Elon Musk’s Twitter Acquisition Shines Light on Going Private Transactions

Tesla CEO Elon Musk recently made headlines when he acquired social media giant Twitter Inc. for approximately $44 billion. Upon completion of the transaction, Twitter will become a privately held company.

Twitter first became a publicly-traded company in November 2013 after raising $1.8 billion in an initial public offering. In his letter to Twitter announcing his acquisition offer, Musk argued that the company now needs to become private “to go through the changes that need to be made.” 

How Does a Company Go Private?

The term “going private” refers to a transaction (or series of transactions) that transforms a publicly-traded company into a private one. In many going-private transactions, including Musk’s acquisition of Twitter, a controlling shareholder acquires the shares of minority shareholders for cash, debt, or stock. This reduces the company’s shareholder base and allows it to elect to terminate its status as a public company.

As described by the Securities and Exchange Commission (SEC), several different types of transactions can result in a company going private, including:

• Another company or individual makes a tender offer to buy all or most of the company’s publicly held shares;
• The company merges with another company; or
• The company declares a reverse stock split that reduces the number of shareholders of record. In a reverse stock split, the company typically gives shareholders a single new share in exchange for a block—10, 100, or even 1,000 shares—of the old shares. If a shareholder does not have a sufficient number of old shares to exchange for new shares, the company will usually pay the shareholder cash instead of issuing a new share, thus eliminating some smaller shareholders of record and reducing the total number of shareholders.

Under SEC rules, a publicly held company may deregister its equity securities when they are held by less than 300 shareholders of record or less than 500 shareholders of record, where the company does not have significant assets. Federal securities regulations also mandate that certain disclosures must be made when a company goes private, which includes providing specific information to shareholders regarding the transaction that resulted in the company becoming privately held. Additionally, the company engaged in the transaction and any of its involved affiliates may have to file a proxy or a tender offer statement with the SEC.

When a company’s publicly held securities are delisted from a national securities exchange or an inter-dealer quotation system of any national securities association, Rule 13e-3 and Schedule 13E-3 may also apply. Schedule 13E-3 requires a discussion of the purposes of the transaction, any alternatives that the company considered, and whether the transaction is fair to unaffiliated shareholders. Also, the company must disclose whether and why any of its directors disagreed with the transaction or abstained from voting on the transaction and whether a majority of directors who are not company employees approved the transaction.

What Are the Advantages of Going Private?

As we have often discussed in prior articles, the goal of many start-ups and other growing businesses is to become a publicly-traded company. In addition to the prestige that comes along with being a public company, it is also often easier to raise capital, secure loans, and obtain other forms of financing, for instance, to make acquisitions of competitors.  Being publicly traded enhances the value and liquidity of a company’s employee stock option compensation, and allows company owners and management to cash in by selling or borrowing against their shareholdings. The trade-off is that public companies are subject to additional regulations and costs, including and financial and compliance reporting obligations.

Companies may choose to transition to a privately-held company for a variety of reasons. In many cases, the goal is to avoid burdensome disclosure obligations, corporate governance requirements, and compliance expenses of the federal securities laws, including Sarbanes-Oxley and free up resources to improve the business.

Private companies are not obligated to report quarterly earnings, which allows them to focus on long-term objectives and often take greater risks. With fewer requirements, private companies also have more resources to devote to research and development, capital expenditures, and other initiatives. With less obligations to shareholders, and less exposure to unwanted tender offers, private companies are at less risk of litigation or, as with Musk and Twitter, unwanted suitors.

What Are the Risks of Going Private?

Converting to a private company can also have disadvantages. Most notably, if the acquiring entity adds too much leverage to the public company to fund the deal, it can significantly impair the entity should adverse conditions arise. Accordingly, it is imperative to ensure that debt levels are manageable. Leveraged buyouts gained notoriety in the ’80s when the use of junk bonds to fund them led to unmanageable debt carrying unpayable high-interest charges leading to default and bankruptcy for too many highly leveraged takeovers.   

Going private transactions are also often challenged in court proceedings. To lessen the risk of litigation,  a board of directors must carefully evaluate the merits of becoming a private company and thoroughly document the process. More specifically, the board must exercise reasonable business judgment, consider all relevant factors, and establish a process that ensures the company and its board satisfy their fiduciary duties, including the duty of loyalty and the duty of care.

Key Takeaway

Deciding to take a company private is a significant decision that requires careful examination of both the legal and financial consequences. We encourage businesses that may want to explore this option to work with experienced counsel who can help you thoroughly weigh the risks and rewards, as well as determine your compliance obligations.

If you have questions, please contact us

If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.