Set 4 FI 13 Purchase, Expansion or Sale of Business

Question 1

What are some questions asked when determining whether to change strategy?

Answer 1

• are there synergies involved?
• are certain core competencies required for some business and not others?
• would a different governance structure be appropriate?
• what will be the impact on cash flow, shareholders returns and assets?
• tax implications
• risks and opportunities

Question 2

what are some assets which may be acquired or sold?

Answer 2

a/r
inventories
PPE
identifiable intangible such as customer lists, trademarks etc
value of income tax loss carryforwards

Question 3

and some liabilities?

Answer 3

a/p and accrued liabilities and provisions
loans payable
mortgages payable
net DB pension and retirement obligations
contingent liabilities

Question 4

define synergy. how is it measured?

Answer 4

synergies occur when two companies create more cash flow together than they would separately. measured using free cash flow.

Question 5

what are some potential synergies of merging?

Answer 5

revenue enhancements from access to new markets
cost reductions from access to assets
tax benefits from increasing tax shield or moving to lower marginal rates (e.g. manufacturing in Canada is taxed at a lower rate)
reduction of working capital requirements
reduction of investment in capital assets relative to operation
reduction in WACC by acquiring another company that has excess debt capacity, allowing for a higher optimal debt-to-equity ratio

Question 6

Advantages and disadvantages of acquiring assets instead of shares

Answer 6

+ acquirer can pick and choose which assets to obtain, leaving behind unwanted assets
+ contingent and hidden liabilities are not assumed
+ tax basis of assets and liabilities acquired is the acquisition price. If FMV < book value, there is a tax shield which could be significant and will allow for greater CCA claims.
- selling company may retain assets it does not wish to sell.
- a higher price may have to be paid for assets if no (or limited) liabilities are part of the transaction

Question 7

if group of assets are purchased, how is the price allocated for buying company

Answer 7

pro-rata, unless the assets are considered a “business”. they are recorded at cost, not fair value.

Question 8

what is company is a business?

Answer 8

allocated at the FMV of the identifiable tangible and intangible assets , then remainder is goodwill. defined under IFRS 3.

Question 9

Purchase shares of existing business - difference between this and buying net assets

Answer 9

• consideration paid to shareholders, not the target company
• accounted as an investment
• if controlled, then investment is a subsidiary and eliminated under IFRS when consolidating. ASPE offers a choice.
• if not controlled, may still be a signifcantly influenced investment.

Question 10

Purchase shares of existing business - adv + disadv

Answer 10

+ can be less than buying assets, as only 51% of shares need be bought
+ shares are easier to sell than assets
+ legal structure of target company can be maintained
+ acquirer can use any tax loss carryforwards
- if less than 100% ownership acquired, there will be non-controlling shareholders which may make it harder to approval.
- acquirer has to purchase all assets and liabilities, which may not all be wanted
- no change in tax basis of assets acquired, so no tax shield

Question 11

accounting

Answer 11

upon purchase, investment and consideration recorded. upon consolidation, investment account removed and net assets left.

Question 12

Sale of individual assets, groups of assets, or net assets - accounting and tax implications for selling company

Answer 12

accounting: proceeds recognized, assets and liabilities (if any) derecognized. if cash or other assets received, recognize at FV. if shares received, equity measurement received and recognized dependent upon level of ownership within acquiring company.
tax: selling company will have POD equal to consideration. taxes on capital gains and recapture will be payable, or taxable capital losses will be recognized.

Question 13

Sale of shares

- accounting and tax implications for selling company

Answer 13

accounting: none as only change of ownership
tax: if cash received, shareholders will pay taxes on any capital gains arising on disposition of shares. if shares received, tax deferred until new shares ultimately sold.

Question 14

define de jure vs de facto control

Answer 14

de jure - someone owns more than 50% of shares, and can appoint directors
de facto - someone owns less than 50% but still has control, possibly due to voting rights

Question 15

implications of change in control - accounting/tax/legal

Answer 15

accounting - must be consolidated if control under IFRS. if sig influence, must use equity method. if no longer, can use FVOCI, FVTPL methods.
tax - can trigger change in control of assets, resulting in capital gains, relative to POD. also, share ownership change triggers forced year-end, meaning restrictions on tax credits etc.
legal - might impact sales, debt arrangements etc.

Question 16

what are some motivations for divesting assets?

Answer 16

focus resources on core competencies
eliminate underperforming businesses
comply with regulations
raise cash

Question 17

define a spin-off

Answer 17

splitting one company in two - consisting of the assets, intellectual property, technology and liabilities of what is being divested. run as separate company with different board. non-taxable as no cash transferred. usually done to unlock value.

Question 18

define equity carve-out

Answer 18

assigning assets and liabilities to divest into a separate corporation, for sale, usually retaining majority of shares. might not be taxable depending on proportion of ownership left.