Ask a MoFo: What Are the Private Company Tender Offer Rules?

The following article is part of our "Ask a MoFo" series, where we address some of the frequently asked questions our MoFo startup team is asked during the course of business. These questions span the entirety of the startup lifecycle – from questions relating to incorporation, to tips for a successful exit. We encourage you to submit questions you would like to see answered as part of this series to ECVCevents@mofo.com.

Private company tender offers have become increasingly common due to the significant amount of available capital from venture capital/corporate venture capital, private equity, strategic and cross-over investors as well as headwinds in the IPO and broader public markets. With companies remaining private longer, early employees and investors often seek out opportunities to receive some cash proceeds before a total liquidity event in the form of a public offering or M&A sale transaction. Tender offers can be used to do just that.

Tender offers can also be used to optimize a company’s shareholder base in advance of a public listing (e.g., by providing early investors and/or other early contributors with an opportunity to get out while giving institutional capital market investors an opportunity to get in) or other significant transactions (e.g., providing larger strategic investors with the opportunity to acquire an initial toehold interest in the company before evaluating an acquisition bid).

This article explains what a tender offer is, describes what rules apply to tender offers for private company shares as compared to public company shares, and provides practical tips for conducting a tender offer.

What Is a Tender Offer?

A tender offer generally refers to an offer by a third party or a company to purchase some or all of the outstanding shares of the company from a number of shareholders. What constitutes a “tender offer” is not defined in Securities & Exchange Commission rules, so whether a transaction or set of transactions constitutes a tender offer requires analysis of court guidance. Courts have ruled that a tender offer involves some or all of the following characteristics:

1. An active and widespread solicitation to acquire shares from shareholders of a company;
2. A solicitation that is made for a substantial percentage of the company’s shares;
3. The offer to purchase is made at a premium over the prevailing market price;
4. The terms of the offer are firm rather than negotiable;
5. The offer is contingent on the tender of a fixed number of shares, often subject to a fixed maximum to be purchased;
6. The offer is open for only a limited period of time;
7. The offerees are subject to pressure to sell shares; and
8. Public announcements of a purchasing program precede or accompany a rapid accumulation of large amounts of the target company’s shares.

Not all of the foregoing factors need to be present in order for a transaction to constitute a tender offer. Key factors to consider in an assessment of a private company tender offer include the number of shareholders involved, the amount of shares subject to the offer, and whether the proposed terms are fixed or negotiable. In addition, some courts have indicated that defining a transaction as a tender offer turns on whether, viewing the transaction as a whole, the potential sellers need the protections provided by federal securities laws.

Private Company Tender Offer Rules

Federal tender offer rules apply to transactions involving both publicly traded and privately held companies. While this article focuses principally on tender offer rules applicable to private companies, we also point out some of the significant differences in rules applicable to public company tender offers.

The tender offer rules are generally designed to ensure timely, accurate, and adequate disclosures so that shareholders can make an informed decision as to whether to tender their shares. In any transaction that constitutes a tender offer (regardless of whether public or private), federal securities laws impose a number of requirements, including the following:

• Anti-Fraud Rule. The offeror cannot make material misstatements or omissions or undertake other fraudulent, deceptive, or manipulative acts or practices in the context of the tender offer.
• Minimum Offer Period. The offer must be open for a minimum of 20 business days. Extensions are required for any changes in the price or quantity of shares (the offer must remain open for at least 10 business days) and for other material changes (the offer must remain open for at least 5 business days).
• Prompt Payment. The offeror must promptly pay the consideration offered after the closing of the tender offer or return the tendered shares if the offer fails because of termination or withdrawal.
• Company Position Statement. Within 10 business days from the commencement of the tender offer, the target company must disclose to its shareholders whether it:
  • (1) Recommends they accept or reject the bidder’s offer;
  • (2) Expresses no opinion and remains neutral as to the bidder’s offer; or
  • (3) Is unable to take a position with respect to the bidder’s offer.
• Purchases Outside the Offer. The offeror and certain affiliates and other persons cannot buy the target company’s shares during the pendency of the tender offer other than through that tender offer, subject to a variety of exceptions.
• MNPI. Persons in possession of material nonpublic information (MNPI) that they know, or have reason to know, is MNPI cannot purchase or sell shares in a tender offer. The offeror, company, and certain other parties also cannot discuss MNPI that could foreseeably lead to the foregoing.
  • Practically speaking, this means that MNPI about the company must be disclosed to potential participants (i.e., buyers and sellers, including employees and other service providers), including financial statements, risk factors, capitalization information, and other information material to an investment decision.

Private Company Tender Offer Rules Provide Additional Flexibility

Unlike private company tender offers, public company tender offers must include the following requirements:

• Best Price Rule. The price paid to any tendering shareholder of a particular security must be the highest price paid to any other tendering shareholder in the offer.
• All-Holders Rule. The offer must be made to all security holders of the class of securities sought.
• Pro Rata Cutback. In the event the tender offer is oversubscribed, the cutback mechanic must be pro rata based on the number of shares tendered by each shareholder.
• Withdrawal Rights. Tendering shareholders must be permitted to withdraw securities previously tendered at any point before the offer period expires.

Without the foregoing public company tender offer rules, offerors and companies in private company tender offers can consider bespoke offer terms designed to achieve their objectives as to, among other things, price, participation, timing, and structure.

Practical Tips

Below are several practical tips for parties to consider in connection with a private company tender offer:

• Given the nuances associated with determining whether a transaction constitutes a tender offer and the meaningful consequences of that determination, it is important to involve legal counsel early in the process to ensure the transaction is structured in a lawful and efficient manner, so as to, among other things, avoid potential penalties for noncompliance.
• Companies may consider launching a self-tender as a liquidity option and should determine whether and how such a transaction fits into their overall compensation philosophy and programs, business objectives, projected financial position, and fundraising strategy. Tender offers can be combined with a direct investment in the company by existing or new investors.
• If parties desire to mitigate the potentially onerous tender offer rules, they can consider structuring a transaction in a way that does not qualify it as a tender offer but nevertheless achieves the parties’ commercial objectives.
• A variety of tender offer platforms now make the tender offer process easier to facilitate than it once was. However, there are still many technical and coordination steps that need to be followed in order to conduct a successful tender offer, and discussing the mechanics of that process with counsel and the platform to make sure all of the parties understand the transaction flow is important before the offer begins.
• Even early-stage companies can get caught up in tender offer rules and regulations. For example, a tender offer can be implicated in a venture financing round where a slew of existing stockholders (including early investors and/or management and co-founders) are offered the opportunity to cash out some of their equity by selling it to the lead investor in the round as part of a secondary market transaction.
• Beyond the SEC’s rules, companies and investors should consult with legal, tax, and accounting advisors to understand the various implications of any tender offer.