How To Turn Paper Into Money

Receiving cash for shares provided in an acquisition is not always a simple process.  Counsel should be consulted at the beginning of a transaction to assist in structuring the acquisition to provide liquidity to the seller’s stockholders to the extent possible.

In my last blog, I discussed a transaction involving a Silicon Valley client whose business was being purchased by a publicly held company.  My client and I reviewed the legal methods available to the acquiring company to issue its shares to the shareholders of the selling company.  Each of the methods led to a trade-off between the cost to the acquiring company and the liquidity of the shares issued to the target company shareholders.  My client thought this was all well and interesting, but wanted to know how it would affect her.

The best situation for a target company shareholder, or selling stockholder, is to receive shares that can easily and quickly be turned into cash.  Whether this occurs depends on where the shares fall in the liquidity spectrum.

On the illiquid side of the spectrum are shares issued under a “private placement” exemption.  Although this type of issuance reduces compliance costs for the issuer, the shareholder may need to hold the shares for a period of time before the shares can be sold.  The amount of time the shareholder will need to hold the shares, usually referred to as a holding period, is important because any shareholder required to hold their shares will have to take market risk that the value of the acquiring company’s stock falls after the closing. 

The holding period for a shareholder varies depending on whether the shareholder is an affiliate.  An affiliate is someone under common control with another person.  This can include a relative or spouse of an individual, an officer or director of a company, or, a holder of 10% of a corporation’s stock.  Generally, the holding period becomes longer as the affiliate status becomes stronger.  In an acquisition, a nonaffiliated shareholder may have no holding period, while an affiliate of the target corporation may have a short holding period, following the acquisition closing.  An affiliate of both the target corporation and acquiring corporation has the longest holding period, and may face further sale limitations after the holding period ends.

To alleviate restrictions associated with post-closing transfers, some publicly-held acquiring companies have the ability to register economically for public sale the shares provided to the selling shareholders.  If the registration is successful, the selling shareholders are able to sell their shares free of many of the constraints discussed above. 

On the other side of the liquidity spectrum are shares that are both registered and listed on a well-regarded stock exchange.  If the selling shareholder receives publicly registered shares listed on an exchange, no holding period is required.  If the stock exchange is one where trading is active, and the selling shareholder is not subject to insider trading constraints, sale of the shares can be fairly easy.

At the midpoint of the liquidity spectrum are shares issued under a securities exemption available for states, such as California, that hold hearings judging the fairness of the issuance.  This process requires preparation and delivery of disclosure materials, a hearing by a state agency (the Commissioner of Corporations in California), and a finding by the agency that the transaction is fair.

Shares issued following a fairness hearing have a different status than shares issued directly by the acquirer in a private, exempted transaction.  A key advantage to the fairness hearing procedure is that the shares provided to a nonaffiliate of the target or acquiring company are free of any holding period.  An affiliate of the target company will not have a holding period, but will face other restrictions.  The length of the holding period, and the other restrictions, are somewhat complex and should be reviewed with counsel.