Considering an IPO is a bit like considering marriage. An IPO gives you an entirely new set of ongoing commitments and responsibilities, and those responsibilities involve considering the wellbeing of other people—in this case, your shareholders. Like many people do before deciding to pop the question, company leaders would benefit from considering why “it might not work out.” This is an important question to evaluate because many companies don’t stay public for long. One study showed that five years after an IPO, 55% of small cap companies, 61% of middle cap companies, and 67% of large cap companies remain listed on a public exchange.1 In the case of being public, “not working out” could refer to two separate but related scenarios: delisting–being removed from your stock exchange, and deregistering–removing your registration with the SEC as a public company. Similar to a divorce, delisting and deregistering could each be considered a good or bad outcome depending on the situation. But no matter what, it’s complicated.
Understanding why other companies delist or deregister will help potential IPO companies determine whether an IPO is the best strategy for their future. In addition, being aware of the implications of delisting and deregistering can help IPO companies navigate the potential strategic difficulties of being public. This article will give company leaders a deeper understanding of what might happen when public companies struggle or no longer want to be public; however, this article does not intend to give specific legal advice regarding delisting or deregistering. In order to understand the situations that public companies might be faced with, a company leader should understand not only the definitions of delisting and deregistering, but also when and why each might occur, whether voluntarily or involuntarily.
Delisting and Deregistering Definitions
The first important possibility for company leaders to understand is delisting. When a public company is delisted, its stock is removed from its current stock exchange (such as the NYSE or the NASDAQ). Delisting can occur by the company’s choice, or it can be forced by the stock exchange due to a violation of the exchange’s rules and regulations. Being delisted does not mean that a company is no longer public. In fact, shareholders can still trade their shares on a smaller exchange, or “over-the-counter.” However, being delisted normally leads to a devaluation of the stock, and decreased liquidity for investors. Because delisted companies remain public, they also remain registered with the SEC. This means that the company is still required to meet all of the SEC’s regulatory and reporting requirements.
In addition to delisting, deregistering is another important possibility for the management of an IPO company to understand. To deregister, a company must file Form 15 with the SEC. Filing a Form 15 removes a company’s registration with the SEC under rule 12(g) of the Securities Act of 1933 and suspends that the company’s duty to file reports under rule 15(d) of the Exchange Act of 1944. Once a company has successfully deregistered, the company’s stock can no longer be publicly traded. When a company deregisters, it is also delisted simultaneously because it can no longer be publicly traded.
Involuntary Delisting and Deregistering
In addition to the already tremendous pressure to be successful in a competitive economy, public companies also need to meet additional regulatory requirements. These requirements are placed on them by both their stock exchange and by the SEC. When companies fail to meet these requirements, either because of poor performance or the high costs of remaining compliant, they may be forced to delist or deregister involuntarily.
When a company is struggling to perform, the first problem it will face is involuntary delisting. Involuntary delisting normally happens because a company has violated the rules and regulations of the stock exchange. Every major stock exchange has a list of requirements that companies must comply with in order to stay listed. Exchange regulations include factors such as minimum market cap levels, minimum stock price levels, stock price performance levels, and reporting requirements. When struggling companies fail to meet these requirements, the exchange will notify them of the violation. The exchange will then give the company a period of time to become compliant. If the company does not come into compliance with the exchange’s regulations, it will be delisted. Many companies have face delisting when they are already struggling, such as the recent examples of Pier 1 Imports, and Centric Brands, who are both facing bankruptcy and restructuring.
Involuntary delistings often occur in tandem with Chapter 11 bankruptcy. Under Chapter 11 bankruptcy, management is still allowed to operate the company, with certain restrictions, until a reorganization of debts takes place. Managers do so in the hope of bringing the company back into profitability. Because the company could continue operating after its reorganization, its stock can continue trading during the bankruptcy. However, declaring bankruptcy is a clear indicator that the company is already in distress. If it hasn’t already, the company is likely to be delisted from its exchange. The future of the delisted stock depends on the terms of the reorganization and the approval of the bankruptcy court.
An involuntary delisting can badly damage the company’s reputation, especially among investors. Investors see delisting as a clear sign that a company is struggling, which is why most delisted companies experience a significant drop in stock price following the delisting. To avoid being delisted, companies should go public when they are ready to comply with all stock exchange regulations. Companies should also have a strategy for maintaining compliance moving forward.
Companies that have been involuntarily delisted still have the opportunity to get their stock relisted on a major exchange. The difficulty of relisting depends on the nature of the initial delisting. If a company is struggling overall, and this poor performance led to a forced delisting, the company may need a longer period of time to “right the ship.” However, if a company misses a reporting deadline, it can correct its error and relist on the stock exchange within a relatively short period of time.
