tender offers and going-private transactions

In short

If you own a stock that suddenly gets a buyout offer, I know how your stomach drops and lifts at once. A tender offer is a public invitation from a buyer to purchase shares directly from the owners, usually at a price above the market. A going private deal is when a buyer takes a public company off the stock exchange, so its shares stop trading in the open. The offer has a deadline, and the buyer must keep the offer open for a set period. Your broker will send a notice, and that notice tells you how to say yes or no. Selling in a tender offer is a taxable event, so the after tax result can differ from the headline price. Read the offer papers slowly, and write down the date you would have to act.

The whole of it

What it is

A friend of mine once opened his mail and found a thick envelope about a company he had owned for nine years. He assumed it was junk. It was an offer to buy his shares, and the deadline was three weeks out.

A tender offer is the buyer going straight to the shareholders. Nobody has to go through the exchange order book. The buyer announces a price per share and a time window, and each owner decides whether to hand over shares. The buyer may promise to buy all the shares offered, or only up to a stated amount. Some offers carry a condition, such as the buyer reaching a minimum number of shares before it will close.

A going private transaction is a larger story. The company stops being publicly traded. Its stock leaves the exchange, and it stops filing the regular public reports with the Securities and Exchange Commission, usually called the SEC. The buyer might be a private investment firm, the company's own management, or a larger company. Many of these deals begin with a tender offer. Others happen through a merger vote.

There is a third thing worth knowing about, and it is the squeeze out. After the buyer collects enough shares, it can force the remaining owners to sell at the same price. That second step is often called a back end merger. Owners who held out do not get to keep their shares.

How it works

If you are holding shares, the process starts with a document. The buyer files a Schedule TO with the SEC. The company being bought files a Schedule 14D-9, where its board says whether it recommends the offer or not. You can read both for free on the SEC's EDGAR database. Your broker also sends notices.

The offer must stay open for a minimum number of business days. The SEC's tender offer rules, found in Regulation 14D and Regulation 14E, set that floor. If the buyer changes the price, the rules can push the deadline out. The offer is open to every holder on equal terms, and that is a core idea in the rules, often called the all holders and best price principle.

To accept, the owner tells the broker how many shares to tender. The shares are held in a kind of limbo until the offer closes. While they sit there, they cannot be sold on the market. If the offer succeeds, the buyer pays, and the cash lands in the account. If it fails, the shares come back.

Sometimes the buyer asks for more shares than it wants. When that happens, the buyer takes a share of each person's tender on a pro rata basis. That means each owner gets the same percentage of their tendered shares accepted. The rest are returned.

The numbers, and where to find yours

Every offer has its own numbers, and they live in the offer papers. Look for the price per share, the expiration date, the minimum condition, and the maximum number of shares sought. Look also for how the buyer is paying. Cash is simple. Stock, or a mix, brings extra questions about what you will own afterward.

The SEC sets the legal minimum days the offer must stay open under Regulation 14E, and the current figure is the current figure, which the official source publishes each year. The offer papers on EDGAR show your actual deadline, which may be longer. Taxes matter too. A sale is generally taxed as a capital gain or loss. The rate depends on how long you held, and the dividing line is set by the Internal Revenue Code. The current long term holding period is the current figure, which the official source publishes each year, and the rates are published by the IRS in its guidance on capital gains. Your broker's cost basis record shows what you paid. Find that number first, because everything else leans on it.

A worked example

Let me tell you about a woman I will call Margaret Ellis. She owned 400 shares of a small software company. She bought them years ago at $18 a share. One morning the company announced that a buyer would pay $30 a share in cash through a tender offer.

Her cost was 400 shares at $18, which is $7,200. The offer would pay 400 shares at $30, which is $12,000. Her gain is $12,000 minus $7,200, or $4,800.

Say Margaret held the shares longer than the long term period. Suppose, for the sake of the example, her capital gains rate is 15 percent. The tax would be 15 percent of $4,800, which is $720. After tax, she keeps $12,000 minus $720, or $11,280.

Now suppose the stock had been trading at $26 before the news and jumped to $29 after it. Selling on the open market at $29 would bring 400 times $29, or $11,600. Tendering at $30 brings $12,000. The gap is $400. That gap is small, and it comes with a wait and some risk that the deal falls through.

Say the deal had a minimum condition and only half the owners tendered. The buyer might walk away. Margaret's shares would come back to her, and the price might drop. That risk is why the market price often sits a little below the offer price. The difference reflects the chance the deal does not close. Margaret did not need to guess about any of it. She needed to read the papers and know her own deadline.

Where it goes wrong

I have seen smart folks trip on this, and it is never because they were careless. They were busy. The most common stumble is missing the deadline. A tender offer is not a suggestion that waits around. If the broker's cut off comes a day or two before the official expiration, that is the date that counts for the owner.

Another trouble spot is the holdout idea. Some owners think refusing the offer will force a better price. Sometimes a buyer does raise the price. Often it does not. After a successful tender, a squeeze out merger can take the remaining shares at the same price, or at a price a court later reviews. Owners who disagree may have appraisal rights under state law, which let a court decide fair value. That path is slow and costly. It is not a stroll.

Taxes cause a third kind of surprise. A person with a large gain can face a bigger bill than expected. A person who bought at a high price may have a loss, and a loss can help offset other gains. The rules on offsetting are in the tax code and in IRS Publication 550. Reading that publication takes an hour and can save a headache.

Last, watch for the mix of cash and stock. If the buyer pays partly in its own shares, the owner becomes a shareholder in a different company. Tax treatment can differ too. Stay calm. Ask the broker or a tax professional to explain it before the deadline, not after.

Questions to answer before you leave this page

What is my cost basis, and have I found it in my broker's records? What date does the offer expire, and what earlier date does my broker need my answer? Is the offer for cash, for stock, or for both? Does the offer carry a minimum condition, and what happens to my shares if it is not met? Is the buyer taking all shares, or only some on a pro rata basis? Did the company's board recommend the offer in its Schedule 14D-9, and did I read the reasons? How long have I held these shares, and what does that mean for my tax? Would selling on the open market give me a similar after tax result with less waiting? And finally, who can I call this week, my broker or a tax preparer, if I get stuck?