Taking a Company Private

Georges Dubé:

For these smaller businesses that arguably shouldn't have gone public in the first place, or just small businesses, period, that are in the capital markets, two benefits of being public are just not available to them anymore.

Narrator:

Welcome to Accounting for the Future, a BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but will definitely have to manage for the future.

Armand Capisciolto:

Hello, and welcome to Accounting for the Future. I'm your host, Armand Capisciolto, BDO Canada's National Accounting Standards Partner and Leader of Accounting Advisory Services. On today's episode, I'm joined by George Dubé, a partner at McMillan LLP in their Capital Markets Group. George, welcome to Accounting for the Future.

Georges Dubé:

Thanks a lot, Armand. It's really good to be here. Thank you very much for giving me the opportunity to speak to your listeners.

Armand Capisciolto:

Well, yeah. No, this is great. Thank you for taking the time today. Let's start off. What does a partner in McMillan's Capital Markets Group do?

Georges Dubé:

Well, right now, not too much. I mean, our capital markets have been very tight the last several months, but it looks like things are moving along. I guess, before we get into the podcast too much, I should just say who I am and what my firm does.

My name is Georges Dubé, I'm an equity partner in the Capital Markets Group here in Toronto at McMillan. I practice corporate finance and mergers and acquisitions. My typical client base are public companies, their boards, or their financial advisors, so the underwriting community.

Armand Capisciolto:

So, really dealing with a lot of people in the capital markets. That obviously is the capital markets, both public and the private side of those markets.

Georges Dubé:

Yes, absolutely.

Armand Capisciolto:

When I think about 2020-2021, just busy years. It just seemed like everybody wanted to go public, or they were raising... doing secondary offerings or raising additional money. And now, that has really... There's been a bit of, like you said, a bit of a slowdown. What about when we think about the private markets a little bit, so whatever, talking about private equity or pension funds or that? We don't necessarily see a slow... At least that's something we're not noticing. We're not noticing that they're slowing down at all. It seems like they're still very active in making acquisitions, increasing their investments. Are you seeing something similar on the companies you advise? Are you seeing similar trends with the private markets?

Georges Dubé:

I think it starts with what you said at first. I think with robust equity capital markets a lot of businesses went public to gain access to the capital markets. What's happened with prices going down and share prices getting hit very hard, for these smaller businesses that arguably shouldn't have gone public in the first place, or just small businesses, period, that are in the capital markets, two benefits of being public are just not available to them anymore.

So, what are those benefits? Well, being public, you have a currency, your shares, to do acquisitions. If your share price is trading at a significant discount, well, the board, the company is not going to be diluted to its current equity holders, so they lose that. They've got to only... They have to use cash to execute on acquisitions.

I think the other thing that people don't talk a lot about is the incentives around keeping key employees or management. You go public. You get incentivized at that going public price, but if your equity compensation, your RSUs, or your stock options are pegged at a price that is now 25% or 30% above the current trading price, as a business, your board and your CEO are going to have trouble, perhaps, incentivizing these key employees and managers, because it's tricky. You can't just simply reprice these options, for example, right?

So that's one thing that, from a business point of view is key. You want... If you're a small business, as well, your senior managers are in the public markets dealing with things other than running the business, so they're distracted a little bit, or a lot, actually, if you're the CFO or in that part of the business, dealing with reporting obligations, dealing with IR responsibilities, dealing with questions from shareholders. Sure, it sounds glamorous. Oh, I'm getting a call from teachers or CPP or an institutional shareholder, but many of these calls are from small shareholders, as well, and you have to take the call, and it takes time out of your day. So, I think, just to recap there, I think in this environment, the benefits of going public might not be there anymore for certain businesses, especially when it comes to the value of your shares and their usefulness in terms of incentivizing employees and managers and acting as a currency in acquisitions.

Armand Capisciolto:

Yeah, and those are two really important benefits of being public. Yeah, when every, especially the one you'd mentioned about incentivizing employees is a really interesting one, and especially we're even seeing it in the environment right now where a lot of the tech companies, that that is exactly how they incentivize employees as their struggling. That makes it... They're struggling. They're laying off people, but even the people they want to keep may not stay because those options may never be in the money at this point, and why stick around for them to vest and that, so it's a really interesting one.

