Let’s Make a Deal
M&A Deal Structures that work
Cheryl Slusarchuk, TJ Kang
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Road Map
1. Tax: Maximizing deal value
2. Deal timelines
3. Cross-border deals
4. Managing the process
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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1. Tax: Maximizing deal value for
employees and shareholders
¬ Assets vs. shares – determining factors
¬ Other considerations
¬ Capital gains exemption
¬ Employee options
¬ Non-compete payments
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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What is the difference between asset
and share structure to shareholders?
A
B
C
5%
10%
25%
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Assets vs. shares (cont’d)
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Assets vs. shares (cont’d)
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Assets vs. shares (cont’d)
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
Asset vs. share sale – an example
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Asset vs. share sale – an example (cont’d)
Share Sale
Capital gain
Aggregate CGE
Taxable capital gain (50)%
Tax (43.7%)
$50,000,000
$ 7,500,000
$21,250,000
$ 9,286,250
After tax proceeds =
$40,713,750
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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%)
$
Eligible (25.78%)
Non-eligible (33.71%)
$4,640,400
$ 272,208
Tax @ regular rates (25%)
$ 6,125,000
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
67,500
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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What is the difference between asset
and share structure to shareholders?
A
B
C
5%
10%
25%
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Tax factors influencing structure?
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Tax factors influencing structure? (cont’d)
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Hybrid Transaction
¬ 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
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Capital Gains Deduction - QSBC
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Employee Stock Options (cont’d)
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Non-Compete Payments (cont’d)
Shareholder
Shareholder
100%
100%
Ineligible Interest
Eligible Interest
Holdco
Opco
100%
Opco
Opco 2
LP
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2. Deal timelines
NDA(s)
Preparation
& Contact
LOI 1st Drafts
(if any)
Preliminary
Negotiations
Sign Agreements
Agreement
Negotiation
Disclosure Schedules
Buyer Due Diligence with Seller Staged Disclosure
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
Consents
& Approvals
Closing
Post Closing
Payments
(Adjustments)
Final
Payments
Structures
¬ Share Purchase Agreement
¬ Asset Purchase Agreement
¬ Merger/Amalgamation
¬ Plan of Arrangement
¬ TO Bid (exempt or otherwise)
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Which deal structure has the shortest
theoretical timeline?
A
Shares
B
C
Assets
Plan*
*Plan means Plan of Arrangement
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Which deal structure has the shortest
theoretical timeline?
A
Shares
B
C
Assets
Plan*
*Plan means Plan of Arrangement
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Deal timelines
Sign
Agmt
+10
Shares
+20
+30
+40
+50
Close
Assets
Close
Plan
Close
Interim Court
Approval
Shareholder
Approval
Final Court
Approval
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
+60 days
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3. Cross-border deals: Complications
with non-cash purchase price
¬ 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)
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Exchangeable Share Structure
¬ 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).
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3. Cross-border deals: Complications
with non-cash purchase price
What percentage of proceeds needs to be in cash to
cover tax liability?
A
B
C
12.5%
21.8%
43.7%
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Exchangeable Share Structure (cont’d)
Former Holders of
ES (after exchange)
Shareholders of
Purchaser
Non-resident
Purchaser
Foreign
Canada
Callco
Common
Shares
(all voting)
Holders of
ES
Exchangeable
Shares
ES acquired upon
exchange
Exchangeco
Target
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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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
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Exchangeable Share Structure (cont’d)
What percentage of proceeds needs to be in cash to
cover tax liability?
A
B
C
12.5%
21.8%
43.7%
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Exchangeable Share Structure (cont’d)
¬ Who pays the incremental cost of structure?
¬ Purchaser?
¬ Tax benefit of deferral – better ROI
¬ Balance between cost of structure vs increased
ROI
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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4. Managing the process
¬ Three variables
¬ Money
¬ Time
¬ Scope
¬ Touch any one and the other two are affected
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Base Deal
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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Added Services as % of Base Deal Costs
30
25
20
15
10
5
0
Specialty
Plan
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
Exchangeable Shares
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Reducing Deal Costs
¬ 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
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
Questions and Discussion
McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797
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McCarthy Tétrault LLP / mccarthy.ca / October 2012 / Docs #11872797