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Generating Liquidity from Illiquid Assets: A Guide to Private Company Tender Offers

Christopher Corey McKinnon

Generating Liquidity from Illiquid Assets: A Guide to Private Company Tender Offers

Private company tender offers have become increasingly common, especially among late-stage, highly valued startups. In fact, in the last two quarters (Q4 2023 and Q1 2024), six of the top 10 most highly valued startups in the world have disclosed participation in, or plans to complete, tender offers, including ByteDance, SpaceX, OpenAI, Stripe, Databricks and Canva. As explained by the factors described below, high-value startups have been waiting for IPO and M&A windows to re-open and have been facing growing pressure from longtime employees and early investors to achieve an exit. These late-stage companies have responded by sponsoring tender offers to generate partial liquidity.

Demand for Liquidity

Over the past couple years, there has been a significant slowdown in IPO and M&A exit activity among venture-backed startups. Exits by U.S. venture-backed startups hit a decade low in 2023. Venture capital funds depend on their portfolio companies going public or being sold to generate liquidity to distribute excess capital to their limited partners. Given the slowdown in exit activity, in 2023, distributions to limited partners of U.S. venture capital funds were at their lowest levels in over a decade.

2023 exit activity hits a decade low
US VC exit activity

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Average US VC fund distributions, from funds age five to 10 years old, as a share of beginning net asset value

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Supply of Capital

Meanwhile, investors are sitting on record-high dry powder (investable capital). However, these investors with ample reserves remain reluctant to deploy capital at, what they perceive to be, elevated valuations. Valuations in investment rounds have started to come down but not fast enough to encourage substantial investment activity across stages and sectors.

68.6% US VC dry powder remains in 2021 and 2022 vintage funds
US VC dry powder ($B) by vintage

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2023 median valuation is the third-highest annual valuation in past decade
Range of US late-stage VC pre-money valuation ($M)

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Valuation Arbitrage

Fund sponsors can invest in startups at discounted prices by buying shares from existing shareholders in a tender offer, rather than buying shares directly from the company in a new issuance. Unlike in the public company context, where tender offers are generally priced at a premium to the market price, private company tender offers are generally priced at a discount to the price paid in the company’s latest fundraising round.

Given the foregoing combination of factors, private company sponsored tender offers are on the rise. In light of this trend, this article summarizes key rules and takeaways to keep in mind when considering a private company tender offer.

What Is a Tender Offer?

A tender offer includes an offer to purchase shares of a company from existing shareholders. SEC rules do not define exactly what constitutes a tender offer. Instead, courts have ruled that a tender offer is an offer that:

  1. Involves an active and widespread solicitation of shareholders;
  2. Seeks a substantial percentage of the company’s shares;
  3. Is priced higher than the market price;
  4. Includes fixed, rather than negotiable, terms;
  5. Is conditioned upon the tender of a fixed number of shares;
  6. Is only open for a limited period of time;
  7. Pressures shareholders to respond; and
  8. Would result in the offeror acquiring a substantial position in the company.

Not all of these factors need to be present in order for a transaction to constitute a tender offer. Courts have adopted a “totality of the circumstances” test in determining whether a transaction involves a tender offer that should be subject to SEC regulation.

Private Company Tender Offer Rules

Tender offer rules are designed to ensure timely, accurate and adequate disclosure so that shareholders can make informed decisions as to whether to tender their shares. If a transaction amounts to a tender offer (regardless of whether the target is public or private), federal securities laws impose a number of requirements, including the following:

