Let s Make a Deal M&A Deal Structures that work Cheryl Slusarchuk, TJ Kang
Road Map 2 1. Tax: Maximizing deal value 2. Deal timelines 3. Cross-border deals 4. Managing the process
1. Tax: Maximizing deal value for employees and shareholders 3 Assets vs. shares determining factors Other considerations Capital gains exemption Employee options Non-compete payments
What is the difference between asset and share structure to shareholders? 4 A B C 5% 10% 25%
Assets vs. shares (cont d) 5 Asset sale Two tiers of income tax (corporate and personal) Need to allocate purchase price among assets and assess each asset to determine net aftertax yield to vendor corporation
Assets vs. shares (cont d) 6 Asset sale (cont d) Need to determine the best way in which to distribute the proceeds of sale to the shareholders Tax-free accounts available? Timing of dividends - tax deferral advantage and overall tax savings Winding-up corporation and distributing proceeds Withholding tax on non-resident shareholders
Assets vs. shares (cont d) 7 Share sale One asset being transferred (shares) so no allocation of purchase price (unless multiple class of shares) Assuming individual vendor, one tier of income tax (personal) Capital gains treatment Access to lifetime capital gains exemption ($750,000) Tax treatment of deferred or contingent sale proceeds
Asset vs. share sale an example 8 Assumptions 20 shareholders taxed at highest B.C. marginal rate 10 can access $750K CGE Target QSBC Sole asset is IP created by Target Buyer indifferent to share vs. asset purchase Disposition results in $50MM of gain at either shareholder or target level
9 Asset vs. share sale an example (cont d) Share Sale Capital gain $50,000,000 Aggregate CGE $ 7,500,000 Taxable capital gain (50)% $21,250,000 Tax (43.7%) $ 9,286,250 After tax proceeds = $40,713,750
10 Asset vs. share sale an example (cont d) Asset Sale Gain $50,000,000 Non-taxable distribution from CDA $25,000,000 Taxable Income (50%) $25,000,000 Dividend distribution $18,807,500 Addition to CDA $25,000,000 Dividend Tax Tax @ SBD rate (13.5%) $ 67,500 Eligible (25.78%) Non-eligible (33.71%) Tax @ regular rates (25%) $ 6,125,000 $4,640,400 $ 272,208 Net Corporate Income Tax $ 6,192,500 Aggregate Dividend Tax $4,912,608 Net amount available for distribution to Shareholders $43,807,500 After tax proceeds = $38,894,892
11 What is the difference between asset and share structure to shareholders? A B C 5% 10% 25%
Tax factors influencing structure? 12 Tax status of Target CCPC Shareholders of Target Availability of CGE, RRSPs, Non-resident Purchaser Indifferent to share vs. asset purchase Tax Rates Vendor Purchaser Shareholders of Target
13 Tax factors influencing structure? (cont d) Income generated from sale of assets Ordinary income Property Business Capital gains (or capital gains equivalent) Tax cost ACB and PUC of Target shares to shareholders of Target Assets of Target that are subject of sale
Tax factors influencing structure? (cont d) 14 Availability of deferral Vendor stakeholders Share sale Vendor corporation Asset sale Tax assets in vendor corporation Existence of NOLs, ITC, CCA, CEC $750,000 CGE How many? Tax accounts CDA RDTOH GRIP
Hybrid Transaction 15 Purchaser dictates asset sale transaction Value to vendor in accessing CGE Difference between after tax return on asset sale vs. share sale may be bridged by a hybrid transaction
Capital Gains Deduction - QSBC 16 Individual resident in Canada is entitled to an exemption from tax on $750,000 of capital gains realized on the disposition of shares of a qualified small business corporation Trusts cannot claim the deduction but can allocate and designate amounts eligible for the deduction
Capital Gains Deduction QSBC (cont d) A QSBC share must meet three tests: the small business corporation test; the holding period ownership test; and the holding period asset test Subject to certain exceptions, ownership test requires the shares not to have been owned by a person other than the person claiming the exemption within 24 month period preceding sale
18 Employee Stock Options Discrete regime for the taxation of options acquired by persons in their capacity as employees at law includes directors excludes independent contractors Key considerations any tax deferral on exchange of options any tax deferral on exchange of option shares for shares of purchaser availability of ½ deduction
Employee Stock Options (cont d) 19 CCPC Options deferral of taxable benefit until sale of shares CCPC at the time of grant of options Other Options no deferral of taxable benefit Withholding tax obligations ½ deduction FMV options ½ deductions for CCPC Options 2 year hold period
20 Non-Compete Payments Manrell and Fortino held non-compete payments to be non-taxable receipts Proposed subsection 56.4(2) requires a taxpayer to include in income amounts in respect of restrictive covenants that are received or receivable in the year by the taxpayer or a nonarm s length person
21 Non-Compete Payments (cont d) Joint election for capital gain treatment for amounts related to the disposition of an eligible interest provided that multiple conditions are satisfied Shares of a corporation that carries on a business to which the restrictive covenant relates or shares of a holding corporation where 90% of their value is attributable to eligible interests in one other corporation
