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Carve-Outs in M&A Deals Conducting Due Diligence, Structuring Provisions to Protect Buyers and Sellers, and Addressing Unique Employment and Benefit Issues

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WEDNESDAY, MAY 9, 2012

Presenting a live 90-minute webinar with interactive Q&A

Charles J. Morton, Jr., Partner, Venable, Baltimore

John A. Wilhelm, Partner, Venable, Tysons Corner, Va.

Stephen Guy, Managing Director, KPMG Corporate Finance, Baltimore

William Steciak, Principal, KPMG Transaction and Restructuring Services, Chicago

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M&A Market Update and Introduction to Carve-Outs

Stephen W. Guy Managing Director and Group Head KPMG Corporate Finance LLC May 9, 2012

M&A Market Landscape

7 © 2012 KPMG Corporate Finance LLC, a Delaware limited liability company, is a member of FINRA and SIPC and is registered as a broker-dealer with the SEC. KPMG Corporate Finance LLC is also registered as a municipal advisor with the SEC and MSRB. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

Global and U.S. M&A Activity

■ 2012 was expected to be a robust M&A year, but Q1 volumes have disappointed

■ Q1-12 global deal volume is the lowest since Q1-10

■ However, there has been a recent surge in the number of IPOs over the past 6 months

– Private equity firms are using buoyant equity markets to take more of their portfolio companies public

– There were 36 private equity backed IPOs in Q1-12 representing 35% of global IPOs deals, the most since 2000

427 451 396

605

525 550 569

718 661 677

621

554 537

7,442 8,148

8,517

10,971 10,315

10,716 10,717

12,879

11,505

12,641 12,478 13,233

10,675

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

-

100

200

300

400

500

600

700

800

900

1,000

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12

Deal Volum

e

Dea

l Val

ue ($

b)

Deal Value Deal Volume

195 188

100

226 167

207 203 223 235 255 266 219

150

2,004 2,228 2,440 3,033 3,159 3,224 3,284

3,810 3,478 3,854 3,714 3,820

3,232

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

-

100

200

300

400

500

600

700

800

900

1,000

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12

Deal Volum

e

Dea

l Val

ue ($

b)


Global M&A activity U.S. M&A activity

Source: Capital IQ and Financial Times


M&A Volume by Sector

-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*


-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*

Dea

l Val

ue ($

b)

-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*

Deal Volum

e ('000s)

-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*

Dea

l Val

ue ($

b)

-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*


-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*-

5

10

15

-

100

200

300

400

500

600

700

2009 2010 2011 2012*

Deal Volum

e ('000s)

Consumer Discretionary Consumer Staples Energy Financials Healthcare

Industrials Information Technology Materials Telecommunications Utilities

Note: *2012 deal value and deal volume are annualized based on Q1-12 Source: Capital IQ


1.2x

9.0x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

Ente

rpris

e Va

lue

Mul

tiple

1.3x

9.2x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

Ente

rpris

e Va

lue

Mul

tiple

Average M&A Multiples by Sector

Consumer Discretionary Consumer Staples Energy Financials Healthcare

Industrials Information Technology Materials Telecommunications Utilities

1.2x

9.7x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

2.9x

7.0x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

EV/Revenue EV/EBITDA

3.6x

12.1x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

2.3x

9.9x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

1.7x

10.1x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

1.1x

8.9x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

EV/Revenue EV/EBITDA

2.0x

10.1x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

2.2x

9.8x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

2009 2010 2011 Q1-12

Source: Capital IQ


M&A Volume by Deal Size

1,321 1,534 1,475 1,764 1,639 1,648 1,582 1,832 1,640 1,832 1,800 1,907 1,415

1,029 1,356 1,437

2,052 1,729 1,958 1,928 2,413

1,924 2,214 2,214 2,285

1,591

444

566 713

1,039

847 941 1,031

1,301

1,022

1,234 1,118 1,163

835 104

120 137

176

152

184 208

264

234

231 197

193

166

-

1,000

2,000

3,000

4,000

5,000

6,000

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12

Dea

l Vol

ume

$0m - $5m $5m - $50m $50m - $500m > $500m

Global M&A Volume by Deal Size

Note: Chart represents only transactions with disclosed values Source: Capital IQ


