Fred recently shared his expertise on taking a client private and what M&A Advisors should consider.
M.A.: What company or firm issues should M&A Advisors consider before taking a client off the exchange's?F.J.: There are a wide variety of legal issues for both the company and the directors, especially the outside directors. All of these, however, can be reduced to 4 words, to wit fair price, fair dealings. The entire price negotiation needs to be arms length, and fair to the shareholders. The process also must not have any secret agendas, like treating insiders and management in any preferable way to the detriment of the shareholders. As a result of this complete transparency concerning fair price; fair dealings, there is a definite added importance placed upon the independent corporate directors.
Since these independent directors have the full burden to protect first and foremost the interests of the stockholders, the inside directors may well have a bias towards the interests of management, and their own ongoing roles with the company. The outside directors owe a strong duty of loyalty solely to the shareholders. Therefore the M&A Advisor in a transaction must clearly understand the roles each Board of Directors member plays, and be confident that they will uphold their fiduciary obligations. Otherwise, the transaction may subsequently become entangled in all manner of legal problems, which in turn may cause serious problems for the investment banker representing the transaction.
M.A.: What is the process should Advisors take on such a client?
F.J.: The short version is to be certain the client public company has excellent and experienced securities counsel to guide it through the legal hurdles, while the investment bankers find and negotiate with appropriate ready, willing and able new investors. In its most basic form, this transaction is simply a recapitalization, i.e. an institutional investor normally acquires the interests of numerous public investors.
That said, one of the most common mistakes investment bankers make, not only in this sort of a transaction but in too many of their dealings, is that they do not take enough time to thoroughly research the circumstances surrounding the proposed transaction before they ever get involved themselves. Does the company have a logical reason for wanting this sort of transaction to occur? Do they have the appropriately skilled legal counsel representing them? Do the independent directors have separate legal counsel representing them? Is the company current and compliant with all their accounting and Sarbanes-Oxley requirements, assuming they need to be?
Are all the legal, EPA, etc. corporate skeletons (almost every business has at least a few of these) understood? If the answer to any of these is negative, then the investment banker needs to fully understand why the circumstances prevail, and what will be done to resolve these matters. Without that clear understanding in advance, the proposed transaction will either eventually fail, or at least be seriously delayed until this matters can be appropriately resolved.
M.A.: What stage are companies typically at when you work with them (are they listed on the exchanges for long or are they usually small-cap firms that have recently decided that the market conditions don't work for them)?
F.J.: Take-private transactions range from multi-billion dollar New York Stock Exchange companies to quite small OTC Bulletin Board and Pink Sheet public companies.
Size per se is seldom the determining factor, other than the obvious point that there are many more smaller companies than larger ones in the USA. In fact, given the climate of today's economic times and conditions, of the roughly 16,000 public companies in America , it is probably fair to say that 10,000 or so of those companies should not remain public. The reality is that they no longer have an investor base that is loyal and committed to the long term success of the company. Too often the trading volume has slipped below 100,000 shares per day. The stock has too often fallen below $10 per share, and even $5 per share. There is no independent analyst coverage. The company may well be in an "out of investor favor" with the market. As a result the stock value of the company has fallen to the point where it is no longer a useful currency for either raising new capital or making acquisitions. Either way its use would cause illogical dilution.
On top of that, the company is paying huge fees for the privilege of being public and getting absolutely no benefit from that cost. Prudent Boards of Directors will call investment banking professionals to assist their companies when they first realize these negative conditions either do or are about to exist. Too often, however, we get approached months after the trend downward is fully established. While a good advisor can help stop the downward slide, if we arrive too late often significant shareholder value has been lost.
M.A.: What are some of the legal issues that Advisors are most likely to run into?
F.J.: The legal issues are myriad. The entire go-private transaction requires very competent and experienced legal counsel. I emphasize "experienced". This is not the corporate moment when you want a rookie representing you. There are numerous Sarbanes-Oxley pitfalls that require careful guidance throughout this process. In addition, the Board of Directors needs to focus on objective representations, with emphasis on the precarious position of the outside directors. We usually urge the outside directors to seek separate counsel during this process.
