In order to remove shares of a publicly traded company from the stock market, the Companies Law suggests a mechanism of a complete tender offer, which requires obtaining the almost absolute approval of over 95% of the company’s shareholders. In the last few years, there has been an increase in the number of cases where an offer maker, wishing to delete a public company from trading and turning it into a private company, chooses an alternative transaction structure, which is less familiar, but has significant advantages, which is the reverse triangular merger.
Background
Turning a private company into a public one is a complex process which includes substantial benefits, alongside disadvantages which are not trivial. In most instances, the issuing of the company’s securities to the public is the highlight of the company’s development, and constitutes an important level in the continuation of the company’s advancement, as well as granting diverse options to the company’s shareholders to realize their investments and their holdings in the company.
On the other hand, the opposite process of turning a public company into a private one is also one that is not simple, which can be performed in two major methods[1]: a complete tender offer, or alternatively a reverse triangular merger.
The choice between these two methods is not easy and involves legal considerations alongside practical considerations, at the base of which is an educated analysis of the company’s array of forces and the extent of cooperation between the different organs within the company.
Complete Tender Offer
As part of a complete tender offer, the offeror, whether he is a current holder of controlling interest or not, is obliged to receive a consent from the majority of the shareholders in the public company, which is over 95%, as a condition to completing the transaction, purchasing all of the shares and turning the company from a public company to a private one.
It seems that there is no need to elaborate that this requirement is complex and difficult to obtain, and is a significant obstacle in most complete tender offers. In many cases, this requirement prevents a potential offeror to publish a tender offer in the first place out of an educated fear that he will not have the necessary majority.
And if this hurdle is not enough, the legislator has set in section 338 of the Companies Law, 1999 (“the Companies Law”) a built-in mechanism of a court supervision over the process of making the tender offer, in the form of an appraisal remedy for the fair value of the transaction, according to which shareholders which have not given their consent to the tender offer are entitled to approach the court claiming that the transaction was completed at a price which does not constitute a fair price for their holdings. It is important to note that as shall be more detailed below, in a merger transaction, the legislator has not set a parallel mechanism in the law, thus in the event of shareholders who wish to make claims regarding the profitability of the merger and the fair value of the company’s shares, they are forced to approach the court asking for other remedies, such as discrimination against the minority, performing a prohibited distribution etc..
On the other hand, as part of a complete tender offer the offeror has a significant advantage due to the fact that as opposed to a merger process, in a complete tender offer there is no requirement for the company’s board of directors to approve the transaction and the entire process actually takes place directly between the offeror and the shareholders in the public company.
Reverse Triangular Merger
Removing a publicly traded company from the stock market and turning it into a private company as part of a reverse triangular merger is a mechanism which has become more and more common in recent years in the Israeli capital market.
In a standard merger transaction, the merger is between two companies with a synergetic commercial activity, the acquiring company and the target company. As part of the merger, the target company is absorbed into the acquiring company, the target company’s activity is transferred to the acquiring company and the target company is terminated and ceases to exist.
In a reverse triangular merger there is an inherent difference from a regular merger transaction, since at the beginning of the process there are no two companies involved with a synergetic commercial activity, and most arguments which stand at the base of the transaction are not mere commercial arguments, but rather legal corporate arguments. Thus, at the beginning of the process, there is a target company with a commercial activity and beside it the potential purchaser establishes a new company without any commercial activity, which is supposed to act as the acquiring company. The target company is merged into the new company, transfers all of its activity to it and then terminated. Thus, at the end of the process, the offeror holds the acquiring company which operates the activity of the acquired formerly public company, which has now been terminated.
In this case, a person wishing to remove a publicly traded company from the stock market can do so by merging the public company with a private company which he owns. In most instances, the private company is a new company which is established solely for the purpose of the merger and has no business activity whatsoever. Its entire purpose is to acquire the commercial activity of the public company and to serve as a convenient basis for the continuation of the holder of controlling interest’s activity. At the end of the merger, the public company ceases to exist and the offeror is left with a private company which has the activity of the formerly public company. Corporately speaking, this is a merger according to clause 320 of the Companies Law, which requires obtaining the consent of the board of directors in each of the two merging companies, as well as the consent of their shareholders.
The main difference between these two transactions is the required majority amongst the public company’s shareholders in order to complete the transaction: while completing a complete tender offer requires almost an absolute majority of over 95%, completing a reverse triangular merger requires a regular majority amongst the shareholders who do not have a personal interest in approving the transaction[2]. Thus, and for example, a holder of controlling interest wishing to delete a public company holds 45% of its share capital and he estimates that for the transaction he offers he will be granted consent from shareholders holding approximately another 40% of the company, is most likely to perform the transaction in the form of a reverse triangular merger, since he doesn’t have enough vote to complete tender offer.
In this regard it should be noted that the same holder of controlling interest must ensure that the board of directors of the public company is not an oppositionalone, since without the directorate’s approval it will be impossible to complete the merger transaction.
Board of Directors or General Meeting?!
Much has been written about the fact that due to the centralized structure of the Israeli capital market, there is an inherent difficulty in performing an offensive (hostile) move to take over a company. In practice, most transactions for purchasing companies require full cooperation with the major organs in the acquired company, i.e. the company’s board of directorsand its shareholders.
Allegorically to the aforementioned, even in a case where a holder of controlling interest wishes to remove a publicly traded company from the stock market which he has control over, he must do so while cooperating with the company’s organs, by one of two methods: in the case of an almost complete cooperation on behalf of the rest of the company’s shareholders, despite the existence of anoppositional board of directors – the holder of controlling interest shall choose the route of a complete tender offer.
Alternatively, and in a case where the holder of controlling interest estimates that the rest of the shareholders will not be inclined to cooperate with him in the required voting rate, he must ensure that the company’s board of directors sees eye to eye with him concerning the transaction and to complete it as a reverse triangular merger. It must be noted that in most instances, the holder of controlling interest in a public company appoints most of the directors in the company’s board of directors , thus his ability to set “friendly” processes in motion within the company’s board of directors is tangible and reasonable.
Summary and Conclusions
Prior to approaching a major structural change such as removing a publicly traded company from the stock market, it is important to understand the array of powers and interests within the company. Turning a public company into a private company as part of a reverse triangular merger, as opposed to a complete tender offer, assists the offer maker in dealing with a substantial minority within the public company which objects to the transaction, so long as the company’s board of directors understands the transaction’s attractiveness and supports it.
On the other hand, in case there is a difficulty in obtaining the public company’s board of directors blessing, the offer maker is left with the mechanism of a complete tender offer, and in this case he will have to persuade almost all of the company’s shareholders in order to complete the transaction.