In August of 2018, Supermicro Computer Inc. was delisted from the NASDAQ. Supermicro’s auditors discovered material weaknesses in the internal accounting controls in the areas of revenue recognition and financial controls. To correct these issues, the company took the time necessary to restructure their leadership and strengthen the company’s internal controls. These processes took time, however, and caused the company to miss the deadlines for filing several of their reports with the exchange and the SEC. This led to the company being delisted from the NASDAQ. To make bad things worse, a negative news report came out later that year claiming that Supermicro and other companies had Chinese spyware chips that had been placed in their computers during the manufacturing process. This caused Supermicro’s shares to fall even further. However, despite these difficulties, Supermicro was able to restructure their internal controls successfully and show that the spyware reports were false. After about 18 months, the company relisted their stock on the NASDAQ in January of 2020.
Involuntary deregistering normally happens when a company has filed for Chapter 7 bankruptcy and is going out of business. In this case, the business is liquidated, and the company’s assets are sold in order to pay off creditors in order of priority. There is some potential for shareholders to be paid off in this case, but they are last in line. After the bankruptcy process is completed, the company and its shares will no longer exist.
Voluntary Delisting and Deregistering
While companies should generally avoid involuntary delisting, there are a number of strategic reasons why a company may choose to delist and/or deregister. First, deregistering can dramatically decrease expenses in legal, accounting, D&O insurance, and investor relations areas. Because the company no longer has to report to shareholders and the SEC, it can reduce staff and outsourcing expenses in each area. Second, some companies may not be fairly valued by the market. Many public companies become “orphans” shortly after listing, meaning the company is not tracked by analysts, has sparse trading volume, and receives very little interest from institutional investors. These factors could lead to the company being undervalued. If the company is significantly undervalued, then it may not be possible for investors to achieve their desired returns while the stock is publicly listed. Third, the leadership structure of a public company might not allow founders and managers the flexibility they want or need to be successful. Strategically, private companies are less driven by the short-term gains that keep shareholders happy in public companies. Managers in private companies no longer have to report to or be held accountable by public shareholders. Because of this, private company managers have significantly more decision-making power which can make the company more agile. In addition, private company leadership can also gain a competitive edge by keeping more information private rather than publishing it in public reports.
Public companies may have a variety of reasons to consider going private. However, the desire to reduce regulatory burdens is not sufficient justification to go private. Rather, the decision to go private must be strategically sound and in the best interest of the company’s stakeholders because going private is complicated, lengthy, and expensive. Gaining a basic understanding of the processes required to go private will help many companies decide whether it is the correct strategic decision.
The Process for Going Private
There are several ways for a company to go private. These include a cash out merger, tender offer, reverse stock split (under certain conditions), or a sale of all assets to a newly formed private company. Each of these options is subject to a variety of laws and regulations that exist to protect stockholders. Some of these options are easier to execute than others, depending on the situation. However, the company will face intense scrutiny and potential lawsuits no matter which method the company chooses. Generally, each method also involves potentially high costs because of the complex rules and regulations that apply under several different laws.
The law requires that the company management and the board of directors be able to justify the decision and show why it is in the best interest of the company’s stakeholders. The company must also make numerous disclosures to keep shareholders informed. An article included on the SEC’s lists the required disclosures:
“In addition, disclosure is required as to: (1) whether or not the transaction is ‘fair’; (2) whether the approval of a majority of the minority stockholders is required; (3) whether an independent special committee approved the transaction; (4) whether a majority of independent directors approved the transaction; (5) whether a ‘fairness opinion’ was rendered from an outside party, and, if so, (6) the material factors upon which the fairness opinion was reached. Fairness opinions are usually limited to whether the going private transaction is fair ‘from a financial perspective.’”4
In these disclosures, company leadership is required to explain what led up to the decision, what the reasons are for going private, and why other alternatives are not being pursued. In addition, company leaders have to carefully explain their stake in the company and how this transaction might benefit them. After all of the necessary disclosures are made, the decision is often subject to a shareholder vote as well.
Because of their sensitive and difficult nature, the transactions surrounding going private are subject to intense legal scrutiny. Laws such as the Williams Act have been passed to prevent hostile takeovers that are unfair towards shareholders. Often, shareholders will bring lawsuits against the company, questioning the adequacy of the price and the validity of the decision-making process. Overall, a company will have to keep their stockholders and the SEC informed and satisfied through each step of the proceedings.
