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Management Buyout (MBO) Transaction: What Does 'Going Private' Mean?

 


Generally, a company is said to be “going private” when a buyout group, usually management of a public company or a third-party affiliate, cashes out enough shares to allow the company to de-register its stock with the Securities and Exchange Commission (the “SEC”) and de-list the stock from the company’s stock exchange. 

For purposes of this article, we will assume generally that a “going private” transaction would take the form of a management buyout, or “MBO,” in which corporate management initiates the buyout with financing supplied by an LBO (leveraged buyout) fund or similar investor. Private equity funds that various industries are now “chasing” good deals and seeking out retired management for new investments. There is plenty of money available from funds that understand the business and have reasonable expectations.

 

The Primary Reason to go Private

Importantly, going private also enables a company to shed the ever-growing regulatory burdens of being public. Public status was always a reporting and record keeping burden, but the Sarbanes-Oxley Act of 2002 (“SOX”) substantially increased the costs of being public. SOX requirements have prompted a number of companies in other industries to go private or at least seriously consider the option.

 

Among the Many New Requirements Under SOX are the Following:

  • Companies must establish and maintain review procedures for “internal control over financial reportingperhaps the most costly aspect of SOX. One recent survey estimated that the annual costs of compliance with this provision alone averaged more than $4 million per company; 

 

  • The chief executive officer and chief financial officer must certify that the company’s periodic reports are not materially misleading and that internal control over financial reporting is adequate (with potential personal liability); 

 

  • Company loans to directors or executive officers are prohibited; 

 

  • Periodic and beneficial ownership reporting has been accelerated; 

 

  • New reporting rules limit disclosure of non-GAAP financial measures and require enhanced disclosure of off-balance sheet arrangements; 

 

  • Companies must maintain procedures for audit committee preapproval of audit and non-audit services, as well as “whistleblowerguide-lines; and 

 

  • Companies must establish a code of ethics and ensure that the audit committee includes an “audit committee financial expert” (or explain why they have not done so).
 

Shortly following the adoption of SOX, the New York Stock Exchange, Nasdaq and the American Stock Exchange revised their listing standards to establish numerous corporate governance requirements and restrictions, including rules that make it more difficult for a director to be deemed “independent.” The recent corporate scandals that precipitated SOX have also contributed to a significant increase in the cost of acquiring and maintaining director and officer liability insurance – and made it more difficult to find and retain qualified directors to serve on the board. 

 Besides the enhanced regulatory concerns and expenses facing public companies, many smaller public players have been unable to fully realize the advantages of being a public company. Although some public companies benefit greatly from the increased access to capital, the stock of some never sold for much more than the initial offering price and in some cases, less. 

Even successful offerings do not always attract a large institutional shareholder base and broad analyst coverage. The capital markets are effectively closed for many small companies that are “in the orphanage– Wall Street slang for companies whose stock is so thinly traded that they are unable to attract the analyst coverage necessary to enable them to raise capital and fuel continued growth.


An Overview of the Going Private Process

For some companies, the challenges of new competitive era that has emerged in the 21st century, coupled with the regulatory burdens and costs flowing from the Sarbanes-Oxley Act of 2002, simply make it impractical for these companies to continue their public existence. By exiting the public securities market, these companies believe that they can recover the value of a business that is undervalued in the public market, reduce (or even eliminate) the quarterly pressure to “meet earnings,operate with more confidentiality and less public scrutiny and perhaps even recognize certain tax benefits that are not typically available to a public company. As noted earlier, a private company may be better able to survive in an already highly competitive industry that is faced with new modes of competition, a steady increase in FCC-authorized stations and a splintering audience base. 

The decision to go private, however, cannot – and should not – be made in haste. The board of directors has fiduciary duties of loyalty, care and good faith to both the company and its shareholders, and a decision to go private can backfire if it is not made with appropriate consideration of all relevant factors. Further, simply because a company believes it is too expensive or burdensome to continue as a public company does not mean that it will thrive as a private company. Problems stemming from a company’s inefficient operations, inconsistent cash flow, slim margins, or a weak advertiser base will not be miraculously resolved simply because a struggling public company becomes private. 

A going private transaction can be accomplished in one of several ways, such as by a tender offer, a cash-out merger (or a combination of the two), or a sale of assets. A true going private transaction is always done for cash. Regardless of the type of going private transaction or the identity of the buyout group, the company must adhere to a number of important detailed substantive, procedural and regulatory requirements. 

We mentioned above the importance of working through and resolving the directors’ fiduciary duties early on in the process, which requires a focus on both substantive and procedural factors. One of these factors will, in most cases, include the appointment of a special committee of disinterested, independent members of the board of directors to ensure that the going private transaction is fair to the company and the public shareholders and that the buyout group pays a fair price for the company. It is the responsibility of the special committee to ensure that fair dealing and “arms’ length” negotiations occur, even (and especially) if the special committee is dealing with members of management. 

Since the special committee (or, in the absence of the special committee, the independent directors) will ultimately be responsible for making a careful and informed decision about whether to engage in a going private transaction, it is important that they fully understand the issues surrounding the valuation of the company and the terms, conditions and pricing structure of the proposed transaction. This cannot be stressed enough, since part of the company’s public disclosure requirements will consist of a detailed description of all steps that were taken to ensure that the interests of minority shareholders were protected and that the price paid for the shares was fair. The involvement of the special committee is critical in helping the company establish fairness and the semblance of armslength negotiations.

Even if the directors or the special committee determines that an MBO is in the company’s best interests, it is important that the management group carefully weigh the pros and cons of the transaction before engaging in a going private transaction. A going private transaction is not a quick process, requires a great deal of intellectual and financial capital and will be heavily scrutinized by both the SEC and the plaintiffs’ bar (which will not hesitate to file a lawsuit if it appears that the MBO is not in the best interests of the shareholders or is procedurally deficient). The members of the buyout group should have the same strategic objectives and should be in agreement on the means to achieve them in order to maximize the perceived benefits of exiting the public marketplace. 

In addition, there are numerous conflicts of interest that arise in an MBO because the interests of the management buyout group and the company are not aligned. The company (specifically, the independent directors or special committee on behalf of the company) must endeavor to get the best price possible for the company’s shares, while the management buyout group has an interest in paying as little as possible for those shares to complete the going private transaction. 

Since the members of management that comprise the buyout group will likely remain employed by the company during the going private transaction, it is important that they (and the board) recognize at the outset the difficulties that such a situation can create. It is therefore critical that the members of management who wish to conduct an MBO request and obtain authority from the independent directors or special committee prior to pursuing the going private transaction. 

https://www.linkedin.com/in/khalil-g-58704713b/ 

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