Acquiring a Corporate Subsidiary or Division

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Presenting a live 90-minute webinar with
interactive QA
Acquiring a Corporate Subsidiary or
Division Strategies for Buyers and Sellers in
Carveout Deals
1pm Eastern 12pm Central 11am
Mountain 10am Pacific
THURSDAY, FEBRUARY 10, 2011
Todays faculty features
Dennis J. White, Partner, Verrill Dana,
Boston Scott T. Whittaker, Member, Stone Pigman
Walther Wittmann, New Orleans Murray J. Perelman,
Partner, Bennett Jones, Toronto, ON,
Canada Steven J. Joffe, Managing
Director-Corporate Finance, FTI Consulting, New
York
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Acquiring a Corporate Subsidiary or Division
Strafford Publications, Inc.
Steven Joffe steve.joffe_at_fticonsulting.com NEW YORK
Murray J. Perelman mjp_at_bennettjones.com - TORONTO
Dennis J. White dwhite_at_verrilldana.com - BOSTON
Scott T. Whittaker swhittaker_at_stonepigman.com NEW ORLEANS
February 10, 2011
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What Is A Carve Out?

• Disposition of a Business Unit byA Corporate
  Seller
• The Business Unit Can Take Different Forms
• A long-standing subsidiary
• An unincorporated division
• A new subsidiary into which assets have recently
  been dropped

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A Carve-Out PresentsDistinct Opportunities and
Challenges

• Opportunities a buyer may be positioned to
  provide what the business unit requires to
  perform at a new, higher level
• Challenges the buyer must understand what it is
  buying and what the business unit requires to
  operate and succeed

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The Reasons for the Business Units Disposition
Can Be Varied

• The business unit no longer fits with the
  sellers overall business strategy
• Sale to generate cash to pay off debt, finance an
  attractive acquisition, stay solvent
• Disposition compelled by antitrust or other
  regulatory reasons
• A buyer would be well advised to understand the
  true reasons it affects timing, pricing,
  leverage

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Business Units Are Rarely Self-Sustaining

• Typically, the business unit is dependant in some
  fashion upon the corporate parent or corporate
  affiliates.
• administrative/operational support
• vendor relationship
• customer relationship
• intellectual property
• It isn't always just one way
• This reality must constantly be kept in mind in
  planning due diligence, negotiating deal terms
  and fashioning post-closing transitional
  arrangements.
• Can (should) a Seller plan ahead?

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Due Diligence Must Be Tailored To GainA True
Picture of the Business Unit

• Financial Statements for a business unit may be
  unavailable, incomplete or misleading
• the Parent may never have prepared consolidating
  financials
• allocation of group overhead may not reflect
  business realities
• related-party transactions such as the leasing of
  property or the provision of raw materials may
  not be priced at market
• external payables and receivables may be
  intermingled with other members of the
  consolidated group

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Due Diligence Must Be Tailored To GainA True
Picture of the Business Unit (cont.)

• there may be group liabilities such as those
  associated with pension liabilities, tax
  liabilities and environmental liabilities for
  which the business unit may continue to be
  jointly and severally liable
• a lack of Sarbanes-Oxley required controls may
  present a problem for a buyer that is public or
  plans to be public
• Affiliate Transactions
• Group Liabilities
• Operational Support Needed

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For the Corporate Parent, Spinning OffThe
Business Unit Can Trigger Tax Liabilities

• The term spin off has different meanings to
  financial and tax professionals
• for financial professionals a spin off may
  involve nothing more than issuing stock of a
  subsidiary to the public to provide needed
  capital to its parent
• for tax professionals a spin off would involve
  a distribution of the stock of a subsidiary to
  the shareholders of its parent
• A spin off in a financial sense will not result
  in a tax with respect to the issuance of new
  shares of the subsidiary unless a corporate
  parent sells its own shares
• If more than 80 percent of the stock of the
  subsidiary (by vote and value) is sold to the
  public the subsidiary will no longer be eligible
  for inclusion in a consolidated federal income
  tax return filed by its parent

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For the Corporate Parent, Spinning OffThe
Business Unit Can Trigger Tax Liabilities (cont.)

• the tax attributes (e.g. net operating loss carry
  forwards) of the subsidiary will leave the
  consolidated group but after reduction for
  attributes used by the group in that year
• any loss sustained by the parent when it sells
  its own stock of the spin-off subsidiary may be
  disallowed for tax purposes under so-called
  uniform loss rules
• A spin off in a tax sense will not result in a
  tax to the parent or its shareholders if the
  distribution of stock by the parent satisfies the
  following requirements
• the distribution includes at least 80 percent of
  the total combined voting power and at least 80
  percent of the total number of all other classes
  of stock of the subsidiary

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For the Corporate Parent, Spinning OffThe
Business Unit Can Trigger Tax Liabilities (cont.)

