ACQUISITIONS OF SUBSIDIARIES AND DIVISIONS First Run Broadcast: November 10, 2016 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Buying part of an operating company is entirely unlike buying the entire company. When the buyer takes some but not the assets of a particular business line or operating unit, there are issues of allocating debt and other liabilities, as well as potential successor liability. Crucially, there are issues of assigning certain client/customer contracts and the transitioning of both rank-and-file employees and managers. Also unlike acquisitions of entire companies, buying a division or subsidiary involves complex transition service agreements between the seller and the buyer, ensuring the continuance of perhaps essential lifelines to the acquired division or subsidiary or the seller. This program will provide you with a practical guide to structuring and drafting agreements for acquisitions of divisions and subsidiaries. Acquisitions of part of an operating company divisions and subsidiaries Asset purchases v. entity acquisition Allocation of debt/liabilities and successor liability Identifying essential assets and personnel necessary for post-closing success Management transitions and employee retention Transition services agreements post-closing agreements between seller and acquirer Tax considerations in asset v. entity deals Speaker: Frank Ciatto is a partner in the Washington, D.C. office of Venable, LLP, where he has 20 years experience advising clients on mergers and acquisitions, limited liability companies, tax and accounting issues, and corporate finance transactions. He is a leader of his firm s private equity and hedge fund groups and a member of the Mergers & Acquisitions Subcommittee of the ABA Business Law Section. He is a Certified Public Accountant and earlier in his career worked at what is now PricewaterhouseCoopers in New York. Mr. Ciatto earned his B.A., cum laude, at Georgetown University and his J.D. from Georgetown University Law Center. James Marky is an attorney in the Washington, D.C. office of Venable, LLP, where he represents companies in connection with mergers and acquisitions, financing transactions, reorganizations and other strategic transactions across a broad range of industries. He drafts and reviews contracts including complex services and technology agreements, on behalf of private and Fortune 500 companies. He also advises clients on corporate governance best practices and coordinates subsidiary maintenance. Mr. Marky earned his B.S. from Cornell University and his J.D., cum laude, from William and Mary School of Law.
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Let's Make A Deal: Sales of Subsidiaries and Divisions Frank A. Ciatto faciatto@venable.com / 202.344.8510 James D. Marky jdmarky@venable.com / 202.344.4409 Venable LLP 1 2012 Venable LLP
Overview Divisions and Subsidiaries Asset Purchase vs. Stock Purchase Allocation of Debts and Liabilities & Successor Liability Certain Pre-Closing Considerations Management Transition and Employee Retention Post-Closing Considerations: Transition Services Agreements Tax Considerations 2
Subsidiaries and Divisions: Defined Subsidiary A separate entity that is owned and controlled by another entity (the parent company) Division A separate operating unit of a corporation Unlike a subsidiary, a division is not a separate legal entity 3
Asset Purchase vs. Stock Purchase Terminology Asset Purchase: Purchase of assets from the seller, such as equipment, inventory, intellectual property, goodwill, etc. The buyer purchases specific assets from the seller and may assume certain liabilities, but does not acquire legal ownership of the seller as an entity. Stock Purchase: Purchase of the stock of the target. Through a stock purchase, the buyer purchases the target s stock directly from its shareholders. The buyer acquires legal ownership of the target as an entity, including all of its assets and liabilities. 4
Asset Purchase Advantages for the Buyer Asset Selection The buyer selects specific assets that it wishes to acquire, while excluding any assets that it does not want to acquire. Limitation on Liabilities The buyer may limit the liabilities of the seller that it acquires along with the assets. Tax Benefits Subject to potential negotiation with the seller, the buyer may allocate the purchase price among the acquired assets in order to reflect their fair market value. 5
Asset Purchase Advantages for the Seller Asset Selection The seller may retain certain valuable assets not conveyed to the buyer. Control & Continuing Operations The ownership of the legal entity of the seller remains unchanged and the seller may continue as an operating company with any assets retained following the sale. o Non-competition and non-solicitation considerations The seller may retain certain tax attributes/benefits not conveyed to the buyer. 6
Asset Purchase Disadvantages for the Buyer Complexity An asset purchase may be more time consuming and complex than a stock purchase. The buyer must identify the specific assets and liabilities of the seller to be acquired and those to be excluded. Assignability & Third-Party Consents Asset purchases require the transfer of title and assignment of assets, including contracts and permits, to the buyer. Third-party consents for such transfer and assignment may be required, which may prolong a transaction and delay closing. 7
Asset Purchase Disadvantages for the Seller Complexity May be more time consuming and complex than a stock purchase. Assignability & Third-Party Consents Third-party consents for assignment may be required, which may prolong a transaction and delay closing. Liabilities The seller remains responsible for liabilities, unless expressly assumed by the buyer. 8 Taxation If the seller is a C-Corporation, then the consideration received by the seller from the buyer is subject to taxation at the corporate level and again upon distribution of proceeds to the seller s shareholders).
