Understanding Tender Offers the Affect on Investors
One of the things you are going to encounter many times in your life as an investor in common stock is an event called a tender offer. Given how you will need to make choices related to those presented to you, I wanted to write an introduction to the topic, offer a basic explanation of tender offers, explain some of the regulations surrounding these transactions, and otherwise give you a broad, general overview of how they work and why they matter.
My hope is that, by the time you have finished reading this article, you feel more comfortable when you suddenly go to the mail and open an envelope, or log in to your brokerage account and see an announcement, telling you that one of your positions is subject to a tender offer and that you must make an election (a choice) before a certain deadline.
The Definition of a Tender Offer
A tender offer is a public offer, made by a person, business, or group, who wants to acquire a given amount of a particular security. The term comes from the fact they are inviting the existing stockholders to "tender", or sale, their shares to them. In effect, a tender offer is a conditional offer to buy. The individual or entity making the offer says, "I am willing to buy your stock at $[x] if you tender (sell) it to me but only if a total of [y] shares are tendered to me by all stockholders. Otherwise, the deal is off and we pretend like it didn't happen." Of course, I'm simplifying, but that's the crux of the matter.
Usually, tender offers are proposed in the hopes a would-be acquirer can accumulate enough common stock to either get a major presence on or completely take over, the board of directors. One benefit of a tender offer from the perspective of the acquirer is that, if the acquirer comes to own a large enough percentage of the outstanding stock, he or she can force all remaining stockholders to sell out and take the company private or merge it into an existing publicly traded business even if they didn't accept the original tender offer; e.g., it could cause it to become a subsidiary of a holding company and only the holding company has any stock in the newly-purchased operation.
Often, a tender offer is used in cases where the management and board of directors do not believe the takeover would be in the best interest of the shareholder, and they, therefore, oppose it as they consider it incompatible with their fiduciary duty. Accordingly, it is the means by which a hostile takeover can be accomplished by acquirers/investors who want to take control over the objection and fight of incumbent directors and executives.
Tender offers are by far more common in the stock market than a so-called proxy war, which is another way to attempt to take control of a business. As you learned in an older article of mine, The Proxy Statement for New Investors, a company's annual proxy statement breaks out important information including matters on which stockholders must vote. In a proxy war, the individual, business, or group who wants to take over management tries to convince stockholders to vote for their slate of directors, effectively kicking out the old directors and seizing control of the business.
In some cases, this is done by corporate raiders who want to strip the company of its valuable assets, selling it off piece-by-piece. However, in other cases, it is done by well-meaning investors who are tired of seeing a company mismanaged by insiders who enrich themselves despite their incompetence, continually ruining the returns shareholders might otherwise have enjoyed.
If you have ever experienced a proxy fight, you know your mailbox is going to be full as each side sends you a slew of documents to review and you have to pick one you want to win, casting your vote accordingly.
How Tender Offers Work on Your End, as an Investor
Imagine you own 1,000 shares of Company ABC at $50 per share for a market valuation of $50,000. One day, you wake up and log in to your brokerage account. You are notified that Firm XYZ has made a formal tender offer to buy your shares at $65 per share but that the deal will only close if, say, 80 percent of the outstanding stock is tendered to the acquirer by stockholders as part of the transaction. You have a couple of weeks to decide whether or not you will tender your shares.
If you decide to accept your tender offer, you must submit your instructions prior to the deadline or else you will not be eligible to participate.
It's usually as simple as telling your broker, either on the phone, in person, or through the brokerage website, "Sure, I'll sell out at $65 per share" and waiting to see what happens. (Of course, if you have physical stock certificates, it's an entirely different procedure but those are fairly rare these days.)
If the tender offer is successful and enough shares are tendered, the transaction is completed and you'll see the 1,000 shares of Company ABC taken out of your account and a deposit of $65,000 cash put into it. If the tender offer fails because fewer than 80 percent of the shares were tendered to the would-be acquirer, the offer disappears and you don't sell your stock. You're left with your original 1,000 shares of Company ABC in your brokerage account.
If you reject the tender offer or miss the deadline, you get nothing. You still have your 1,000 shares of Company ABC and can sell them to other investors in the broader stock market at whatever price happens to be available. In some cases, the people behind the initial tender offer will come back and make a secondary tender offer if they did not receive enough shares or want to acquire additional ownership in which case you might have another bite at the apple. However, as mentioned earlier, if you don't tender but enough people do, you're probably going to be forced out of your ownership, anyway, as the enterprise is taken private down the road.
