Market Update Current Deal Activity, Valuations and Outlook MA... · 2016 M&A CONFERENCE . Email...
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M&A 2016 INDIANAPOLIS ▼ JUNE 9 CONFERENCE 1
Transcript of Market Update Current Deal Activity, Valuations and Outlook MA... · 2016 M&A CONFERENCE . Email...
M & A 2016 I N D I A N A P O L I S ▼ J U N E 9 CONFERENCE
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Tax Issues in M&A – Look Before You Leap
Rosanne Ammirati, Partner | Katz, Sapper & Miller Daniel Corsaro, Partner | Ernst & Young Melissa Pozniak, Partner | BKD Moderator: Brian Fennerty, Partner | Faegre Baker Daniels
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Overview
1. Opportunities Involving LLCs 2. Considerations when Converting to a Corporation 3. Tax Receivable Agreements
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General Issues/Opportunities Involving LLCs
►Pass through vehicle ► No entity level tax – single level of tax ► Income / gains / losses from LLC pass through to the equity holders and
retain their character in the hands of the equity holders ► Tax basis in equity interests increases for allocated net income, after
distributions ► Offer flexibility on exit
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General Issues/Opportunities Involving LLCs
►Advantages upon exit ► Sale of assets is tax efficient
► No entity level tax ► Provide a step-up to purchaser ► May have ordinary gain for sale of “Hot Assets” ► Allows tax free deferral for seller roll-over units
► Sale of LLC interest is tax efficient ► Provide a step-up to purchaser ► May have ordinary gain for sale of “Hot Assets” ► Allows tax free deferral for seller roll-over units
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Issues May Arise With Certain Investors
►Trade or business income is problematic for certain investors ►Tax exempt entities shouldn’t be “in business” to make money ► If there is enough trade or business income, it could jeopardize tax
exempt status ►At a minimum, tax exempt entity becomes subject to unrelated business
income tax (“UBIT”) ►Foreign investors do not want to be deemed to be engaged in a U.S.
trade or business ►Some private equity funds with tax-exempt or foreign investors are
simply prohibited in their organizational documents from investing in any pass through entity
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Acquisition Structures to Avoid UBIT
►Use C corporation as acquisition vehicle ► But all investors must pay double tax
► Insert “blocker corporation” into entity ownership chain ► Permits LLC trade or business income to be “trapped” in blocker corp. ► To get money out, blocker corp. must make dividend distribution to its
equity holders ► Blocker corp. equity holders thus always have dividend income (i.e., no
trade or business income) ► Applies only to the affected investors (i.e., tax exempts or foreign persons)
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Where Is the Blocker Corp. Placed?
►Some private equity funds have one blocker corp. established above the limited partnership level through which all of their tax exempt or foreign investors invest ► Permits taxable limited partners to still take advantage of flow through
benefits of LLC treatment ► i.e., elimination of one level of tax
► Anticipates and eliminates possible adverse exit consequences
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One Blocker Corp. Above the Limited Partnership
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SPONSOR General Partner
Co-Investor
Management Investors
Dedicated Acquisition LLC
Private Equity Fund Limited Partnership
TAX EXEMPT Investor 3
Shareholder in Blocker Corp. 1
TAX EXEMPT Investor 4
Shareholder in Blocker Corp. 1
Blocker Corp. 1 Limited Partner
TAXABLE Investor 1
Limited Partner
TAXABLE Investor 2
Limited Partner
Target Assets
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Where Is the Blocker Corp. Placed?
►Some tax exempt entities establish their own blocker corp. before investing at the limited partnership level ► Eliminates reliance on equity sponsor to establish blockers on behalf of tax
exempt limited partners ► Anticipates and eliminates possible adverse exit consequences ► Avoids non-tax administrative issues of having multiple owners of a
corporation
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Multiple Blocker Corps Above the Limited Partnership
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SPONSOR General Partner
Co-Investor
Management Investors
Dedicated Acquisition LLC
Private Equity Fund Limited Partnership
TAX EXEMPT Investor 3
Shareholder in Blocker Corp. 1
TAX EXEMPT Investor 4
Shareholder in Blocker Corp. 1
TAXABLE Investor 1
Limited Partner
TAXABLE Investor 2
Limited Partner
Target Assets
Blocker Corp. 1 Limited Partner
Blocker Corp. 2 Limited Partner
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Where Is the Blocker Corp. Placed?