Average M&A Multiples by Deal Size

Global M&A Multiples by Deal Size

Note: Chart represents only transactions with disclosed values Source: Capital IQ

1.0x

1.7x1.9x

2.7x

8.0x

9.6x

10.0x

11.4x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12

Ent

erpr

ise

Val

ue M

ultip

le

$0m - $5m $5m - $50m $50m - $500m > $500m

EV/EBITDA

EV/Revenue


Abundance of Available Investable Capital

■ The market is flush with capital that needs to be deployed

■ Financial investors have over $400b in dry powder

■ Strategic acquirers (made up of the S&P 500) are holding an additional $1.7 trillion in investable cash

■ The M&A markets should benefit from the nearly $2.1 trillion of “dry powder”

PE Investors Sitting on $425b of Dry Powder S&P 500 Companies Cash Balance

916 1,005 1,045

1,494 1,559 1,687

0

300

600

900

1,200

1,500

1,800

2006 2007 2008 2009 2010 2011

Cas

h an

d eq

uiva

lent

s ($

b)

197257

333

439478

521477

425

$-

$100

$200

$300

$400

$500

$600

2004 2005 2006 2007 2008 2009 2010 2011

Cap

ital O

verh

ang

($b)

Source: Private Equity Growth Capital Council and Capital IQ


Increased Leverage Capability for M&A

■ Leverage on M&A transactions has remained stable, and is currently above 4.0x EBITDA

■ Total loan volumes in Q1 2012 have increased since Q4 2011, but are still below Q2 2011 levels

■ 2011 total leverage on middle market transactions reached $374 billion, compared to $236 billion in 2010

■ However, the volatility in Q4 2011 has put deal pricing under some pressure

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

Jan-

10Fe

b-10

Mar

-10

Apr-1

0M

ay-1

0Ju

n-10

Jul-1

0Au

g-10

Sep-

10O

ct-1

0N

ov-1

0D

ec-1

0Ja

n-11

Feb-

11M

ar-1

1Ap

r-11

May

-11

Jun-

11Ju

l-11

Aug-

11Se

p-11

Oct

-11

Nov

-11

Dec

-11

Jan -

12Fe

b-12

Mar

-12

Mul

tiple

of E

BITD

A

First Lien Debt/EBITDA Second Lien Debt/EBITDA

Other Sr. Debt/EBITDA Sub Debt/EBITDA

43.4 65.9 54.2 72.7 141.2 119.0 53.1 60.8 109.8-

20

40

60

80

100

120

140

160

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 3Q12

$ in

bill

ions

Middle Market LBO Credit Statistics

Total Leveraged Loan Volume

Representative Debt Pricing

Tranche Pricing (bps)

Revolver L + 350 - 450

Senior Term A L+ 550 - 650

Senior Term B L+ 650 - 700

Mezzanine 13% - 14% current pay & 3% - 4%PIK

Source: LCD and Capital IQ

Note: Actual pricing varies by size, ABL vs. cash flow and credit rating


Factors Impacting M&A in 2012

Low borrowing costs

Anticipated 2013 capital gains/dividends tax increase

China and Eurozone uncertainty

Oil prices and Middle East instability

U.S. 2012 Presidential election year

Carve-Out Market Landscape


Motivations for a Carve-Out

■ Market for corporate control

– Asset is more valuable to alternative management team

– Division no longer has a “strategic fit”

– Returning to the core business (undiversifying)

■ Unlocking hidden value

– Creation of pure play – get the market to understand the business, once the unit is revalued, the parent will be revalued as well