Non-Compete Payments (cont d) 22 Shareholder Shareholder 100% Opco Eligible Interest 100% Holdco Ineligible Interest 100% Opco Opco 2 LP
2. Deal timelines 23 NDA(s) LOI (if any) 1 st Drafts Sign Agreements Closing Final Payments Preparation & Contact Preliminary Negotiations Agreement Negotiation Consents & Approvals Post Closing Payments (Adjustments) Disclosure Schedules Buyer Due Diligence with Seller Staged Disclosure
Structures 24 Share Purchase Agreement Asset Purchase Agreement Merger/Amalgamation Plan of Arrangement TO Bid (exempt or otherwise)
Which deal structure has the shortest theoretical timeline? 25 A B C Shares Assets Plan* *Plan means Plan of Arrangement
26 Structures (cont d) Facts that Impact Structure cross-border with non-cash consideration exchangeable share structure otherwise Target investors pay tax without liquidity event securities compliance on both sides of the border perception of significant liabilities within Target share purchase not likely favours asset deal with less desirable tax result for Target investors, which ideally leads to price adjustments time constraints (e.g., target running out of money) favours Share Purchase
27 Structures (cont d) Facts that Impact Structure (cont d) cap table including number of investors and their amenability large number of investors or intractable investors means Share Purchase impractical favours Merger/Amalgamation or, more likely, Plan of Arrangement complexity of options, warrants, shares or other securities favours Plan of Arrangement value in revenue generating contracts to Buyer commercial paper important including assignment/change of control, termination, release of source code and trailing obligations if commercial paper generally has no assignment but not change of control clauses then Asset Purchase less likely
Which deal structure has the shortest theoretical timeline? 28 A B C Shares Assets Plan* *Plan means Plan of Arrangement
Deal timelines 29 Shares Sign Agmt +10 +20 +30 +40 +50 Close +60 days Assets Close Plan Close Interim Court Approval Shareholder Approval Final Court Approval
3. Cross-border deals: Complications with non-cash purchase price 30 Tax complication of receiving consideration that includes shares of a foreign corporation receiving illiquid stock no automatic or elective tax deferral Exchangeable share structure Main purpose of exchangeable share structure is to defer tax until Canadian shareholder has a liquidity event (e.g. can sell the shares received in lieu of cash)
Exchangeable Share Structure 31 Main characteristics of exchangeable share structure Purchaser establishes Canadian acquisition corporation ( Exchangeco ) and owns all common shares and all voting rights of Exchangeco. Canadian shareholders sell their shares of target in consideration that includes exchangeable shares of Exchangeco. Exchangeable shares are exchangeable at option of holder into shares of the non-resident Purchaser. Purchaser establishes a Callco to acquire the exchangeable shares from the holder. The holders of exchangeable shares will, contractually, have economic rights equivalent to those enjoyed by holders of shares of the non-resident Purchaser (e.g., dividend or other distributions, voting).
3. Cross-border deals: Complications with non-cash purchase price 32 What percentage of proceeds needs to be in cash to cover tax liability? A B C 12.5% 21.8% 43.7%
Exchangeable Share Structure (cont d) 33 Shareholders of Purchaser Former Holders of ES (after exchange) Non-resident Purchaser Foreign Canada Callco Common Shares (all voting) Holders of ES ES acquired upon exchange Exchangeable Shares Exchangeco Target
Exchangeable Share Structure (cont d) Canadian shareholders benefit from roll-over provisions as they continue to hold shares in a Canadian corporation. A joint election would be required to be filed by Exchangeco and each shareholder 34 Whether Canadian shareholder can obtain a full or partial tax deferral is dependant on the amount of cash proceeds and cost base of share of target. Fully deferred if cash proceeds is less than or equal to cost base Canadian tax is triggered when exchangeable shares are exchanged for shares of foreign parent corporation. Amount of tax is calculated at the time of the exchange based on the then prevailing fair market values
Exchangeable Share Structure (cont d) 35 What percentage of proceeds needs to be in cash to cover tax liability? A B C 12.5% 21.8% 43.7%
Exchangeable Share Structure (cont d) 36 Who pays the incremental cost of structure? Purchaser? Tax benefit of deferral better ROI Balance between cost of structure vs increased ROI
4. Managing the process 37 Three variables Money Time Scope Touch any one and the other two are affected
Base Deal 38
39 Added Services as % of Base Deal Costs 30 25 20 15 10 5 0 Specialty Plan Exchangeable Shares
Reducing Deal Costs 40 Target prepares due diligence site Target starts disclosure schedules immediately after comments on first draft of agreement Planning, extra internal staff, frequent communications, scheduled closing Most important: Strong internal project/deal manager
Questions and Discussion 41
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