Regulations of Tender Offers in the United States
Tender offers are subject to extensive regulation in the United States. These regulations are meant to protect investors, keep capital markets efficient, and offer a set of ground rules that can give stability to the business potentially begin acquired so it can react; e.g., to prepare defenses in hope thwarting a hostile takeover. Specifically, tender offers mainly fall under the purview of two regulations, The Williams Act and SEC Regulation 14E. Let's look at each individually.
The Williams Act — Part of the Securities Exchange Act of 1934, which itself was one of the most important laws in the history of the United States capital markets as it effectively formed much of the foundation of what is the modern financial system responsible for producing the greatest standard of living increases in human history, the Williams Act actually didn't make it into the law until a 1968 amendment proposed for its eponymous backer, New Jersey Senator Harrison A. Williams.
The amendment requires that an individual, company, or other group of people seeking to acquire control of a business follow a set of guidelines meant to increase fairness to capital market participants and to allow interested parties, including a company's board of directors and management, to have the time necessary to form and present their case for supporting or rejecting the tender offer to the stockholders.
For example, the Williams Act states that a tender offer must be 1. registered under federal law, 2. disclosed in writing to the Securities and Exchange Commission including an explanation of the source of funds used in the offer, 3. give a reason the tender offer is being made, 4. announce any intended plans the individual, business, or group extending the tender offer has for the acquired company, if the tender offer is successful, and 5. disclose the existence of any understandings, contracts, or other agreements concerning the subject of the tender offer. The law also states that tender offers must not be misleading or contain false or incomplete statements meant to trick someone into voting a certain way.
One of the most well-known rules arising out of the Williams Act is the requirement for anyone who buys or somehow comes to control more than five percent (5 percent) of a company's outstanding stock to immediately disclose this fact to the regulators and the public. This rule applies if a person, business, or group acquires more than five percent of any class of a company's stock. (For an illustration of multiples classes of stock existing in the same corporation, read A Real Life Example of Dual Class Structure in a Public Company - A Look at Ford Motor's Class A and Class B Shares.)
These rules usually apply to mutual fund managers, hedge fund managers, asset management companies, registered investment advisors, and similar individuals who control or manage investments for other people, as well. For example, because I am the managing director of Kennon-Green & Co., which is a global asset management company, and I exercise discretionary authority over client portfolios through the investment committee, if we were to purchase or somehow come to control 5 percent or more of a given company's stock, we'd have to file the appropriate paperwork with the regulators, making this public knowledge.
The required form depends on the type of filer and some other conditions. Generally, the required form is known as a Schedule 13D and it must be submitted within ten days of the 5 percent ownership threshold being crossed. Furthermore, the Schedule 13D must be amended "promptly" — a term that the Securities Act of 1934 does not describe and is thus left up to regulatory interpretation — to reflect any material changes in the position.
Certain types of investors are permitted to file a shorter, easier-to-use disclosure form known as a Schedule 13G. On top of this, annual amendments are also required to update the markets with the status of ownership. However, these things are far beyond the scope of our discussion about tender offers.
Regulation 14E (Rules 14e-1 to 14f-1) — These cover a slew of tender offer rules, each detailed and specific. For example, it is against the law for a person to announce a tender offer if he or she doesn't reasonably have a belief that he or she will have the funds available to them to consummate the deal, if accepted, because this would result in wild fluctuations of the stock price, making market manipulation easier.
Furthermore, it would reduce faith investors and business managers had in the capital markets because people would have to wonder if a tender offer was legitimate or not every time they received word their company had been subject to one, distracting everyone involved.
To help those of you who are interested in learning some of the nitty-gritty details about how tender offers work, I've linked to the Cornell University Law School's Legal Information Institution, which graciously hosts a copy of the actual law's text, organized in a way that it has built-in cross-references to related passages so you can read the source material yourself. They are definitely worth studying at least once and I encourage anyone who is curious about this sort of thing to take a few minutes out of your day to enjoy them.
- Rule 14e-1: Unlawful tender offer practices
- Rule 14e-2: Position of subject company with respect to a tender offer
- Rule 14e-3: Transactions in securities on the basis of material, nonpublic information in the context of tender offers
- Rule 14e-4: Prohibited transactions in connection with partial tender offers
- Rule 14e-5: Prohibiting purchases outside of a tender offer
- Rule 14e-6: Repurchase offers by certain closed-end registered investment companies
- Rule 14e-7: Unlawful tender offer practices in connection with roll-ups
- Rule 14e-8: Prohibited conduct in connection with pre-commencement communication
- Rule 14f-1: Change in majority of directors
Some Final Thoughts on Tender Offers
Keep in mind that once you accept a tender offer, you are selling your stock. This means you may owe capital gains taxes on any increase in the value of the shares you enjoyed over the period during which you held your ownership unless you happen to hold the shares in tax-deferred or tax-free accounts such as a Traditional IRA or Roth IRA.