Cheryl Slusarchuk, TJ Kang · ¬ favours Merger/Amalgamation or, more likely, Plan of Arrangement ¬ complexity of options, warrants, shares or other securities ¬ favours Plan of

Let’s Make a DealM&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

1. Tax: Maximizing deal value foremployees and shareholders

¬ Assets vs. shares – determining factors

¬ Other considerations

¬ Capital gains exemption

¬ Employee options

¬ Non-compete payments

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What is the difference between assetand share structure to shareholders?

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5% 25%10%

A B C


Assets vs. shares (cont’d)

¬ Asset sale

¬ Two tiers of income tax (corporate andpersonal)

¬ Need to allocate purchase price among assetsand assess each asset to determine net after-tax yield to vendor corporation

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¬ Asset sale (cont’d)

¬ Need to determine the best way in which todistribute the proceeds of sale to theshareholders

¬ Tax-free accounts available?

¬ Timing of dividends - tax deferral advantage andoverall tax savings

¬ Winding-up corporation and distributingproceeds

¬ Withholding tax on non-resident shareholders

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¬ Share sale

¬ One asset being transferred (shares) so noallocation of purchase price (unless multipleclass of shares)

¬ Assuming individual vendor, one tier of incometax (personal)

¬ Capital gains treatment

¬ Access to lifetime capital gains exemption($750,000)

¬ Tax treatment of deferred or contingent saleproceeds

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¬ 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 eithershareholder or target level

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Asset vs. share sale – an example


Asset vs. share sale – an example (cont’d)

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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

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Gain $50,000,000 Non-taxable distribution fromCDA

$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%)

$4,640,400$ 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 fordistribution to Shareholders

$43,807,500 After tax proceeds = $38,894,892

Asset Sale

Asset vs. share sale – an example (cont’d)

What is the difference between assetand share structure to shareholders?

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5% 25%10%

A B C


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¬ 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

Tax factors influencing structure?

Tax factors influencing structure? (cont’d)13


¬ 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 ofTarget

¬ 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

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¬ Purchaser dictates asset sale transaction

¬ Value to vendor in accessing CGE

¬ Difference between after tax return on assetsale vs. share sale may be bridged by a hybridtransaction

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¬ Individual resident in Canada is entitled to anexemption from tax on $750,000 of capital gainsrealized on the disposition of shares of a“qualified small business corporation”

¬ Trusts cannot claim the deduction but canallocate and designate amounts eligible for thededuction

Capital Gains Deduction - QSBC


¬ 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 requiresthe shares not to have been owned by a person otherthan the person claiming the exemption within 24 monthperiod preceding sale

Capital Gains Deduction – QSBC (cont’d)


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¬ Discrete regime for the taxation of optionsacquired by persons in their capacity asemployees at law¬ includes directors

¬ excludes independent contractors

¬ Key considerations¬ any tax deferral on exchange of options

¬ any tax deferral on exchange of option shares forshares of purchaser

¬ availability of ½ deduction

Employee Stock Options


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¬ 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

Employee Stock Options (cont’d)


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¬ Manrell and Fortino held non-compete paymentsto be non-taxable receipts

¬ Proposed subsection 56.4(2) requires a taxpayerto include in income amounts in respect ofrestrictive covenants that are received orreceivable in the year by the taxpayer or a non-arm’s length person

Non-Compete Payments


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¬ Joint election for “capital gain” treatment foramounts related to the disposition of an “eligibleinterest” provided that multiple conditions aresatisfied

¬ Shares of a corporation that carries on abusiness to which the restrictive covenantrelates or shares of a holding corporation where90% of their value is attributable to eligibleinterests in one other corporation

Non-Compete Payments (cont’d)


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Shareholder

100%

Opco

Shareholder

100%

Holdco

100%

Opco

Eligible InterestIneligible Interest

Opco 2

LP

Non-Compete Payments (cont’d)


2. Deal timelines23

NDA(s) 1st Drafts

Preparation

& Contact

Preliminary

Negotiations

Post Closing

Payments

(Adjustments)

Consents

& Approvals

Agreement

Negotiation

LOI

(if any)

Sign Agreements

Buyer Due Diligence with Seller Staged Disclosure

Closing Final

Payments

Disclosure Schedules


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 shortesttheoretical timeline?

