Corporate & Securities Blog

Private Company Stock Buybacks and Tender Offers: Useful Tools If You Follow the Rules

In assessing whether voluntary stock repurchases or tender offers may make sense for a privately held company, there are several business and legal factors to consider. Public companies regularly use open-market stock repurchase programs, individually negotiated stock repurchases and issuer tender offers for various reasons. These include acquiring company shares they believe are undervalued, providing additional liquidity opportunities for their investor base and accommodating certain shareholders looking to reduce or exit their investment.

Although it is not nearly as common for private companies to pursue these techniques, there are a number of situations in which private companies may use them to accomplish similar goals. Read on for an overview of key business and legal considerations that private companies should keep in mind when contemplating the use of a stock repurchase or tender offer.

Reasons to Pursue Buybacks or Tender Offers

Many companies choose to remain private or delay their initial public offerings (IPOs) for multiple reasons, including periodic softness in the IPO market; a desire to further grow their businesses to support increased valuations for either an IPO, additional private capital infusions or sale of the company; and a reluctance to incur the direct and indirect costs of being a public company. Although private company investors generally have become more accepting of these choices, there are often circumstances in which investors (particularly early-stage venture capital investors) and employees (who often hold meaningful amounts of shares, options and restricted stock) are looking to monetize some or all of their investment in the near term rather than wait for an IPO or other exit event, and companies are willing to consider alternative ways of providing liquidity to them.

In addition, companies choosing to stay private for a longer period often have a larger number of shareholders than pre-IPO companies have had in the past. In order to facilitate later-stage investments and/or prepare for an IPO, companies may benefit from reducing the number of shareholders (particularly smaller shareholders), eliminating one or more outstanding classes or series of securities, or both. Later-stage investors may want a simplified capital structure to ensure their superior rights, and, as a practical matter, a company with few shareholders and a simplified capital structure can reduce the number of issues to be resolved in connection with undertaking an IPO. In both cases, selective repurchases or tender offers may provide ways to accomplish these goals.

Buybacks vs. Tender Offers: Which to Choose?

The choice between share repurchases from one or a number of shareholders or undertaking a broader-based tender offer is usually driven by several considerations, including the company’s goals, the preferences or demands of current and potential investors, the availability of financing and regulatory concerns. Although each situation is different, as a general matter, the choice between share repurchases and tender offers may be summarized as follows:

Providing a liquidity opportunity to one or a few shareholders on individually negotiated terms and not necessarily at the same time. Share repurchases are likely to be the better choice.
Providing a liquidity opportunity to a larger number of shareholders. A tender offer is likely the better choice and may even be necessary to comply with U.S. Securities and Exchange Commission rules, as discussed below.
Cleaning up capital structure to accommodate new investors or as pre-IPO preparation. Either share repurchases or tender offers, depending on the circumstances.

Securities law compliance is one particular driver of the choice between repurchases and a tender offer. Although a majority of the SEC’s rules covering tender offers apply only to public companies, a number of them apply to any tender offer — public or private company — and complying with those rules may impact a company’s choice of approach.

Legal Compliance: Is It a Buyback or Tender Offer?

Before pursuing share repurchases or a tender offer, it is advisable to consult with counsel regarding regulatory, disclosure and related issues. A company’s charter, bylaws, shareholder/investor rights agreements and similar governing documents may limit and, in some cases, even prohibit the acquisition of its stock. In addition, state corporation laws may inhibit a company’s ability to effect share repurchases or tender offers, as acquisitions by the company of its securities are considered to be returns of capital (similar to cash dividends), and state corporation laws impose certain limitations on a company’s ability to return capital.

Compliance with federal securities laws and SEC rules can also present challenges for private companies. Determining whether planned share repurchases have risen to the level where they could be deemed a tender offer is a critical step before proceeding with any share repurchases. Other than the potential disclosure issues discussed below, no federal securities laws or SEC rules directly govern share repurchases. Specific SEC rules apply to private company tender offers, but no bright-line test separates share repurchases from tender offers.

Courts considering the issue apply what is commonly referred to as the Wellman test to define the boundary between repurchases and tender offers. The Wellman test looks at eight factors in analyzing whether repurchases rise to the level of tender offers that trigger the SEC’s tender offer rules:

  • An active and widespread solicitation of shareholders to acquire their shares.
  • The solicitation for repurchases is made for a substantial percentage of the company’s stock.
  • The offer to purchase is made at a premium over the prevailing price/value of the stock.
  • The terms of the offer are firm rather than negotiable.
  • Completion of the repurchases is contingent on the tender of a fixed number of shares, often subject to a fixed maximum number to be purchased.
  • The offer is open only for a limited period of time.
  • The offerees are subjected to pressure to sell their stock.
  • Any public announcements of a purchasing program precede or accompany the rapid accumulation of large amounts of the company’s securities.

