March 08, 2012
In our last two articles we discussed the costs and benefits of a Chinese company remaining as a publicly listed company in the U.S. and how, if a company has less than 300 shareholders, it may be able to cease reporting or, “go dark,” under the Securities Exchange Act of 1934 (the “Exchange Act”) in order to reduce its costs as a public company. In this article we will discuss the more expensive and time consuming process of “going private.” As previously discussed, the difference between “going dark” and “going private” is that when a company “goes dark”, it merely stops filing reports (e.g. 10-Ks and 10-Qs) with the SEC, but when a company “goes private” it actually repurchases the shares from its public shareholders. As a result, going private is usually more expensive and more time consuming. However, the benefit to the company is that it no longer has any remaining minority shareholders once the process is complete and it can operate as a private company.
The two most commonly used methods to go private are (a) a tender offer with a back end short form merger and (b) a long form merger requiring a proxy statement to be filed with the SEC. However, both methods share many common elements. In both cases, the company will have to file a Schedule 13E-3 with the SEC explaining the plan to take the company private, the consideration to be paid to the minority shareholders and discussing the overall fairness of the transaction. Using either method, the company or, in some cases, an affiliated group of purchasers will need to purchase the shares held by the minority shareholders. In the case of a tender offer, the company actually makes an offer to purchase back sufficient shares such that the company and its affiliated purchasers own over 90% of the company’s outstanding shares following the tender offer. Once this threshold is met, the company can then eliminate the remaining minority shareholders with a short form merger, which does not require a shareholder vote. If the insiders already own in excess of 90% of the company’s outstanding stock, they may be able to skip the first step. The second method, a long form merger, requires the approval of a majority of the company’s shareholders and, therefore, the filing of a Schedule 14A proxy statement together with the Schedule 13E. Usually, the terms of the merger will provide for a cash payment in exchange for shares of the minority shareholders in connection with the merger, thus eliminating the minority interest in the merged company.
Both of the two methods require that the transaction be fair to the minority shareholders. In its Schedule 13E-3 and Schedule 14A, the company will need to disclose why it believes the transaction to be fair and how it made that determination. As a result, we recommend that a company seeking to go private take certain protective steps to insure the fairness of the transaction. The company’s board of directors should organize a committee of independent directors to assess the fairness of the transaction. The special committee should then hire an investment bank or valuation firm to determine the fair value of the transaction. Very often, an investment bank will also be hired to assist in financing the purchase of the minority shares if the company and existing affiliated shareholders do not have sufficient cash to pay for the transaction. It is also common for the special committee to hire an independent legal counsel to advise it with regard to the transaction. It is important to note that while these protective steps are not technically required by law, failure to take these steps will substantially increase the likelihood of a shareholder lawsuit against the company and its affiliates. Such a lawsuit could potentially include a request for injunctive relief in order to stop the transaction until such time as the court determines the “fairness” of the transaction, which would substantially slow down the transaction and could substantially increase the cost of the transaction. Taking these steps will not eliminate the risk of such a lawsuit but they will greatly reduce the risk and would effectively shift the burden of proof as to fairness to the plaintiffs. It is also important to note that, as discussed above, Schedule 13E-3 requests detailed information as to the fairness of the transaction and how such fairness was determined.
A company that wishes to go private should anticipate a timeline of approximately 4 to 6 months to complete the transaction. In addition to the cost of purchasing the minority position from the shareholders, the company should also anticipate paying additional fees for investment banking, legal and valuation services.
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