Acquiring a Corporate Subsidiary or Division Strategies for Buyers and Sellers in Carveout Deals

1. Presenting a live 90-minute webinar with interactive Q&A 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 Today’s 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 The audio portion of the conference may be accessed via the telephone or by using your computer's speakers.Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

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4. Strafford Publications, Inc. Acquiring a Corporate Subsidiary or Division February 10, 2011

5. 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

6. 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

7. The Reasons for the Business Unit’s Disposition Can Be Varied • The business unit no longer fits with the seller’s 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

8. 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?

9. 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

10. 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

11. 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

12. 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;

13. 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

14. 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”

15. 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

16. Structuring The Transaction (cont.) • Methods of obtaining the right assets and avoiding unwanted liabilities: • Due Diligence • Documentation: reps and warranties; covenants and indemnification

17. 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

18. 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 PP&E 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

19. 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

20. 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

21. 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

22. 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”?

23. Post-Closing Arrangements/Transitional Services Agreements (cont.) • Some typical TSA provisions • Duration, extension rights • Pricing – a la carte or fixed rate?

24. You may also use the Chat function to ask questions, or email questions to financelaw@straffordpub.com CLE CODE: TLVUDE

25. Please join us for our next legal conference, “Key 2010 Delaware Rulings for M&A, 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.