Venture capitalists have long trumpeted the superiority of public exits, but that glossy refrain has grown tinny in 2002. From falling stock prices to strengthened reporting regulations, many small public companies have begun chafing under their own SEC registrations. Perhaps now is the time for these companies to reverse course and go private with the aid of venture capital firms.
Consider, for example, a company that got venture financing in the mid-1990s. The deal went through several venture rounds before a public offering in 1998. The founders got some money out, but left a lot to ride in the public market. The venture group exited with a 250% compounded annual return. After the offering, the stock rose from its initial price of $10 to peak at $25. Then came the crash and the stock now trades for less than $1.50 per share.
For this company, being public may be more of a bother than a benefit. Should it go private? Very possibly, yes. The expense and management risks of staying public far outweigh the minimal benefits provided.
Going-private is affected by several broad legal concerns. The basics involve SEC regulations, primarily Rule 13(e), which governs disclosure to shareholders, as well as corporate law notions of how to fairly deal with shareholders.
These corporate law concepts vary somewhat from state to state. Delaware has adopted a standard requiring “fairness in the transaction,” while other states like Massachusetts require that the transaction meet a legitimate “business purpose” test.
Know The Law
Structuring a going-private transaction from a corporate law perspective can influence the likelihood that the transaction will have a successful outcome.
Certain structures, like reverse stock splits, may require a different level of corporate approval-depending on the state law involved-than would a merger or an asset sale. Lock-up agreements can be pre-negotiated to ensure success of the transaction.
A tender offer may be used in instances where large block shareholders own insufficient shares. Additionally, with Delaware corporations, a tender offer may be necessary to obtain share ownership in excess of 90% in order to force a mandatory merger on minority shareholders.
To minimize the risk that the transaction may be questioned as being unfair to minority shareholders, an independent and disinterested committee of the company’s board of directors should be established to negotiate with management a fair price to be paid for shareholders’ stock. This committee also would engage independent counsel and financial advisers to advise the committee on the fairness of the offer.
The financial advisers provide the independent committee with a report validating the fairness of the price, and this report is presented to shareholders in the public filings required by the Securities & Exchange Commission. In some states, such as Delaware, use of the independent committee actually shifts the burden of proof of the fairness of the transaction to anyone seeking to challenge the deal.
In almost all instances, the going-private transaction will involve some form of leveraged buyout and, depending on the company’s cash resources, an outside capital source may be necessary. This is where the venture world can participate and profit.
Having sold the company to the public at a high price, the venture capitalists can now finance the going-private transaction at a depressed price. The venture company may be positioning itself to recover a substantial profit when the market reverses course and the company is again taken public, sold or some other liquidation event occurs.
Jonathan Bell is a corporate finance attorney in the Boston office of the international law firm of Greenberg Traurig LLP.