Going private transaction: Meaning, Criticisms & Real-World Uses

What Is a Going Private Transaction?

A going private transaction refers to the process by which a publicly traded company converts into a privately held company, ceasing to have its shares listed on a stock exchange. This strategic move falls under the umbrella of corporate finance, specifically within the realm of mergers and acquisitions. When a company undergoes a going private transaction, its equity securities are no longer available for trading on public markets, leading to the delisting of its shares. The primary aim of a going private transaction is typically to remove the company from the scrutiny and regulatory burdens associated with being a publicly traded entity.

History and Origin

The concept of taking a company private has evolved alongside the development of public markets and corporate governance. Early instances of companies transitioning from public to private ownership were often driven by specific circumstances, such as a desire for greater operational flexibility or a belief that the public market was undervaluing the company.

A notable period for going private transactions, particularly those involving significant debt financing, was the leveraged buyout (LBO) boom of the 1980s. During this era, private equity firms and management teams frequently acquired public companies, using large amounts of borrowed capital, to take them private. This allowed for intensive financial restructuring away from public scrutiny.

In more recent history, the "going private" trend continued, with one prominent example being Dell Inc. In 2013, the computer giant, led by its founder Michael Dell and private equity firm Silver Lake Partners, completed a $24.4 billion leveraged buyout to take the company private. This significant deal, considered one of the largest technology buyouts at the time, aimed to allow Dell to pursue long-term strategic initiatives without the pressure of quarterly earnings reports and public market demands. The Wall Street Journal reported on the pending deal in early 2013, noting that the offer was approximately a 25% premium to Dell's stock price before the deal became public⁶. Reuters also covered the transaction, highlighting the involvement of Michael Dell and Silver Lake Partners, supported by a $2 billion loan from Microsoft⁵.

Key Takeaways

A going private transaction removes a company's shares from public stock exchanges, making it privately owned.
Motivations include avoiding regulatory compliance, focusing on long-term goals, and addressing perceived undervaluation.
Common methods involve tender offers, mergers, or reverse stock splits.
The transaction typically requires the acquisition of outstanding shares from public shareholders.
Companies undertaking a going private transaction are subject to specific regulatory oversight, such as SEC Rule 13e-3 in the United States.

Formula and Calculation

While there isn't a single universal "formula" for a going private transaction, the core financial aspect revolves around the valuation of the company and the price offered to existing public shareholders.

The total cost of a going private transaction can be conceptualized as:

\text{Total Cost} = \text{Offer Price Per Share} \times \text{Number of Outstanding Public Shares} + \text{Transaction Costs}

Where:

Offer Price Per Share: The price at which the acquiring party offers to buy each share from public shareholders. This often includes a premium over the pre-announcement market price.
Number of Outstanding Public Shares: The total number of shares held by the public that need to be acquired.
Transaction Costs: Legal, advisory, financing, and regulatory fees associated with the transaction.

Funding for this cost often comes from a combination of the acquirer's equity, new private equity investments, and significant debt financing. The determination of the offer price is crucial, as it must be attractive enough to gain shareholder approval while being financially viable for the acquiring entity.

Interpreting the Going Private Transaction

Interpreting a going private transaction requires understanding the motivations behind it and its potential implications for the company, its former shareholders, and the market. From the perspective of the company's management and the acquiring parties (often led by the existing management or a private equity firm), going private is frequently seen as an opportunity to implement significant operational changes or pursue a new capital structure without the quarterly pressures and public disclosure requirements that come with being a public company.

For public shareholders, the offer price is a key factor. A substantial premium over the market price often indicates the acquiring party's confidence in the company's long-term value, even if they believe the public market is currently undervaluing it. Conversely, if the offer is perceived as too low, it can lead to opposition from minority shareholders.

The decision to go private can also signal a belief that the company's future growth strategy requires a longer time horizon than public markets typically accommodate or that it needs to undergo a complex restructuring that would be difficult to execute under public scrutiny.

Hypothetical Example

Imagine "GreenTech Innovations Inc." (GTI), a publicly traded company specializing in renewable energy solutions. GTI's stock has been stagnant for several years, despite strong underlying technology, because its long-term research and development projects require significant upfront investment with no immediate payoff. Public investors, focused on short-term quarterly results, have not rewarded these efforts.

A group of GTI's founders, along with a large private equity firm, believe the company needs five to seven years to fully develop its next-generation technology without market pressure. They decide to initiate a going private transaction.

Offer Development: The founders and private equity firm propose a tender offer to buy all outstanding shares at $25 per share, representing a 30% premium over GTI's current trading price of $19.
Financing: The private equity firm commits a substantial equity investment, and the remaining funds are secured through debt financing from a consortium of banks.
Shareholder Approval: GTI's board of directors, after receiving a fairness opinion from an independent financial advisor, recommends the offer to shareholders. Despite some initial skepticism, the premium is attractive enough for most shareholders to accept.
Completion: Once a sufficient number of shares are tendered, GTI completes the transaction and delists its shares from the stock exchange. It is now a privately held company.

Freed from public reporting obligations, GTI can now focus on its long-term R&D, make strategic acquisitions, and adjust its operations without fear of immediate stock price reactions. After several years, if successful, the private equity firm might seek an exit strategy, such as another initial public offering (IPO) or a sale to a larger company, potentially realizing significant returns.

