Pandemics, Poison Pills, Public and Private
Try saying that three times really fast. The title of this article is more than a mere alliteration for many companies, and is, instead, a reality that many businesses face in light of COVID-19 (C-19).
Pandemics Promulgate Poison Pills
In recent months, there has been an upheaval of markets on an unprecedented level in response to the C-19 Coroanvirus pandemic, which has impacted companies across nearly every sector resulting in the volatility of stock prices declining, and many market-wide sell-offs. This upheaval, of course, sets the stage for hostile takeovers and increased shareholder activism. Hostile takeover activities and shareholder activism tend to go hand-in-hand with market volatility and generally follow investor uncertainty in tumultuous times. As a result, we will likely see an increase in the adoption of stockholder rights plans, otherwise known as “Poison Pills” as a defense against hostile takeovers.
As the pandemic continues to stifle stock prices, many investment bankers are recommending that companies adopt shareholder rights plans to prevent strategic buyers and private equity firms from buying at prices that are not reflective of the real, long-term value.
In a nutshell, a shareholder rights plan, sometimes referred to as a “poison pill,” deters bidders from making takeover bids without the support of the board of directors by threatening these bidders with the prospect of massive dilution of their common stock positions if they exceed a certain ownership threshold. Typically, a shareholder rights plan takes the form of the issuance of interests in preferred stock that, when a bidder buys target stock above a specified threshold (usually, 10%-15%), allow all holders except the bidder to buy the company’s common stock at half-price unless before crossing the threshold the bidder has won the support of the board of directors for its bid or other plans for the company.
Proactive Protection for Publicly Traded Companies
Historically speaking, many public companies protect themselves from takeover and activist threats through provisions in their charters and bylaws. For example, some companies will employ staggered boards, or enact supermajority requirements, fair price provisions, and limitations on the shareholder’s ability to call special meetings or take action by written consent. Still, pressure from proxy advisory firms have all but dismantled these traditional defenses in most companies’ governance documents, making it necessary for a company to create subtle, incremental changes that don’t attract the attention of proxy advisory firms and which make it more difficult for activists to effect change to the board.
Some other strategic defenses that have proven themselves valuable include the implementation of what is called a Staggered Board Defense, where a company might segregate its board of directors into different groups while selectively putting up a number of these for election at any one meeting. This tactic makes it difficult for activists to remove the entire board.
A preemptive defense against hostile takeover might be to establish differential voting rights where the holder of securities, for example, might be limited to the number of votes they can cast based upon a prescribed number of shares.
Finally, as a preemptive strategy to mitigate hostile takeovers, many companies are establishing ESOP’s (Employee Stock Ownership Plans) where employees have an option to buy into a tax-qualified retirement plan that offers tax savings to both the employee and the corporation. Actions such as establishing an ESOP means that the company will now likely have ownership with people who are friendly to the company and who will likely vote in conjunction with the company, as opposed to the views of a potential acquirer.
If, however, a board discovers that it can’t reasonably prevent a hostile takeover, it might lean towards employing a “White Knight Defense,” where a friendlier firm is allowed to buy a controlling interest (typically paying a premium above the acquirer’s offer). Then after the acquisition, a restructuring ensues in the direction of, or the very least, with support of the company’s management.
As an alternative to the White Knight Defense, a company might respond by making a public-to-private deal, where investors buy out most of a company’s outstanding shares, moving it from a public company to a private one, effectively de-listing it from a public exchange. While this is not typical, as an IPO is generally the goal of companies, the process of going private is more straightforward and includes fewer regulatory hurdles. Typically, a company that is seen as undervalued in the market will opt to go private.
One needs only to look at Tesla (TSA) as an example of an interest in privatization. Tesla CEO, Eon Musk recently tweeted that he was considering taking the company private at $420 per share. The price was a substantial boost from the trading price at the time. Following his announcement, TSA shares spiked more than 10% with trading halted following the news frenzy which ensued. Musk justified his intentions in a letter to employees where he stated:
“As a public company, we are subject to wild swings in our stock price that can be a major distraction for everyone working at Tesla, all of whom are shareholders. Being public also subjects us to the quarterly earnings cycle that puts enormous pressure on Tesla to make decisions that may be right for a given quarter, but not necessarily right for the long-term.”
Irrespective of how your business responds to the possibility of hostile takeovers or shareholder activism, the battleground will inevitably be in the boardroom. With C-19 seemingly in full swing, the show must go on, and publically traded companies are responsible for conducting shareholder meetings, even in the face of C-19 concerns.
In a recent announcement from the U.S. Securities and Exchange Commission (SEC), Issuers, under state law, must hold annual meetings and comply with federal proxy rules which require, among other things, the delivery of proxy materials. However, it might be a challenge, due mainly to C-19, to make these materials available promptly, thus forcing a company to change the date, time, or location of a shareholder meeting. To this end, the SEC has made conditional provisions for companies who have to reschedule due to difficulties arising from C-19. The SEC provides these conditions, where the company:
- issues a press release announcing such change;
- files the announcement as definitive additional soliciting material on EDGAR; and
- takes all reasonable steps necessary to inform other intermediaries in the proxy process (such as any proxy service provider) and other relevant market participants (such as the appropriate national securities exchanges) of such change.
