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Private Equity

3 Biggest Challenges of Take-Private Transactions

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About one year ago, Pitchbook declared that private equity-backed take-private deals were making a comeback. It seemed strange, in part, because take-private deals can be very challenging to complete.  Private equity firms might also avoid bargain hunting in an inflated public market, although fierce competition for returns forces funds to find creative paths. There actually are plenty of reasons take-private deals could be an attractive proposition in the second half of 2016, but private equity players need to know which obstacles stand in their way.

Why Go Private?

Investors and corporate actors show a reasonable appetite for public-to-private transitions. The private market’s lack of disclosure requirements — and reduced personal liability — are valuable commodities for directors and executives. Private companies maintain more flexible operations without the scrutiny of public markets. With a private status, competitors don’t get access to salary figures or quarterly financial statements.

To that point, strong companies no longer need public markets for fast financing or brand recognition. Look no further than Uber. Led by CEO Tranvis Kalanick, Uber already raised more than $8 billion in venture capital and is valued at more than $62 billion.

Increasingly, today’s shareholders and financial media emphasize short-term, quarter-based analysis. Prudent managers would likely jump at the opportunity to shift to a longer-term, sustainable decision-making process.

A few years ago, Grant Thornton published a white paper on running your business like a marathon, not a sprint. Several major take-private dealmakers cited this paper (or its inspiration from the Harvard Business Review) as motivation, including Dell’s 2013 transition, then the largest corporate privatization in history. (Dell came back last year and helped put together the new largest take-private in the history of buyouts.)

Going private is not easy. The process can be long, complicated, and full of annoying obstacles. Here are the three biggest hurdles dealmakers have to clear before taking a public company private:

1.   Handling the SEC and Judicial Review

Take-private deals are challenging to structure, compared to most deals. Topping the list of challenges are the SEC’s rigorous disclosure requirements. Going-private is the only private equity transaction where regulators actively opine on price. “These are very difficult transactions,” says turnaround ace Paul Gallagher, CEO of Hirsch Solutions, Inc. “You have to detail everything, almost like a public transaction.”

The SEC recently put a squeeze on take-private transactions, emphasizing potential breaches of fiduciary duty or other subjective legal quagmires. Consequently, dealmakers and their counsel have to double down on their diligence efforts and Regulatory Compliance to avoid damaging exposure. The courts can be equally demanding.

Take, for example, the “duty of entire fairness” standard, which is required by many state jurisdictions, including corporate-friendly Delaware. Under this standard, reviewers can (and often do) scrutinize everything. Dealmakers might have to defend, among other things, the timing of the transaction, how it was structured, initiated, negotiated, disclosed to stockholders, and how approval was obtained. Each one of these concepts is nebulous enough to be a potential landmine.

Other disclosure obligations include:

  • All communications with investors and security analysts prior to announcement. Any possible announcement which might be interpreted as the initiation of the take-private process.
  • Any and all solicitations (broadly defined); proxy-related communications; presentations to security analysts, holders, or employees; tender offers (filed under correct schedules), which must remain open for at least 20 business days, generally.
  • Detailed notes of every contact and every discussion relating to a deal — including all persons present, all topics discussed, and the various decision-making processes.
  • Every engagement with a financial advisor or consultant, including the terms of engagement, valuation methods used, and especially any conflicts of interest.
  • Descriptions of all purposes, alternatives, potential effects, and reasons for transactions.
  • Any reasons for rejection of any offers received, any dissents or abstentions by shareholders or directors, and descriptions of factors supporting “fairness.”

Obviously, these are very tedious requirements and it’s easy to misstep. Intelligent dealmakers will lean on experienced support for everything from simple note-taking to minimizing litigation exposure.

2. Structuring the Deal

There are really two dominant take-private deal strategies: merger agreement or tender offer (leveraged buy-outs, or LBOs, are done as merger agreements). Each deal is different, but cash tenders need to be considered even if the merger agreement ultimately seals it. (The SEC does provide a quick rundown of legal deal structures.)

Mergers are the most traditional take-private structure, although cash tender offers are today’s method of choice, having experienced a resurgence in the wake of additional regulatory scrutiny and shareholder activism. Mergers are negotiated between the acquirer and the target board of directors, after which shareholder’s vote to approve or reject the deal.

Tender offers act a little like hostile takeovers (indeed, most of them were hostile takeovers before the SEC passed the “Best Price Rule” in 1980). In a tender, the acquirer floats a per-share price to the target shareholders. Each shareholder has the option to sell their stake at the offer price. Often times, shareholders receive a premium from the acquirer to expedite the process; the dealmaker sacrifices costs to obtain faster results.

Tenders become more attractive if the target has a large retail shareholder base (retail investors are notoriously absent around vote time, adding uncertainty to merger votes). “If only 49% of shareholders vote, even if 100% of those are for the measure, it won’t pass,” Gallagher points out. “You always need 50% of the total outstanding shares, plus one.”

Sometimes it doesn’t have to be that complicated. In Delaware, for example, any owner with a 90% share base can force minority shareholders to accept any deal, so long as it is executed at “fair value.” For most deals, though, timing is important and tenders help with timing. If possible, the dealmakers should launch the tender offer at the same time they file with the SEC.

3. Timing the Deal

“Timing is extremely important, obviously,” says Gallagher, reflecting on a take-private deal he helped structure after the downturn in 2008. “Our case was pretty straightforward,” he continued. “We simply didn’t need access to the public market after the Great Recession. Our decision was easy, but not all of them are.”

The private equity industry is more attuned to market timing than most. Exit timing is a constant pressure for firms, and this is true whether taking a private company public or vice versa. Unfortunately, bidders and dealmakers can not always control when a deal takes place.

It is extremely helpful to have a friendly board of directors. If the takeover is hostile, the target board has many delaying tactics at its disposal. These can frustrate the bidder, and risk pushing the price to uncomfortable levels. Then there’s the SEC review. If the dealmaker has all of his or her ducks in a row, the review and proxy revision process (often substantial and seemingly petty) might only take four-to-six weeks. It is not uncommon for tender offer statements to receive direct amendments or other revisions from the SEC.

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