not have the liquidity or available capital to compensate minority shareholders for their shares.
If the transaction is initiated by an affiliate of the company, or if the company could be deemed to be making an acquisition of its own shares, the affiliate and/or the company is required to file a Schedule 13E-3 with the SEC. When Rule 13e-3 applies, the company is said to be “going private” under SEC rules. While SEC rules do not prevent companies from going private, they do require companies to provide information to shareholders about the transaction that caused the company to go private.
Schedule 13E-3 requires a discussion of the purposes of the transaction, any alternatives that the company considered, and whether the transaction is fair to all shareholders. The Schedule also discloses whether and why any of its directors disagreed with the transaction or abstained from voting on the transaction and whether a majority of directors who are not company employees approved the transaction.
The SEC will comment extensively on the proposed transaction, and this process can take four to six months.
The simplest way for a public company to go private is for the company to de-register its securities – a process known as “going dark.” The SEC allows a company with fewer than 300 shareholders to terminate the registration of its securities and to become a private company. Going dark is different from the other going private transactions in that no transaction or cash-out occurs, and no disclosure documents are required to be filed with the SEC or distributed to shareholders.
Conclusion
Taking a public company private may be an attractive alternative for small to mid-sized companies when the advantages of being a public company are outweighed by the costs and burdens of being public.
A public company should consider the following matters in deciding whether to go private:
- Is the company taking advantage of its public status?
- Can the company use its stock as incentive compensation or acquisition currency?
- Is the company able to access the public equity and debt markets;
- Is the company prepared for the effect that going private will have on the balance sheet and on its stock price?
- Is a shareholder lawsuit likely? A conflict of interest may exist if existing management retains an interest in the resulting private company.
- Is the company prepared for intense scrutiny by the SEC and the time involved in a merger or tender offer going private transaction?
When the circumstances are right, going private may allow a company to benefit from being able to refocus its energies on the implementation of a long-term strategy designed to result in long-term growth for the company as well as increased value for investors. Once private, the company may also become an attractive investment opportunity for private equity investors.
By Steve Kronengold and David C. Zuckerbrot. © March 2009. All rights reserved.
This article is provided for educational, informational and non-commercial purposes only. The content of this article is not intended to provide legal advice on any subject matter and should not be relied on as such.