On the other side of that, those are some pros of being a public company that right now, in this environment, don't exist, but markets go up and down, and things can change. Even the date we're recording this, it's really timely because just yesterday it was announced, there was a very large, go private type of transaction that was announced being Fairfax wanting to take Recipe Unlimited private. For those of you who don't know who Recipe Unlimited is, you think Swiss Chalet, Keg, a lot of the restaurants that you go down any main strip in any city in Canada, that they're all on that main strip, right?

Georges Dubé:

Yeah.

Armand Capisciolto:

When we see this happening, this is something we've... This is not the only transaction. This is something that we're noticing, with our client base anyway, is that there's this trend of companies going private. So you talked about a couple pros related to being public, but when a company is coming to you for legal advice related to managing the capital markets and managing their investments, and they say, "Well, we're thinking of going private," what are the pros and cons that you talk to them about in that setting?

Georges Dubé:

Well, a couple things. First of all, yes, I mean, Prem Watsa's taking Recipe private is a signal, I think. Prem is very entrepreneurial, very capital markets savvy. It's surprising. We don't do any work on this transaction, but that's not the surprising part. What's surprising is I'm looking at the paper this morning, and they've been public for quite some time, and the market price for the shares was languishing, and so I think one of the advantages here...

This is a great example, because you're dealing with a company that there was tremendous uncertainty, no revenue at all, probably, during COVID, when everything was shut down, and now they're getting their feet back, but going back to my earlier point, you've got management teams here that can't get incentivized anymore. Their stock must be totally out of the market. But here's an opportunity. We're coming out of the cycle. He can, or the managers of this business can reposition the company in a coherent manner, without the burden of these continuous disclosure obligations.

Obviously, these guys, it seems that, I mean, there's a key shareholder, as well, that's on board with this transaction. They have the necessary financing to do it and carry it out, and they're giving their smaller shareholders an opportunity to get liquid here. I mean, just sort of to recap, to answer your question specifically, like what do I speak to about on with clients that come in the door and want to go private?

I think that the key things are, number one, what type of transaction is it? Because, i.e., if it's a private equity sponsored transaction, you're going to need financing, so is the financing going to be there? Is it a synergistic transaction with another strategic operator, just meaning like another operator in the same industry? Because it's more likely you don't need financing there. Then, lastly, is it just a sale, a complete sale, to an arms-length party? What are you contemplating?

Usually, when we say going private, it has the connotation that, yeah, I'm leaving the capital markets, but the managers are sticking around to manage the business, but it could also... That's why I mentioned this third possibility. Is it a sale, that you're contemplating, to a third party, and you're walking away? Because that changes the dynamic, so structure that you're thinking about. Are you sticking around, the current managers? Are you sticking around? And are you going to need financing to pull this off? Because I think that's a key question in today's market place. Interest rates are moving.

I think I saw an article earlier in the week in the Wall Street Journal about how, in the States, it's getting complicated for certain private equity funds to get their financing at a certain favorable pricing, so if they're involved in a transaction, there's going to be some uncertainty about them, perhaps, being able to buy your business at a sufficient premium, while at the same time getting sufficient debt, which they traditionally do to finance the acquisition, right?

Armand Capisciolto:

No, and the financing is a big deal, right? Especially in a rising interest rate environment, because the deal may have made sense at X%. They can easily cover their financing cost, but at Y%, maybe it doesn't make sense anymore. It's not going to give the equity investors the return they want, and then the deal can fall apart. Yeah, with a lot of uncertainty in the market right now, I would assume, it is deals where you're contingent on pulling financing together are going to be harder to get done than deals when everybody has the money already.

Georges Dubé:

Oh, for sure. I guess the other thing that is the obvious there, that I didn't mention, is in addition to like, okay, what type of transaction are you contemplating? I think the other, I guess the most obvious thing there, is your shareholder constituency, right? Are they going to be on the side of the transaction or not? The typical key factor there relates to pricing.

