Going Private: What It Means, How It Works, and Types of Buyouts

Companies sometimes choose to transition from public to private ownership, driven by strategic objectives. Going private offers businesses greater flexibility and reduced regulatory scrutiny, enabling a focus on long-term growth without the pressures of quarterly earnings reports.

Key Corporate Changes in Private Status

When a company goes private, it undergoes significant changes in its structure, financial reporting, and governance. A key shift is the delisting of its shares from public stock exchanges, which requires buying back shares from public shareholders, often at a premium. This reduces the need for detailed financial reporting to the Securities and Exchange Commission (SEC), cutting compliance costs and regulatory burdens.

The transition impacts the company’s capital structure. Freed from catering to public market investors, companies can optimize their debt-to-equity ratios to align with strategic goals. This often involves restructuring debt or securing new financing arrangements, such as mezzanine debt, which combines features of debt and equity.

Governance also changes significantly. Boards of directors are often restructured to include representatives from private equity firms or other major stakeholders, streamlining decision-making. Executive compensation packages may shift to emphasize long-term performance metrics over short-term stock price movements.

Types of Buyouts

The move from public to private ownership can be achieved through different buyout strategies, each with distinct financial and operational implications.

Management Buyout

In a management buyout (MBO), the company’s existing management team acquires a substantial or complete ownership stake, often with external financing. This type of buyout reflects management’s desire for greater control over the company’s strategic direction. MBOs typically involve leveraging company assets to secure debt financing, which impacts the balance sheet and financial ratios. Under Generally Accepted Accounting Principles (GAAP), acquisitions must be recorded at fair value, affecting financial statements. Tax treatment under the Internal Revenue Code (IRC), such as limits on interest expense deductions, also influences MBO financing structures.

Leveraged Buyout

A leveraged buyout (LBO) involves acquiring a company using a large amount of borrowed money, with the company’s assets serving as collateral. This approach enables buyers to make significant acquisitions without committing substantial capital. The high debt-to-equity ratio in LBOs affects credit ratings and the cost of capital. Under International Financial Reporting Standards (IFRS), the acquired company’s assets and liabilities must be consolidated into the buyer’s financial statements, impacting metrics like return on equity (ROE) and earnings before interest, taxes, depreciation, and amortization (EBITDA). The success of an LBO depends on the company’s ability to generate enough cash flow to service the debt, making cash flow projections and interest coverage ratios critical during due diligence.

Private Equity Acquisition

In a private equity acquisition, a private equity firm buys a company, often aiming to restructure and improve operations before selling it for a profit. These transactions typically involve a mix of equity and debt financing. Private equity firms conduct detailed financial modeling to assess potential returns on investment (ROI) and internal rates of return (IRR). Operational improvements and strategic changes are implemented to enhance the company’s value, which may include adjustments to accounting practices. For example, private equity firms might adopt aggressive revenue recognition policies under GAAP or IFRS to boost earnings. The ultimate financial outcome for private equity investors depends on the exit strategy, whether through a sale or an initial public offering (IPO).

Financing Methods

Choosing the right financing method is critical when companies decide to go private. Debt financing is common, with companies issuing bonds or securing loans to fund the buyout. Interest rates on these instruments are often tied to benchmarks like the Secured Overnight Financing Rate (SOFR). Companies must evaluate interest rate fluctuations and their impact on the cost of capital, especially in light of Federal Reserve rate adjustments.

Equity financing, which involves issuing preferred or common stock, provides funds without the immediate burden of debt repayment but can dilute existing ownership. Valuation of shares often adheres to International Valuation Standards (IVS) to ensure fair market value. Companies must consider how equity financing affects their weighted average cost of capital (WACC) and shareholder equity.

Hybrid options, such as convertible bonds or mezzanine financing, combine debt and equity features. Convertible bonds offer lower interest rates with the potential for conversion into equity, while mezzanine financing involves subordinated debt that may convert to equity. These instruments require careful structuring to balance risk and reward, with attention to covenants and conversion terms.

Regulatory Steps

Navigating the regulatory landscape is a critical part of transitioning to private ownership. Companies must file a Schedule 13E-3 with the SEC, detailing the transaction’s terms and its impact on shareholders. This filing ensures transparency and fairness, requiring disclosure of conflicts of interest and the methodology used to determine the buyout price.

Tax considerations also play a significant role. The Internal Revenue Code (IRC) includes provisions that affect the taxability of such transactions. For example, IRC Section 368 governs reorganizations, influencing the tax treatment of mergers and acquisitions. Companies must analyze these provisions to determine their impact on capital gains, losses, and potential tax deferrals.