►Sometimes blocker corp. must be interposed between target entity and private equity fund ► Adverse exit consequences exist ► Taxable limited partners do not get benefit of LLC structure
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Blocker Corp. Above Target Entity
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SPONSOR General Partner
Co-Investor
Management Investors
Dedicated Acquisition LLC
Private Equity Fund Limited Partnership
TAX EXEMPT Investor 3
Shareholder in Blocker Corp. 1
TAX EXEMPT Investor 4
Shareholder in Blocker Corp. 1
TAXABLE Investor 1
Limited Partner
TAXABLE Investor 2
Limited Partner
Target Assets
Blocker Corp. 1
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Use of a Blocker Corp.: Sale of Business
►Sale of business scenario: ► Asset sale by LLC or sale of LLC units by blocker corp. yields double tax
► Gain on sale of LLC assets flows through to blocker corp. where it is taxable or sale by blocker corp. of LLC units generates taxable income to blocker corp.
► Only way to get money out of blocker corp. is to declare dividend / distribution ► Dividend income is taxable to limited partners (may be capital treatment if
blocker corp. is liquidated)
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Use of a Blocker Corp.: Sale of Business
►To avoid double tax, blocker corp. shareholder wants to sell stock in blocker corp., LLC unit holders want to sell LLC units
►But Buyer may resist buying two different types of equity or may value C corp. shares lower than LLC units ► Buyer has greater diligence risk (blocker corp. and LLC; historic tax and
operational) ► Buyer inherits cumbersome structure ► Purchase of C corp. shares does not permit tax basis step up in business
assets; whereas purchase of LLC units does ► Because of inability to achieve tax basis step up in business assets, C corp.
shares are arguably worth less than LLC units
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Use of a Blocker Corp.: Sale of Business
► If Buyer agrees to buy LLC units and blocker corp. shares, then ► Sellers have a purchase price allocation question because sellers are not
all selling the same thing ► What’s fair?
► How much is the haircut? ► How is the haircut allocated among the sellers?
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Use of a Blocker Corp.: Sale of Business
► If Buyer insists on buying LLC units only and blocker corp. beneficiaries have leverage, then ► Blocker corp. beneficiaries may insist on tax true-ups in LLC Agreement
because of their double tax ► LLC Agreement must become considerably more complex ► Tag along and drag along rights also become more complex – what’s
tagging or being dragged, LLC units or blocker corp. shares?
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Blocker Corp.
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To benefit some, All sellers must tolerate More complexity
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Tax Considerations for Conversion from Partnership to Corporate Taxation
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Tax Considerations
►Form of Conversion
►LP/LLC Unit Class Valuations
►Equity Based Compensation
►Tax Filings
►Methods of Accounting
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Form of Conversion
►Check the Box Conversions ► Possible Retroactive Treatment for 75 days
►Assets Over Transfers
► Statutory Conversions
► Interests Over Conversions
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Form of Conversion
►Gain Recognition ► Entity gains allocated to owners ► Owner Gain
►Suspended Losses
► At-risk Losses ► 704(d) – Basis Limitations ► Passive Activity Losses
►Step-ups and Allocation Among Assets
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Multiple Class LP’s and LLC’s
►Valuation of Existing Interests into Different Classes of Corporate Stock
►Valuation of Existing Interests into Single Class of Stock
►Valuation/Vesting Issues of Profit Interests or Other Equity Based Compensation
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Equity Based Compensation
►Dealing with Vesting Issues
►New Equity Based Compensation Programs
►Existing Options
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Tax Filings ►Tax Year – Flexibility for Corporations
►State Registrations
►State Income/Franchise Taxes
►Prior NOL’s/Carryovers
►Estimated Tax Requirements
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Methods of Accounting
►New Elections Permitted/Required
►Cash Method ($5MM limitation)
►LIFO
►481(a) Adjustments
►R&E
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IPO Issue/Opportunity
►A company that is contemplating an IPO will often have a significant tax attribute. ► Net operating loss carryover (“NOL”). ► Ability to achieve a “basis step up” in its assets with a tax benefit that
exceeds any tax cost to obtain it. ► Corporate transfer to a new corporation in a “busted” tax-free transaction. ► Partnership incorporation.
►Market may not be willing to pay an incremental price reflecting the
value of the resulting tax benefit.
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Potential Solution
►A tax receivable agreement (“TRA”) allows the sellers or historic owners to receive most of the tax benefit.
►Typical TRA terms require the company to pay the sellers a specified percentage of the tax benefit as well as any additional tax benefit derived from the TRA payment itself.
►Typical TRA terms provide that the payments are made when and if the company actually realizes the tax benefit.
► However, because the obligations under some agreements can extend for several years, TRAs often allow the company to terminate its obligations by paying a lump sum equal to the present value of future payments assuming the company can realize the benefit as quickly as possible.
► Similarly, sellers will often seek assignment rights.
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Tax Treatment of Payments
► In a basis step up transaction, the payments should be viewed as additional purchase price for the assets.
► Installment sale treatment and capital gain with some imputed interest to recipients.
► Additional basis to the company when payments become fixed and determinable as well as imputed interest.
► More tax benefit to the company and more payments under TRA. ►Treatment not clear in other circumstances
► Dividend? ► If so, how and when measured?
