Tender Offer & Its Effect on Investors

In the world of company funding, there are numerous types of investors. And with investors comes different types of securities for their investments, like common stock, preferred stock and stock options. A stock option is generally referred to as monopoly money. This is because you cannot convert them to cash unless the business goes public. Even though a majority of the companies today choose to stay private, some are exploring different ways to give their employees more liquidity. Even investors look for a common liquidity option. If you are an investor in common stock, one of the many things that you will come across in your life is a tender.

Tender Offer

Tender offers are becoming increasingly common these days as company funding from angel investors and venture capital firms in private companies look to sell their shares when the company goes public. As the returns on their investments can be sky high, and the gain from these investments in the millions, it’s important to know how to do a tender offer the right way.

What is a tender offer?

A public bid for shareholders to sell their holdings is a tender offer. A tender offer is a proposal that an investor offers to the stakeholders in a publicly traded business. This process starts when the investor puts an advertisement, then an offer to buy is printed and mailed to the company’s shareholders. A tender offer has many benefits such as: if a stock is sold for more than it was worth at that time, illiquid equity can be monetized, the proceeds can be used to exercise any remaining options you have for a more diverse portfolio, good tax treatment, pay your debt off, or save it for future. The tender offer must comply with the regulations of the SEC. Some of the rules are to include certain disclosure needs, manner of publication, withdrawal rights, and a minimum offering period.

Purpose of Tender Offer

A tender offer is generally proposed in a company when they want the acquirer to buy a majority of the common stock. This is for them to either gain a major position or to take over the board. A benefit of this is that if the acquirer gets to buy and own a majority of the outstanding shares, they can encourage other shareholders to sell out and make the business private. They can also choose to merge with an existing publicly traded company even though the original tender offer was not accepted.

In other words, it can become a subsidiary of a business. Only the holding company will have stock in the operation that is newly purchased. A tender offer is often used when the board and management do not agree that the takeover will be good for the shareholders and stand against it. So it is the way through which investors can have a hostile takeover of the business and take control.

Types of tender offer

There are two types of tender offer:

• Issue tender offers (share buybacks) – The issue tender offer is known as share buybacks. This is when the business makes an offer to buy back the stocks from the stockholders.
• Third-party tender offer – A tender offer when the third party looks to attain another business share is called a third-party tender offer.

Is a tender offer good or bad?

A tender offer has many advantages and disadvantages. Some of the advantages are that until a set number is tendered, an investor is not required to buy the stock. This eliminates the outlay of huge upfront cash and in case the offer fails, it prevents the investor from liquidating the share positions. For releasing the liability to buy the shares, an acquirer can include an escape clause. In a majority of the cases, an investor will gain control of the target business within a month if the offer is accepted by the stockholders. Generally, they earn more than a normal investment in the market.

Tender offers might be good in many ways, but it also has some disadvantages. Investors have to pay attorney costs, SEC filing fees, and other charges for specialized services. This makes it an expensive way for the completion of a hostile takeover. Since depository banks are the ones who verify the tendered stock and they issue payments from the investor’s side, it turns out to be a long and time-consuming procedure. Additionally, if in any case other investors get involved in the hostile takeover then the offer price will rise. Since there is no guarantee that the first investor will get the deal, he might even lose the money.

How Tender Offer Works for Investors?

To understand how tender offers work for investors we will use the help of an example. Sam owns 2,000 shares of Zero Inc at $100 per share. This makes the market valuation of his shares $200,000. One day when he opened his brokerage account he was notified that Space Ltd made a tender offer to buy the shares he owns at $130 per share. But the clause on this is that 70% of the shares that are outstanding are tendered to the acquirer by the shareholders as a part of the deal. He has 2 weeks to decide if he wants to tender his stock or not.

Accepting a tender offer

If Sam decides that he will accept this offer, he will have to give his instructions before the deadline or he can not participate. This process is nothing more than Sam telling his broker that he will sell his shares at $130/share and wait to see what will happen. This is the case for digital shares, in case Sam has physical share certificates then the process will be totally different. If enough shares are tendered and the tender offer goes through, then Sam will see his 2,000 shares of Zero Inc leave his account with a deposit of $260,000 in his account. If in any case, the would-be acquirer tendered less than 70% of the shares, then the tender offer will fail and the offer will disappear. Sam will keep his 2,000 shares in his account.

