Key Stages of Privatisation

3. Methods of Sale

a) Trade sale

i) What type of situation it is suitable for

Trade sales are generally used for selling small or medium-sized enterprises, though they have also been used for selling larger enterprises or industries. A government may consider privatising an enterprise using a trade sale if it wants to keep the company’s ownership in a relatively small number of hands for practical reasons such as the coherent management of the enterprise. Compared to flotations, trade sales can normally be completed more quickly, and have often been used in cases where the Government wanted to introduce new skills or new methods into the enterprise.

ii) External advisors

In a trade sale the vendor will certainly need an external financial advisor and will probably also need to consult some other external specialists about other issues, for instance the marketing of the enterprise or its legal position.

A fuller explanation about external advisors is given in Part One, 2 (b) above.

iii) Reforms and restructuring

Various reforms and restructuring may be needed before a trade sale. They may include:

• Changing the legal form of the enterprise so that it can be sold
• Making its sale possible with new legislation in Parliament
• Reorganising the structure of the enterprise to make it more suitable to run as a company, which may involve breaking it down into more than one separate unit
• Increasing the size of the management team
• Introducing new working practices for the management and other employees
• Writing off the enterprise’s debts

The vendor may wish to make only enough reforms to make the enterprise saleable and attractive to potential buyers, and leave the rest to the successful bidder after they have completed the sale. However, they may also wish to regulate the reforms a new owner wishes to make in order to avoid serious social or political repercussions.

These are explained in more detail in Part One, 2 (c) above.

iv) Valuation and pricing

After the effects of any reforms have gone through it is necessary to calculate the value of the enterprise for sale before proceeding to the sale itself. This should be carried out by an independent external advisor who has no conflict of interest in providing a value for the enterprise.

For a more detailed discussion of the pre-sale valuation, see Part One, 2 (e) above.

v) Marketing the enterprise

The vendor should ideally try and market the enterprise to the widest range of potential bidders, to maximize the competition between bids and thus increase the chance of a high sale price. There may well be important legal considerations which affect the nature of the marketing, for instance regulatory requirements and rules governing the advertisement of such opportunities.

However, there are various ways in which the vendor can publicize the sale, for instance in the financial press or trade journals. The vendor may perhaps also wish to directly inform companies which they think are likely or suitable to make bids for the enterprise, for instance companies that have bought similar enterprises in the past. However, while targeted marketing may be used together with general advertisement of the sale, it should not be used in replacement of general advertisement of the sale, as this could undermine faith in the integrity of the process. The vendor should try to publicize the sale as widely as possible.

In the initial stages of bidding the vendor may not wish to provide comprehensive information about the enterprise to the bidders, for such reasons as commercial confidentiality, or to stimulate imaginative, competitive bids. On the other hand the vendor will want to provide enough information to encourage initial bids, and also to minimize the risk that shortlistedbidders will withdraw or significantly reduce their bids at a later stage when further information may be made available to them.

Whatever amount of information is provided, the important thing is that it is made available equally to all potential bidders. Otherwise the process will not be considered fair, and the bidders’ (and also perhaps the public’s) confidence in the integrity of the sale process will be undermined.

When publicizing the sale of the enterprise, the vendor may also wish to let potential bidders know of the criteria which they consider to be important, and on which they will assess the bids. In this way the bidders can obtain a good idea of what the vendor is looking for, and what they hope to achieve by the privatisation.

A discussion of potential bid criteria can be found in Part One 2 (f) above.

vi) Evaluation of bids and bidders

The vendor should evaluate bids according to the sales criteria established before the announcement of the sale.

They might use a tender evaluation plan, which incorporates the priority to be given to each criterion. Such a plan can be useful for providing a fixed methodical approach for evaluating the different bids, but it has some weaknesses, as many of the criteria may be qualitative rather than quantitative, and so difficult to measure in themselves, and with regard to each other.

Vendors give different weighting to different criteria when considering bids, but judgements about weighting will often be subjective, as different people have different opinions about what is most important. Despite these issues about subjectivity, each bid should be considered consistently, using the same criteria.

However, there can be no sure system by which to choose the best bid, and whereas it is helpful to look at specific aspects of the bids and judge them to a set of criteria, it is also necessary to consider each bid as a whole, taking into account the relationships and weighting of importance between the various criteria. It is risky to give too much weight to aspects which can be measured (e.g. price) at the expense of ones which can’t, but may also be of great importance (e.g. future plans for the enterprise). The same applies to choosing one major objective, a quantifiable one, and treating all the others as constraints which must be satisfied. Bids should be judged in their whole.

With regard to the price offered for the enterprise, the vendor should take account of the floor price which was set after the pre-sale valuation, beneath which the enterprise will not be sold. The vendor may not have disclosed this amount to the bidders in the early stage of bidding, so as to maintain a competitive atmosphere. If all or some of the bids are above the price then all is well and the bidders need not be informed of it. However, if none of the bids meets this price then the vendors may inform the bidders of it and suggest that they adapt their bids in order to meet it. The bidder should only consider bids which offer the floor price or more for the enterprise. If no bidders are prepared to offer this price, even after they have been informed of it, then the enterprise should not be privatized.

vii) Preferred bidder

If the sale process has produced a number of initial bids which satisfy the sale criteria, the vendor needs to decide whether or not to reduce the number of bidders who will enter the next stage. There is something of a dilemma here, in that the vendor may need to reduce the number of bidders to what is manageable, but also keep enough of them in play to maintain competitive tension between serious bids.

