Going private buyout

What Is a Going Private Buyout?

A going private buyout is a transaction where a publicly traded company's shares are acquired by a private entity, typically a private equity firm, a group of investors, or the company's existing management, resulting in the company being delisted from public stock exchanges. This type of transaction falls under the broader financial category of corporate finance. The primary goal of a going private buyout is to transition a public company back into private ownership, often to restructure operations, make long-term investments, or avoid the scrutiny and regulatory burdens associated with being a public entity. A going private buyout fundamentally changes a company's ownership structure and its reporting requirements.

History and Origin

The concept of taking a company private has existed for many decades, but it gained significant prominence with the rise of private equity in the latter half of the 20th century. Early leveraged buyouts (LBOs) in the 1980s, which often involved taking public companies private, became a hallmark of this era. These deals frequently used substantial amounts of borrowed capital to finance the acquisition.

A notable example of a going private buyout in recent history is the acquisition of Dell Inc. by its founder Michael Dell and private equity firm Silver Lake in 2013. This $24.4 billion deal was one of the largest leveraged buyouts since the financial crisis.¹³ The decision to take Dell private allowed the company to undergo a significant transformation away from the declining personal computer market towards business software and technology services, without the constant pressure of quarterly earnings reports and public market scrutiny.¹² Michael Dell explicitly stated that the private structure would provide the "time and flexibility to really pursue and realise the end-to-end solutions strategy."¹¹

Key Takeaways

• A going private buyout transforms a publicly traded company into a privately owned entity.
• The transaction typically involves a private equity firm, a group of investors, or existing management buying out public shareholders.
• Companies often pursue a going private buyout to gain operational flexibility, reduce regulatory compliance costs, and focus on long-term strategic goals.
• These transactions frequently involve significant debt, making them a type of leveraged buyout.
• The U.S. Securities and Exchange Commission (SEC) has specific rules, such as Rule 13e-3, to protect minority shareholders in going private transactions.

Formula and Calculation

While there isn't a single universal "formula" for a going private buyout, the core financial aspect revolves around the valuation of the company and the financing structure of the acquisition. Key considerations include:

Enterprise Value (EV) Calculation (as a basis for valuation):

Where:

• Market Capitalization is the total value of a company's outstanding shares.
• Total Debt includes all short-term and long-term borrowings.
• Cash and Cash Equivalents are highly liquid assets.

The acquisition price in a going private buyout is typically set at a premium to the company's pre-announcement share price. This premium aims to incentivize existing shareholders to sell their stock. The funding for this acquisition often comes from a combination of the acquirer's equity, new debt financing, and sometimes additional equity from other investors. The debt portion can be substantial, leading to a high debt-to-equity ratio post-acquisition.

Interpreting the Going Private Buyout

A going private buyout signals a fundamental shift in a company's strategic direction and operational priorities. When a company undergoes a going private buyout, it is often seeking to escape the short-term pressures of the public markets, such as the need to meet quarterly earnings expectations and the associated reporting requirements.

The decision to go private can be interpreted as a belief by the acquiring party that the company's true value is not being fully recognized by the public markets, or that significant operational improvements and long-term value creation can be achieved more effectively away from public scrutiny. It can also indicate that the company needs to make difficult or unpopular strategic decisions, such as significant restructuring or investments, that might be met with resistance from public shareholders focused on immediate returns. For investors, the premium offered in a going private buyout represents a liquidity event, allowing them to exit their investment at a predetermined price.

Hypothetical Example

Imagine "Tech Innovations Inc." (TII), a publicly traded software company, is struggling with intense market competition and has seen its stock price stagnate. TII's management believes that to innovate and remain competitive, they need to invest heavily in research and development and expand into new, risky markets. These long-term initiatives would likely depress short-term earnings, which would be negatively received by public shareholders.

A private equity firm, "Evergreen Capital," approaches TII with a proposal for a going private buyout. Evergreen Capital offers a 30% premium over TII's current stock price, valuing the company at $5 billion. Evergreen plans to finance the acquisition using $1 billion of its own equity and $4 billion in borrowed funds, making it a highly leveraged transaction.

Upon completion of the going private buyout, TII's shares are delisted from the stock exchange. Evergreen Capital, now the primary owner, works with TII's management to implement a new strategic plan focused on long-term growth and market disruption, free from the pressure of quarterly reporting. Over the next five years, TII successfully launches new products, expands its market share, and significantly increases its free cash flow. Evergreen Capital then considers an initial public offering (IPO) or a sale to another company to realize its returns.