Rejecting a tender offer

If Sam decides to reject the tender offer or in any case, he misses the deadline, then he will not get anything. He still has the 2,000 shares and will be able to sell them to others in the share market at the available price. In some cases, the investors that offered the tender make another offer if they did not receive the number of shares they wanted initially. They might also make a second offer in case Sam had more than 2,000 shares of the company and only sold 2,000 initially. But as mentioned above, one disadvantage here is that in any case Sam did not tender but others did and the investor received the 70% he was looking for. Then Sam can be forced to sell out and the enterprise could be made private.

How long do Tender offers take?

Every tender offer is subject to anti-fraud provisions and specific procedure requirements that relate to how long it should stay open, how fast the holder should be paid for the securities they tendered, and also the specific conditions that the bidder should adhere to in order to extend the offer. This will include the tender offer that results in the ownership of 5% or less of the shares. These are also known as mini tender offers. A tender offer is to be open for at least 20 days. Every offer has an expiry date (the 21st day), but the bidder has the power to extend that date. If in any case the expiration date is extended, there should be a press release regarding the same.

Tender Offer Regulations in the US

Tender offers are subject to significant rules and regulations in the US. The purpose of these regulations is to protect the investor, offer ground rules that provide stability to the acquired company so it has the liberty to react and keep the capital markets efficient. When looked at, a tender offer is governed by two regulations, the Williams Act and the SEC regulation 14E. Let us understand them in-depth:

Williams Act

The Williams act is a part of the Securities Act of 1934. This act states that a company, individual, or group of people who are seeking to acquire control of a company should follow the set guidelines. The guidelines are set in order to increase the fairness for capital market participants. Also, they allow the interested parties (Company’s BOD and management) to have time to form and display their case for either rejecting or supporting the tender offer.

According to the Williams act, a tender offer must:

• Present a reason for the tender offer being made
• Be registered under the federal law
• Disclose any existence of contracts, agreements concerning the subject, or understanding of the tender.
• Announce, if they have any existing plans to extend the tender offer if the first offer was successful.
• Disclose the source of the funds used for the offer to the SEC.

Additionally, the law also states that the tender offers should not be misleading and should not contain any incomplete or false statements in order to trick anyone into voting for a certain decision.

Regulation 14E

Regulation 14E especially rules 14e-1 to 14f-1 covers many tender offer rules. Each of these rule is specific and detailed.

One of them is that it is illegal for someone to announce a tender offer if they do not have the required funds to go through the deal if it is accepted. This is so because announcing a tender offer will fluctuate the share price wildly. This makes market manipulation easier.

Additionally, it will reduce the faith everyone had in the capital market as everyone will be wondering if the tender offer was real or not every time a tender offer is received.

Taxes on Tender Offer

If your business allows you to exercise options and sell the resulting stock in one single transaction and you choose to do so, then you will have to pay ordinary income tax on the difference between the strike price and the price at which you sold them. Also, if you make more profit, the extra income will push you to a higher tax bracket. If you have tender stock that you already own then you will have to pay capital gains tax on the difference. If you hold the shares for one year after exercising and two years from the grant date, you will be subject to long-term capital gains. If you sell before the holding period cited above then you will be subject to short-term capital gains.

How to decide if you should participate in a tender offer

Deciding if or not to participate in a tender offer is your decision, but here are a few points to assist you in deciding:

• Talk to your financial advisor as they can assist you in deciding if it is a good decision to take part in the offer. They will give you advice with regards to your goals and current financial situation.
• Read all the documents thoroughly. Go through the company documents to get an idea of how the company is performing.
• Attend the info sessions. At these sessions, you can get relevant information and also ask questions like who is qualified to take part and when is the offer expiry date.

Before participating in the tender offer, ask yourself if:

• You need to look at your goals and ask yourself if you need the money or can you wait?
• Check how the business is doing? Do you think the share value will continue to rise?
• Do you think the price offered is fair?
• How much will it cost you to exercise your remaining share options?
• When do you think the next event of liquidity will happen?

If all your answers push you towards accepting the offer, then do so. If you do not need the money and see the price of the shares rising, then hold onto them.

Need Expert Assistance in Valuing Your Business?

A tender offer will only be made if the investor or acquirer sees potential in the business and values it at a higher worth. In order to invest in a business, you need to have the knowledge of valuing them. A valuation can be done by many methods, but choosing the right one for your target company is essential for the right results. Involving a professional is best as they have the knowledge and can best value a business.

Eqvista is backed by professionals that can not only help you in evaluating your company but also provide you with tools that adhere to the rules and regulations for assisting you in various other tasks like cap table management, 409a valuations, share management, and more. Contact us today to know more about our services.