Stock Purchase Advantages for the Buyer Simplicity Unlike an asset purchase, a stock purchase generally does not require the target to transfer title to individual assets, making a stock purchase less time consuming and complex. Fewer third party consents required (change of control vs. assignment). Control The buyer acquires control over the target, not just specific assets. 9
Stock Purchase Advantages for the Seller Lower Taxes Generally, the purchase price is taxed at the lower capital gains rate (as opposed to the higher income tax rate). Taxation occurs only at the shareholder level rather than at both the corporate and shareholder levels (no double taxation like with an asset purchase from a C-Corporation). Liabilities All of the target s liabilities stay with the target and therefore effectively transfer to the buyer. Simplicity Generally, no transfer of title to individual assets is required. Fewer third party consents required (change of control vs. assignment). 10
Stock Purchase Disadvantages for the Buyer Liabilities The target s liabilities stay with the target and therefore effectively transfer to the buyer. This assumption may include unknown future liabilities. Fewer Tax Benefits Unlike in the case of an asset purchase, the buyer generally does not get a stepped up basis in the target s assets. Less Selectivity Unlike in the case of an asset purchase, the buyer cannot select certain assets to acquire and others to exclude. 11
Stock Purchase Disadvantages for the Seller Control & Continuing Operations The target s shareholders do not retain any control over the target company. The entire target is transferred to buyer as an entity, so the target s shareholders are unable to retain any assets or continue to operate the target s business in any manner. 12
Allocation of Debts and Liabilities The Basics The issue: Before the closing of an asset purchase, the seller and buyer must determine the manner in which debts and liabilities will be allocated and either transferred to the buyer or retained by the seller. Types of Debts and Liabilities Known: Debts/liabilities that are disclosed to the buyer during the due diligence process. o Known debts/liabilities are allocated between the buyer and the seller in an asset purchase in the asset purchase agreement or identified in the disclosure schedule. Unknown: Debts/liabilities that are not known to the buyer or seller or not disclosed to the buyer at the time of the closing. o Asset purchase vs. stock purchase 13
Allocation of Debts and Liabilities Identification and Disclosure Representations & Warranties: Representations and warranties (and related disclosure schedules) are given by the parties to provide specific information about their respective businesses, operations and/or ability to effect the transactions. Statements asserting or confirming certain information about the business or operations of one party to the other party. Indemnification obligations may apply in the event of a breach or inaccuracy of representations and warranties. Disclosure Schedules: Memorialize exceptions to the representations and warranties contained in the purchase agreement. 14
Allocation of Debts and Liabilities Successor Liability General Rule: Successor liability is a common law presumption that an asset purchaser does not assume any of the seller s liabilities. States have developed a series of exceptions to this general rule. Default Rules Merger or consolidation: The buyer assumes the debts and liabilities of the seller. Asset purchase: The buyer does not assume the debts and liabilities of the seller. *Limited exceptions to the general rule for asset purchases: Express or implied agreement of assumption De facto merger Mere continuation Fraud ** Note that these exceptions may vary from state-to-state, as successor liability is a common law doctrine. 15
Successor Liability Exception 1: Express or Implied Agreement of Assumption Express Assumption: If an asset buyer (who would normally be exempt from liability under the doctrine of successor liability) expressly agrees to assume certain liabilities of the seller, such buyer will be liable pursuant to the terms of the agreement. Implied Assumption: In determining whether the asset buyer impliedly assumed the debts and/or liabilities of the seller, courts typically assess the following factors: Ambiguous language in the purchase agreement Post-closing conduct of the asset purchaser 16
Successor Liability Exception 2: De Facto Merger The Exception: If a purported asset sale is the legal equivalent of a merger, then the buyer will be found to have assumed the liabilities of the seller. Factors: Vary by state Continuity of the seller s enterprise (e.g. same management, personnel, assets, stockholders, etc.) Immediate dissolution of the seller s corporation upon completion of the transaction (or soon thereafter) Asset purchaser s assumption of the seller s obligations 17
Successor Liability Exception 3: Mere Continuation The Exception: An asset buyer is responsible for the seller s liabilities if such buyer acts as a mere continuation of the seller. In essence, the buyer is a reorganized form of the seller. Factors Similar identity of officers/directors Stock transfers between the selling and buying corporations Successor holds out to the public as being a continuation of the previous corporation Inadequate consideration paid for assets 18
Successor Liability Exception 4: Fraud The Exception: An asset buyer is responsible for the seller s liabilities if the transaction s purpose was to hinder or defraud the seller s creditors. Factors Seller was insolvent at the time of the transfer Seller was undercapitalized at the time of the transfer Buyer paid inadequate consideration in exchange for the transfer 19
