Companies choose to leave the public arena and go private for many reasons. Good luck getting them to talk about it. Once they're private, they have the privilege of revealing only what they want to.
Dell and H.J. Heinz are the latest household names to say adios to being public. They are far from the first to run for cover into the private world. Burger King, though public now, has switched back and forth, and Arby's, Reader's Digest, Mervyn's, Levi Strauss & Co., Jo-Ann Fabric and Craft Stores, and many others have done so too in recent times.
In 2005, researchers from the Olin School of Business at Washington University, the University of Amsterdam, and the Ross School of Business teamed up to study the move toward private ownership. They found every year since the tech bubble burst, the number of public firms delisting has been rising. In 1999, 35 companies went private, but by 2003, 86 companies had delisted, and more than 200 companies applied to delist in 2004.
The reasons for doing it vary, and there’s been much speculation and analysis over why Dell and Heinz are making the transition. “For Dell to reinvent itself will be challenging at best. The company made its name and its business selling customizable PCs, and that market is not so hot anymore. In order to change, the folks at Dell will have to get very creative,” says Steve Balzac, president of consulting firm 7 Steps Ahead. “When that experimentation is carried out in public, then it's going to be Monday-morning quarterbacked to death.”
The scrutiny will come from both outside and inside Dell’s corporate walls, which could effect the company’s ability to succeed under its new status. “For employees at the company, that constant drumbeat of 'Did they screw up again?' is demoralizing to the extreme,” Balzac adds.
Quite simply, says Rita Gunther McGrath, associate professor, Columbia Business School, “Dell needs the peace and quiet to restructure their business model without howling from the analyst community.”
The situation was vastly different for Heinz, which was acquired by Berkshire Hathaway and 3G Capital for more than $28 billion. “They were likely motivated more by being able to cash in on the value of the brand at a significant premium over its pre-acquisition sale price. Berkshire Hathaway loves brands like this that prove they are able to sustain margins over a long period of time,” McGrath says.
Why Going Private Can Pay Off
The list is long for the reasons to switch from public to private. “Lower expenses, long-term focus, confidential information, flexibility of corporate affairs, avoiding exposure to securities litigation, avoiding costs of staying public, and recapturing shareholder value,” says Robert Dow, a securities attorney and partner with law firm Arnall Golden Gregory, who has assisted several companies with the change.
Indeed, public-company CFOs have many reasons to envy their privately-held counterparts. Managers can focus on the long-term performance, rather than quarter-to-quarter earnings. They can have more freedom in realigning benefits packages without extensive disclosure and shareholder pushback, adds Dow. And they can avoid the rigorous requirements from the Securities and Exchange Commission and keep information about competitive information close to the vest. The key reason to be public – access to capital – is not always prevalent if it has become an “orphan,” says Dow, because of poor trading volume, limited public float, low stock price, or lack of research coverage and institutional investor interest. For smaller companies built on the innovations of an entrepreneur, the reasons for backing away from public scrutiny can be fairly simple. “Like a burnt-out movie or rock star, sometimes they just want to get out of the limelight and be able to run their business quietly, without all the glare of publicity and investors second-guessing every move,” says Dow.
According to Adam Hartung, managing partner of consulting firm Spark Partners, there is one chief reason to go from public to private: “By changing the corporate structure from a C Corporation to an alternative, such as LLC, Subchapter S Corp, or even proprietorship, the owners avoid double taxation on dividends. So if a company would like to pass through losses to the owners' personal income statement, or pass through high cash flows, being private offers opportunities to reduce taxes.”
However, companies that go private for this reason will rarely admit it. Instead, says Hartung, they give opaque explanations. “This is done because the management or new owners claim they cannot make various decisions that will benefit the company while public,” he says. “This is pure balderdash. There are no decisions a private company can make that a public company could not make. There is no managerial benefit from ownership change.”
Or a company could be going to the other side because of a third-party takeover. This frequently happens when the company's stock is under-valued and has fallen out of favor in the market. A competitor, private equity fund, or other interested party says, “‘Hey, I can buy this company cheap.’ It makes an offer to buy the shares,” explains Dow.
Why Going Private Isn't a Panacea for Hurting Companies
One major challenge in switching can be negotiating the financing to buy out the public shares, says Dow. The company – or the new private owners – has to come up with enough money to buy out all the small shareholders, usually at a premium, to get the shareholders to approve the deal or tender their shares. Unless the company has a wealthy founder, the managers will have to find that money somewhere, which may involve private equity funds, other institutional investors, or lenders.
“Those financing sources will extract a pound of flesh in terms of price or control,” Dow says. They may demand high interest rates or dilution, for example. A related challenge is simply deciding who controls the company and how will it be managed going forward.
Then too, companies that are subsequently “restructured” are inherently lower in value, says Hartung. They have fewer assets, products, employees, vendors, and customers. They have large debt service requirements, and minimal cash flow beyond debt payments, says Hartung.
Indeed, there can be a destructive consequence of going from public to private, “when acquiring companies load them up with debt and 'flip' them,” points out McGrath. “There have been some sad examples of this in the past, including Simmons Bedding Company and Mervyn's.”
Although most of us won’t be privy to the details, Dell and Heinz face a tough transition since they are older, risk-averse organizations that lack the nimbleness of an entrepreneurial firm, Balzac suggests. “Changing that culture is going to take a lot more than just going private. It's going to require recognizing that what made those companies exciting places to work isn't there anymore,” he says. “Putting the spark back will necessitate creating a new, vibrant vision and adapting the organizational narrative to reframe the decision to go private as a strategic move and not a sign of failure or desperation.”
At least they can work it out among themselves, quietly, privately.
Sheryl Nance-Nash is a freelance writer specializing in personal finance, small business, general business, and career-related topics.