A large contingency of business is adopting virtual shareholder meetings during this unprecedented time in our history. These changes, of course, require amendments to bylaws to support such a move, consideration of regulatory prohibitions, state laws which may override such implementations, and feasibility of access by shareholders, all of which may or may not work to the advantage of the company. Still, in light of C-19, these kinds of policy changes and adoptions seem to be more favorable to the very same environment where hostile takeovers and shareholder activism thrive– considering that virtual opportunities equate to more active participation (if only due to the convenience factor).
In a recent article from the National Association of Corporate Directors, author, Cathy Conlon responds to some consideration around virtually connecting with shareholders amid the current pandemic. She writes:
Boards should also consult with their corporate governance teams to understand where they are in the process—and what it will take to make the switch now:
- Have our proxy materials been printed and distributed yet? If not, should we consider switching to a virtual meeting this year?
If we aren’t ready to make the switch, what’s our contingency plan? Many companies are scheduling a VSM as a back-up to their physical meeting and alerting shareholders that a change of venue may occur.
- How are we going to communicate our plan to shareholders in the event that we do make a switch after original notifications have gone out? Companies are choosing among various options, including distributing notifications, creating recorded messages for shareholders, and posting information on the company website.”
- With C-19 leaving many companies in a state of uncertainty, surrounded by a vacuum of opportunity for shareholder activism, it is all the more important for leadership to huddle around experts who understand the necessity of facilitating strategic plans which ensure the best interest of the companies they serve, to meet the unforeseen challenges with experience and wisdom.
Prime Time for Private & Family Businesses
For Private/Family Businesses the current state of the economy lends itself to a great opportunity to transfer shares to the next generation as business values are depressed with COVID impacts. Rob Ferguson of Ferguson Interests notes,
“I remain very bullish on Family Business getting thru this time. I believe many will thrive in this environment of opportunity once COVID is in the past.”
As the effects of COVID-19 continue to threaten economies, family businesses are certainly not immune to the economic fallout brought on by safety protocols such as temporary closures and social distancing. Still, family businesses are in a unique position to not only survive the pandemic, but to be leaders in the post-COVID economic recovery. The short-term my be difficult, but many family businesses understand that resilience is the key and are focused on the big picture and the long-haul. For many, the time is ripe for executing intrafamily transfers as a function of their estate planning objectives.
Since business appraisers are the ones who determine the fair market value of shares for “gifting” or other kinds of intrafamily transfers by estimating the value of the business and considering how the shares might be viewed on public markets and evaluating expectations around cashflows and risks, a family business might be in a better position than others post-COVID.
Being that shares in a family business are not publicly traded, appraisers will also consider appropriate discounts and/or reduction in value based on this fact. The size of the discount or reduction include factors such as the holding period before liquidity is expected, the amount of distribution expected, the capital appreciation over the holding period, and any incremental risk associated with illiquidity. According to Family Business Magazine:
“The impact of the pandemic on the magnitude of the marketability discount is more ambiguous than the effect on the as-if-freely-traded value. Some of the factors are likely to be neutral relative to the pre-pandemic environment, while others may be negatively or positively affected.”
The fact is that the fair market value of shares in a family business has likely diminished from just a couple months ago, and whether you have intentions to sell a family business at a reduce value or not, values are reflected by current market conditions, in accordance with the IRS rulings which state:
“The fair market value of specific shares of stock will vary as general economic conditions change from ‘normal’ to ‘boom’ to ‘depression,’ that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal. Uncertainty as to the stability or continuity of the future income from a property decreases its value by increasing the risk of loss of earnings and value in the future.”
For all intents and purposes this actually provides and opportunity for tax efficiency in transfers of wealth for estate planning purposes. When you consider the “cost” in estate taxes, procrastination in implementing decisive gifting programs while conditions are most favorable can end up costing more. To help visualize this we recommend a really good cases study on Decisive vs. Hesitant Planning.
For many middle-market companies, Rob Ferguson of Ferguson Interests is the ally, advisor, and activist for the companies interests. Rob is a business advisor for Family, and Private Equity owned businesses that need practical solutions in the following areas; leadership development, succession planning, corporate governance, strategic implementation, revenue, and profit growth.
He has ten years of CEO experience creating value with a public company and a fifth-generation family-owned company. Rob has led companies through the phases of growth to turnarounds. During his career, he has conducted more than $100 million of acquisitions and grown business from $30 million of revenue to more than $350 million. Rob successfully managed as the CEO of the restructuring and sale of a $100 million revenue family business. Before his CEO experience, Rob held executive positions in general management, sales, and operations over a fifteen-year period.
Since 2010 Rob has been helping small and middle-market companies with some of their toughest business problems as a CEO advisor or Board member.
His current clients are in various industries; consumer products, energy services, distribution, manufacturing, agriculture. Rob currently sits on three family boards and is the lead independent board member for two companies.
Acting as an intermediary for capital, acquisitions, and mergers is another service that Rob provides to both Private Equity and Family business. He has worked with Private Equity firms on targeting acquisition candidates and conducting operational due diligence. He has also helped smaller family businesses with their capital needs by connecting the appropriate financial resources to the family business.
Rob is a member of the National Association of Corporate Directors, the Turnaround Management Association, and the Association for Corporate Growth. He serves as President of the Curing Children’s Cancer Fund. He remains active with his alma mater, Texas A&M University in student recruiting, and volunteering time at the Mays Business School Center of New Ventures and Entrepreneurship.