Take-private transactions in the US have been on the rise since the first half of 2024. Ropes & Gray, the US law firm, predicts 40 total take-private deals by the end of the year. When it comes to these transactions, valuations and strategic rationale are the most commonly discussed topics. However, what often goes unnoticed is the fate of public shareholders.
So what happens to shareholders when a company goes private? To answer this question, we prepared a dedicated article explaining the most common outcomes of take-private transactions for stockholders. In this article, you will also learn about the tax implications of offers provided to shareholders in take-private deals.
Understanding privatization: What is it, and how does it happen?
Privatization means that a publicly traded company can become privately owned by its management team through corporate buybacks, or by another company, usually a private equity firm or an investment bank. Its shareholders agree to the offer made by the acquirer, allowing the latter to purchase shares of the company.
Publicly traded companies may initiate stock buybacks to reduce the volume of circulating outstanding stock as part of the privatization process. This is usually done to streamline the ownership structure and simplify the buyout process.
Stock market delisting is what happens to public shares when a company goes private. Its stock can’t be traded on a public stock exchange anymore, and investors can’t access it through online brokers. This transaction is the opposite of an initial public offering (IPO). But if an IPO gives greater visibility and investing exposure, what drives public companies to revert to private ownership again?
To lessen the regulatory burden
A public-to-private company is no longer subject to time-consuming regulatory obligations imposed by the Securities and Exchange Commission (SEC) and the Sarbanes Oxley Act (SOX). It can redirect more valuable resources to activities that benefit its business operations.
To overhaul the business model
A privately-held company can make more confident decisions without the scrutiny that typically affect public companies. Private equity investors give delisted companies the flexibility to initiate corporate restructuring without the pressure of public shareholders, media, or intricate corporate governance regulations.
To escape market volatility
A public company may decide to delist its stock from a major stock exchange during a recession or a period of high market volatility and low valuation. The strongest public entities tend to endure recession, while less resilient ones escape unfavorable circumstances by going private.
What happens to your stock if a company goes private?
Shareholders of a publicly-owned company typically sell their shares to an acquirer when it is taken private. How acquirers compensate the selling shareholders depends on several scenarios.
Cash buyout
A private equity buyout is the most common scenario when a company goes private. An acquiring entity makes a cash tender offer to buy a public company’s shares at a premium price.
The offered price exceeds the market value to incentivize the existing shareholders to sell ownership interest in the target company. Shareholders are more inclined to approve such transactions when the terms are beneficial.
Example:
Company A trades at $100 per share (market stock price). Company B offers $125 per share (above the current market price) to compensate the shareholders of Company A. The shareholders receive cash compensation equal to the per-share offer multiplied by the number of shares they own. For instance, a shareholder with 100 shares would receive $12,500 (125 x 100).
Stock swap
A stock swap means that the public company’s stock is converted to private shares at a specified ratio when the company goes private. The exchange ratio depends on multiple factors and may not always be 1:1. It can be higher or lower like during reverse stock splits when one company reduces the number of shares of another company after buying it.
It can be adjusted based on the premium offered to the shareholders and the financial considerations of the acquiring company. Stock swaps are not that common because private acquirers prefer to have fewer shareholders.
Example:
Company A trades at $100 per share and is taken private by Company B. Instead of paying cash, Company B initiates the stock swap and adjusts the ratio to 1:1.25 to reflect the premium offered for outstanding shares during the transaction.
It means each shareholder of Company A will receive 1.25 private shares for each public share held. For instance, a shareholder with 100 public shares held (worth $10,000) will receive 125 private shares (worth $12,500).
Cash and stock offer
Shareholders may be offered shares in the newly-private corporation alongside usual cash compensation. Acquiring companies may use this approach to offset the immediate privatization effects on their financials, although such scenarios are more common in public-to-public transactions.
Example:
Company A trades at $100 per share. Company B is willing to pay a premium ($125 per share) but wants to reduce the immediate cash expenditures. Consequently, Company B pays each shareholder of Company A $50 in cash and 0.75 private shares per public share.
As a result, a shareholder with 100 public shares receives $5,000 in cash and 75 private shares (worth $7,500). The total value of this shareholder’s compensation is $12,500 and reflects the $25 per-share premium paid by the acquirer.
Forced equity buyout: What happens to minority shareholders?
A forced private buyout occurs when a transaction obtains shareholder approval (from the majority of voting shareholders) without the consent of smaller shareholders. The minority shareholder rights in the privatization of companies are limited to fair compensation; they can’t block a public-to-private transaction.
So, can a minority shareholder be forced to sell shares? Under specific circumstances, such as drag-along provisions in corporate bylaws, remaining shareholders can be forced to sell shares when a specific event occurs, such as privatization or the sale of the company. The good news is that they can be compensated at the same level as majority shareholders.
When a company goes private, what happens to the stock owned by employees?
Publicly-traded stock owned by employees (vested stock) is treated similarly to the stock of regular shareholders when the public company goes private.
The vested stock is removed from the public exchange, and shareholder-employees are generally subject to cash offers, stock swaps, or mixed offers. That is also true for a management buyout when a company is generally interested in retaining stockholder employees.
Unfortunately, as a common consequence, when a company buys another company, what happens to the employees is job loss. In this scenario, the departing shareholder-employees are forced to sell their vested shares, often under unfavorable terms, and are not eligible to purchase remaining shares.
What happens to unvested shares when a company goes private?
Unvested stock refers to company shares that have been awarded to employees but are not fully owned by them. The stock vesting process typically requires several conditions to be met (like certain milestones such as years of employment). Therefore, employees eligible for stock options may be in the vesting process for some time.