Not all of these factors are relevant (or as relevant) to private companies, and no particular factor or group of factors is determinative, so even with these guidelines, it is not always clear when repurchases have crossed the line into a tender offer. Most companies that want to avoid compliance with the tender offer rules limit the number of shareholders from whom they repurchase securities and individually negotiate the terms of the repurchase with each shareholder. These techniques counter several of the key factors cited in the Wellman test.

If possible, a company may want to preserve flexibility and avoid the distraction and expense of complying with these requirements and related private tender offer best practices, such as preparing a formal offer to purchase. A company in this situation may prefer to achieve its goals through individually negotiated repurchases between each selling stockholder and the company.

If the repurchases, either by design or by application of the Wellman test, trigger the tender offer rules, the company will be required to adhere to the following requirements:

  • The tender offer must be held open for at least 20 business days.
  • The number of shares subject to the offer and the amount of consideration being offered cannot be changed unless the tender offer remains open for at least 10 business days from the date that the notice of the change is provided (with some limited exceptions).
  • Consideration for the tendered shares must be paid promptly upon completion of the tender offer. (As a practical matter, this means the company must have the cash on hand by the closing of the offer.)
  • The tendered shares must be returned promptly to shareholders if the tender offer is terminated or withdrawn prior to completion.
  • Any extension of the tender offer must be announced to all holders, and the extension notice must inform them of the amount of shares already tendered.
  • The company must disclose its position with respect to the tender (meaning that it must recommend “for” or “against” shareholders tendering their shares or state that the company does not take any position).
  • Repurchase transactions outside of the tender offer while the tender offer is open are essentially prohibited.
  • Disclosure of the issuer’s position is required with respect to the offeror’s tender offer for the issuer’s securities.
  • Anti-fraud rules apply, such that the company should not pursue tender offers (or repurchases generally) when it is in possession of material nonpublic information.

Disclosure Considerations

Because the SEC’s anti-fraud rules generally apply to repurchases and tender offers specifically, in the context of negotiated repurchases and tender offers, the focus of the anti-fraud rules is primarily on information asymmetry. In other words, does the company have in its possession material undisclosed information that the shareholder would reasonably need to know to make an informed decision as to whether to sell or tender the shares to the company?

In public company tender offers, SEC rules mandate that certain disclosures be provided to recipients of the tender offer. Although those mandates do not apply specifically to private company tender offers because of potential liability under the anti-fraud rules, private companies undertaking tender offers usually provide some sort of disclosure documentation to recipients of the tender offer. The types of disclosure, including the level of detail, will vary from situation to situation. Evaluating the appropriate level of disclosure in repurchase and tender offer situations is substantially similar to evaluating the appropriate level of disclosure if the company was offering its securities to investors for purchase, and factors like the level of sophistication of the shareholders and the shareholders’ access to information about the company are particularly relevant to the evaluation. This is another area where consultation with securities counsel is advisable.

While different companies take different approaches, the disclosure-related documentation for a private company tender offer typically consists of the following:

  • An Offer to Purchase, which contains the specific details of the offer, including the total number of shares proposed to be purchased, the offer price, allocation methodology (if the offer is oversubscribed and not all tenders will be accepted in full), the termination date of the offer and detailed instructions on how to participate.
  • A disclosure document that may be a part of the Offer to Purchase.
  • A letter of transmittal for use by participating shareholders to tender their shares.

Pricing and Other Considerations

Public company tender offers are often priced at some premium to the current market price of the shares in order to encourage shareholders to tender. The pricing of private company tender offers varies based on the surrounding circumstances. Because the purpose of the tender offer is often to provide liquidity opportunities to current shareholders, a price at or near the current fair market value (often determined by the latest 409A valuation or some other observable value, such as a recent capital-raising transaction) is often used. One practical pricing consideration involves an assessment of the company’s planned timing for an IPO: If the tender offer price is meaningfully lower than the IPO price and the tender offer and IPO are close in time to one another, the company may face complaints from shareholders.

In addition to the pricing considerations, it is important to take into account other agreements, arrangements and understandings that are in place and may impact the ability of the company and/or some of the shareholders to pursue and complete a tender offer. Investor rights and similar agreements could limit or prohibit company buybacks or require approvals or waivers from certain security holders. Those agreements may also include rights of first refusal or similar rights that could be triggered by a tender offer without the agreement or waiver of the rights holders. It is important to review all relevant governing documents and key agreements for issues that may impact a tender offer.

Meet the Author

Thomas L. Hanley
Thomas Hanley focuses his practice on advising public and private companies on corporate and securities law issues, including capital-raising transactions, mergers and acquisitions, corporate governance, SEC compliance and corporate litigation. Tom also counsels management, in-house counsel, boards of directors, board committees and investors on fiduciary duty issues, takeover defense, proxy contests/contested elections and related issues.

thanley@stradley.com
215.564.8577

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