  • Minimum Offer Period. The offer must remain open for at least 20 business days from commencement. If the terms of the offer change before the offer expires, those changes must be disclosed to eligible sellers and the offer must remain open for at least (i) 10 business days following disclosure of any highly material changes (e.g., to price or quantity of shares sought) or (ii) 5 business days following disclosure of any other material changes.
  • Position Statement. The target company must state a position to eligible sellers (recommending they sell or hold), or state no position, regarding the offer within 10 business days of commencement.
  • Antifraud Rules. The offeror cannot make material misstatements or omissions in the offer documentation or otherwise undertake fraudulent, deceptive or manipulative acts with respect to the offer.
  • MNPI. Persons in possession of material non-public information (MNPI) cannot purchase or sell shares in a tender offer. In practice, this requires that MNPI be disclosed to potential participants (i.e., buyers and sellers), including financial statements, risk factors, capitalization information and other information material to an investment decision.
  • Prohibited Transactions. The offeror and certain other parties may not purchase the type of shares sought in the offer while the tender offer remains outstanding, other than through the tender offer at closing, subject to certain exceptions. Sellers cannot tender more shares than they own (i.e., no short or hedged tendering).
  • Prompt Payment. The offeror must promptly pay for, or return, the shares tendered (generally within 3 business days per SEC guidance).

While this article focuses principally on tender offer rules applicable to private companies, some of the key differences that apply to public company tender offers are described below.

Public Company Tender Offer Rules

Unlike private company tender offers, public company tender offers must comply with the following additional requirements, among others:

  • Tender Offer Statement. The terms of the offer must be set forth in a tender offer statement on Schedule TO and filed with the SEC.
  • Best Price Rule. The price paid to everyone must equal the highest price paid to any other shareholder for the same class of shares purchased.
  • All-Holders Rule. All holders of shares of the class of shares sought in the offer must be allowed to participate.
  • Pro Rata Cutback. If oversubscribed, the amount shareholders can sell must be pared back on a pro rata basis.
  • Withdrawal Rights. Tendering shareholders must be permitted to withdraw any previously tendered shares at any time before the offer expires.

By not being subject to the foregoing public company tender offer rules, among others, parties involved in private company tender offers can include creative terms designed to achieve their objectives as to, among other things, price, participation, timing and structure. For example:

  • Eligible Sellers. Offerors can make the offer available only to certain classes of shareholders (such as investors, employees or management) or to holders of only certain classes of shares (such as common or preferred stock).
  • Fixed Price Per Share Class. Offerors can pay different classes of stock different prices.
  • Favored Securities. Offerors can solicit a specific number of shares of different classes of stock or apply cutbacks on a first-come, first-served or a class-by-class basis.

Key Takeaways

Below are key takeaways for parties to consider in evaluating private company tender offers:

  • When a third-party investor commences a tender offer to acquire shares of a private company, the target company tends to be significantly involved in order to (i) identify eligible sellers, (ii) manage any transfer restrictions or procedures, (iii) share financial and other information about the company and (iv) update their stock ledger and re-issue stock certificates to reflect the new ownership. Because of this, hostile tender offers, where the company is not supportive of the transaction, are rare in the private company context. Because of that, even though the target company may not be a buyer or seller in a third-party tender offer, private companies can retain influence over the terms, including, among other things, price, eligible sellers, sale amounts, timing, the terms and conditions of the offer and what information about the company is disclosed.
  • Private companies may consider launching a self-tender, or facilitating a third-party tender, to acquire shares from existing shareholders as a partial liquidity option to motivate longtime employees and placate early investors who may have expected an earlier exit event. Those companies should determine whether and how that type of liquidity option (structured as a one-off transaction or series of transactions amounting to a sustainable liquidity program) fits into their overall compensation philosophy, financial position and fundraising strategy. A self-tender offer can be done using cash on hand or can be combined with a direct investment in the company by investor(s).
  • Tender offer rules can impact even early-stage investors and employees. For example, a tender offer can be implicated in a venture financing round, where a number of existing shareholders (including early investors, founders and employees) are offered the opportunity to cash out some of their equity by selling it to the lead investor in the round as part of a secondary market transaction that may constitute a tender offer.
  • If parties desire to mitigate compliance burdens associated with navigating the numerous private company tender offer rules, they can consider structuring a transaction in a way that does not result in a tender offer but nevertheless achieves the parties’ commercial objectives.