What Is a Tender Offer? How This Liquidity Option Works

May 5, 2023

There may come a time in a company’s life cycle when an investor shows up and says, “I like what this company is doing and I would like to buy a significant percentage of its common stock.” This investor may then submit a bid to buy that stock from the company’s shareholders. To entice the shareholders to part with their shares, the investor may even offer to buy the shares at a bit of a premium. At this point, it’s up to the individual shareholders to decide  whether to sell their shares to the bidder or not.

What we have just described is a typical example of a tender offer. There are other examples in which different circumstances apply. A bidder may conduct a tender offer for any number of reasons, and in some cases the bidder may not be a third-party investor but rather the company itself. Regardless of the specifics, most tender offers have two big things in common: there is a bidder (or “offeror”), and there are individual sellers (the shareholders).

If you’re an employee with stock options or other types of equity, you may have the opportunity to participate in a tender offer. But should you do it? What are the pros and cons of cashing in on your equity via a tender offer? In this guide, we’ll review everything you need to know about this liquidity option. 

  • What is a tender offer?
  • How does a tender offer work?
  • What are the different types of tender offers?
  • How is income from a tender offer taxed?
  • Pros and cons of tender offers for shareholders
  • Your next steps as a shareholder

What is a tender offer?

A tender offer is a bid or solicitation to buy a significant percentage of stock from a company’s current shareholders. 

In some cases, the bidder may be a third-party investor interested in acquiring equity in the company. In other cases, the company may assume the role of the bidder if it’s interested in buying shares back from shareholders. 

Tender offers are not conducted on a whim. These transactions are overseen by the U.S. Securities and Exchange Commission (SEC), and as such they are subject to various rules and regulations. We’ll go deeper on some of these regulations later, but first let’s explore how tender offers work and why you may be compelled to participate in one as a shareholder.

Why would I participate in a tender offer?

With an increasing number of companies opting to stay private rather than IPO, a tender offer can be a nice liquidity option for private-company employees holding stock options or other types of equity. Rather than wait for their company to go public before exercising their options and cashing in on their equity, employees may be able to monetize their equity in a tender offer.

Keep in mind that both publicly and privately traded companies can participate in tender offers (though oftentimes for very different reasons). If you’re an employee at a publicly traded company, you’ll likely find that the offer price for your shares in a tender offer is higher than the current market price. In this case, you may be enticed to participate in the tender offer instead of betting on the market value of the stock to continue to climb. 

How does a tender offer work?

The specific details of a tender audience can vary depending on the bidder and the company involved. But here’s a general, step-by-step overview of how a typical tender offer might play out: 

  1. A bidder offers to buy shares from current shareholders by submitting a tender offer.
  2. The terms of the offer are communicated to the sellers (i.e. the company’s individual shareholders). These terms include the specified price offered to purchase each share, as well as any conditions that may apply. For example, a condition may state that the bidder must purchase at least one million shares for the offer to be guaranteed. If this condition isn’t ultimately met, the bidder could walk away from the offer altogether.
  3. The individual shareholders evaluate the offer and decide whether or not to accept. 

How long do I have to participate in a tender offer? 

SEC rules stipulate that a tender offer must be open for a minimum duration of 20 business days. Section 14(e) and Regulation 14E of the Securities Exchange Act also require that the offer remain open for 10 business days following a change in the offer price or the percentage of shares being sought.

So, as a shareholder you’ll have a window of time in which to make up your mind. 

Don’t take this as an opportunity to sit on your hands until the last minute! Within that 20-day window, be sure to pore over the terms of the offer and attend any info sessions your company’s equity team may hold. You may also want to contact a financial advisor, who can help you zoom out and determine if real cash now (versus potential cash later) makes more sense for you in the bigger picture. 

What are the different types of tender offers?

OK, so we’ve teased that there are a few different types of tender offers, and that not all of them involve a company graciously offering liquidity incentives to employees. Let’s take a look at three general types of tender offers you may encounter as a shareholder.

Share buyback

Also known as an “issuer tender offer,” this is the type in which a company requests to buy back shares from its shareholders. A buyback can occur for a number of different reasons—maybe the board of directors are feeling really good about investing in themselves, or maybe (in the case of a public company) they just think the stock market is deeply undervaluing the stock. 

Third-party tender offer

In this type of tender offer, an outside investor or third party offers to buy shares from shareholders. This can be done with the approval and sponsorship of the company itself, and in many cases it is. But there’s another case in which a third-party company can issue a tender offer to shareholders without a company’s approval. Let’s briefly chat about that… 

Hostile takeover

The words “hostile takeover” have a bit of a Succession vibe to them, and there can be a bit of drama involved in this mergers-and-acquisitions tactic. In a hostile takeover, the bidder is really an acquirer looking to take control of a target company by purchasing shares from the company’s shareholders. This is generally done after making a tender offer that the board of directors rejects, thus giving the acquirer no choice but to make an offer to shareholders directly. The Williams Act of 1968 was passed to ensure that individual shareholders have certain protections in these types of tender offers.     

How is income from a tender offer taxed?

The IRS always takes their cut, but the tax implications of selling your shares in a tender offer may vary depending on the status of those shares.

If you already own the shares you’re selling (say, for example, they are RSUs or stock options that you’ve already exercised), you will pay capital gains tax on the difference between your strike price and the tender offer price. Which type of capital gains tax you pay—short-term capital gains or long-term capital gains—depends on how long you’ve held the shares after exercising your stock options.

If you’re exercising options and selling them in the same transaction as part of a tender offer, taxes work a bit differently. In this case, you’ll pay ordinary income tax on the difference between your strike price and the tender offer price.

Taxes and their implications can vary depending on your individual circumstances, so we highly recommend getting in touch with a tax advisor before deciding whether to participate in a tender offer.

Tender offer pros and cons for shareholders

Now that we’ve defined tender offers and discussed how they work, let’s review some of the key pros and cons for shareholders to consider. 

Pros for shareholders

  • An opportunity to liquidize your equity assets into cold, hard cash
  • The offer price in a tender offer is usually higher than the current value of your shares

Cons for shareholders

  • You may have “seller’s remorse” if the value of your shares rises after you sell them in a tender offer
  • Exercising and selling your options in a single transaction may have undesirable tax implications

Your next steps as a shareholder

A tender offer can be a great opportunity to turn your hard-earned equity into cash, but participating in a tender offer isn’t for everyone. The specific terms of the offer, combined with personal factors such as your conviction in the company’s growth, can make the decision tougher than it seems on its face. 

If you’re a founder and want to chat more about your equity options, Pulley is here to help. Schedule a call with us and start the next chapter of your equity journey today.

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