Transcript SESSION TITLE - Schuck Law Group

Transactions for Existing ESOP Companies:
Acquisitions, Mergers, Spinoffs
Garry R. Karch
Managing Director
Butcher Joseph Hayes LLC
[email protected]
(312) 224-0622
William W. Merten
Partner
McDermott Will & Emery
[email protected]
(312) 984-7647
Edwin G. Schuck, Jr.
Attorney at Law
Schuck Law Group
[email protected]
(213) 683-5376
Schuck Law Group
Introduction
•
•
•
•
•
•
•
•
•
This presentation is intended to provide an overview of transactions for existing ESOP
companies, encompassing acquisitions, mergers and spinoffs.
It will address business, legal and financial issues related to the areas mentioned
above.
Additionally, it will cover the role of the ESOP trustee and fiduciary issues in the
decision making process related to M&A transactions.
We will review issues related to valuation and the use of the tax shield created through
the 100% S-Corp ESOP structure to finance transactions on more advantaged terms
than those available to a non-ESOP company.
The implications of spinoffs will be discussed in the context of acquisitions where little
or no value is imputed by a strategic buyer buyer to a particular division.
We will also cover the tax considerations when ESOP companies are involved in
corporate finance transactions as merger partner, buyer or seller.
The issue of leaving target company employees outside the ESOP or bringing them in
will be covered, as well as the use of the rollover of target company employee benefit
plan monies to assist in the financing will be discussed.
Acquisition financing issues will be discussed and, finally,
Acquisition corporate governance issues will be covered.
Schuck Law Group
General Thoughts
•
•
•
•
ESOP companies can be successful acquirors and merger partners.
The existence of an ESOP does, however, add a layer of complexity to
transactions that would not otherwise be present.
There are additional due diligence issues that need to be reviewed and
decisions made as to how the ESOP will be treated following the transaction
closing.
What does an ESOP company need to be successful in the acquisition or
merger environment?
•
•
•
•
•
•
A well thought out strategy
Detailed planning
Extensive due diligence
An understanding of key acquisition and transaction issues that arise from the
existence of the plan
The proper financing
A culture fit with the company being acquired or merged with
Schuck Law Group
ESOP Acquisitions vs. More Traditional
Alternatives
•
Comparison vs. asset acquisitions
•
•
•
Comparison vs. non-ESOP stock acquisitions
•
•
•
Structure simplicity/complexity
Tax aspects
Structure simplicity/complexity
Tax aspects
Comparison vs. recapitalization
•
•
Structure simplicity/complexity
Tax aspects
Schuck Law Group
Acquisition of Target Companies with ESOPs
•
Section 1042 transactions with S-Corp
or C-Corp Buyer
• Planning issues
• Trustee considerations
• Existing plans
• Combined plan limits
• Include or exclude target company employees
• Valuation
• Rollover of target company prior plan funds
Schuck Law Group
Acquisition of Target Companies with ESOPs -2
•
Section 1042 structure with S-Corp buyer
•
Structure and process
•
•
•
•
Advantages
•
•
•
ESOP at each entity
1042 Transaction at seller
Merger of plans and entities
Financial
Other
Disadvantages
•
Complexity – separate trustees and financial advisors
• Additional issues
•
•
Conversion of share classes
Voting rights
Schuck Law Group
Acquisition of Target Companies with ESOPs -2
•
Section 1042 structure with C-Corp buyer
•
Structure and process
•
•
•
Advantages
•
•
•
Exchange of seller shares for acquiror shares
Followed by Section 1042 Transaction by sellers
Financial
Other
Disadvantages
•
Complexity – separate trustees and financial advisors
• Additional issues
•
•
•
Recapitalization into multiple classes
Delaying distributions until acquisition loan is repaid – impact on existing loans
Dividend tracking – possible non-deductibility
Schuck Law Group
Acquisition of Target Companies with ESOPs -3
•
Transactions where Section 1042 is not desired by Sellers
•
Stock purchase
•
•
Structure
Advantages
• Financial
• Other
•
•
•
Disadvantages
Additional issues
Asset Purchase
•
•
Structure
Advantages
• Financial
• Other
•
•
Disadvantages
Additional issues
Schuck Law Group
Other Acquisition Considerations
•
Acquisition Fiduciary Issues
•
•
•
Acquisition Corporate Governance Issues
Acquisition Financing Considerations
•
•
•
Potential issue from “diluting” current employees’ ESOP benefits
Incremental retained earnings generated by the 100% S-Corp ESOP
structure provide additional cash flow for acquisition purposes
Repayment of acquisition debt receives favorable tax treatment
Additional plan considerations
•
•
With a larger employee base, extremely high benefit levels that could
cause a potential 409(p) issue can be rationalized if future allocations
are made to both acquiror and target employees
Rationalization of benefit plans
Schuck Law Group
ESOP Companies and Mergers
•
Many of the same considerations apply when looking at ESOP
companies as merger candidates as did in the acquisition
discussion.