M.A.: Where are you seeing such exits from (US, EU, Asia, etc� or all of the above)?
F.J.: The take private movement exists with all stock exchanges worldwide, though in the USA the practice is more common. Worldwide, however, the cost/benefit ratio argues that there is often little or no merit to remain public. While we don't have any precise statistics on this matter, our careful monitoring and international contacts suggest that as is the case in the United States, it is estimated that about 60% of all public companies worldwide shouldn't be public today given their marketplace and financial circumstances.
I stress that percentage to be a very unscientific amount, but we believe it is about correct. The simple fact is that for the majority of public companies worldwide, the "being public" process has not been a long term financial benefit. It may indeed be a great ego benefit to certain owners and managers. It probably was a logical thing to do and be at one time. But taking a longer view, for most companies the reality is that for the management time and on-going expense, as well as the legal effort and risks involved, it has been and probably will continue to be a poor investment.
M.A.: What are some of the particular concerns of shareholders?
F.J.: In addition, a gnawing concern for all shareholders is, "Are we as shareholders getting a fair deal in this buyout, in fact are we getting the best available deal given the market and company conditions?" It all goes back to fair price; fair dealings. Are we as shareholders being treated equitably, given market conditions? Better yet, is there a better value for the shareholders elsewhere?
This is exactly the place where Boards of Directors get into problems, because indeed there often is a conflict of interest on the board, not withstanding their obligations to the contrary. The inside board members are often managers of the company who want to keep their jobs. As a result they are oriented towards finding a new partner who will benefit them the most long term.
The outside directors, at least those who are truly independent, must therefore see through that situation and become even more strenuous in protecting the shareholders. Often this makes for very combative board meetings. This is also exactly why as the investment banker to the transaction, we urge the independent directors to seek their own legal counsel. With that and the proper independent fairness opinions valuing the offer(s), fair price; fair dealings have the best chance of happening.
M.A.: What type of capital is available to those who exit exchanges; and how much of an average improvement do they see on the bottom line? Does this vary by industry?
F.J.: The benefits to a public company that does go private are numerous. One of the biggest issues is that they are now relieved from quarterly reporting, and as a result can accomplish long range planning and goals, instead of having to have a short term perspective. Of course, they often save millions of dollars in compliance and reporting costs. Significantly, the company, as a result of going private, usually now has a much deeper-pocket partner that can help them grow out of the public fishbowl.
Today, there are many hundreds of private equity groups, hedge funds, and strategic buyers worldwide who are capable and experienced in engaging in a take-private transaction. A word to the wise, however, is to prefer working with those investors who are experienced in this process. As with using experienced attorneys, the transactions go smoother, quicker, and with a higher probability of closing if all parties are knowledgeable and experienced with this process. An investment banker who likewise has been through this process before should be able to facilitate this process efficiently.
To that end, the investment banker will be very deliberate in their early due diligence process, because as has been emphasized before, it is imperative that a quality team of experts is assembled to represent a ready, willing and able public company. If all of that is accomplished very early in the process, then there is an abundant supply of equity to close these transactions. Senior debt financing remains tight with limited leverage worldwide. As a result, investors are using a greater equity percentage than has been seen in many years. 60% to even 100% equity is not unusual today. This is done to get the transactions closed, with the goal to refinance at a later date. For the once public, now private company, their world changes dramatically.
Those millions of dollars and thousands of hours of time spent on being public can now be invested in building a company. The new investor should logically have the capacity to support internal and external corporate growth. This certainly includes going on an acquisition campaign, seeking under-funded targets that can be acquired at bargain prices.
We see those newly private companies growing rapidly even in this environment via acquisitions and mergers of former competitors, suppliers, and occasionally even customers. While the percentages may vary by industry, the fact is the trend is positive for those companies that do go private now.
M.A.: Thanks Fred.
This interveiw appeared in M&A Alerts March 26, 2010
The M&A Alerts is published bi-monthly by The M&A Advisor
Roger Aguinaldo, CEO & Founder
Phone:718.997.7900 • info@maadvisor.com
Fred Jager, President
Hunter Wise Financial Group, LLC
(949) 732-4100
fjager@hunterwise.com