Going Private: Understanding the Impact on Stock Prices & Companies

The decision to take a publicly traded company private makes sense for a number of reasons. Public companies must report information to the Securities and Exchange Commission, a process that is time-consuming and expensive and that releases confidential information to competitors. The SEC has strict reporting requirements that must be met. Going private eliminates the need. The Sarbanes-Oxley Act subjects corporate executives to liability for corporate malfeasance. Going private reduces that liability. Additionally, going private concentrates ownership into fewer hands and allows management to run the company with tighter controls. Going private also makes pricing the stock and trading shares for small investors challenging.

Investor Risk

Taking a company private has a major impact on the liquidity of its stock. When a company goes private, it voluntarily stops submitting the forms required of a public firm, instead filing much simpler, less comprehensive paperwork -- going dark is the expression used when a company makes this decision.

Investors who hold their stock after a firm goes private find themselves handicapped when they want to sell their stock. When the stock is no longer publicly traded, its price must be imputed from the valuation of the company. Since the object of going private is to stop trading in the stock, the stock becomes illiquid with any sale being negotiated on a case-by-case basis. In some cases the stock may be so thinly traded that investors must accept almost any price they can get.

Value of Stocks During Downsizing

A key requirement in going private is to downsize the number of stockholders of record to 300 -- or to 500 if the company lacks significant assets. Before it takes action, management files SEC form Schedule 13E-3 to tell stockholders of the intent. Then, management takes steps to reduce the number of stockholders:

• Reverse Stock Split. Suppose a company has 600 stockholders. If it announces a 1-for-10 reverse stock split, it consolidates its outstanding shares into one-tenth the previous amount. If stockholders do not have enough shares to accomplish the split, the company buys the shares at the market price, reducing the number of shareholders.
  
• Management Buyout. With this option, management buys shares from other stockholders until the number of stockholders is reduced below the required threshold. Management uses company cash to buy shares, a process that can be expensive. Typically, management offers to pay a premium to induce stockholders to accept the offer, which results in stockholders receiving more than market value for their stock.