Armand Capisciolto:

Yeah, like even what I was reading today on the Recipe deal is I think that, and this is early days, just announced, that the price is at a pretty significant premium of the current share price, but I think still below the IPO price, which different shareholders are in different positions that they're depending on when they... For some, they might make out really well, and others it might still be at a loss, right?

Georges Dubé:

Yeah, for sure. I'm just reading here in the newspaper. It's like, so it went public in 2015 at $23 a share. It climbed to $37 a share within the first year of being a public company, so presumably some people got liquid and got off there, but then it... Yeah, you're right. The closing trading price was $13.51 on Monday, before the announcement of the transaction, so a lot of movement there.

Armand Capisciolto:

Well, and it's interesting, just as you talk about that pricing. I think, when we think about the public markets and quarterly reporting, and the continuous disclosure, and the public markets have both long-term investors and short-term traders involved, so when you're taking a company private, you can take a much longer-term look. They might say, "Well, what really... Yes, we got through COVID. There were some rough times, but the long-term value might actually be more at some of those prices that were previously done, previously hit, and now, being private, without people looking over our shoulder constantly about what happened in this three-month period..." They can execute, maybe a long-term plan to get back there, and without that short-termism driving things, right? I would assume that's a big advantage to being private.

Georges Dubé:

Yeah, absolutely. Again, the key, the key attribute is really your managers, your team, is not going to be as distracted dealing with a large constituency of public shareholders. You're going to still have a shareholder. You're still going to have a shareholder constituency, but they're going to be either the managers themselves or one or two or a handful of key institutional shareholders. It's an easier dialogue, and those sophisticated parties will be arguably more attuned to allowing the managers to run the business.

Armand Capisciolto:

Now, when we talk about this, and about the advantages and how a company is saying, "Okay, I'm going to do this," and obviously, we're not going to get into all of the details, because we could be here for a couple of hours, talking about all of the details of how they do this, but what are some of the mechanisms that companies can use to go private? How do they do this?

Georges Dubé:

That's a good question. I mean, the devils in the detail. Typically, when you're in the public markets, you have to tread carefully and thoughtfully is what the advice I typically give. From, I guess, a process point of view, you're going to... I guess, the first thing is your board's going to have to make a decision of whether, if a transaction comes forward, the board's going to have to make a decision on whether to pursue it and, if so, how to do that. In a closely held public company with a significant founder or just, like in your example here with Recipe, where you have two shareholders holding almost half the company, the board gets a pretty big hand here to pursue the transaction, but how do you protect the minority shareholders in this instance?

So typically, what would occur is the board makes a decision to strike a committee of independent directors, so people who are on the board but are not going to be partaking in the transaction or do not represent the interest of a shareholder that's going to be participating in a transaction. The other two things, I guess, that happen are the board should hire independent financial advisors. That can be a BDO, as long as you're not the auditor of the company, or an independent investment bank is typically what you see. Then the other key factor is the board, or the independent committee, in this instance, should get independent legal advice, so hire independent legal counsel. It sounds self-serving, but it's also you're trying to protect the transaction.

The business people are better off hiring people who are independent and technically competent because, ultimately, you're going to have a deal that's going to be what we call protected from attack, either from a minority shareholder or an interloper, who wants to derail the transaction or acquire the business at a different price or on different conditions. That's how you start. The board, independent advisors, both on financial and legal, and then to execute on the transaction...

Again, not to be too detail-oriented at this point, so your listeners stay with us, I think the key... There's a couple of techniques, but the techniques of going private depend a lot on who the potential buyer is. So for example, if you're a foreign company in the United States that's a public company, you'll probably want to go by way of arrangement for tax efficiencies, just highly, it depends on the parties involved.

The short answer is there's two basic ways. You do a takeover bid, or you do a plan of arrangement. The key differences there are a takeover bid might take a little longer, just mechanically it has to take a couple steps to complete the transaction, but the corollary is the arrangement involves the court system. You go to court to bless the transaction, and in that instance, you're giving... It creates a little deal uncertainty, in the sense that you might be dealing with a judge that might not be commercially astute, depending on which jurisdiction you're dealing with, or also gives a forum for interested parties to contest the transaction.

