What Would You Do?

[jackellis]

Here's a little puzzle to entertain you all on a Friday.

A private company needs to purchase a certain number of shares from former employees, which it could purchase from three former executives who hold more than the required number of shares by themselves. Another 60 or so employees together also hold enough shares to satisfy the purchase requirement. The value of the shares is determined by an appraisal that arguably undervalues the shares.. The company can meet certain conditions that allow it to legally buy shares from the three executives without making the same offer to the other shareholders.

The three executives have determined that it is in their interest to hold out for a price that's higher than the appraisal and would yield a reasonable profit. Smaller shareholders know nothing about the company's need to buy common shares at the moment.

Let's say the company agrees to pay considerably more than the appraised value for shares held by the former executives. You are one of the former executives who can sell shares and you are also one of the founders. You know some of the smaller shareholders have expressed an interest to sell in the past and they might be willing to take the appraised value rather than a higher price.

What would you do?

[Uncle Cracker]

Maybe buy shares myself from rank-and-file shareholders at face value, and then resell to the company at a profit... Either that, or if I can get enough shares to leverage the corporate buyback, hold out and negotiate an even higher price.

[JR]

Is the company not liable for class action by the smaller shareholders if they agree to buy back the shares from the three executives at the higher rate?

JR

[leehljp]

Open and honesty is something that has long disappeared from the general population. Many people still applaud heroism and know that freedom does not come without responsibility, but the foundations of freedom are built upon values that that come from within one's own character - independent of how others behave.

I wish people would get out of the "I am in this for me only" selfishness and do what is right even when no one else knows about it.

My above sentiments are not about a "goodie two shoes hypocrite" philosophy but my wish that people would return to caring for their fellow man in every day times - just like they do for our military guys who actually fight for and protect our freedom and rights. It does no good for our guys in uniform to fight for freedom when we who are back home tear it down from within by backstabbing each other - especially when they are unaware of it.

In that situation I would suggest to do what is right and honest with integrity and character - and that isn't always popular by a long shot. But, those who do what is right and honest should expect LOTS of criticism - which comes with the territory.

[shoottx]

Dutch auction share repurchases

The introduction of the Dutch auction share repurchase in 1981 allows firms an alternative to the fixed price tender offer when executing a tender offer share repurchase. The first firm to utilize the Dutch auction was Todd Shipyards. A Dutch auction offer specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a supply curve for the stock.[2] The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at or below the purchase price on a pro rata basis to all who tendered at or below the purchase price. If too few shares are tendered, then the firm either cancels the offer (provided it had been made conditional on a minimum acceptance), or it buys back all tendered shares at the maximum price.

[edit] See also

* Auction Rate Security

[Shep]

I would first make an offer to the employees at the highest price they can buy for. If they do not get enough interest from the employees, I would then offer the same deal to the executives.

This accomplishes two things:
1. The employees feel like they are being treated fairly by the executives and reminds them they are working for a good company.

2. They actually might not want to sell with the higher price because the feel that if they hold it longer the price may increase/be a better long term investment. In this case the Executives would be able to sell at the higher price.

Just becuase a price is high doesn't mean everyone will sell

[poolhound]

Jack,

I take it that this is in fact a real scenario and not merely an acedemic puzzle. And you therefore can not supply many of the details (which would be inapropriate), however there are many missing pieces in this puzzle even before one where to look at moral over legal obligations.

You say the company is private by which I take that to mean NOT publicly traded, but what type of company is it i.e. C corp S or limited partnership or even and LLC. Whatever it is there should be operating agreements and a wide variety of other documents that will state their responsibilities to shareholders. Some entities will have more stringent legal compliance issues.

Also there are often differnet classes of stock eg preferred or special issues and these may need (or be able) to be treated separately.

Bottom line IMHO is talk to a lawyer ASAP and first understand the legal issues involved and ensure you understand if what is being proposed is clearly kosher or if its in the grey zone what the potential risks are.

Then there is the moral dillemma and that I would not wish to begin to comment on as that a whole different can of worms.

[jackellis]

I take it that this is in fact a real scenario and not merely an acedemic puzzle.

It is a very real scenario and even if I didn't have to worry about how much I should disclose, it would take too long to lay out all of the relevant details. What I can say is the following: Nearly all of the afected stockholders are former employees - current employees hold unexercised stock options. The company is a privately held, venture funded C corporation. Other classes of shareholders support the current management's proposal and I am comfortable that it has a solid legal basis. There's nothing adversarial about the situation, though there are some inherent conflicts of interest (mostly mine).

It's all about fairness, not about what is or is not legal. The reason I posed this question is to help stimulate my own thinking and to make sure I'm not overlooking an important point before I respond to the current management regarding their proposal early next week. So, if any of you have other opinions or thoughts, they are most welcome.