Successor Liability How a Buyer Can Avoid Successor Liability Purchase the assets of the seller, rather than the entity itself (unless one of the aforementioned exceptions applies). Ensure that the purchase agreement states that all liabilities should remain with the seller. Alter composition of employees and management upon completion of the transaction. Create a new entity that is distinct from the seller, including a trade name that is distinct from that of the seller. 20
Pre-Closing Considerations Identifying Essential Assets and Key Personnel Essential Assets: It is imperative that a buyer identify all essential assets of the seller to be acquired in an asset purchase, particularly when the buyer is not acquiring substantially all of the seller s assets. Key Personnel: In both asset and stock purchases, it is important to identify key personnel as early as possible. Transition Team: Individuals who may assist with transaction matters and help ensure a smooth transition. Retention Post-Closing: Uncertainty may result in attrition, so it is important to identify key employees and communicate throughout the process to alleviate any concerns. Benefits/Compensation: Compare benefits packages and salary offerings of the target and the buyer and develop integration plan. 21
Management Transition and Employee Retention Select Executive Leadership: Choose which individuals from target and buyer will assume or retain leadership roles postclosing. Identify Organizational Structure and Define Management Roles Communicate: Keep executives and other employees informed regarding organizational changes. Job descriptions and chain of command Title, pay, and benefits Mechanisms for executives and employees to communicate concerns and ideas to management. 22
Management Transition and Employee Retention Financial Incentives: Consider the necessity of offering employee retention incentives. Resources and Support: Ensure that employees are supported throughout the transition process by way of credible leadership, transparency, and access to professional development resources. Information: Provide employees with access to information. Address Concerns: Employees will necessarily have questions about basic needs with regards to their employment, such as Will I have a job after closing? and How will my role change once the deal is closed? 23
Post-Closing Considerations Transition Service Agreements Defined: A Transition Services Agreement ( TSA ) is a contract between a buyer and a seller in an asset purchase in which the seller agrees to provide certain ongoing business support services to the buyer post-closing (e.g. accounting, management, HR, IT, etc.). Key Components: Fees: Initial fees and any additional fees if scope of services expands. Term Performance Standards Liabilities: Allocation of liability for third-party vendors contracted by seller to provide the services? Dispute Resolution: How will disputes pertaining to the TSA be resolved? 24
Tax Considerations Asset Purchase Taxing the Seller The seller recognizes gain equal to the difference between its adjusted basis of the assets and the purchase price. If Seller is a C-Corporation: Double taxation; gain on sale is taxed at the (i) corporate level and (ii) shareholder level. IF Seller is an S-Corporation: Single taxation; gain on sale is taxed at the shareholder level, but usually at an income tax rate, instead of the more favorable capital gains rate. Taxing the Buyer The buyer acquires assets with a basis in each equal to fair market value, or a step up in basis. Purchase price is allocated among the assets according to class and fair market value. o Opportunity to allocate to depreciable assets (e.g. equipment). 25
Tax Considerations Stock Purchase Taxing the Seller The shareholders of the target are taxed on the difference between the purchase price and their tax basis in the stock. Single taxation; gain on the sale is taxed only at the shareholder level. Generally, the gain is taxed at the capital gains rate, rather than at the less favorable income tax rate. Taxing the Buyer Unlike an asset sale, the buyer cannot acquire a stepped-up basis in the assets. Buyer s tax basis in the stock is equal to the purchase price. 26
Tax Considerations Special Case: Section 338(h)(10) Elections What is a Section 338(h)(10) Election? An election under the U.S. federal tax code that allows a buyer in a stock purchase to acquire stock but be taxed as if it acquired assets. When is a Section 338(h)(10) Election Permitted? Buyer: Must be a an S-Corporation or a C-Corporation Seller: Must be one of the following corporations: o o o A corporation that is a subsidiary in a consolidated group; A corporation that is a subsidiary in a group eligible to file a consolidated return (even if such corporation has not filed a consolidated return); or An S-Corporation 27
Tax Considerations Special Case: Section 338(h)(10) Elections Amount of Acquisition: The buyer must acquire at least 80% of the target s stock. Process Joint election: The election must be made by both the seller and the buyer. Timing: The election must be made within a specific period of time following the date of the closing of the transaction. 28
Contact Information Frank A. Ciatto, Partner faciatto@venable.com t 202.344.8510 f 202.344.8300 James D. Marky, Associate jdmarky@venable.com t 202.344.4409 f 202.344.8300 Venable LLP 575 7 th Street, NW Washington, D.C. 20004 29
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