Taking a Company Privateor “Dark”

Transaction Options for Public Companies

Presented toNational Association of Corporate

DirectorsBy

Tom BriggsBreckenridge, Colorado(970) 453-6404tombriggs@comcast.net

Matt HafterGrippo & Elden LLC(312) 704-7733mhafter@grippoelden.com

Greg Prattgpratt3651@aol.com

Going Private – What Does It Mean?

• Public private– Transaction between issuer and affiliates

intended to cause securities to be held by less than 300 shareholders of record or delisting from exchange

• Going dark– Delisting from exchange and withdrawing from

public reporting; but no significant changes in ownership and stock can be traded on pink sheets

• Private more private– Private company can become “more

private” by taking out non-affiliated shareholders and concentrating ownership

Reasons to Go Private

• Greater focus and efficiency– Assets owned by those who value them

more highly– Greater control – Better measurements of performance

• Resolve differences among stockholder groups and other constituencies

• Costs of being public outweigh benefits

When Public Ownership No Longer Makes Sense

• SOX compliance• Costs of accounting, legal, PR, D&O

insurance, etc.• Demands on directors for greater expertise

and attention• Public markets are not exclusive source

of capital• Public markets may not offer liquidity• Executive talent does not require public

status• Disclosure of company information

Candidates forGoing Private or Dark

• Market capitalization under $250 million• Book value substantially exceeds market

value• Only a few analysts covering company• Low daily average volume (under 50,000

shares)• Substantial shareholder blocks with

differing agendas; or substantial inside ownership

How to Accomplish

• Tender offer– Odd lot holders (less than 100 shares)– All non-affiliated

• Cash out merger• Reverse stock split (followed by

forward split)• Negotiated block purchases• Private equity purchase

Legal Issues

• Conflict of interest between affiliates (inside group leading the buyout) and non-affiliates (stockholders being bought out)– Affiliates on both sides of deal as buyers and

sellers negotiating to buy company from themselves

– Risk that affiliates use superior knowledge and bargaining power to dictate terms and non-affiliated stockholders do not get best deal

• Careful deliberative process often ignored

Legal Issues (con’t)

• Sale of control– May invite/require competing offers or

market test of price– Lock up arrangements cannot be too

restrictive

• Fraudulent transfer– Leverage may leave company

insolvent

Director Responsibilities

• Business Judgment Rule – judicial deference based on presumption of proper decision making– Duty of care – thorough, informed, skeptical,

deliberative; process oriented– Duty of loyalty – protection of minority

interests; includes duty of full disclosure – Good faith – subjective belief that

transaction benefits company and stockholders

Entire Fairness Test

• Applied when traditional Business Judgment Rule presumption is not appropriate

• Standard of review – “de novo” examination of:– Fair dealing – procedure– Fair price – substantive terms

Ways to Mitigate Risk

• Independent committee– Authority to negotiate at arms’ length

with no constraints imposed by affiliates• Price• Negotiating process

– Advice of independent counsel, financial advisors and other resources of the full board

– Carefully evaluate pros and cons

Ways to Mitigate Risk (con’t)

• Price must be fair compared to benchmarks– Historical market price– Liquidation– Size of premium compared to pre-

announcement prices– Traditional valuation models – cash flow

analysis and market comparables

• Fairness opinion must confirm that price is fair to non-affiliated stockholders

Ways to Mitigate Risk (con’t)

• Bifurcated stockholder vote– Separate approval by majority of the non-

affiliated stockholders

• Fiduciary “out” enabling company to accept better offer

• Disclosure of all material information – If public company, SEC Schedule 13E-3– If private company, disclosure comparable

to Schedule 13E-3

Disclosure is Key to Process

• Part of the duty of loyalty• For public companies, typically

included with proxy or tender offer materials

• For private companies, more flexible but some tender offer disclosures apply

Basic SEC Disclosuresin Schedule 13E-3

• Offers by unaffiliated parties within prior 18 months

• History of negotiations• Alternative transactions that were

considered• Positions of outside directors

SEC Disclosures

• Fairness of transaction• Description of fairness opinion and

other reports• Other considerations

– Lock-up period– Break-up fees– Fiduciary out clause– Feasibility of financing – Probability of closing

Going “Dark” – An Alternative

• Delist from stock exchange• Deregister stock with SEC• Stock may continue to trade on Pink

Sheets– Must monitor shareholders of record – broker

“kick outs” or creeping over limit– Brokers need Rule 15c2-11 information to

trade

• More likely to be covered by Business Judgment Rule

Going Dark

• SEC Form 25 accomplishes delisting and deregistration

• Suspends all SEC reporting (including SOX compliance)

• Shareholders “of record” must be less than 300 (500 in some circumstances)– If greater than 300 (or 500), then must

file Schedule 13E-3 and formally go private

Life After Going Dark• “Near term” stock price drop after

announcement (10% est.)• Reduced trading liquidity on Pink Sheets• Negative perception from employees,

customers, vendors• Reliance on private equity and debt• Less effective employee benefits• But …..

– Significant cost savings ($500K - $1.5M)– Voluntary periodic disclosure

Issues for Directors• Use a Special Committee of independent

directors• Objectively evaluate pros and cons• No direct or indirect benefit to any officer

or director• Assure fairness to all shareholders• Independent counsel and financial advisor• Fairness opinion• Run a good process – keep detailed and

accurate records of all meetings and proceedings

Practical Problems

• Timing– Risk of putting company in play and

inviting competing bids– “Upside-down” process – requires PE

group to incur expense, conduct due diligence and arrange financing before deal is locked up

– Risk of SEC review

Practical Problems (con’t)

• Transaction emphasizes process but pressure to move quickly

• Turns colleagues on board into adversaries

• Large team of professionals to manage

• Difficult to explain to stockholders that being public is no longer desirable

• No clear metrics for safety

Relevance to Other Transactions

• Stockholder derivative litigation or other litigation where directors are defendants

• Change of control transactions– Structure and conduct of auction– Approval process

Mitigation techniques are relevant to many other situations confronting public and private companies

Other Transactions

• Transactions with interested parties– Between portfolio company and PE

group (especially if PE director)– Between operating company and real

estate partnership that owns plant – Loan to company with which director

is affiliated