Page/Link:

Page URL:

HTML link:

Citations:

• MLA style: The pros and cons of going private: going private is not a panacea for an ailing public company, but there is no question that the downsides of being public, especially for a small company, may be bigger than ever..www.thefreelibrary.com/The+pros+and+cons+of+going+private%3a+going+private+is+not+a+panacea. -a0127715163
• Chicago style: The Free Library. S.v. The pros and cons of going private: going private is not a panacea for an ailing public company, but there is no question that the downsides of being public, especially for a small company, may be bigger than ever..www.thefreelibrary.com/The+pros+and+cons+of+going+private%3a+going+private+is+not+a+panacea. -a0127715163

When Regulation Fair Disclosure took effect in October 2000, the term safe harbor was coined to describe the language that public companies now routinely use to qualify forward-looking statements. Who could foresee the rough waters that loomed ahead for those public companies, especially small-cap and mid-cap companies?

Now, in the wake of The Sarbanes-Oxley Act of 2002, the cost and exposure of being a public company has never been higher—due to the dramatically increased regulatory, insurance and compliance costs, the surge in shareholder litigation and the overall decline in the public markets. These same small public companies may have little to no research coverage and are trading at historically low multiples, with little trading activity in their stocks. The result: It’s no wonder that many companies find it once again appealing to return to the calm waters of being a private company in order to grow.

A public-to-private or going-private transaction enables a company or an investor group that may or may not include existing shareholders to acquire all or substantially all of the publicly held shares of stock of a company in order to take the company private. By going private, the company eliminates public ownership of the stock, de-lists from the public exchange on which its stock is traded and eliminates the need to comply with federal disclosure and proxy requirements.

A going-private transaction commonly takes the form of: 1) a merger, whereby the parties execute a merger agreement and the company sends its stockholders a proxy statement soliciting votes on the merger; 2) a tender offer, whereby the acquirer purchases shares directly from the public company’s stockholders; or 3) a reverse stock split, in which the public company solicits shareholder approval to amend its charter to provide for the combinations of a larger number of outstanding shares into one share, and then cashes out the small holders that are left with only fractional shares.

Why Go Private?

These days, small and mid-cap companies bear disproportionately high costs and risks associated with having publicly traded securities. According to various studies, the costs of compliance for public companies have grown 130 percent since 2001, and are expected to keep increasing in the near future. Due to the Sarbanes-Oxley regulations and increases in shareholder litigation, many smaller companies will spend between $1 million and $2 million for legal and accounting fees, insurance and investor relations.

At the same time, the cost of directors’ and officers’ (D & O) liability insurance alone has more than doubled, making it more difficult and expensive to attract and keep qualified directors and audit committee members. Sarbanes-Oxley also imposes new risks on officers requiring that they certify, in each of the company’s Forms 10-K and 10-Q, that the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. These requirements divert management’s focus from strategic initiatives to compliance.

According to The Wall Street Journal, more than half of Nasdaq-listed companies and firms with capitalization below $50 million have no analyst coverage. Some might say that not having intense analyst scrutiny is a good thing, but without coverage, many such companies are unable to attract institutional investors and face depressed and volatile trading prices—exposing them to hostile takeover risk, litigation and limited liquidity.

Going private and returning to the good old days sounds like the ideal solution, but is it? Are you a good fit for going private?

The fact is, going private is not a panacea for an ailing public company, since a public company and its management must overcome significant hurdles to effectively execute a going-private transaction. Most public-to-private candidates are fundamentally healthy businesses. Typically, these companies have a strong customer base, a defensible niche with potential growth and a stock that is undervalued relative to its peers.

Since a good part of the transaction is often financed with debt, the company should have hard assets and/or the ability to generate stable cash flow. It must be clear to third-party investors (private equity funds, commercial banks and other institutional investors) that they are going to see a return on their investment.

Historically low interest rates, and the resulting low cost of capital, will make debt service more manageable for companies that go private in the near future. However, the banks and investors financing the transaction must be ensured that the private entity will have sufficient cash flow to operate effectively, particularly because the company may be fully leveraged after financing the transaction.

The burden of financing a going-private transaction often is reduced by significant insider participation. In the best scenarios, all shareholders with meaningful ownership positions and members of senior management of a going private company agree to roll over their existing equity.

