Part 3 in the Nasdaq Private Market series on private company secondary auctions.
While tender offers have become widely accepted as the main type of secondary transaction for private companies, auctions may have even greater benefits to participants. This article will explain what those benefits are, in addition to the risks that companies should be aware of when considering this type of program.
Companies that run auctions can benefit from competitive price discovery from sophisticated, institutional buyers. This can lead to a more transparent process for both buyers and sellers. Additionally, auctions provide valuable data points for those who may not be eligible or do not elect to sell in the transaction. The aggregation of buy-side demand may also lead to more price competition from buyers who may be willing to outbid one another to secure an opportunity to invest in high-growth companies.
A higher price is obviously advantageous for a seller. However, it may also deter some buyers from entering the process, which is why buyers traditionally favor one-on-one transactions that leave room for negotiation around investment terms and price. A sponsor or issuer looking for less negotiation around terms (e.g., information rights) and price (e.g., price per share) may elect to have a standardized letter of intent signed by each buyer before they place any bids. This letter of intent defines the rights given to each successful bidder upon completion of the transaction, reducing prolonged negotiations and expediting the completion of the transaction.
Depending on the structure, companies may also be able to carry out the entire auction in less time than it takes to hold a traditional tender offer. Traditional tender offers are required by law to keep the offering open for a minimum of twenty (20) business days. Thus, auctions offer timing flexibility that traditional tender offers do not.
In addition to a shorter transaction duration, both buyers and sellers may get the added benefit of paying or receiving a better price per share. Each of the many different types of clearing price calculations may be able to provide more advantageous pricing for clearing bids in certain auction types – leading to a benefit for both sellers and buyers.
Auctions also provide the same level of customization, if not higher, than tender offers. Companies can (i) name price floors and ceilings to control bidding, (ii) project or limit the amount of shares eligible to be sold in a transaction, (iii) permission certain buyers into the process, and (iv) control what information they disclose to all participants.
Lastly, tender offers can include an auction component, thus bringing together the benefits of both secondary transaction structures. Auctions Compared to Tender Offers: Potential Advantages and Disadvantages
Auctions Compared to Tender Offers: Potential Advantages and Disadvantages
|Auctions||Offers potentially more competitive bidding processes.|
Provides additional data points for future transactions, direct listings, and IPOs.
Creates a centralized, standardized manner to collect bids.
Creates a more market-driven price discovery process; more transparent clearing price calculations.
Limits negotiations from third parties.
No need for a lead purchaser to set price.
|Certain auctions may be more complex and time consuming.|
Auction mechanics are new and must be thoroughly reviewed by legal counsel.
Limited guidelines from legal experts can create ambiguity.
|Tender Offers||Traditional, standard method for secondary transactions.|
Most legal counsels have experience with these types of transactions.
Provides a more linear approach to creating offer prices.
Existing, proven processes in place can lead to more efficient transactions.
|Uses a “black box” approach to price discovery.|
Lack of transparency mainly benefits buyers.
Potential for prolonged negotiations.
Difficult to forecast the probability of successful transaction prior to closing.
Even though auctions have many potential benefits for transaction participants, there can be drawbacks. For certain price discovery processes (e.g., buy-side auctions), sellers may have little to no input on the final transaction price and may feel “left out” from the price discovery process, even though they have the option not to accept the price identified. If sellers are not included in the process ahead of the auction, it may be difficult for companies to forecast sell-side demand from their shareholder bases. Additionally, there is a risk of a price mismatch between buyers and sellers during an auction. Buyers may not incorporate sentimental value or sweat equity into the price like sellers may, thus leading to low bids and high asks.
For dual-sided auctions with a single clearing price, the auction may be undercut by one large seller if that seller decides to sell for a very low price, bringing down the final clearing price for all sell-side participants and offering less liquidity than may have originally been planned. As companies decide to run auctions, it is important to find ways to mitigate the risks caused by the inherent disadvantages in different auction structures.
NPM has developed a solution to alleviate some of the stress private companies experience around making sure sellers do not feel “left out” of the price discovery process. The NPM solution is to hold a seller indication of interest process before the auction. The process would allow eligible sellers to enter a proposed quantity and price at which they would be willing to sell shares, all on a controlled platform that can be accessed only by company-permissioned sellers. In addition to providing sellers with a voice in the pricing process, it can also potentially help companies with forecasting the sell-side participation in a secondary transaction. NPM can provide aggregated information around participation rates and amounts tendered from past transactions, but the most accurate way for an issuer to forecast sell-side demand is to ask the sellers themselves. In order to address possible price mismatches by buyers and sellers, NPM allows companies to implement price floors and/or ceilings for transactions. This gives “guidelines” for pricing for both buyers and sellers and can lead to more reasonable bids that are more likely to match in the clearing price calculation. It also limits the downside for potential sellers in case there is a large seller who can sway the clearing price with a very low ask.
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