What’s a tender offer, and how do they work? An introduction for new startup founders

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Liquidity is typically music to any shareholder’s ears, and tender offers are a common path toward that end. That said, there are some important considerations when conducting a tender offer. 

Read on for details about what tender offers mean in a private company setting: how they work, when they come in handy and who benefits. 

What is a tender offer in a private company setting?

In simple terms, “tender offer” simply means that stockholders of a company (any stockholders) are offered the opportunity to “tender” (i.e. sell) their stock at a fixed price. 

Generally speaking, a tender offer is a liquidity event designed to enable security holders in a private company to sell some or all of their shares or other securities (such as options) either to another investor or back to the company. In other words, a tender offer lets people cash out.

All tender offer participants do not have to have the same characteristics (i.e. optionholders and holders of preferred stock alike can participate) and the company has full discretion to determine who can participate, but once the criteria is set, all participants must be offered the same rights and opportunities.

Tender offers are subject to rules developed by the Securities and Exchange Commission (SEC). However, the SEC does not have a clear definition of what constitutes a tender offer in terms of a dollar amount or number of participants (oy!). 

Accordingly, whether an event is considered a tender offer usually depends on specifics. For example, five or fewer participants probably isn’t a tender offer, but if there are more than 10 participants, you are likely in tender offer territory, which means SEC rules apply. So it’s important to consult a legal expert before engaging in any offers to purchase stockholders’ equity, to ensure it’s  done properly and does not trigger any regulatory or tax concerns.

Why engage in a tender offer?

The most common impetus for conducting a tender offer are liquidity for management or service providers and cleaning up a company’s cap table. 

With respect to the former, tender offers create opportunities for management and service providers to liquidate their valuable stakeholdings for cash PRIOR to a liquidity event like a sale, acquisition or IPO. 

Because startups are usually private companies, there often isn’t a market for founder and employee equity. Tender offers can be a  way to reward early team members, support founders who are living on a less-than-FMV salary or increase employee morale by showing that the company’s value has grown over time. 

Tender offers are also a great way to get rid of stakeholders who are taking up valuable real estate on the cap table. In a company’s nascent stages, it may fundraise from many small investors. Over time, this can lead to a very unwieldy list of who owns which shares and at what rates, making the cap table administratively burdensome to manage. In an effort to address this issue, a company may elect to conduct a tender offer to redistribute ownership so it’s concentrated in a smaller group of holders.

What are the rules on how to conduct a tender offer?

While the SEC does not have a clear definition of what constitutes a tender offer (see above), once an event is categorized as a tender offer, SEC rules kick in, specifically Regulation 14E under Rule 240 of the Securities Exchange Act of 1934.

There are many provisions set forth in Regulation 14E, some of which are more or solely applicable to public companies. The most important rules to remember for a private company tender are:

• The offer must be open for a minimum of 20 business days. There is a minimum 10-business-day extension period for changes in price/quantity, and 5 business days for other material changes
• The company must disclose its position on the offer to the participants (i.e. recommend accept or reject, no opinion or unable to take a position)
• The offeror (the buyer) and its affiliates cannot purchase the target company’s securities during the offer period EXCEPT through the tender, subject to certain exceptions
• Individuals with material nonpublic information (MNPI) cannot purchase or sell securities in a tender offer (i.e. all participants must receive uniform information about the offer — key facts cannot be furnished to some but not others)
• The offeror must make “prompt payment” of the purchase price after the offer closes

Why does the SEC care about regulating tender offers?

The SEC views tender offers as being a “high pressure tactic.” The commission essentially wants to prevent fraud and potentially unsophisticated parties from engaging in the purchase or sale of securities without the proper information. 

How are tender offers communicated to participants? 

The details of a tender offer should be communicated in a formal Offer to Purchase with all relevant exhibits affixed. Any communications, including letters, emails or other communication forms from the CEO or other officer should include details of the transaction in plain language. 

The company should set up a data room with pertinent information and materials about the transaction and the company (including its financial position), which minimizes the opportunity for miscommunication, omissions of material information or any claims from participants with respect to receiving incongruent information.

What are common mistakes in engaging in tender offers?

The following are common mistakes that private companies make when conducting tender offers:

• Not engaging legal counsel and tax advisors
• Not explaining the terms and mechanics of the offer with enough detail to participants
• Not leaving the offer for long enough (or extending the period as required for material changes in the terms and/or information about the company)
• Opening an offer without enough cash or a firm commitment from a third party to fund the repurchase of securities
• Not preemptively responding to FAQs which are typically listed in the Offer to Purchase, so as to avoid providing inconsistent information to participants

Tender offers can be a great way to offer early service providers liquidity and to consolidate a company’s cap table. That said, there are important considerations of which companies should be aware before gearing up for a tender offer. 

The best choice a company can make before taking any steps toward conducting a tender offer is consulting with their legal counsel and tax advisors to ensure that the process runs smoothly and there aren’t any violations of the tender offer rules, which could result in serious penalties.

Kim’s Korner is a series of articles by Ballard Spahr’s emerging company and venture capital attorneys. The column is not legal advice. The substance of the column is derived from our experience working with founders and details many of the current critical issues facing startups.