The Barriers

Before management decides to take the company private, there are three significant challenges to consider:

1. Finding the necessary funding to support the transaction can be a challenge. Financing routes run the gamut from senior debt to subordinate debt to equity investments to asset leaseback plans and employee-funded stock buybacks. And, if money is slow to come, other bidders may appear, ready to take the company out from under management.

2. Going public is an expensive proposition, but retiring from the spotlight isn’t cheap, either. Small to midsize companies can spend several hundred thousand—even up to $1 or $2 million—in legal and accounting fees. In many cases, the company must have three sets of legal and financial advisors: one each for the acquired company, the bidding group and a special committee of the public company’s board (charged with conducting the negotiations with the acquirer, protecting minority shareholder interests and ensuring that the consideration received is fair, from a financial point of view, to the public shareholders). Various Securities and Exchange Commission (SEC) filings require extensive, detailed disclosures, which can generate significant additional costs.

3. Going private is not a quick fix. It can take at least six months to complete a simple going-private deal and up to 18 months for a complex deal. The time involved in selecting the special committee and completing the transaction for SEC review can be considerable, as well. Hiring corporate finance professionals with expertise in this area can help cut down the time this process takes, so it makes sense to get experienced partners on board early in the process.

How important are partners who add value? In any going-private transaction, the stakes are high. Due to the cost, time and risks involved, it is important that all participants pursue the transaction with the highest level of commitment, trust and integrity. Management and the board must carefully evaluate the track record and style of the organizations that will deliver the financing, legal advice, securities filings and fairness opinions that are required for a successful going-private transaction.

These outside advisers must be committed to seeing the public company safely through to becoming private once again, and be partners who are willing and able to deliver value beyond the transaction.

And is the private life indeed right for your company? For many small and mid-sized public companies, a going-private transaction is a sound strategy. Out of the public spotlight, a company is free to concentrate on successful long-term business goals. But it’s not a cheap or an easy process, and again, it’s no panacea; it needs to be weighed against a myriad of potential pitfalls, and it can’t change a troubled ugly duckling into a swan.

RELATED ARTICLE: Music Publisher Reprises Life As a Private Company

In 2003, Integrity Media, a Christian media/communications company focused on publishing and distribution of Christian music, books and other related products, faced a crossroads. The Sarbanes-Oxley Act of 2002 had created extensive new reporting and compliance requirements, and soon the regulatory burden of life as a public company looked as if it would outweigh the diminishing benefits of being public, especially for a small-capitalization company like Integrity.

Integrity’s investor relations, legal and accounting expenses were expected to dramatically increase in 2004. The company further projected that in 2005, compliance with Sarbanes-Oxley would require additional legal, audit and regulatory fees. In addition to these significantly higher operating costs, management felt that remaining public would divert its attention from running the business and focusing on long-term strategic initiatives for future growth.

After careful consideration, Integrity’s board of directors thought it was advisable, fair and in the best interest of its public stockholders to take Integrity private and create a liquidity event for non-management shareholders that would not have been possible if Integrity had simply deregistered its common stock.

Although the public-to-private transaction would require a significant amount of time and near-term expense, Integrity’s board and management took smart steps. They created a special independent board committee to protect the interest of the public shareholders. Management also determined that it would roll the vast majority of its stock into the new privately held company.

Through the company’s current senior lender, Integrity developed a relationship with a private investment firm, Key Principal Partners (KPP), which provided the $15 million investment to fund the purchase of the company’s non-management shareholder stock. Together with the other advisors, the group provided the necessary expertise and capital to complete the transaction. One of KPP’s vice presidents was also elected to Integrity’s board.

As a private company, Integrity will no longer have to divert significant funds and resources to comply with Sarbanes-Oxley. Today, Integrity Media has a bright future, selling music and videocassettes, compact discs, printed music and Christian books. The company maintains one of the largest revenue-producing catalogs in the industry, with more than 2,800 song titles.

Transaction Partners:

Key Principal Partners (www.kppinvest.com)—Private investment firm

LaSalle Bank (www.lasallebank.com)—Senior lender

Alston & Bird, LLP (www.alston.com)—Legal counsel

John Sinnenberg (JRS@keyprincipalpartners.com) is managing partner of Key Principal Partners, an investment firm based in Cleveland and an affiliate of Key-Corp, the bank holding company.