M&A V: Corporate Divestitures

Question 1

Why do corporations often divest business segments (or subsidiaries)?

Answer 1

• To eliminate an underperforming business
• To eliminate a business that does not fit well with other business lines
• To raise cash
• To correct market mispricing
• To align incentives of subsidiary managers
• To appease regulators

Question 2

A sale of a subsidiary can be completed as what two types of transactions?

Answer 2

• Non-taxable transaction

- Taxable transaction

Question 3

The buyer and seller may, for tax purposes, elect to treat a taxable stock sale as what?

Answer 3

• Taxable asset sale by filing an election under IRC Sec. 338(h)(10)

Question 4

A non-taxable sale of a subsidiary is structured and treated similarly to what?

Answer 4

• Tax-free acquisition of a freestanding C-corporation

Question 5

The consideration in a tax-free subsidiary sale is generally what?

Answer 5

• Stock of the acquiring company

Question 6

In a tax-free subsidiary sale, the selling company takes what basis in the stock received?

Answer 6

• Substituted basis in stock received (i.e. basis of stock received is assigned the stock basis of the sold subsidiary)

Question 7

In a tax-free subsidiary sale, the acquiring company takes what basis in the subsidiary’s stock and assets?

Answer 7

• Carryover basis

Question 8

What are three ways a corporation can divest a subsidiary?

Answer 8

1) Sell subsidiary
2) Do a spin-off
3) Equity carveout

Question 9

What happens in a divestiture?

Answer 9

Sell assets, divisions, subsidiaries to another corporation or combo of corporations or individuals

Question 10

What happens in a spinoff?

Answer 10

• Parent corporation distributes, on pro rata basis, all the shares it owns in subsidiary to its own S/Hs
• No money generally changes hands
• Non taxable event (as long as it jumps through substantial hoops)

Question 11

What happens in an equity carveout?

Answer 11

• Also called partial IPO
• Parent co. sells a percentage of the equity of a subsidiary to the public stock market
• Receives cash for the percentage sold
• Can sell any percentage, often just less than 20%, just less than 50%, are chosen

Question 12

Why is a nontaxable subsidiary sale not desirable?

Answer 12

-B/c gain duplicated when stock is sold later on

Question 13

What is the consideration in a nontaxable subsidiary sale?

Answer 13

• Stock of Acquiring Co.

Question 14

What is the character of the gain or loss in a taxable subsidiary asset sale?

Answer 14

• Depends on type of asset sold

Question 15

What is the character of the gain or loss in a taxable subsidiary stock sale?

Answer 15

• Capital

Question 16

The 338(h)(10) election decision must be made by whom?

Answer 16

• Both the buyer and the seller

Question 17

If STOCKB = ASSETB, would the selling co. want to make a 338(h)(10) election? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 17

• Seller indifferent to election

Question 18

If STOCKB > ASSETB, would selling co. want to make a 338(h)(10) election? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 18

• Seller’s after tax wealth maximized if FOREGO election

Question 19

IF STOCKB < ASSETB, would selling co. want to make a 338(h)(10) election? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 19

• Seller’s after tax wealth maximized if MAKE election

Question 20

If purchase price = ASSETB, what is the Acquirer’s 338(h)(10) preference? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 20

Indiferrent

Question 21

If purchase price < ASSETB, what is the Acquirer’s 338(h)(10) preference? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 21

Forego 338(h)(10)

Question 22

If purchase price > ASSETB, what is the Acquirer’s 338(h)(10) preference? (Assuming Price = PriceNo338h10 = Price338h10)

Answer 22

Prefer 338(h)(10)

Question 23

Why does ACQ_PRICE338h10 increase as the basis change amortization period decreased from 10years to 5years?

Answer 23

• Tax savings from basis step up recognized sooner with 5 year amortization period as opposed to 10 year amortization period

Question 24

Under what conditions does a 338(h)(10) election make sense?

Answer 24

• If ASSETB > STOCK B
• And Price > ASSETB
• Then election mutually beneficial to both parties

Question 25

Under what conditions does a 338(h)(10) election not make sense?

Answer 25

When STOCKB > ASSETB > PRICE