(Illustration by Ken Orvidas.)

The Private Life
The tough decisions that Daniels and Atwell confronted are ones that more and more entrepreneurs who have taken their companies public, and the directors who sit on their boards, will have to grapple with as the crushing financial burden of complying with Sarbanes-Oxley bites into their profits. They must determine if their companies derive enough benefit from being public—in access to the capital markets, in credibility with customers or suppliers, in marketing clout—to offset those costs. Increasingly, the answer appears to be no.

TOP VIEW The difficulties and costs of maintaining a public listing—in particular, the burdens of complying with the notorious Sarbanes-Oxley Act—have prompted a growing number of small companies to turn their backs on the public markets by going “dark.” While the allure of being a privately held corporation may seem attractive to harried corporate executives and board members, the process itself is fraught with difficulty and legal peril for those undertaking it.

Every year since the technology stock bubble burst, a growing number of companies have applied with the SEC to delist their stock, according to a study by the Olin School of Business at Washington University in St. Louis, the University of Amsterdam and the Ross School of Business at the University of Michigan. Data compiled by FactSet Mergerstat shows that by midsummer of this year, some 55 companies filed with the SEC their intent to go private through some form of buyout of their publicly traded stock. Both the number of transactions and their value are climbing: In 2004, only 64 companies went private, and while 110 companies took that route in 2003, the value of those deals was a mere $7.9 billion, compared to $45.8 billion in the first half of 2005.

 Those figures do not include a larger and more-rapidly growing group of companies like Nicolet that do not use a buyout to go private. These other types of going-dark transactions may have resulted in as many as 190 additional companies going private, based on their SEC filings.

However, the process of making the decision to go private and then implementing it is a difficult, costly, time-consuming and potentially hazardous one for the senior managers and directors. “If I had known in advance what the hurdles would be,” says a director of a small Midwestern industrial company that discussed the possibility of going private, “I wouldn’t even have had the subject raised in the boardroom. It’s expensive—and shareholders foot those legal bills—and it could have led to all kinds of undesirable outcomes for us in the long run if we had gone ahead.”

In stark contrast to the process of going public, going private again is more likely to be met with litigation than celebration. “I warn any client that is going private that they will be sued; it’s automatic,” says Thomas Magill, a partner at Gibson, Dunn & Crutcher who has provided legal advice to dozens of companies that have gone private. “The plaintiffs will claim that the special committee formed to consider the transaction has breached its fiduciary duties before that committee has met or made any decisions.” Magill’s clients have been approached by shareholders’ lawyers seeking higher valuations almost as soon as they announce a deal. To improve chances of winning such a suit, management should get a valuation or multiple valuations from truly independent firms. The company should offer the high end of the range, or even above it.

The risk of litigation is not stopping a wide range of companies from forging ahead, however. The massive $11.4 billion buyout offer for SunGard Data Systems from seven private equity funds—an offer that was welcomed, and even encouraged, by the company’s board and management—helped boost the value of this year’s actual and proposed going-private transactions. Officers of the financial technology company have since described the Sarbanes-Oxley-related costs as one of the factors that made them amenable to such a deal.

Some companies are fledgling businesses that went public in the tech stock boom and have struggled ever since; others are market veterans such as San Diego–based Anacomp, a data-services company that went dark early in 2005 after more than two decades as a publicly traded company. Community banks, such as Nicolet Bankshares, may form the biggest single industry group by number of transactions, if not by value, say lawyers who have studied the trend.

The catalyst for Nicolet’s decision to go private was an offhand comment by its accounting firm to the bank’s chief financial officer, Jacqui Engebos, that Nicolet was paying the price for being public. Daniels convened a meeting of the board’s executive committee—himself, Atwell and four of the 13 outside directors on the 15-member board. They were reluctant to decide that going private was the right response to the problem, Daniels says, agonizing over their responsibility to the community and their fiduciary duty to the shareholders. “Eventually it came down to the question of whether the regulatory costs and time burden of being a public company lined up with the bank’s mission,” Daniels says. The answer was no.

Realizing that being a publicly traded company has become too expensive is often the reason behind decisions to go private, Magill says. It can also be used as a rationale when executing a buyout for completely different reasons, such as pressure to manage financial performance on a quarter-by-quarter basis rather than with a focus on long-term returns. “It’s tough living in the fishbowl the way that public companies are required to do,” Magill says. “A short-term management focus may not be in shareholders’ best interests.”

Primrose Path
Still, going private is not for the fainthearted. The transactions are still viewed with suspicion on the part of many investors, particularly when management is leading or involved in a buyout or when a controlling shareholder (such as the founder) is proposing the transaction. “It’s tempting to do this for a variety of reasons, but it’s a delicate process that poses immense fiduciary challenges to managers and directors alike,” says Michael Ryan, a partner at Cleary Gottlieb in New York.

A buyout transaction is particularly thorny, says Ryan—more so if being proposed by a majority shareholder whom minority investors will see as having access to inside information of some kind. Almost by definition, say those who specialize in advising on these transactions, the price being offered will seem inadequate to the minority investors. Meanwhile, the process is likely to be seen as infuriatingly slow and cumbersome—not to mention risky—by the majority owner. “I have seen people get very frustrated, saying, ‘What do you mean I have to find someone on the board who isn’t my crony and put the final decision in their hands?’ ” Ryan says. “ ‘What do you mean I have to give them a budget to hire bankers and lawyers to negotiate against me? What do you mean, another bidder can come in and offer more and force me to change my bid?’ ” That last possibility, Ryan and others agree, often dissuades entrepreneur-owners from taking the buyout route: They are trying to go private to have greater control over the business they founded, not to lose it altogether in a bidding war with some third party.

In comparison, a going-dark process like Nicolet’s is relatively straightforward. It typically involves a reverse share split that reduces the number of shares outstanding, enabling the company to buy out shareholders who end up with fractional amounts of stock, or a cash tender offer to acquire stock, all to reduce the number of shareholders below the crucial 300 level. In some cases, companies that have failed in their buyout bids resort to going dark. However, that does not solve everything and does not eliminate the potential for litigation. Daniels said the bank still had to pay $125,000 in legal fees and other expenses, including $70,000 for a fairness opinion from an investment bank. “We heard horror stories about this, like a bank that priced its deal just below the fairness opinion valuation and ended up with lawsuits flying,” Daniels says. The independent directors opted to offer $18.25 a share to Nicolet investors—squarely in middle of the range proposed by the fairness opinion and a premium to the prevailing market price of $15.40 a share. Compared to the IPO price of $10 a share and the $12.50 paid by investors in the 2002 follow-on offering, Daniels says, “that seemed to most folks like a pretty good return; somewhere around 20 percent a year.”

Daniels is well aware that going private does not mean that he can ease up on governance. Rather, he says, the fact that Nicolet’s stock is no longer publicly traded simply removes one lot of costs and one group of stakeholders. “Going dark can’t mean going silent; we have a responsibility to other stakeholders and to the community,” he says.

“There are companies that probably shouldn’t be public, particularly if they don’t need access to the capital markets for financing,” says Susan Shultz, CEO of the Board Institute, a Phoenix firm that assesses the effectiveness of both private and public company boards. “But going private doesn’t mean that boards can toss governance rules out the window.” Indeed, she maintains that without the public market to act as a check and balance on management, the demands on an independent director to act as a counterweight to management increase. “Having top-notch governance can be even more important when you are private,” she says. Cutting Sarbanes-Oxley compliance costs is one thing, she adds; pinching pennies on governance is quite another.

Suzanne McGee is a freelance Journalist who covers corporate finance and governance.