Armand Capisciolto:

Oh, okay, interesting, very interesting.

Georges Dubé:

That's the process at a high level. I guess the only other thing I'd want to draw to your listeners is, and it goes back to the what do you do when you're first contemplating doing something like this, getting competent financial and legal advisors. One of the key things in the going private arena is, typically, your boards, especially if management's involved in this transaction, you're going to need a formal valuation, depending how the transaction is structured. There's techniques to structure around needing to fulfill that requirement, and sometimes, depending on the facts, you just can't avoid it. But just knowing that early on impacts timing and other considerations related to being able to successfully carry out the transaction.

Armand Capisciolto:

Yeah, it's interesting about the valuation and even the... what you were talking about with independent counsel on both sides, right? At the end of the day, you don't want to show that there was any conflicts, because that gives, as you were saying, people an opportunity to contest the deal, whatever. What we've seen, for the clients that we've had that have gone through this, is whether required or just a board saying, "No, we want a valuation. We want to make sure this is going to be a fair deal," always seems to help the process along.

Georges Dubé:

Yeah, absolutely. I mean, remember the valuation can address an actual or perceived balance of access to information, right? The managers have access to information that the small shareholder doesn't, and so, seeing that should be a sign that the price that's being offered is, if it's within the range established by the valuation, is a fair one, right?

Armand Capisciolto:

Yeah, and it's a good segue to my next question, because I want to talk about information a little bit and continuous disclosure requirements, because we, obviously because of the news in the past couple days, we've used a relatively large transaction, a large company, as an example to talk about, but as we both know, the Canadian capital markets and the public companies in Canada, there's a lot more small companies that are public companies in Canada than large companies.

And even when I look back at 2020 and 2021, a lot of companies that were going public, relatively small in size or tech startups or biotech startups and that. I think some of those companies, unfortunately, struggle with being a public company, right? They struggle now with meeting quarterly requirements and press releasing everything that they have to press release and may not have that investment in the what I'll call the kind of financial reporting, regulatory infrastructure that is needed to be a public company.

I think some of them then come to the realization, "Wow. I should've stayed private. This is a little bit more than I thought it was." When you're talking about these arrangements and different ways of going public, and I know the answer is likely going to be, "It depends," but can they just go do this and go private, or do they have to... If they've fallen behind on their continuous disclosure requirements, do they have to bring themselves up to date, so that all the parties have all the relevant information?

Georges Dubé:

Yeah, for sure. You're going to have to be up to date, from a historical point of view. And then prospectively, the actual transaction, shareholders have an opportunity to vote, either directly or indirectly, like tendering their shares to a takeover bid or just voting in favor of pursuing an arrangement at a shareholder's meeting, that they based on sufficient information to make an informed decision. That's the buzz phrase.

What does that mean? Well, there's a litany of requirements that need to satisfy that standard. What's an informed decision? How can one make an informed decision? Our Securities Act sets out those financial and other requirements that would be required in any vote or decision made by the shareholders.

Armand Capisciolto:

Okay, okay. No, George, this has been very informative. Any last comments you want to leave our listeners with on this idea of taking a company private?

Georges Dubé:

Yeah, well, I think, Armand, you said it well when you said, "It's up and down." Right now, there's just a lot of uncertainty, but it seems that the markets always move, like there's always something going on. I was a bit facetious at the start, saying that we haven't been doing anything, but it seems that there is a strong desire for companies in arguably technology and particular the cannabis space here in Canada, too, to start considering whether they've had enough of the capital markets. It seems like, based on recent transactions that have been announced, that things are starting to move a little bit, but it's more likely in the next three to six months that you'll see strategic buyers buying industry participants or assisting current management teams in taking companies private, rather than private equity. That seems to be the thought process on the street here in Toronto.

Armand Capisciolto:

Okay, very interesting, very interesting. George, again, thank you so much for your insights on this topic. Myself, our audience, appreciate your time and expertise. I'd like to thank you, the listeners, for tuning in today. I'm Armand Capisciolto, and this has been BDO's Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you liked it. We'll see you next time.