– Sell high – Example: tech in the late 90’s

■ Improving management incentives

– Easier to run, more able to focus efforts

– Superior performance management

– Reduce bureaucracy/decision making authority

■ Reduce agency costs

■ Tax/regulatory factors

– No shareholder tax, usually

– If selling newly issued sub shares, then non-taxable

– If selling shares owned by parent, then taxable on gain


Overview of Carve-Out Activity through the Economic Downturn

■ Carve-out volume remained steady despite lagging economy

– Vast majority of executives expected an uptick in carve out activity as a result of the recessionary environment

■ Carve-out values decreased

– Average size of global divestitures increased by 24% from 2005 to 2007, but subsequently fell by nearly the same percentage, coinciding with the economic downturn

■ Credit markets turmoil only modestly affected divestiture plans

– Only a third of executives delayed their divestiture plans as a result of credit market turmoil

Implications

■ Smaller deals are harder to execute

– Generate less interest

– Require same amount of due diligence

– Can take longer if no stand-alone management team in place

■ Tightened credit markets, combined with economic malaise resulted in lower valuations across all industries and limited the field of potential buyers

Trends


Key Drivers of Carve-Out Activity

Reasoning

Most Important Reasons for Divesting Carve-Outs

4%

11%

8%

14%

66%

15%

12%

20%

50%

15%

0% 20% 40% 60% 80% 100%

Too much risk

Not profitable

Profitable but didn't meet targets

Needed cash/capital

Not core to business strategy

g

Ranked #1 Ranked #2 Source: KPMG International and The Wharton School

Reasons for failure to divest

■ Parent taking a portfolio management view and considering the “pruning” of non-core operations

− Two-thirds of executives stated that this was the most important reason for divestiture

■ Need cash to improve company’s financial position

− Two-thirds of executives stated that this was one of the top two reasons for divestiture

■ As economic conditions deteriorate, the need for cash becomes the more prevalent reason for divestiture

■ Roughly 40% of executives stated their company has unsuccessfully attempted to divest an entity

■ The most important reasons for failure include:

− Failure to obtain price sought (67%)

− Buyer came back with reduced terms (38%)

− Unable to find buyer (33%)

− Buyer unable to secure funding (32%)


Carve-Out Buyer Landscape

■ Strategic buyers, both foreign and domestic, rate as the best buyers across the board because they:

– Offer the highest valuations

■ Strategic buyers generally can integrate a carve-out within existing operations and take advantage of current management and expertise in the industry

■ Foreign strategic buyers often viewed as the best payers, but not necessarily the case

– Are better positioned to integrate the entity

– Purchase the most carve-out transactions

■ Financial buyers, both foreign and domestic, are perceived as less ideal carve out counterparties

– Financial buyers often lack existing business operations in the industry

■ Must invest more to successfully manage a divestiture

– Financial buyer interest and ability to pay ebbs and flows with the overall credit markets

■ Most executives expect buyer interest in carve-outs to increase, particularly among foreign buyers (both strategic and financial)

– Foreign buyer interest particularly increases when the dollar weakens

– Rise of prominent global companies in China, India, and other emerging markets further fuels the trend toward foreign buyers

– Even mid-market companies are increasingly thinking global in their carve-outs


Carve-Out Sale Processes & Outcomes

34%

58%

54%

78%

6%

18%

31%

45%

0% 20% 40% 60% 80% 100%

Financial - Foreign

Financial - Domestic

Strategic - Foreign

Strategic - Domestic

y y

Sold to Considered

Types of Buyers Considered and Sold to

Source: Deloitte 2008 Divestiture Survey

■ Auction with limited distribution is most favored sales process

■ Direct negotiation with single buyer is slightly less favored but also very common

■ Roughly 90% of companies executing carve-out transactions utilize outside professional service providers

Type of Process

■ Six to 12 months is the most prevalent timeframe from when a company decides to sell the entity until when the purchase agreement is executed

■ Roughly a quarter of transactions took less than 6 months

Timing

■ Domestic strategic buyers were the most likely end buyer

■ Financial buyers often considered initially, but rarely selected in the end

Outcome


Carve-Out Trends and Leading Practices

■ Carve-out activity has continued to accelerate as the economy has improved

– It’s time to consider your divestiture strategy.