Practical Applications

Going private buyouts are prevalent in the landscape of private equity and mergers and acquisitions. They serve several practical purposes for companies and investors:

• Strategic Restructuring: Companies can undergo significant overhauls, such as divesting non-core assets or investing in new technologies, without public market pressure.¹⁰
• Reduced Compliance Costs: Public companies face extensive regulatory requirements, including those mandated by the Sarbanes-Oxley Act (SOX) and SEC filings like Schedule 13E-3. A going private buyout eliminates many of these costly and time-consuming obligations.
• Long-Term Focus: Management can shift focus from short-term quarterly earnings to long-term value creation, allowing for more patient capital deployment and strategic planning.⁹
• Protection of Sensitive Information: Private companies are not required to disclose as much financial and operational information as public companies, which can be advantageous in competitive industries.⁸
• Leveraged Returns: Private equity firms utilize substantial debt to finance these buyouts, aiming to amplify returns on their equity investment if the company's performance improves. This use of financial leverage is a key characteristic.
• Tax Benefits: Interest on debt used in a leveraged buyout may be tax-deductible, offering a potential tax advantage to the acquiring entity.
• Industry Consolidation: Going private transactions can be part of broader industry consolidation strategies, where larger entities acquire smaller, publicly traded companies.
• Management Alignment: Management teams often receive significant equity stakes in the private entity, aligning their incentives directly with the success of the private ownership.

The U.S. Securities and Exchange Commission (SEC) plays a crucial role in regulating going private transactions through Rule 13e-3, which requires extensive disclosures to protect unaffiliated shareholders.⁷ This ensures that all material information is provided, allowing shareholders to make informed decisions regarding the fairness of the transaction.⁶

Limitations and Criticisms

While a going private buyout offers various advantages, it also carries inherent limitations and criticisms:

• High Debt Levels: Many going private buyouts are highly leveraged, meaning the acquired company takes on substantial debt. This can make the company vulnerable to economic downturns or rising interest rates, increasing the risk of bankruptcy if cash flows are insufficient to service the debt.
• Conflict of Interest: When existing management or affiliates are involved in a going private buyout, there can be a perceived conflict of interest, as their incentives may diverge from those of public shareholders. SEC Rule 13e-3 aims to mitigate this by requiring disclosures regarding the fairness of the transaction to unaffiliated shareholders.⁵
• Lack of Liquidity for Shareholders: Once a company goes private, its shares are no longer traded on public exchanges, eliminating the liquidity that public markets provide. This means investors who did not sell their shares during the buyout may find it difficult to sell their stake later.
• Potential for Undervaluation: Critics sometimes argue that going private buyouts can undervalue a company, especially if the deal is initiated during a period of low stock prices or market distress. Independent committees and fairness opinions are often used to address this concern.
• Exclusion of Public Scrutiny: While reduced regulatory burden is an advantage for management, it can be viewed as a disadvantage by the broader public and some investors who value the transparency and accountability that come with being a publicly traded company.
• Limited Exit Opportunities for Acquirers: The private equity firm or acquiring group eventually needs an exit strategy, typically through another IPO or a sale to a strategic buyer. If market conditions are unfavorable, or the company's performance is subpar, these exit opportunities may be limited, impacting returns for the acquirers.⁴
• Increased Litigation Risk: Going private transactions are associated with a heightened risk of litigation, particularly from disgruntled shareholders who believe the offer price was too low or that the process was unfair.³

Going Private Buyout vs. Spin-Off

A going private buyout involves taking a publicly traded company private, removing its shares from public exchanges, and typically consolidating ownership under a private entity. The aim is often to gain operational flexibility, reduce regulatory burdens, and implement long-term strategies away from public market pressures. The entire company ceases to be publicly traded.

In contrast, a spin-off is a corporate action where a parent company separates a division or subsidiary into a new, independent company. Shares of the new entity are distributed to the existing shareholders of the parent company, often on a pro-rata basis. The spun-off entity then trades publicly on its own, and the parent company remains publicly traded (though its business focus may change). The primary purpose of a spin-off is usually to unlock shareholder value by allowing two distinct businesses to operate independently, each with its own management, strategy, and access to capital markets. While a going private buyout removes a company from the public domain, a spin-off creates a new, separate public entity from an existing part of a public company.

FAQs

Why do companies choose a going private buyout?

Companies choose a going private buyout for several reasons, including gaining greater operational flexibility, reducing the costs and time associated with regulatory compliance (such as SEC filings), avoiding the pressure of short-term quarterly earnings, and making long-term strategic investments without public market scrutiny.

Who typically initiates a going private buyout?

A going private buyout can be initiated by various parties, most commonly a private equity firm, a group of investors, or the company's existing management. These parties aim to acquire all outstanding public shares.

What are the main benefits for the acquiring entity in a going private buyout?

The main benefits for the acquiring entity include complete control over the company's strategy and operations, the ability to implement long-term plans without public market pressure, reduced regulatory and reporting costs, and the potential to realize substantial returns when the company is eventually sold or taken public again.²

What happens to existing shareholders in a going private buyout?

Existing public shareholders typically receive a cash payment for their shares, often at a premium to the market price before the buyout announcement. They cease to be shareholders of the company once the transaction is complete. The SEC's Rule 13e-3 is designed to ensure fairness to these unaffiliated shareholders.¹

Is a going private buyout the same as a delisting?

A going private buyout results in a delisting of the company's shares from public exchanges, but delisting can occur for other reasons too (e.g., failing to meet listing requirements, or a decision to delist without an immediate private buyout). A going private buyout specifically refers to the transaction of acquiring all publicly held shares to take the company private.