How Privatization Affects Investors

Explaining the Benefits & Drawbacks

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It’s not often that a major publicly-traded company goes private but that’s exactly what is happening now that Tesla CEO Elon Musk is becoming the owner of social media giant Twitter.

The deal wasn’t made without some drama, as Twitter put in a poison pill defense after Musk made his intention known. But in the end, his perseverance won them over and they agreed to accept his purchase offer of $54.20 a share.

The $44 billion deal won’t close for a while, but it will likely reshape the company. And it will obviously make an impact on Twitter shareholders. Let’s dig in to find out how privatization affects investors and learn the benefits and drawbacks of taking a company private.

The Short Version

  • When a person or a company buys another company and delists it from an exchange, it becomes a privately-held company.
  • The biggest benefit to shareholders is that they are often paid a premium price for agreeing to sell their shares.
  • Investors may have to pay capital gains tax on any money they receive.

What Is Privatization?

Privatization is the opposite of a company going public. A publicly-traded company often goes private when the majority of its shares are bought by a shareholder, like in the case of Twitter. In order for a company to become privately held, the shareholders must agree to the sale.

When a company is privatized, it’s de-listed from the exchange it's listed on, such as the Nasdaq or New York Stock Exchange. That means its shares can no longer be bought by the public. It also means it may no longer have to report its financial statements to the Securities and Exchange Commission (SEC). Nor will it face as much regulatory scrutiny from the government.

Many other famous companies besides Twitter have privatized. Dell Computers was delisted in 2013, after 25 years as a publicly-traded company, while Panera Bread went private in 2017.

Some companies that go private can also make an initial public offering again a few years later. Burger King, for example, went private in 2010, then re-listed in a reverse merger in 2012.

How Privatization Affects Investors

When a company decides to delist or someone buys it, shareholders are usually paid a premium price. It can take a while for the deal to close and things normally operate as usual in the meantime.

Until the deal is final, anyone can buy shares of the company using their brokerage firm. However, once the company is delisted, members of the public can no longer buy shares. If you buy shares at a price higher than the premium offered, it could result in a loss.

Another way that privatization affects investors is through taxes. Because shareholders often receive cash it’s considered a taxable event. So, if you owned shares of Twitter and accept the tender offer, you’ll have to report it to the IRS as a short-term or long-term capital gain.

Read more >>> Paying Taxes on Investments 2022 Guide

What Happens To Shares When a Public Company Goes Private?

Going private is generally straightforward, although it can take some time for all of the paperwork to get sorted. There are usually fewer regulatory approvals to get than when a company goes public.

In order for the privatization of a company to happen, there are a few things that can occur. The most common situation is when another company or shareholder makes an offer to buy the company.

This is what happened when Elon Musk offered to buy Twitter for $54.20 a share or $44 billion. If you bought 20 shares on February 8, 2022 for $35.98 a share or $719.60, you’ll receive a premium of $54.20 a share or $1084. That’s a profit of $364.40.

Another way that a company can privatize is by merging with another company or declaring a reverse stock split which reduces the number of shareholders. A company can then delist if its securities are held by less than 300 shareholders of record or less than 500 shareholders of record if the company has no major assets.

If a company wants to go private using one the above means, it has to provide the information to shareholders and may also have to file a proxy or tender offer with the SEC. In many cases shareholders must approve of the privatization of the company.

What Happens to Shareholders When a Public Company Goes Private?

When a company goes private, shareholders often benefit financially. One of the main lures for companies to go private is the premium price that the new owners will pay to shareholders.

For example, Toys “R” Us went private in 2005 for $26.75 a share, which was double the stock’s price in January 2004. This meant if an investor had bought stock of the toy company earlier that year, they would have received double the stock price when the company was sold to private investors.

However, it's important to point out that after investors receive this cash payout, they're no longer a shareholder and they can no longer participate in any future growth the company may experience. Privatization can provide a quick return on investment. But that return may not be as high as investors would have received had they remained shareholders for decades.

Of course, there's no guarantee that a company will growth in the future. It could also decline or even go bankrupt. Privatization (usually) allows shareholders to receive a nice return on their investment immediately, regardless of the company's future successes or failures. And that can make it attractive, even despite the fact that its upside is capped.

Privatization also an attractive option for the company itself, especially as executives can also make significant financial gains. And the company will have fewer reporting and regulatory requirements, freeing up time for the company to focus on other aspects of its business.

Pros & Cons of Privatization

There are many reasons why a company goes from being publicly-held to privately. Here are a few of the pros and cons of how privatization affects investors:

pros

  • As a shareholder, you'll receive a set price for your shares, which often results in financial gain.
  • Privately-held companies do not have as many reporting and regulatory obligations, which can save it money.
  • Private companies usually have more money to devote to research and innovation.

cons

  • If you receive a tender offer, it’s considered a taxable event.
  • After the privatization is complete, past shareholders will no longer be investors in the company
  • It can be harder for a private company to raise equity, especially if it has high levels of debt.

The Bottom Line

If you own shares of Twitter or another public company that is delisting, it’s import to know how privatization affects investors. The good news is that shareholders often receive a premium buyout offer and usually stand to make significant financial gains.

However, it's important to know that you’ll likely have to pay taxes on those gains. And keep in mind that you'll be relinquishing your ownership stake, so you'll no longer share in the company's financial gains (or losses).

Further reading:

Moriah Costa

Moriah Costa is a freelance financial journalist specializing in specializing in business and investigative reporting. Moriah obtained her Master's in Financial Journalism from City, University of London and holds a BA in Journalism from the Walter Cronkite School of Journalism and Mass Communication. Her work has appeared in Thomson Reuters, the Arizona Republic, Washington Business Journal, Benzinga, and more. When she isn't writing or reading the news, she makes art journals and travels around Europe.

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