More than 1,300 U.S.-listed public companies have less than $10 million in EBITDA (earnings before interest, taxes, depreciation and amortization), and many of these microcap companies could be destroying shareholder value by staying public.
A typical microcap company spends $1.0 million to $2.5 million per year to stay public. Costs include preparing and filing financial and proxy statements with the Securities and Exchange Commission, complying with Sarbanes-Oxley, and employing investor relations personnel, among other costs. The management team must also divide its time between overseeing these public company requirements and operating the business.
By going private, companies with EBITDA of $1 million to $10 million should be able to increase EBITDA (and in turn enterprise value) by 10% to 100%. Not every microcap company should go private, but the boards of directors of all of these companies should consider the pros and cons of such a transaction.
A microcap company may choose to remain public for many reasons, but the most compelling might be access to funding to realize its growth potential. Follow-on equity offerings are often critical for rapidly growing or development-stage companies. But microcap companies with low growth prospects likely do not need additional equity capital. Out of the 1,300 public companies with EBITDA less than $10 million, 583 have revenue growth of less than 10% per year over the last three years. These low-growth companies do not need to remain public for access to equity capital.
Microcap companies may also choose to stay public to use their stock as an acquisition currency. Mature companies with low organic growth often seek to grow through acquisitions. Small companies may prefer to issue stock (instead of paying cash) for an acquisition if they lack cash reserves and the capacity to borrow. Sellers in an acquisition more readily accept stock in lieu of cash from a publicly traded buyer than from a private buyer, whose stock could be difficult to value and ultimately monetize. But out of the 583 low-growth microcap companies identified above, 422 have not made an acquisition in the last three years.
Given their low-growth prospects, the above 422 companies should evaluate the benefits of remaining public versus the costs. Some may determine that being public helps them market their products, recruit talent, or other advantages, and together these benefits may outweigh the potential savings of going private. Others may decide that going private would increase value and proceed down that path.
Once a company determines that going private should improve value, additional considerations emerge, including the “fairness” of the transaction to shareholders. In fact, one of the most highly scrutinized corporate transactions involves a large shareholder (who is usually the CEO and a board member) buying the public shares of a company to take the company private. The board of directors can maximize shareholder value and limit litigation exposure by following a rigorous process to ensure the fairness of this type of related-party going-private transaction, as further explained below.
- It is highly advisable that the board of directors form a special committee of independent directors to negotiate with the insider and obtain the best available price for the public shareholders.
- The special committee should engage its own legal and financial advisers.
- The special committee’s financial adviser should perform a valuation of the company and might also conduct a market check to surface any other interested buyers. Ultimately, the financial adviser should render a fairness opinion stating that the price is fair to the public shareholders.
- As advised by legal counsel, there are other “protections” that could be written into the agreements on the deal. For example, shareholder approval could be conditioned on a “majority of the minority” vote in favor of the transaction.
More than 400 small public companies could potentially increase EBITDA from 10% to 100% by going private and collectively unlock $2 billion to $3 billion of enterprise value. The boards of directors of these companies should consider going private by conducting a thorough process using experienced advisers to maximize shareholder value and limit exposure to litigation.
Mark Kwilosz, CFA, is a managing director at Duff & Phelps, LLC where he provides M&A advisory services, fairness opinions, solvency opinions and other advisory services to corporate boards of directors and their management teams. For more information, please visit www.duffandphelps.com.
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