The words “Hostile Takeover” in the headline of a business publication are sure to generate a substantial amount of reader interest. Many storylines, fiction and non-fiction, paint a hostile takeover as the death knell for a company. While it makes for interesting reading, it’s important to know that a “tender offer” is at the heart of every takeover, friendly or not.
This article will look at what a tender offer is, how it works, its advantages and disadvantages, regulations associated with tender offers, and more. Whether you intend to buy or sell shares related to a takeover, this article will serve as a foundation for deciding whether or not to participate.
What is a Tender Offer?
A tender offer is a bid to purchase a shareholder’s stock in a company, with the buyer’s objective being to obtain either some or all of the outstanding shares for a specified price within a specified time period. It is a strategy often employed by one company to acquire another.
Shareholders in a publicly traded company have voting power concerning the matters of the company, such as the election of individuals to the board of directors. Their shares are valuable to a group of investors, or another company, that wants majority voting control of a company, or at least a significant amount of voting control. They make an offer to shareholders to entice them to tender (sell) their stock.
Different Types of Tender Offers
There are two types of tender offers to consider, issuer tender offers and third party tender offers. Let’s look at each.
Issuer tender offers, commonly known as stock buybacks, are offers made by the issuer of that stock. A company buying back its own stock is typically motivated to do so for three reasons:
- Boost the stock price and shareholder value
- Optimize excess case
- Obtain internal control of shares
Companies owning a majority (50.1%) of outstanding shares (known as “the float”) are protected from a hostile takeover from an entity that wants to become the majority shareholder of the company.
Third party tender offers are offers by another company or a group of investors, such as a hedge fund, that usually want to seize control of a company. If the tender is successful, the new majority shareholders can elect a new board of directors and control the company’s direction.
Example of a Tender Offer
You own 1000 shares of Class A (voting) stock in Company A (the target company) that is publicly traded. Its current stock price is $50 per share. Company B (the potential acquirer) makes a tender offer to buy your shares for $60 each (20% over the market price) for a limited amount of time. Your decision now will be to reject or accept that tender offer.
If you accept the offer, you will be paid $60 for each share you own, totaling $60,000. After the sale, you no longer own your shares and don’t have voting rights with Company A.
If you reject the offer, you maintain ownership of your 1000 shares and retain your voting rights with Company A.
How Does a Tender Offer Work?
The example of the tender offer just given gives you a 10,000 foot view of a tender offer. However, there are some finer points involved, as well.
Most tender offers are made at a premium, a specified price higher than the stock’s current share price. That premium must be enticing enough to get enough shareholders to accept the offer.
For example, if you are a shareholder and your stock has been appreciating at a rate of 2% per year for the three years you’ve owned it, a tender offer representing a premium of 15% higher than the current stock price probably would be very motivating for you to tender your shares.
It’s also important to note that one of the stipulations of a company initiating the tender offer is frequently that a certain percentage of the current shareholders must accept the offer for anyone to sell their stock for the premium offered. This is typically done by a company that wants to obtain a controlling interest in another company.
The capital markets are not fond of uncertainty, so it’s not uncommon to see the value of the shares of the targeted company drop after the tender offer is made, as some investors decide to sell their shares instead of taking a “wait and see” approach concerning shareholder reaction to the offer.
The Purpose of a Tender Offer
Essentially, the purpose of a tender offer is about control. One company or entity has the objective of obtaining enough of the outstanding shares of another company to control the future of that company.
There are instances where the purpose of a tender offer was to acquire and then sell or dismantle the acquired company. However, there are other instances where the acquiring company essentially righted a sinking ship and saved a company from insolvency.
Who Holds a Tender Offer?
A tender offer is typically held by a company or group of investors who want to control another company. The target company’s board of directors may or may not have knowledge that a potential acquirer is planning to make a tender offer. If the board is unaware, the tender offer is made directly to the shareholders and a “hostile takeover” is now the objective of the company tendering the offer.
When Does a Tender Offer Take Place?
A tender offer can take place at any time, and at the discretion of the company extending the offer. Because the offer is being made for a premium price higher than the current market value of the target company, the company making the tender offer must have enough liquidity to acquire a stated maximum number of shares, per SEC regulations.
Tender Offer Advantages
One advantage of a tender offer is safety for the entity making the offer. That entity can stipulate a minimum number of shares that must be tendered, eliminating a large capital outlay.
Another advantage is that a tender offer can include escape clauses that prevent an acquiring company from being bound to buy tendered shares. For example, an escape clause could be that the acquirer can refuse to purchase shares if the government denies the acquisition because of antitrust concerns.
Tender Offer Disadvantages
The most significant disadvantage of a tender offer is the expense. The cost can mount as an acquirer pays SEC filing fees, attorney costs, and any other fees for services needed pertaining to the offer.
The amount of time needed relating to a tender offer must also be taken into account. Depository banks must verify tendered shares and issue payments on behalf of the acquirer.
Tender Offer Regulations and Disclosures
Because of the impact of tender offers on shareholders, investors, employees of a target company, and the capital markets, safeguards have been put in place by the U.S. government. Two to be aware of are the Williams Act (an amendment to the Securities Exchange Act of 1934) and Regulation 14E established by the SEC.
The Williams Act is designed to establish a fair market and level playing field for everyone involved. It puts into place requirements for an acquiring company to make a tender offer that is at least 15% to 20% above the current market price of a target company’s current market price.
It also requires that full disclosure be made to all shareholders and gives them ample time (at least 20 days) to evaluate all of the terms of the offer and what the potential impact could be to the target company.
Regulation 14E primarily protects the capital markets. Accordingly, it has established rules that must be followed by any acquiring entity that will obtain the bulk of a target company’s stock through a tender offer.
For example, Regulation 14E makes it illegal for anyone to make a tender offer without being certain that they will have the capital needed when the transaction is consummated. This protects the integrity of the market by keeping the stock’s price from fluctuating erratically.
- A tender offer is made when shareholders are requested to tender their stock at a specified price during a specified time period.
- The offer made by an acquiring entity is typically set at a premium above the current market price to give shareholder’s added incentive to accept the offer.
- A hostile takeover is when a targeted company’s board of directors has no knowledge of a tender offer made directly to shareholders.
- Tender offers are often conditional on a minimum number of shares being tendered to guarantee the company making the tender offer ends up with controlling interest in the target company.
- Government and SEC rules and regulations have been put into place to ensure the acquiring entity makes full disclosure, and shareholders have ample time to review the offer before tendering their shares.
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