■ It’s simple but true: more bidders generally yield higher value deals

– Though tempting, sweetheart deals may not maximize value.

■ Although domestic buyers dominate the market now, international buyers are elbowing their way in

– Think global as the playing field just got bigger

■ The Boy Scout motto applies: “be prepared“

– A prepared seller is focused on more than getting the financials in order and data room populated

– Position the business from a buyer’s perspective.

■ Transactions usually take longer than planned to complete

– Come to the table prepared to discuss separation details – not just dollars.

■ With a divestiture, generally comes a transition services agreement (TSA)

– Use TSAs as a deal-making – not deal-breaking – strategy and don’t forget to take stranded costs into account.


Key Carve-Out Considerations & Challenges

■ Multiple parties with divergent agendas

– Allegiance of spin-off management team shifts throughout process from seller to buyer as they look to best position themselves individually for the future

■ Highly complex carve-outs as a result of closely integrated businesses

– ERP implementations have led to tightly integrated business units that are difficult to unravel

■ Transition Service Agreement (TSA)

– The seller often must provide transitional services to the carved-out entity during an interim period when the business is preparing to stand alone

– Selection of the right people to execute and manage conflicts with TSAs is key to avoiding legal wrangling

■ Business Disruptions

– Fear of change can upset employee morale and productivity

– Maintaining business continuity while simultaneously focusing on meeting the demands of the divestiture process can stretch employees thin and disrupt the normal flow of business

■ Disproportionate SG&A Cost Structure

– Sellers often carve out a sizable business unit while neglecting to adjust their SG&A cost structure to reflect the new size of the business


Ways to Maximize Value in a Carve-Out

■ Create a proactive divestiture strategy

– Regularly review what assets are core, and which ones are non-core

■ Create a clear carve-out plan early in the deal cycle

– Include talent retention and necessary short-term investments, designed to avoid value dilution of the pending sale

■ Put a robust transaction team in place

– Charge the team and advisors with facilitating a competitive auction designed to maximize the number of bidders

■ Position the business from a buyer’s perspective

■ If you initially don’t get the value you want but want to bring a deal back to the table

– Do this quickly so you don’t lose momentum and all your diligence work is still relevant.

■ The more you understand your Transition Services Agreements and associated costs, the more you can leverage them to secure a successful carve-out and avoid stranded costs


Knowledge @ Wharton/KPMG survey

■ KPMG and Knowledge@Wharton, The Wharton School of the University of Pennsylvania, have teamed to conduct the 2012 M&A Outlook Survey

■ Survey is based on 875 executives’ insights and opinions with 70% of executives expecting to complete an acquisition in 2012

■ One-third of respondents remain optimistic for 2012 M&A

■ However deal environment still murky, with two-thirds of respondents expecting full recovery in 2013 or later

■ Companies that survived the economic downfall are leaner and better prepared to weather uncertain conditions

■ U.S. election cycle, tax uncertainty and European economic woes will have significant impact on how companies pursue transactions

■ Interest in emerging markets still present, but stability of developed markets continues to hold allure

■ Due diligence issues continues to challenge dealmakers

Source: KPMG International and The Wharton School

KPMG Link: http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Pages/executives-show-guarded-optimism.aspx

http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Pages/executives-show-guarded-optimism.aspx�


KPMG M&A Predictor

KPMG’s M&A Predictor is a forward-looking tool that helps clients forecast worldwide trends in mergers and acquisitions. The Predictor was established in 2007. It looks at the appetite and capacity for M&A deals by tracking and projecting important indicators 12 months forward.

■ Despite recovering from the dark days of 2009, the first six months of 2012 are expected to be challenging

■ Confidence dips in global markets

■ Lack of confidence will restrict deal flow

■ Consumer staples, technology, and healthcare sectors are predicted to fare better than others

■ Forward P/E rations down 5% since June 2011

Source: KPMG International

KPMG Link: http://www.kpmg.com/global/en/issuesandinsights/articlespublications/ma-predictor/Pages/default.aspx

http://www.kpmg.com/global/en/issuesandinsights/articlespublications/ma-predictor/Pages/default.aspx�


Stephen W. Guy Managing Director and Group Head

Background

Steve joined KPMG Corporate Finance in 2001. His experience in both advisory and corporate capacities includes a wide range of corporate finance responsibilities, including execution and advisory work covering mergers, acquisitions, divestitures, private equity investments, financings, valuations, and strategic assessments.