Practical Applications

Going private transactions have several practical applications across various financial and corporate scenarios:

Strategic Repositioning: Companies that need to undertake significant operational changes, divest non-core assets, or invest heavily in long-term projects without immediate returns often opt for a going private transaction. This allows them to avoid short-term market pressure.
Undervaluation Correction: If a company's management or a financial sponsor believes the public market is significantly undervaluing its true potential, a going private transaction can be used to acquire the company at a price they consider fair, with the expectation of realizing higher value later in a private setting.
Reducing Regulatory Compliance Burden: Public companies face extensive reporting requirements from regulatory bodies like the Securities and Exchange Commission (SEC). For example, the SEC's Rule 13e-3 imposes significant disclosure obligations on issuers and their affiliates engaging in "going private" transactions, requiring filings like Schedule 13E-3 to protect public shareholders,⁴. Going private can alleviate these burdens and associated costs.
Leveraged Buyouts (LBOs): Many going private transactions are executed as leveraged buyouts, where a large portion of the purchase price is financed through debt. This strategy is popular with private equity firms seeking to acquire companies, improve their performance, and then exit through a sale or re-IPO, often within a three to seven-year timeframe.
Management Buyouts (MBOs): Existing management teams may partner with private equity firms or other investors to take their company private. This gives management greater control and a direct equity stake in the company's future performance.

Limitations and Criticisms

While going private transactions can offer significant benefits, they also come with limitations and criticisms, particularly concerning the interests of public shareholders.

One major criticism revolves around potential conflicts of interest. When management or an affiliate initiates a going private transaction, they are essentially on both sides of the deal—as buyers and fiduciaries to the public shareholders. This dual role can lead to concerns that the offer price may not be truly fair, potentially shortchanging public investors. The SEC explicitly addresses these concerns, requiring detailed disclosures about the fairness of the transaction in filings such as Schedule 13E-3,.
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For example, when Dell went private in 2013, the transaction faced scrutiny from some investors, including activist shareholder Carl Icahn, who argued that Michael Dell and Silver Lake were acquiring the company at an undervalued price, effectively getting a "steal". ²Such disagreements highlight the challenge of determining a truly equitable price in a transaction where the public market's influence is being removed.

Another limitation is the substantial amount of debt often used in leveraged buyouts to take a company private. While this can amplify returns for the new private owners, it also increases the company's financial risk. A heavy debt financing burden can make the company vulnerable to economic downturns or unexpected business challenges, potentially impacting its ability to invest in growth or even leading to bankruptcy if it cannot service its debt.

Furthermore, once a company is private, its shares are illiquid. Public shareholders who do not tender their shares in the transaction may find themselves holding stock in a private entity with no active trading market, making it difficult to sell their stake later.

Going Private Transaction vs. Leveraged Buyout

While often used interchangeably, "going private transaction" and "leveraged buyout" are related but distinct concepts.

A going private transaction is the overarching process by which a publicly traded company's shares are removed from public exchanges, converting it into a privately held entity. The primary outcome is the change in ownership status from public to private. This can be achieved through various mechanisms, such as a cash tender offer for all outstanding shares, a reverse stock split, or a merger where public shareholders receive cash or other consideration. The key characteristic is the cessation of public trading and reporting.

A leveraged buyout (LBO) is a specific method of financing an acquisition, often (but not exclusively) used to execute a going private transaction. In an LBO, a small equity investment is combined with a large amount of borrowed money (debt) to finance the purchase of a company. The acquired company's assets are often used as collateral for the debt, and its future cash flows are expected to service that debt. While many going private transactions are, in fact, LBOs due to the significant capital required to buy out public shareholders, not all LBOs result in a company going private (e.g., an LBO might involve one private company acquiring another, or a public company acquiring another public company using an LBO structure).

In essence, a going private transaction describes the result (a company becoming private), while a leveraged buyout describes a common means by which that result is achieved, particularly when led by private equity firms.

FAQs

Why do companies go private?

Companies go private for several reasons, including escaping the short-term pressures of public markets, reducing regulatory and reporting costs, gaining operational flexibility to implement long-term strategies, addressing perceived undervaluation by public investors, or to facilitate a financial restructuring without public scrutiny.

What happens to shareholders when a company goes private?

In a going private transaction, public shareholders are typically bought out. They receive cash for their shares, and their ownership in the company ceases. The offer price usually includes a premium over the stock's pre-announcement market price to incentivize shareholders to agree to the deal. After the transaction, the shares are delisting from the public exchange.

How is a going private transaction typically funded?

Going private transactions are often funded through a combination of equity and debt. The acquiring party, which could be the existing management, a private equity firm, or a consortium of investors, contributes equity. A significant portion of the funds typically comes from debt financing arranged with banks or other lenders, often structured as a leveraged buyout.

What is SEC Rule 13e-3?

SEC Rule 13e-3 is a U.S. Securities and Exchange Commission (SEC) regulation designed to protect public shareholders in "going private" transactions. It requires the issuer of securities or its affiliates involved in such a transaction to file a Schedule 13E-3 with the SEC. This filing mandates extensive disclosures, including the purpose of the transaction, its fairness to unaffiliated shareholders, and any reports or appraisals from independent advisors. This rule aims to prevent fraudulent or manipulative practices in these types of deals,.
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Can a company that went private become public again?

Yes, a company that has gone private can become public again. This often occurs after a period of private ownership where the company undergoes significant operational improvements, growth, or financial restructuring. The new owners (e.g., a private equity firm) may then choose to take the company public again through an initial public offering (IPO) or sell it to another public company, seeking to realize a return on their investment.