If a public company goes private during that period, unvested stock may be converted to a cash offer. However, a private acquirer may cut expenses related to unvested stock to maximize the return on its investment portfolio. That is why some companies terminate unvested stock completely, without compensating regular stockholder-employees.
What happens to stock if a company goes private: Overview of tax implications
Take-private transitions can be taxable for shareholders depending on the structure of the transactions involved.
Cash offer
Shareholder compensation in the form of cash is subject to immediate capital gains taxes. The value of the stock purchase is the tax basis (cost basis) for calculating the capital gains tax. The capital gain constitutes the difference between the tax basis and the cash offer.
Example:
An investor purchased one share in Company A for $70 which constitutes the tax basis. Company B made a cash offer at $125 per share. To calculate the capital gain, the investor needs to subtract $70 (tax basis) from $125 (cash offer). The resulting capital gain is $55. This amount ($55) is subject to immediate capital gains tax.
Stock swap
Shareholders may not be subject to immediate capital gains taxation during the exchange of shares in a take-private transaction. In such an event, shareholders are taxed when they realize capital gain by selling their private shares. The tax basis of new shares will be the same as the tax basis of old shares.
Example:
An investor purchased 100 shares in Company A at $100 per share ($10,000). This amount ($10,000) is the tax basis of the investor’s public shares. The 100 investor’s public shares are exchanged for 75 private shares during the take-private transaction, which is also a reverse stock split.
The tax basis for calculating the capital gain tax doesn’t change during the transaction — it is still $10,000, even though the per-share basis is $133 ($10,000 ÷ 75 = $133).
Cash and stock offer
The tax implications of the cash and stock portions in mixed offers are different. A shareholder will pay capital gains taxes on the cash portion. However, the capital gains taxes on the stock portion will be deferred until the shareholder sells private shares.
Example:
An investor purchased 100 public shares in Company A at $100 per share. The shareholder’s total investment is $10,000, and it’s also the cost basis for the capital gains tax. Company A has been acquired by Company B for $125 per share.
Company B pays shareholders of Company A $50 and 0.75 in private shares per public share. The shareholder receives $5,000 in cash and 75 private shares worth $7,500, so the total compensation equals $12,500, which reflects the premium paid by the acquirer.
The cash portion is subject to immediate capital gains tax. To determine the gain, the shareholder must calculate the allocated cost basis of the cash portion. This is done by dividing the cash portion ($5,000) by the total compensation ($12,500) and multiplying this amount by the original tax basis ($10,000).
The shareholder can use the following equation: ($5,000 ÷ $12,500) × $10,000 = $4,000. This amount ($4,000) is the allocated cost basis of the cash portion. Consequently, the capital gain on the cash portion is $5,000 − $4,000 = $1,000.
As for the stock portion, its allocated cost basis is $6,000. If the shareholder sells the stock portion immediately after the transaction, the capital gain from the stock portion will be $1,500. The combined capital gain for the cash and stock will be $2,500 at the movement of the transaction, which equals the $2,500 premium paid by the acquirer. However, if the shareholder decides to hold private shares, they can delay the capital gains tax on the stock portion until they sell it.
Please note that the above examples illustrate the general idea of capital gains tax calculations and the approximations of what happens to shareholders’ stock in take-private transactions. The impact of a merger and acquisition on shareholders is deeper than that.
The above examples don’t consider numerous nuances, such as the holding period of shares, the transaction’s tax status, capital loss carryovers, and other unique circumstances. A personal finance or accounting consultation is highly advisable for precise calculations.
How do take-private transactions impact the stock liquidity of public companies?
Broadly speaking, the liquidity of a stock is decreased once the stock issuer ceases trading on public markets. Let’s explore a few reasons why this happens.
The private market is limited
A public-to-private company loses access to the global public market, which is around ten times as large as the private market — ~$130 trillion of public trading value (2023) versus ~$11 trillion of private markets (2022). That means private investors, particularly individuals, have fewer opportunities to sell their shares in the private market.
There are equity transfer restrictions
Private companies often write down equity transfer restrictions, limiting the shareholders’ ability to exit. Lock-up periods, during which shareholders cannot sell their private shares, are also common.
Those restrictions may include a general prohibition on sales for some period after the investment is made, as well as various rights of the non-transferring investors in connection with any transfer made by an investor after that date, such as rights of first offer (ROFO) or first refusal (ROFR) and tag-along or co-sale rights…
Gregory V. Gooding
Partner at Debevoise & Plimpton, LLP
Private shares are difficult to evaluate
The value of private companies is hard to predict due to the private nature of business data and the lack of representation in public markets. According to PitchBook, 60% of professional valuations of private companies are less than 85% accurate. With private share prices essentially being a mystery, it’s hard to find buyers willing to accept the risk.
How to write a stock pitch? Check the nuances of well-crafted stock presentations in our dedicated article.
Final words
- Public companies typically go private to escape market volatility, ease regulatory scrutiny, and have greater strategic flexibility.
- Stockholders of public companies that go private typically sell their shares at a premium and exit the business entirely. In rare scenarios, the shareholders receive equity in private companies.
- Shareholders of public companies that go private face different tax implications depending on the offers made by private buyers. Cash offers typically result in immediate capital gains taxes, while mixed offers open opportunities to defer taxes.
- When a public company goes private, the liquidity of its stock decreases substantially due to the smaller size of the private market, equity transfer restrictions, and valuation difficulties.
