How do public-company buyouts work?

Question

I'm looking at the impending buyout of Dell and wondering how it works in practice.

My understanding is that most public companies' shares are owned by individuals, or groups of individuals through a mutual fund or retirement plan.

So in this case, if a buyout is planned, the only way for it to be successful is if everyone agrees to the buy offer and sells their share to the would-be new owner.

But if it's a large company with millions of shares, as Dell presumably has, how can they force every shareholder to sell their share? How can they make a company go-private if, say, 25% of the shareholders decide to keep their shares and not sell it for any amount?

Answer 1

Thanks for your question Dai.

The circumstances under which these buyouts can occur is based on the US takeover code and related legislation, as well as the laws of the state in which the company is incorporated.

It's not actually the case that a company such as Dell needs to entice or force every shareholder to sell. What is salient is the conditions under which the bidder can acquire a controlling interest in the target company and effect a merger. This usually involves acquiring at least a majority of the outstanding shares.

Methods of Acquisition

The quickest way for a company to be acquired is the "One Step" method. In this case, the bidder simply calls for a shareholder vote. If the shareholders approve the terms of the offer, the deal can go forward (excepting any legal or other impediments to the deal).

In the "Two-Step" method, which is the case with Dell, the bidder issues a "tender offer" which you mentioned, where the current shareholders can agree to sell their shares to the bidder, usually at a premium. If the bidder secures the acceptance of 90% of the shares, they can immediately go forward with what is called a "short form" merger, and can effect the merger without ever calling for a shareholder meeting or vote. Any stockholders that hold out and do not want to sell are "squeezed out" once the merger has been effected, but retain the right to redeem their outstanding shares at the valuation of the tender offer.

In the case you mentioned, if shareholders controlling 25% of the shares (not necessarily 25% of the shareholders) were to oppose the tender offer, there would be serveral alternatives. If the bidder did not have at least 51% of the shares secured, they would likely either increase the valuation of the tender offer, or choose to abandon the takeover. If the bidder had 51% or more of the shares secured, but not 90%, they could issue a proxy statement, call for a shareholder meeting and a vote to effect the merger. Or, they could increase the tender offer in order to try to secure 90% of the shares in order to effect the short form merger. If the bidder is able to secure even 51% of the shares, either through the proxy or by way of a controlling interest along with a consortium of other shareholders, they are able to effect the merger and squeeze out the remaining shareholders at the price of the tender offer (majority rules!).

Some states' laws specify additional circumstances under which the bidder can force the current shareholders to exchange their shares for cash or converted shares, but not Delaware, where Dell is incorporate.

There are also several special cases. With a "top-up" provision, if the company's board/management is in favor of the merger, they can simply issue more and more shares until the bidder has acquired 90% of the total outstanding shares needed for the "short form" merger. Top-up provisions are very common in cases of a tender offer.

If the board/management opposes the merger, this is considered a "hostile" takover, and they can effect "poison pill" measures which have the opposite effect of a "top-up" and dilute the bidders percent of outstanding shares. However, if the bidder can secure 51% of the shares, they can simply vote to replace the current board, who can then replace the current management, such that the new board and management will put into place whatever provisions are amenable to the bidder.

In the case of a short form merger or a vote to effect a merger, the shareholders who do not wish to sell have the right to sell at the tender price, or they can oppose the deal on legal grounds by arguing that the valuation of the tender offer is materially unfair. However, there are very few cases which I'm aware of where this type of challenge has been successful. However, they do not have the power to stop the merger, which has been agreed to by the majority of the shareholders.

This is similar to how when the president is elected, the minority voters can't stop the new president from being inaugurated, or how you can be affected if you own a condo and the condo owners' association votes to change the rules in a way you don't like. Tough luck for you if you don't like it!

If you want more detail, I'd recommend checking out a web guide from 2011 here as well as related articles from the Harvard Law blog here.

I hope that helps!

Answer 2

As a TL;DR version of JAGAnalyst's excellent answer: the buying company doesn't need every last share; all they need is to get 51% of the voting bloc to agree to the merger, and to vote that way at a shareholder meeting. Or, if they can get a supermajority (90% in the US), they don't even need a vote.

Usually, a buying company's first option is a "friendly merger"; they approach the board of directors (or the direct owners of a private company) and make a "tender offer" to buy the company by purchasing their controlling interest. The board, if they find the offer attractive enough, will agree, and usually their support (or the outright sale of shares) will get the company the 51% they need.

Failing the first option, the buying company's next strategy is to make the same tender offer on the open market. This must be a public declaration and there must be time for the market to absorb the news before the company can begin purchasing shares on the open market. The goal is to acquire 51% of the total shares in existence. Not 51% of market cap; that's the number (or value) of shares offered for public trading. You could buy 100% of Facebook's market cap and not be anywhere close to a majority holding (Zuckerberg himself owns 51% of the company, and other VCs still have closely-held shares not available for public trading). That means that a company that doesn't have 51% of its shares on the open market is pretty much un-buyable without getting at least some of those private shareholders to cash out. But, that's actually pretty rare; some of your larger multinationals may have as little as 10% of their equity in the hands of the upper management who would be trying to resist such a takeover.

At this point, the company being bought is probably treating this as a "hostile takeover". They have options, such as:

• The "Poison Pill" (everyone who owns stock and agrees by contract not to sell their shares gets large amounts of free or cheap stock, so what's available on the market is no longer 51% of total shares),
• The "Pac-Man Defense" (you're trying to buy me? Well then I'll buy you; your stock price tanked on the news of the offer, since your expected dividend payments just went WAY down, while demand for my stock just soared on the same news giving my major shareholders a lot of buying power), or
• The "Golden Certificate" aka "superstock" (holders of shares of this stock, known in the market as "Class F", form their own separate voting pool, a majority of which must approve any motion of public business such as a tender offer, even if the public vote is unanimously in favor. The downside is that all other stock classes are effectively non-voting, and prices are adjusted by the market accordingly).
• A "White Knight" (Hey, EvilCorp is trying to buy our company, we don't want that, let's see if Angels Inc is willing to make a better offer, cause we like their management and business model better).
• The "Golden Parachute" (not really a defense against the company being bought, unless it's ludicrously opulent, but a good way out for the upper management; in the event of a hostile takeover, the executives and VPs get large severance packages, usually enough to be set for life if they wanted).

However, for companies that are at risk of a takeover, unless management still controls enough of the company that an overruling public stockholder decision would have to be unanimous, the shareholder voting body will often reject efforts to activate these measures, because the takeover is often viewed as a good thing for them; if the company's vulnerable, that's usually because it has under-performing profits (or losses), which depresses its stock prices, and the buying company will typically make a tender offer well above the current stock value.

Should the buying company succeed in approving the merger, any "holdouts" who did not want the merger to occur and did not sell their stock are "squeezed out"; their shares are forcibly purchased at the tender price, or exchanged for equivalent stock in the buying company (nobody deals in paper certificates anymore, and as of the dissolution of the purchased company's AOI such certs would be worthless), and they either move forward as shareholders in the new company or take their cash and go home.