[crokett]

Ethically speaking I think it is only fair to include everyone who might want to sell in on the deal and not just the executives. Also, in terms of what's best for the company it seems to me that buying shares back at a lower price is better than buying them back at a higher price. After all, stock is a debt to shareholders and wouldn't you like to retire debt as cheaply as you can?

[Rand]

I can't claim to know very much at all about corporate finance but:

The "need" to buy common shares seems fishy to me. A company sells shares in order to raise capital. It seems to me that a lot of things could be done with the excess money.

The only reason I can see for a company to buy back it's own stock is to pump the price up so the major shareholders can sell and line their own pockets.

If the company has too much cash maybe it should pay it's employees bonuses or pay a dividend to the shareholders instead.

[bfrikken]

You know some of the smaller shareholders have expressed an interest to sell in the past and they might be willing to take the appraised value rather than a higher price.

I think what you mean to say here is :

You know some of the smaller shareholders have express an interest to see in the past and they might be willing to take the appraised value IF THEY DIDN't KNOW THERE WAS a higher price.

[jackellis]

You know some of the smaller shareholders have express an interest to see in the past and they might be willing to take the appraised value IF THEY DIDN't KNOW THERE WAS a higher price.

There isn't a higher offer on the table. The largest shareholders have individually decided they won't take the appraised value, but enough shares from small holders might be tendered at the appraised value so that shares from the larger holders are not required. In that case, larger shareholders have to wait for their exit.

The "need" to buy common shares seems fishy to me. A company sells shares in order to raise capital. It seems to me that a lot of things could be done with the excess money.

The only reason I can see for a company to buy back it's own stock is to pump the price up so the major shareholders can sell and line their own pockets.

If the company has too much cash maybe it should pay it's employees bonuses or pay a dividend to the shareholders instead.

In this case, appearances are deceiving. The Company needs cash and it also needs shares it can use for various other business purposes I can't describe but know to be legitimate. The root of the problem here is a contractual arrangement that limits the total number of common shares that can be authorized and issued.

It is entirely possible that small holders might decide to sell now for appraised value and larger shareholders might receive more (or perhaps nothing) later, but that's a problem all investors face at various times. The large shareholders have no information advantage over the small holders. Of course, another option is to amend the contract provisions that created this situation, but I don't think that will happen.

[vaking]

Firstly - the fact that somebody is a former cofounder or a former employee or a former executive is irrelevant. That person is nobody current except a shareholder. Let's concentrate on present and future, not the past.
Secondly - it is not clear from the discussion if the company is interested in buying back any shares while preserving its cash (that means at a minimal price) or the company is interested in buying shares from specific people. That may be not because the company has limited number of shares to operate with but because former cofounder has too much control over current company decisions through his shares.
In my opinion the answer largely depends on this second consideration. If the company just wants its shares back at minimal cost - facililitate the offer to buy shares from small shareholders. It is also likely to increase the value of remaining shares, so it is to the benefit of former executives (large shareholders) as well as the company. If the company wants specific shares back - that will not go very far.

[cgallery]

It would depend a little on whether you're interested in selling. I'd negotiate the best price you can, and then decide.

There is no moral or ethical dilemma here. Larger blocks of shares often sell at a premium. There are many valid reasons why a buyer would prefer to negotiate with three rather than sixty. Especially where many of the sixty are employee-owners.

[leehljp]

There is no moral or ethical dilemma here. Larger blocks of shares often sell at a premium. There are many valid reasons why a buyer would prefer to negotiate with three rather than sixty. Especially where many of the sixty are employee-owners.

CG, no disrespect intended, but I disagree on a point. Larger blocks often do sell at a premium for a couple of reasons and no argument there.

But there is always an ethical question that arises when status, inside information, relationships, conflict of interest personnel - when these restrict the flow of information or otherwise determine the outcome in even a semi-public or even private company - outside of single family holdings.

You can have "legal" rulings but they are not always "ethical" in the sense that they are totally fair and honest. If I, or you, or your mother were one of the workers, how would you feel when you learned that the executives got a higher price than you were offered?

The REAL problem becomes evident when the workers quit working for the company and start working for the dollar at that point. The results can be catastrophic - today's economy is replete with huge companies filled with people who work for the money instead of the company. Companies who push little by little for more and more for the "executives" until there is a huge divide, at which point it becomes a "We verus Them" and the "employee organizations" step in and change the employees to money oriented instead of company/job oriented and ta-da - failed companies.

Root cause - smallish greed and "advantage taking" by executives in a "legally right" but conflict of interest, inside information, because of their status, position, rank, influence.

When status, rank, influence or position is used for the gain of all, no problem - but when used for "self gain" it becomes ethical.