Tender Offer

A tender offer is, in the SEC's description, "typically an active and widespread solicitation by a company or third party (often called the 'bidder' or 'offeror') to purchase a substantial percentage of the company's securities." When the company buys its own securities it is an issuer tender offer; when someone else buys them it is a third-party tender offer, often the first step in an acquisition. A tender offer is open only for a limited time, is made to each holder individually, and has fixed terms, and the price is usually set above the market price to persuade holders to sell. A holder "tenders" by instructing the broker, or the depositary running the offer, to sell the shares on the offer's terms.

The rules that protect the holder. Tender offers are regulated under the Securities Exchange Act, and which rules apply depends on whether the offer is for equity or debt, whether the bidder is the issuer or a third party, and whether the securities are of a class registered with the SEC or issued by a company that files periodic reports. The SEC says that all tender offers, mini-tender offers included, are subject to anti-fraud provisions and to procedural rules on how long the offer stays open, how quickly holders are paid and how an offer is extended. The core of those procedural rules is SEC Rule 14e-1: a tender offer must stay open at least 20 business days, must stay open at least 10 more business days after any change in the price or the percentage of securities sought, must pay or return securities promptly when it ends, and can be extended only with a public notice by 9 a.m. Eastern time on the next business day.

For most tender offers there is more. The bidder files a Schedule TO with the SEC, along with the document usually called the Offer to Purchase, both available on EDGAR under the target company's name. Holders may withdraw tendered securities at any time while the offer remains open. The offer must be open to all holders of the class, and every holder must receive the best price paid to any other, so a bidder cannot pay one holder more than another. When an offer seeks less than all the shares and more are tendered than the bidder will buy, it must accept them as nearly as possible pro rata, according to how many each holder tendered.

Mini-tender offers. An offer that would leave the bidder owning 5 percent or less of a company's shares escapes most of that machinery. The SEC warns that the bidder need not file with the SEC or give withdrawal rights, that the documents are far less detailed, and that the price "may actually be below the market price," since the offers count on holders assuming a premium. A holder who tenders into one may be unable to change their mind.

Private companies and employees. A company with no class of shares registered with the SEC and no reporting obligation is outside the SEC's issuer tender offer rule and its Schedule TO filing. The anti-fraud and procedural rules that reach all tender offers, including the 20-business-day minimum, still apply. Some private, venture-backed companies use tender offers to let employees and early investors sell part of their shares, to the company or to outside investors, before any IPO, which can be one of the few routes to cash for startup equity. Whether vested options must be exercised first, and how the sale is taxed, depend on the plan documents and on the kind of equity held.

A holder facing a tender offer has three choices: tender, do nothing, or sell in the market before the offer closes. If the market price sits below the offer price, the gap is the market's view of the risk that the offer fails its conditions or that tendered shares are prorated.

Take an example of proration. A company offers to buy back 10 million of its shares at $48 each when they trade at $42, a premium of $6, or about 14 percent. Holders tender 16 million shares. Because the company is buying fewer shares than were tendered, it must accept them pro rata: 10 million divided by 16 million, or 62.5 percent of each holder's tender (assuming the company does not use the rule's option to accept small holdings of fewer than 100 shares in full first). Ana tendered 800 shares, so 500 are bought (62.5 percent of 800) for $24,000 (500 times $48), and the other 300 are returned to her. Those 300 shares are back in her account at whatever the market price is once the offer ends, which may well be below $48. A holder who expects heavy proration may tender knowing only part of the order will be filled, or sell some shares in the market instead.

Pros

• The price is usually a premium to the market, paid in cash or in shares.
• SEC rules give holders time to decide, a right to withdraw while the offer is open, and the same price as every other holder.
• Holders can choose: tendering is optional, unlike a mandatory merger.
• For employees of a private company, a tender offer can be a chance to turn shares into cash before an IPO.

Cons

• Oversubscribed offers are prorated, so a holder may sell fewer shares than tendered and keep the rest at a post-offer market price.
• Conditions can let the bidder walk away, and shares are tied up while the offer is pending.
• Mini-tender offers can be priced below the market, carry no withdrawal rights and file nothing with the SEC.
• Tendering shares from a taxable account is generally a taxable event, and the timing is set by the offer rather than by the holder.