• the subsidiary engaged in the active conduct of a
  trade or business, and was not acquired in a
  taxable transaction, during the five year period
  immediately before the distribution
• the parent and the subsidiary engage in an active
  trade or business immediately after the
  distribution
• the distribution is not a device for the
  distribution of the earnings of the parent, the
  subsidiary or both to the shareholders of the
  parent and
• the distribution has an independent business
  purpose

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For the Corporate Parent, Spinning OffThe
Business Unit Can Trigger Tax Liabilities (cont.)

• Financial spin offs are generally used to
  monetize subsidiary value while tax spin-offs are
  often used to separate wanted and unwanted
  business. In the latter case, real care must be
  taken to make sure that any post-distribution
  sale of the stock of the parent or subsidiary is
  not pre-arranged and thereby construed to be a
  device

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Structuring The Transaction

• Two basic structures asset sale or stock sale
• Regardless of structure - buyer must ensure it is
  getting the right assets and assuming the right
  liabilities
• Buyers Beware of Successor Liability
• Statutory Liability e.g. bulk sales laws tax
  laws environmental laws
• Jurisprudential Theories e.g. product line
  theory de facto merger

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Structuring The Transaction (cont.)

• Methods of obtaining the right assets and
  avoiding unwanted liabilities
• Due Diligence
• Documentation reps and warranties covenants and
  indemnification

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Structuring The Transaction (cont.)

• 338(h)(10) elections
• A Section 338 (h)(10) election to treat a sale of
  the stock of a subsidiary as a sale of the assets
  and tax-free liquidation of such subsidiary for
  tax purposes is something that must be considered
  in any carve out
• Section 338 (h)(10) eliminates the need to
  transfer of title of assets and some of the sales
  and other transfer taxes attendant to asset sales

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Structuring The Transaction (cont.)

• The buyer gets to mark the tax basis of the
  subsidiaries assets to market and reduce the
  cost of the transaction because of tax savings
  generated by additional tax depreciation of PPE
  or tax amortization of goodwill or other
  intangibles
• Because the transaction is treated as a tax free
  liquidation of the subsidiary unwanted assets can
  be stripped out of the subsidiary in connection
  with the sale of stock without tax
• Net operating losses of the subsidiary can be
  used to offset any gain in the deemed sale of
  assets which is particularly valuable where
  losses will expire

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Structuring The Transaction (cont.)

• A Section 338 (h)(10) election does present some
  traps for the unwary buyer
• A Section 338 (h)(10) election must be made by
  both the buyer and the seller and the seller may
  condition its agreement to join in an election on
  a make whole payment for any additional tax it
  might incur as a consequence of a deemed asset
  sale, rather than a stock sale
• Some states do not permit Section 338 (h)(10)
  elections and any election for federal income tax
  purposes may result in tax on the deemed sale of
  assets payable by the buyer

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Negotiating Deal Terms

• What Is The Value Of And The Proper Price For The
  Business Unit?
• Representations and Warranties
• Financial Statements and Reporting
• Adequacy of Assets
• Liabilities ERISA, environmental, others
• Earnouts, Seller Paper, Escrows Disfavored

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Negotiating Deal Terms (cont.)

• Third Party Consents
• Release of Liens
• Assignment of Leases, Contracts
• Change In Control Triggers
• Use of Tradenames
• Logistics of Changing Signage, Labeling
• Interim License

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Post-Closing Arrangements/Transitional Services
Agreements

• Who is providing what to whom? Products,
  services or both?
• Availability (and timing) to replace
• Are post-closing arrangements priced into the
  deal already?
• Include ongoing arrangements in the Purchase
  Agreement or in separate standalone documents?
• Do Transitional Services Agreements (TSAs)
  contain usual arm's length commercial arrangement
  contract terms?
• Are any essential services?

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Post-Closing Arrangements/Transitional Services
Agreements (cont.)

• Some typical TSA provisions
• Duration, extension rights
• Pricing a la carte or fixed rate?

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• Please join us for our next legal conference,
  Key 2010 Delaware Rulings for MA, Corporate
  Governance and Alternative Entity Practice -
  Strategies for Dealing With Poison Pills, Top-Up
  Options, Proxy Access, Director Elections and LLC
  Operating Issues, scheduled on Thursday,
  February 24, 2011 starting at 1pm EDT.