Shares Plan*Assets

A B C

*Plan means Plan of Arrangement

¬ Facts that Impact Structure

¬ cross-border with non-cash consideration

¬ exchangeable share structure otherwise Target investors pay tax withoutliquidity 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

Structures (cont’d)

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¬ Facts that Impact Structure (cont’d)

¬ cap table including number of investors and theiramenability

¬ large number of investors or intractable investors means Share Purchaseimpractical

¬ favours Merger/Amalgamation or, more likely, Plan of Arrangement

¬ complexity of options, warrants, shares or othersecurities

¬ 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 ofcontrol” clauses then Asset Purchase less likely

Structures (cont’d)

Which deal structure has the shortesttheoretical timeline?

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Shares Plan*Assets

A B C

*Plan means Plan of Arrangement


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Deal timelines

Shares

Assets

Plan

SignAgmt +10 +20 +30 +40 +50

Close

Close

+60 days

Interim Court

Approval

Shareholder

Approval

Final Court

Approval

Close

3. Cross-border deals: Complicationswith non-cash purchase price

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¬ Tax complication of receiving consideration thatincludes shares of a foreign corporation

¬ receiving illiquid stock

¬ no automatic or elective tax deferral

¬ Exchangeable share structure

¬ Main purpose of exchangeable share structure is todefer tax until Canadian shareholder has a liquidityevent (e.g. can sell the shares received in lieu of cash)

Exchangeable Share Structure31


¬ Main characteristics of exchangeable share structure

¬ Purchaser establishes Canadian acquisition corporation(“Exchangeco”) and owns all common shares and all votingrights of Exchangeco.

¬ Canadian shareholders sell their shares of target inconsideration that includes exchangeable shares ofExchangeco.

¬ Exchangeable shares are exchangeable at option of holderinto shares of the non-resident Purchaser.

¬ Purchaser establishes a Callco to acquire the exchangeableshares from the holder.

¬ The holders of exchangeable shares will, contractually, haveeconomic rights equivalent to those enjoyed by holders ofshares of the non-resident Purchaser (e.g., dividend or otherdistributions, voting).

3. Cross-border deals: Complicationswith non-cash purchase price

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What percentage of proceeds needs to be in cash to

cover tax liability?

12.5% 43.7%21.8%

A B C


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Exchangeable Share Structure (cont’d)

Canada

Foreign

Non-residentPurchaser

Holders ofES

Former Holders ofES (after exchange)

Shareholders ofPurchaser

CommonShares

(all voting)

ES acquired uponexchange

ExchangeableShares

Callco

Exchangeco

Target


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¬ Canadian shareholders benefit from “roll-over”provisions as they continue to hold shares in aCanadian corporation. A joint election would berequired to be filed by Exchangeco and eachshareholder

¬ Whether Canadian shareholder can obtain a full orpartial tax deferral is dependant on the amount of cashproceeds and cost base of share of target. Fullydeferred if cash proceeds is less than or equal to costbase

¬ Canadian tax is triggered when exchangeable sharesare exchanged for shares of foreign parent corporation.Amount of tax is calculated at the time of the exchangebased on the then prevailing fair market values

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What percentage of proceeds needs to be in cash to

cover tax liability?

12.5% 43.7%21.8%

A CB


¬ Who pays the incremental cost of structure?

¬ Purchaser?

¬ Tax benefit of deferral – better ROI

¬ Balance between cost of structure vs increasedROI

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4. Managing the process

¬ Three variables

¬ Money

¬ Time

¬ Scope

¬ Touch any one and the other two are affected

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Base Deal38


Added Services as % of Base Deal Costs

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0

5

10

15

20

25

30

Specialty Plan Exchangeable Shares


Reducing Deal Costs

¬ Target prepares due diligence site

¬ Target starts disclosure schedulesimmediately after comments on first draft ofagreement

¬ Planning, extra internal staff, frequentcommunications, scheduled closing

¬ Most important: Strong internal project/dealmanager

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Questions and Discussion


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Documents

Cheryl Slusarchuk, TJ Kang · ¬ favours Merger/Amalgamation or, more likely, Plan of Arrangement ¬ complexity of options, warrants, shares or other securities ¬ favours Plan of