Creating Liquidity for Shareholders (Robert T. Smith Commentary)

A recent Wall Street Journal article noted that there were more than 7,400 companies listed on U.S. stock exchanges in 1996 at the beginning of the dot-com bull market. That number has now been cut in half. The reasons for this are numerous, including increased compliance costs and the liberalization of securities laws allowing companies more flexibility to raise capital without public registration. With the reduced number of public company investment options, holdings in private shares have inevitably become a larger share of the investment portfolio of many Americans.

Provided a company has access to sufficient (permanent) capital, remaining private is often the best option for the business, but that may not correlate to the needs of the owners. These entities are routinely approached by shareholders seeking to liquidate all or a portion of their holdings.

With this pressure, a private firm has several options to consider in making a market for its shares, short of going public. This commentary discusses common alternatives used by privately held banks as well as nonfinancial companies to create liquidity for shareholders.

► Shareholder matching programs. A routine practice is to maintain “buy/sell” lists of shareholders interested in either buying or selling shares of the company. This is a simple method for the company to help maintain liquidity in its equity. To limit exposure, we recommend that companies do little more than introduce the parties and avoid handling funds, making recommendations to either side or becoming involved in price negotiations.

Most companies communicate availability of this service in an annual shareholder letter. Following introductions, the potential seller and potential buyer are free to negotiate their deal independent of the bank or company.

► Share repurchase programs. A formal share repurchase or tender offer program is also common as a private company grows and the needs of its shareholders evolve. These programs are generally either an open annual offer to shareholders to purchase shares within certain board-approved parameters or a formal tender offer that would typically remain open for only a short time.

Many privately owned banks adopt annual resolutions specifying a repurchase dollar amount that the bank is authorized to spend on stock buybacks during the year, typically based on an appraisal or the most recent year-end book value. These programs are discretionary and the availability could be suspended at any time.

The benefits of repurchasing for shareholders include an increase in book value per share, earnings per share and percentage ownership, along with a refocus on the value of holding the stock long term knowing that liquidity will be available when needed. A routine repurchase program may also result in an increased valuation in subsequent appraisals.

Repurchase programs are common even for smaller community banks throughout the country. Privately held Heritage Bank in Nevada, with total assets of $830 million, recently announced a buyback program to repurchase up to $4 million of its shares, representing about 5 percent of total equity. Similarly, Peoples Trust Co., a $262 million-asset bank in Vermont, announced a repurchase of up to $500,000 of its shares. The consideration allocated to the buyback represented about 2 percent of the company’s total capital.

When considering the size of potential repurchases in view of the regulatory obligations of a bank or holding company, the institution should consider 1) its ability to continue to satisfy regulatory capital requirements, 2) whether prior approval of the firm’s regulators will be required for a share redemption, and 3) whether the transaction could trigger a regulatory application requirement based on the proportionate increase in ownership of non-selling shareholders.

The company must also consider its required disclosure obligations to potential sellers. Because the repurchase involves a securities transaction, the company must determine what nonpublic information is required to be disclosed to the selling shareholder to satisfy state and federal anti-fraud rules. At a minimum, up-to-date financial information should be provided to the selling shareholder a reasonable period before closing. Even under the less formal share repurchase programs (as compared to a tender offer), we recommend that the bank adopt a uniform set of disclosures that will be made available to each selling shareholder.

Conclusion
For any private company, maintaining some degree of oversight on transactions in its shares should be of paramount importance. Sales transactions resulting in new ownership whose interest and visions may not align with the company could create significant distractions and other problems. Offering liquidity options to shareholders can be an effective method of encouraging shareholders to first look to the company before considering other sale alternatives.

Robert T. Smith is a partner in the Little Rock office of Friday Eldredge & Clark. Email him at RSmith@FridayFirm.com.