Business Law Prof Blog

Shareholders Respond to MBOs

In todays Wall Street Journal, an article by Jason Singer ("In Twist for Private Buyouts, Some Shareholders Fight Back"), Mr. Singer described the VNU NV buyout.  Public shareholders demanded that the existing board pursue plans similar to those proposed by the private equity buyout firms for the benefit of the public shareholders rather than support a transfer of the firm to private hands.  The demand increased the buyout price a bit.  But the push back has been too long in coming.  Why do hedge funds, in response to a private buyout, not buy stock and demand of a board to increase value for public shareholders by better operations as a public company, so as to take some of the private buyout groups profits for the public shareholders??  It is a strategy that should work in some of the more notorious buyouts in which management participates. Make the public managers work for the public shareholders or fire them and get some who will; do not let the public managers take the benefits of their information as private owners.

Ackman v Lampert

Jess Eisinger's fine reporting on the Sears Canada takeover by Eddie Lampert (Long & Short, Wall Street Journal) illustrates a growing problem in United States takeovers as well.  Buyers are negotiating complicated side deals with shareholders and the side deals may violate the equal price rule of tender offers, a rule which requires that all shareholders get the same price.  I think the rule, which disallows price discrimination is a bad rule, but it is there.  [Holman W. Jenkins Jr. would excuse the violations therefore perhaps.]  We will see some United States cases on the issue as well. 

Apologizing for Back Dating?

Holman W. Jenkins, Jr., of the Wall Street Journal,  has written his second or third piece on why the back dating scandal is overblown.  (How Backdating is like a 1980s Rockumentary)  As I understand his argument it goes like this.  Company can legally grant "in the money options" to executives.  They did so but mislabeled them "at the money options" so as to work around an "absurd, even imbecilic" accounting rule.  Don't like a bad rule, violations are acceptable.  I had a race car mechanic use the same argument last night to justify cheating on "idiotic" rules designed to make race cars in one class equal.  The argument is, of course, self-serving and also dangerous -- it attacks the system that makes everything work.  If everyone does it, no rule is respected, there is no system.  People who make the argument are free riders; they free ride on those who voluntarily respect the rules and keep the system in place so they have a place to make money by cheating.

London's AIM

Entrepreneurs in the United States depend on venture capital for funding the formative years of their operations. The willingness of venture capitalists, angels and venture capital funds, to place funds with portfolio companies depends on predictions of high rates of return for these high risk investments. The most robust of these predictions depend on the anticipated sale of the company within the next seven to ten years to the public, an Initial Public Offering (IPO). Since the number of IPOs has been down for the past several years, venture capital funding has been corresponding flat.

      The fundamental reason for the small numbers of IPOs is, of course, the reluctance of public investors to buy IPO stock. The technology bubble burst in 2000 and investors still remember their losses in the IPO industries. But the IPO market would be more active if IPOs were not so expensive. IPOs cost too much to do and, once done, a company has much higher ongoing costs. The higher ongoing costs are a significant bone of contention, particularly with the implementation of Section 404 of the Sarbanes-Oxley Act of 2002. Here I want to focus, however, on the costs of the IPO itself.

      In the United States a small company has to pay too much in fees and discounts when it sells its stock to the public. A small company selling fifty-three million dollars of its equity, as measured by the market price at the end of the first day of public trading, can net only forty-five million dollars in cash or less. Moreover, perversely those who charge to do the IPOs, underwriters, are uninterested in the smaller offerings; underwriters do not make enough money on the small offerings to justify their expenditure of time on them. A small company that wants to raise twenty-five million dollars cannot find an underwriter; a fifty million dollar IPO is a practical minimum.

      The London Stock Exchange is successfully marketing a low cost public offering process to small companies, entitled the Alternative Investment Market (AIM). AIM caters to companies in the micro to small cap universe, offering access and liquidity comparable to NASDAQ at a lower total cost to the issuer. Small companies can raise capital on the AIM with fees and underwriting charges that are forty percent of those incurred in the United States markets. Under-pricing losses are less as well. The listing process takes only eight to twelve weeks, compared to the six to eight months required in the United States.

      The AIM market has limited listing requirements. A listed company must have a “nominated advisor” and declare its working capital. The Nominated Advisor (Nomad) vouches for the company, determining its suitability for AIM, and will do due diligence, but the requirements are less stringent than those for a full listing. The Nomad’s certification provides the substitute for the underwriter’s certification in the United States.

      The AIM market is booming. In 2005 AIM had 335 IPOs compared to NASDAQ’s 35. The deal size comparisons are also telling. The average technology IPO deal size on the NASDAQ was $117.5 million, on the AIM it was $18.7 million. The AIM supported the smaller deals. Interestingly, the enterprise value as a multiple of revenue was lower on the NASDAQ 4.7x than on the AIM, at 6.3x. AIM investors were willing to accept more risk. The London market has successfully created a public offering market for small and micro cap companies. To remain competitive, the United States trading markets need to mount a successful competitor to this market.

SOX and Small Business

As the SEC continues to struggle with applying Sarbanes Oxley to small business, it could take a lesson from privately held firms that are deciding to comply with some parts of SOX and not others.  See Jaclyne Badal and Phred Dvork, Sarbanes-Oxley Gains Adherents, WSJ today.  The privately held firms uniformly reject Section 404's audit of internal controls requriement, for example, but do attempt to put some internal controls in place that are appropriate to their business.  The SEC could tailor its rules for small publicly traded companies to follow the wisdom of the privately held companies. 

Lessons on Stock Options

David Reilly in today's Wall Street Journal ("FASB Appears in a New Light on Stock Options") does a wonderful story on those who complained bitterly about the FASB's rule to expense stock options.  Many of the complainers are now facing claims of abusing stock options in the back dating controversy.  As one who was heavily lobbed to write against the expensing rule (I refused) because I do not like heavy government regulation (guilty), I was taken back by the bitterness of the condemnation of the rule (which I thought made sense).  The full story is now emerging;  opponents of the rule were attempting to preserve a black market opportunity.  I makes one wonder --Is there a current controversy in which the opponents are a bit too vocal in opposition?  The proxy rules on shareholder resolutions focusing on board elections and retention come to mind.