When Public Companies go Private
Recent speculation about Tesla’s possible transition from a publicly traded company to a private entity have sparked conversation about the idea of “going private”. While many of us are familiar with the definition of an IPO and the process of establishing an initial offering and making stock available on a public exchange, the opposite move has aroused curiosity and common questions. What does this mean? How does it work? When would a company decide to make this decision? Here are a few quick answers.
Why go from public to private?
In Tesla’s case, the decision to go private appears to be driven by the difficulty of answering to public shareholders, who own a stake in the company and are therefore motivated to weigh in, praise, criticize, or attempt to influence company decisions, particularly at shareholder meetings. When thousands of people are invested in the success or failure of the business, it can be difficult to make moves that put long term gain ahead of short term returns. In addition to regulatory obligations, this is one of the risks and hassles to consider before deciding to sell public shares.
Other common motivations for going private fall under the same general heading: a lack of preparation for the obstacles and problems that public stock sales sometimes entail. Going public is serious! This transition brings an avalanche of regulatory, administrative and reporting requirements. It’s an expensive, complicated move that can come with big rewards, but sometimes it’s the wrong move for certain types of businesses, and this only becomes clear after the fact. If you haven’t decided whether to place an IPO on your list of goals, talk to your legal team and share your concerns.
How can a company go private?
Going private typically requires the support of a large private equity company or a consortium of smaller investment groups, since buying back publicly owned stock can mean an outlay of hundreds of millions of dollars. The private equity group usually finds a lender who can finance a massive purchase of stock. So again, if this support is unlikely, a move from public to private may not be easy or even possible. Keep in mind also that borrowing on this scale will require large interest payments, and this cash flow will usually need to come from company operations. If operations aren’t strong enough or cash flow isn’t steady enough to keep up with the payments, the company’s bond value can be downgraded.
What if shareholders don’t want to sell stock back to the company?
Most of the time, a company that decides to go private will seek to buy back shares at a price that’s higher (sometimes much higher) than the current value of the stock. So usually shareholders have no trouble letting go of the shares they own. But some companies make other options available, for example, the company can set up a special fund and allow public shareholders to participate, providing a brief window every six months or so during which members of the fund can enter or exit.
In summary, going private can be a smart move for companies who want to regain tighter control lost after an IPO, but doing so will require 1) large scale financing 2) very strong potential for growth, and 3) the ability to keep the newly private company on track to success while also paying off new debts -- among a myriad of other considerations.