•
•
•
Acquisition Corporate Governance Issues
Acquisition Financing Considerations
•
•
•
Potential issue from “diluting” current employees’ ESOP benefits
Incremental retained earnings generated by the 100% S-Corp ESOP
structure provide additional cash flow for acquisition purposes
Repayment of acquisition debt receives favorable tax treatment
Additional plan considerations
•
•
With a larger employee base, extremely high benefit levels that could
cause a potential 409(p) issue can be rationalized if future allocations
are made to both acquiror and target employees
Rationalization of benefit plans
Schuck Law Group
Cash Merger as Taxable Asset Purchase
In this transaction, a traditional leveraged ESOP is used to finance the taxable cash
acquisition by statutory merger) by the acquiring company of an unrelated target
company. In effect, the entire purchase price is financed by the buyer with before-tax
dollars. The exempt ESOP loan is repaid with tax-deductible contributions to the plan
and/or dividends on the employer stock held by the plan.
Schuck Law Group
Cash Forward Triangular Merger as Taxable Asset
Purchase
This transaction uses a leveraged ESOP stock purchase to finance a taxable asset purchase from a
target corporation, using a forward triangular merger format. As in the preceding case, the purchase
price is, in effect, fully tax-deductible to the buyer because the exempt ESOP loan is repaid with taxdeductible contributions to the plan and/or dividends on the employer stock held by the plan.
Schuck Law Group
Reverse Triangular Merger as Taxable Stock
Purchase
This transaction effects a taxable stock purchase via reverse triangular merger using the
proceeds of an exempt ESOP loan. As in the asset purchase models, the purchase price is, in
effect, fully tax-deductible to the buyer.
Schuck Law Group
Merger Structures
•
•
•
•
There are a number of other variations on the theme with respect to
the merger alternatives shown on the previous three slides.
Each of these structure can minimize the cost of the transaction by
allowing the acquisition related debt to be repaid with taxadvantaged funds.
While there are significant potential benefits to using any of these
structures (and others that may be appropriate, given the acquiror’s
objectives), the key is to use a team of advisors that is experienced
with both ESOPs and merger structures.
Every transaction starts with in-depth analysis of company and
shareholder objectives. Once those have been clarified, the nuts
and bolts of how the transaction can be put together can be
clarified.
Schuck Law Group
ESOP Transactions and Spinoffs
•
•
•
•
•
ESOPs can provide an interesting spinoff alternative in several
contexts.
A fundamental question regarding the use of a spinoff to unlock
additional value is whether incremental value could be gained for
the businesses shareholders by separating lines of business and
valuing them on their own.
Incremental value can, at times, be realized by the sale of one
business segment at an appropriate multiple, given its nature,
accompanied by the sale of spinoff of another division at its own
appropriate multiple.
In many cases, a buyer is only interested in one segment of the
business and assigns little value to other segments.
In this case, the spinoff of the undesired segment to its employees
and management through the use of an ESOP may be a viable
alternative.
Schuck Law Group
The Tax-Free Spinoff as the Separation Vehicle
•
Structure Considerations
•
•
•
Tax Considerations
Requirements for a Tax-Free Spinoff
•
•
•
•
Corporate Business Purpose Requirement
Shareholder continuity of interest requirement
Requirement that the distribution not be used primarily as a “device” for the
distribution of earnings and profits
Key considerations
•
•
•
•
•
The separation of multiple lines of business could be done by the parent through
the formation of a subsidiary into which it contributes the assets and liabilities of
the business segment.
“Device”
“Continuity”
Exception for Tax-Free Dispositions
Special “Disguised Sale” Rule
Safe Harbor Provisions
Schuck Law Group
Potential Spinoff Transaction Scenarios
•
Tax-Free sale of some or all of the distributing corporation or distributed
corporation to an ESOP following the spinoff
•
All of the distributing or distributed corporation’s stock is sold to an ESOP in a
Section 1042 transaction close in time to the spinoff
•
•
Less than 50% of the distributing or distributed corporation’s stock is sold to an
ESOP in a Section 1042 transaction close in time to the spinoff
•
•
Tax implications
Less than 50% of the stock of both the distributing and distributed corporation’s
stock were both sold to separate ESOPs in Section 1042 transactions close in
time to the spinoff
•
•
Tax implications
Tax implications
Spinoff of subsidiary to new ESOP set up for employees of subsidiary (with
ESOP holding all shares of the spun-off entity
Schuck Law Group
Summary
•
•
•
•
•
•
•
At their core, M&A transactions involving ESOP companies are still corporate finance
transactions and they must be analyzed in the same manner as more traditional structures.
There are additional benefits provided by the ESOP structure when looking at structural
alternatives.
There are also issues that may need to be dealt with when ESOP companies are involved in
corporate finance transactions.
In-depth due diligence must be performed to determine the impact the ESOP at one company
may have on its merger partner. The expense of expanding the plan must be analyzed
carefully in determining the best way to proceed.
It is critical to use an independent trustee when an ESOP company is involved in any type of
merger, acquisition or spinoff.
There are a number of creative spinoff techniques using ESOP structures that can be used to
increase value to shareholders and structure transactions to minimize taxes and, in some
circumstances, create tax-free distributions to an ESOP.
The to navigating these at times confusing waters is to work with a team of experienced
advisors, attorneys and other ESOP professionals. They have probably seen the structure
you and your business are analyzing and are in the best position to assist you in closing the
optimal transaction.
Schuck Law Group
Questions and Answers
•
•
Thank you for your attention, attendance and participation!
Please feel free to follow up with any of us with additional questions
or comments.
Schuck Law Group