The vendor will probably make a shortlist of bids to move into the next stage of negotiations. Once there are fewer bidders left in the process this is likely to increase competitive tension between those who are left as they will think they have a better chance of success. But the vendor needs to maintain this competitive tension and push on with the sale, or the bidders who have reached the shortlist might be encouraged to reduce their initial offers.

In order to keep up competition, the vendor should try and keep serious bidders in the running, and it is a good guideline to keep at least three bids in play for as long as possible.

Often both the initial bids and the second stage bids are conditional, and the vendor may find that eventually the only way to get the conditions removed from a bid is to give one bidder preferred status by entering into exclusive negotiations with them to complete the sale.

The preferred bidder should obviously be selected in accordance with all the sale criteria, with the premise that this bidder will best meet the sale objectives, and is acceptable to all parties with an interest in the sale. The vendor should also choose a bidder who will not withdraw or press for significant reductions in the bid during the closing stages, and who definitely has the finance in place to pay the sum they are offering.

viii) Final negotiations

Even if the bidder withdraws its formal reservations and conditions on becoming preferred bidder, they may try to exploit the strong negotiating position they acquire with this status. In this stage the vendor needs to be careful not to grant too many concessions.

The likelihood of the bidder trying to reduce the price can be reduced if the vendor discloses early on in the process any information which might cause a bidder to decrease its assessment of the value of the business being sold.

At this stage the vendor can also mention the floor price if necessary, and if it has not been brought up already. They should try to keep up negotiating tension with the preferred bidder in order to conclude the deal as quickly as possible with the best outcome, and should also keep open the possibility of inviting other bidders back into the negotiations if the preferred bidder seeks unacceptable concessions.

ix) Safeguards and regulation

After the enterprise has been paid for and transferred into the hands of the successful bidder, its running is no longer in the sphere of government and responsibility for it rests with the new owner, subject to independent regulation where appropriate.

However, there are instances in which the vendor may want to keep some interest in the now-privatized company, and there are various means by which the vendor can do this:

Golden share: In some circumstances a government may wish to guarantee against the possibility of an unwelcome takeover of a newly privatized company for reasons such as national security, or the vendor may wish to provide a period for the management to adjust to the private sector, and so may arrange to retain a so-called golden share in the company. The agreement of a golden share specifies that that certain provisions in the Articles of Incorporation of a company cannot be changed without the consent of the holder of the golden share.

These provisions vary between different instances, but they often include a prohibition on any one person, or group of persons acting in concert, from controlling more than a certain percentage of the shares of the company. If the Government welcomes foreign investment then this limit need draw no distinction between domestic and foreign investors, but in some cases, for instance industries of strategic importance, the Government may put a limit on the proportion of the shares that can be held specifically by foreign investors.

Residual shares: the Government may also keep a stake in the company by holding a certain proportion of its shares, known as residual shareholding. Though this is more common in flotations than trade sales, it can in theory be used in both.

Clawback: If few or no similar privatisations have been carried out in the past, the market may doubt its chances of success, and thus the vendor may have to accept a rather low price for the enterprise. However, the vendor may wish to negotiate a share of any profits that might emerge within a specified period after the sale, especially if the company is sold on. This is because after an initial period the market’s confidence in the company has often increased, and in numerous cases the new owners have made substantially more profits than was expected. In many such cases the State lost out. This has been most spectacular when the original buyers of the enterprise have sold it on a short time later for a much larger sum than they acquired it for. Thus the vendor is sensible to take steps to secure a share in the profits which result from the enterprise’s new status as a private company, though they might have to accept a lower price for the sale of the enterprise in order to negotiate this. Clawback can also help to mitigate the effects of having had an overly low valuation of the enterprise in the initial stages of the privatisation.

After the privatisation is complete, the state will also want to ensure that the new owners of the company fulfil any guarantees which may have been specified as bid criteria and included in the contract. These may include guarantees to the employees and/or the customers (Part One 2 (f) above).

Governments often claim that an important reason for their decision to privatize is to improve the efficiency and performance of the enterprise. They should therefore monitor the privatized company to see if it meets these aims. If the Government privatises any utilities where provision of a public service is of paramount importance, they may wish to consider regulating the company with mechanisms such as price caps and performance targets.

Price caps set boundaries for the price utility operators may charge customers for their services. In certain utilities whose structure naturally tends towards monopoly (e.g. gas, electricity, railways) there is no real atmosphere for competition to develop. Hence it may be the public duty of the Government to protect the interests of consumers by setting an upper limit on the bills or fares charged for the use of these services.

In a similar way, for utilities which provide a public service in an essentially monopolistic environment, the Government may also decide on a quality of service which they consider to be acceptable, and introduce this as a set of performance targets for the new owner of the enterprise. If the new owner fails to meet these targets the Government may wish to consider fining it as an incentive to improvement.

The transition of certain industries from state to private control often involves, naturally, a period of adjustment, and may require significant changes in its running and working practices. However, there is no reason why poor service should be tolerated in privatized industries any more than it is in state ones.

Next: Management and Employee Buy-out (MBO/MEBO)

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