What Does it Mean When a Public Company Goes Private?

Last month, national bookseller Barnes & Noble announced that it would be acquired by a private equity firm after years of struggling to compete with Amazon. Barnes & Noble is a publicly held company, so the transaction has been referred to as “going private.”

What exactly does it mean when a public company reverses course and goes private? More importantly, what impact could this have on the business and on your investment portfolio if you are a shareholder of the company?

The Opposite of Going Public

You may have heard the term “going public.” This refers to when a privately held company offers shares of stock to the general public and everyday investors. Public companies’ shares are usually offered for sale on a public stock exchange like the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market.

Going private is the opposite of going public. Here, a publicly held company decides that it would benefit by going back to private ownership. In addition to Barnes & Noble, a number of other high-profile companies have gone private in recent years, including Dell Computers, Panera Bread, Burger King and H.J. Heinz.

There are several different ways that public companies can go private. With a management buyout (MBO), existing management pools its resources to purchase all or a majority of the public company’s shares. With a management buy-in (MBI), external management (such as a private equity firm) purchases the shares and moves in to replace the existing management team.

And with a leveraged buyout (LBO), external acquirers use leverage (or borrowed funds) to purchase shares. Because they involve large amounts of debt, LBOs are usually reserved for large transactions, with the assets of the acquired and acquiring businesses used as collateral for the debt.

Read More: How Does an IPO Work?

Why Companies Go Private

Going private can give struggling public companies an opportunity to restructure, make operational changes and turn things around with the possibility of going public again in the future once problems have been addressed. It can also free management from the scrutiny brought on by public or activist shareholders.

In addition, private companies don’t have to deal with the costly and time-consuming regulatory, financial reporting, corporate governance and disclosure requirements public companies face. These responsibilities — including remaining in compliance with the provisions of the Sarbanes-Oxley Act (SOX) — can draw management’s attention away from growing the business as executives get caught up in all the details involved in adhering to myriad government regulations.

Private companies also aren’t faced with the pressure of meeting quarterly earnings targets and expectations from investment analysts and “the Street.” These pressures sometimes force management to make short-term decisions that aren’t necessarily in the long-term best interests of the company, such as neglecting research and development and short-changing investment in capital expenditures.

How Going Private Works

The going private process usually looks something like this: A private buyer (either internal or external) makes a bid to purchase the shares of a publicly held company. If the bid is accepted by the majority of voting shareholders, the company will be deregistered with the Securities and Exchange Commission (SEC) and its securities will be delisted from the public exchange and no longer available for public trading.

If you own shares in a public company that goes private, you must sell your shares at the acquisition price that’s agreed to by the parties. For example, if you own 100 shares in a public company and the parties agree to a sale price of $50 per share, you will receive $5,000 for your shares when the company goes private.

What Going Private Means For Investors

So, is going private a good thing or a bad thing for investors? This depends on several factors, including the price paid for shares. For example, if the bid price for a publicly held company going private is lower than what you paid to buy shares, your loss will be locked in and you won’t have the opportunity to benefit from any future appreciation in share prices.

Conversely, if the bid price is higher than what you paid to buy shares, you’ll benefit from the appreciation. Share prices often rise when companies announce that they’re going private since acquirers may have to offer a premium of up to 40 percent over the current stock price to entice existing shareholders to sell. Also, investors may get excited about the turnaround prospects of a business after it goes private.

In the case of Barnes & Noble, the company’s shares jumped 30 percent the day before the announcement when news broke that the transaction was imminent, and another 10 percent the day of the announcement. But this isn’t always the case, and there can be significant risks to going private — especially when excessive leverage is used in the transaction.

Opportunities and Risks

When public companies go private, this presents both opportunities and risks for investors. Your financial advisor can help you analyze these opportunities and risks in relation to your particular financial situation.

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