A public company holds certain advantages versus private companies. For one, selling and buying shares of a public company is relatively easy and straightforward, and thus those are typically attractive to investors seeking a liquid asset. This makes it much easier, at least upon superficial examination, to raise capital. There is also an element of prestige in being a public company which can lead to enhanced attractiveness with respect to suppliers, customers, and employees.
Nevertheless, this comes at a cost. The more obvious disadvantages include the tremendous regulatory, administrative, reporting, and corporate governance requirements. Adherence to a multitude of compliance standards can easily absorb a large share of management's capacity. Less obvious, but to no extent less important, is the constant necessity to fulfill investors' expectations. This shifts the focus away from long-term strategic objectives to the short-term horizon of quarterly earnings reports.
In the first half of 2022, private equity (PE) firms spent roughly $227 billion on public-to-private transactions globally, according to Dealogic data. This corresponds to an increase of almost 40% compared to the same period of 2021. This reflected an environment of heightened economic uncertainty that put pressure on stock market valuations, resulting in many high-quality companies trading at significant discounts compared to pre-crisis levels.
"GO PRIVATE" – HOW DOES IT WORK?
If the shareholders decide that there are no longer significant benefits to being a publicly traded company, they may initiate a process to "Go Private". Here, shareholders may seek a buyout, typically by private equity fund. The transaction involves the PE firm buying a controlling stake in the company.
Another route to take a business private is through a management buyout (MBO) where members of the management team purchase the company. The advantage here is that the management team have intensive knowledge of the company, which resolves the information asymmetry issue that's often associated with M&A transactions. In these scenarios, the management team's objectives are likely to be fully congruent. This along with their deep understanding of the company helps mitigate the risk of not meeting the business plan which serves as a basis for the purchase price determination (whereas external investors or another company looking to acquire the target will be heavily reliant on due diligence).
If a PE firm acquires the company, this can help with additional liquidity and support the company's fast growth. It should not be neglected though, that the management team's agenda and that of the PE firm are not fully aligned and might lead to conflicts as to the strategic direction.
A public-to-private transition can also take place as the result of a tender offer by another company or individual. Here the company (or an individual) makes a public offer to buy the majority or all the shares of the company. Note, if this occurs where the current management of the company do not want the company to be sold, it constitutes a hostile takeover.
If the company that is taken private is merged with another entity with a complimentary portfolio, this can not only lead to operational synergies but also result in a vertical integration, which can have a very positive impact on market position and future sustainability.
Nevertheless, a buyout will in most cases result in a highly leveraged company subsequent to the transaction, as the acquisition will in most cases be financed by debt. In adverse market situations, this could lead to additional pressure due to increases in interest rate costs and the risk to breach covenants.
THERE ARE NUMEROUS ADVANTAGES OF BEING PRIVATE
Despite the common belief that being a public company is more favorable versus private, the latter has at least two major distinct advantages:
- Ability to focus on long-term strategic goals: being publicly listed requires significant focus on meeting the quarterly results expectations every year. Underperformance against market expectations will usually impact the company's share price adversely. This can lead to myopia from both management and shareholders where focus is biased (or completely shifted) towards the short-term. A consequence is under-investment in the longer-term strategy which typically materializes financially and operationally in the future.
- Reduced administrative costs: The administrative costs incurred by public companies are significantly higher, due to the need to comply with stringent reporting requirements, listing fees, higher auditing fees etc. In addition, publicly listed companies need to put substantially more focus on corporate governance and compliance (internal controls framework, risk management systems etc.). Public companies also incur costs regarding investor relations activities. By going private, the administrative burden is significantly reduced, which translates into reduced costs.
GOING PRIVATE ALSO COMES AT A COST
As always, there are two sides to a coin.
Investors with a more speculative approach seek assets with more liquidity. They are unlikely to invest in the long-term growth of a company. The inability to sell the shares at the capital markets whenever the investor group is looking for an exit also means taking companies private are not attractive to them.
Furthermore, the company's ability to structure long-term incentive schemes for the management and/or broader employee participation programs by using RSUs [1] or options is no longer given. Nevertheless, it is possible to arrange alternative, non-share-based incentive schemes which keep both management and employees aligned with the corporate objectives.
In terms of brand awareness, private companies typically have less exposure and lower public awareness compared to public companies. This can impact brand awareness especially among customers and vendors as well as hinder the company from accessing a wider talent pool when hiring employees.
CONCLUSION: SHOULD A COMPANY GO PRIVATE?
There is no single answer to this question, it really depends on the specific situation of the company.
If a company's share price is continually underperforming and market pressures are delaying strategic investments which are beneficial in the medium to long term, the option of going private should be considered. If not, the company may be exposed to the risk of an activist attack where an interested party deliberately shorts the stock to lower the share price, reduce market capitalization, before swooping in to buy the company at a significantly undervalued price.
The overall outcome of the public-to-private transaction also depends on the path which is chosen. If the management team looking to execute a MBO struggle to raise adequate funds for the transaction, PE firms can play a role in providing immediate liquidity.
Being acquired by a PE looking to implement a roll-up strategy can be a great opportunity to strengthen sustainability and enhance growth prospects, especially if enough synergies can be identified and realized. The downside of PE ownership is that it can involve an aggressive operational restructure (which may not be aligned with management's views) and can lead to significant cost-cutting measures without fully considering the longer-term implications.
As a conclusion, the decision to go from public to private is a decision of great importance with far-reaching consequences. Thus, it is a decision which should not be rushed without carefully weighing all alternatives and potential risks. Ideally, a neutral person should be involved in the decision-making process to avoid cognitive and emotional bias that can lead to missed opportunities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