Although going private may seem like a great way to avoid reporting requirements imposed by the SEC and stock exchange, this strategy may prove ineffective. Going private usually involves partnerships with an acquiring firm or organization such as one or multiple private equity firms. Usually, these firms will take a company private through a merger or acquisition. The terms of these transactions will vary, and while some acquiring companies may keep the acquired firm’s stock on the public market, others will buy out the existing shareholders. Buyouts are often leveraged, which creates another stakeholder—the borrowed capital provider—who will likely require financial reports and updates. Because of their new interests in the company, both the acquiring company and the capital provider will likely require regular reports on the acquired company’s growth and profitability. So, while the company may no longer have to report to the SEC after deregistering, that doesn’t mean that the reporting burden will be entirely lifted.
Going private directly is very rare for several reasons. Overall, going private is a complicated process, and it takes months to prepare for the potential litigation and the various reporting requirements. There is also no guarantee for many companies that they can go private, especially if shareholders oppose the idea. An acquiring company might not be able to purchase the needed percentage of shares, and shareholders could insist on prices that are significantly higher than initially anticipated. Because of these various risks, very few companies attempt to go private. Normally going private only happens during an acquisition or merger.
One of the most famous companies to successfully go private is Dell. The company initially went public in 1988. However, leading up to 2013, rapid industry changes were creating problems for Dell’s profitability and future potential. In 2013, the company’s founder and CEO, Michael Dell, decided to take the company private. Partnering with Silver Lake Partners, a private equity company, and several financial institutions, Dell took the company private through a leveraged buyout. The final share price for the buyout was $13.65, and in total the deal was valued at $24.4 billion. Going private allowed Michael Dell to have the flexibility he needed to turn the business around and transition to new markets. Large changes to a company’s structure and cash flows are often difficult, leading to multiple periods of decreased profitability. In addition, going private ends the need to pay dividends or participate in stock buybacks, which Dell claimed was a larger expense than servicing the debts incurred to go private. In the end, going private seems to have been the correct choice. Dell has done very well as a company, expanding into several new important markets. The company went public again in December of 2018 in a transaction that involved converting their Class V stock in VMware into Class C common stock.
Companies could potentially avoid many of the difficulties of going private by choosing to “go dark,” also referred to as “opting out.” Like going private, going dark means that a company voluntarily deregisters their shares under the Exchange Act. This means that the company’s stock can no longer be publicly traded. However, unlike going private, a company does not have to take a shareholder vote or cash out its existing shares. To go dark, a company must meet one of two conditions. First, a company can go dark if it has fewer than 300 shareholders. Second, a company can also go dark if it has fewer than 500 shareholders and less than $10 million in assets in each of the past three years. Going dark means that the company is no longer required to file public shareholder reports.
Going dark can be incredibly beneficial for many companies. In these cases, a company has already provided a liquidity event for shareholders (the IPO), but now has the option to reduce the regulatory burdens imposed by being registered with the SEC. In addition, the company can avoid many of the complexities that a more traditional going private transaction might have. This means that a company can dramatically reduce the regulatory pressures and costs they experience. However, there is a possibility that the shareholders could file a lawsuit against the company for going dark. Going dark decreases the liquidity of a shareholder’s equity in the company. Going dark also signals to investors that the company is struggling or has poor future growth prospects. These signals cause the value of company shares to fall. Falling share prices and decreased liquidity may lead some investors to sue the company. Because of this, companies should take potential lawsuits into account when they are deciding whether or not to go dark.
Implications for Potential IPO Companies
Different companies will face different challenges after going public, depending on the nature of the business and industry. Historically, one of the key determinants of the success of an IPO has been the size of the company. Generally, small cap stocks tend to perform poorly compared to mid and large cap companies. In conjunction with their overall poor performance as an investment class, small cap companies are also more likely to be delisted. There are several important reasons for this, including the increased costs, market structure, and legal issues that smaller companies may not be equipped to handle. This is not to say small companies shouldn’t go public, but it is important for small companies to understand the potential risks before they go public.
The first challenge for smaller companies is the high ongoing costs of being public. Small companies face the same regulations and reporting requirements as larger companies. However, small companies have more limited resources with which to handle these costs. In addition, laws such as Sarbanes Oxley have continually increased the financial burden of legal compliance. Many regulators point to these rising costs as one of the key reasons that small companies are not succeeding in the public market. Other regulations, such as Regulation FD and the SEC’s display rule, have also been cited as having unintended effects such as disincentivizing analysts from covering small cap stocks. With less coverage, smaller companies will have a more difficult time attracting investors and raising stock prices.
While reporting burdens may be part of the equation, the article “Where Have All the IPOs Gone?” in the Harvard Law Review pointed to several other factors that could be causing the decrease in number of IPOs in recent years, particularly for small companies: current market conditions, the economic scope of the IPO, and possible legal issues. First, the fact that the current IPO market overall hasn’t been as successful since the dot com crash might deter companies from considering an IPO. Another problem is that the current business environment appears to more heavily favor companies that are able to achieve rapid growth. Often, rapid growth requires other forms of investment and financing that are more time efficient than an IPO. Smaller companies may not have access to these types of funding.5
Another significant problem that many public companies face is potential lawsuits. Legal burdens can significantly increase costs for the company. One CNBC article reported that 15% to 25% percent of IPO companies get sued soon after going public. The article goes on to say that these lawsuits are often more expensive than small companies can handle, which has had a “chilling effect on the IPO market.”6 In order to prepare for these lawsuits, many companies are turning to insurance options such as Directors and Officer’s (D&O) insurance. However, the costs of these insurance options are also rising, which places an additional financial burden on IPO companies.
While small companies may have accounted for the majority of the decrease in IPOs since the dot com crash, all public companies will face significant burdens and potential hurdles to clear. Middle to large cap companies will face mergers or acquisitions by larger companies more frequently. These types of transactions are difficult to execute well, and they could also create new burdens. Overall, it is important for any company that is considering going public to remember to account for the possible opportunities and challenges that lay ahead.
Understanding all of the associated options and risks for public companies should help leaders understand whether or not an IPO is the correct strategic fit for their company. IPOs are complicated, but so is being public. Becoming a public company comes with a new set of commitments, and they aren’t easy to get out of. Understanding the potential costs of being public and some of the risks that may cause a company to falter will help a company better prepare for public life. When a company is prepared with the right strategy for the near and distant future, it maximizes its chances for success.
- Leuz, Christian, Alexander Triantis, and Tracy Yue Wang. “Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations.” Journal of Accounting and Economics 45, no. 3 (2008): 181–208. https://doi.org/https://doi.org/10.1016/j.jacceco.2008.01.001.
- de Wied, Warren S, Philip Richter, and Robert C. Schwenkel. Harvard Law School Forum on Corporate Governance: “Going Private Transactions.” 18 Apr 2020
- Rexaline, Shanthi. Yahoo! Finance: “What Happens When A Stock Gets Delisted And How It Impacts Investors.” 19 May 2020
- Farris, Ted. Dorsey & Whitney LLP: “’Going Dark’ – Voluntary Delisting and Deregistration under the Securities Exchange Act of 1934 – The Attractions of the ‘Dark Side’.” 17 Mar 2009
- Macey, Jonathan, Maureen O’Hara, and David Pompilio. “Down and Out in the Stock Market: The Law and Economics of the Delisting Process.” The Journal of Law & Economics 51, no. 4 (2008): 683-713. Accessed December 12, 2020. doi:10.1086/593386.
- SEC Investor Publication: “Bankruptcy: What Happens When Public Companies Go Bankrupt.” 3 Feb 2009
- Targett, Ed. Computer Business Review: “What Supermicro Did Next” 2 Mar 2020
- Kilgore, Tomi. Marketwatch: “Super Micro’s stock set to be delisted as filing deadline won’t be met.” 22 Aug 2018
- Assis, Claudia. Marketwatch: “Super Micro to relist shares on NASDAQ raises revenue guidance.” 9 Jan 2020
- Witkowski, Wallace. Marketwatch: “The Dell IPO that isn’t an IPO: What you need to know.” 8 Jul 2018
- Dell’s Website Publication: “Dell is now a private company.” 29 Oct 2013
- Guglielmo, Connie. Forbes: “Dell Officially Goes Private: Inside The Nastiest Tech Buyout Ever.” 18 Nov 2013.
- The Economist. “Dell Goes Private.” 9 Feb 2013.
- Rose, Paul, and Steven Davidoff Solomon. “Where Have All the IPOs Gone: The Hard Life of the Small IPO.” Harvard Business Law Review 6, no. 1 (2016): 83-128.
- NYSE: Noncompliant Issuers
- NASDAQ: Issues Pending Suspension or Delisting
- Morgenstern, Marc, Peter Nealis, and Kahn Kleinman. “Going Private: A Reasoned Response to Sarbanes-Oxley?.” 2004
- Rose, Paul, and Steven Davidoff Solomon. “Where Have All the IPOs Gone: The Hard Life of the Small IPO.” Harvard Business Law Review 6, no. 1 (2016): 83-128.
- Brewer, Contessa and Katie Young. CNBC: “Companies are paying big bucks to insure boards against liability as class-action suits soar.” 9 Jan 2020.