Steve has worked with start-ups, private/family-owned, middle market public and Fortune 500 companies in a number of industries including business services, tech services and software, industrials, government contracting, engineering & construction, facilities management, logistics & transportations, aerospace and defense, healthcare/med devices and industrial services. Additionally, he has extensive international experience, having worked on cross border transactions involving companies based in Canada, Europe, Asia Pacific, and South America.

Professional and Industry Experience

Steve began his career in the currency and commodities trading division at Goldman, Sachs & Co. in New York, and went on to lead the corporate business development activities for a US$4 billion non-regulated subsidiary of Columbia Energy Group. Prior to Columbia, Steve worked in a corporate development capacity for Perot Systems Corporation, a multi-national information technology services and consulting company, where he executed acquisitions, outsourcing engagements, joint ventures, and private equity investments.

Steve is Group Head of the Business Services industry sector and leads the practice’s national institutional referral channel relationships, primarily with large bulge bracket investment banks, wealth advisors, law firms, regional accounting firms, and other key referral channels.

Representative Transactions

• Advised on the sale of RWD Technologies, LLC to General Physics Corporation (NYSE: GPX)

• Advised Empire Investment Holdings on the sale of their portfolio company, VITEC Solutions LLC

• Advised Electrolux AB on the sale of its Baring Industries division to Duray/J.F. Duncan

• Advised RWD Technologies, LLC on the sale of its performance improvement software division to Court Square Capital Partners

• Advised Diversified Maintenance Systems, Inc. on its recapitalization led Frontenac Company

• Advised IZI Medical Products on its recapitalization led by Riverside Partners

• Advised Concept Mining on the sale to Arcelor Mittal (NYSE: MT)

• Advised LifeShield Engineering Systems on its sale to The Sherwin-Williams Company (NYSE: SHW)

• Advised Rock-It Cargo on its recapitalization and raising mezzanine financing with Spring Capital

• Advised Zellweger Luwa Group on the sale of its Luwa Americas engineering division to management

• Advised Hewlett Packard’s Managed Services division on a global acquisition mandate across 22 countries

• Advised CACI International on the review of their capital structure and optimal acquisition financing strategies

STEPHEN W. GUY Managing Director

KPMG LLP 1 East Pratt Street, 6th Floor Baltimore, MD 21202 Tel 410-949-8909 Fax 410-558-6854 Cell 410-409-4159 [email protected] Function and Specialization Steve is a senior member of the Corporate Finance practice, specializing in advising on mergers, acquisitions and divestitures. Education, Licenses & Certifications • BS (Finance and Economics), Virginia Tech,

Blacksburg, Virginia • MBA (Finance), University of Maryland,

College Park, Maryland • General Securities Representative (Series 7) • General Securities Principal (Series 24) • Securities Agent (Series 63) • Investment Banking Representative

(Series 79)


Important Notice

This presentation is confidential and does not carry any right of publication or disclosure to any other party. This presentation is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by KPMG Corporate Finance LLC. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of KPMG Corporate Finance LLC.

The information in this presentation is based upon publicly available information and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change and such changes may be material. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was otherwise reviewed by us.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

While the information presented and views expressed in this presentation and the oral briefing have been prepared in good faith, KPMG Corporate Finance LLC accepts no responsibility or liability to any party in connection with such information or views.

© 2012 KPMG Corporate Finance LLC, a Delaware limited liability company, is a member of FINRA and SIPC and is registered as a broker-dealer with the SEC. KPMG Corporate Finance LLC is also registered as a municipal advisor with the SEC and MSRB. KPMG Corporate Finance LLC is a subsidiary of KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

29

Legal Considerations for Carve-Out Transactions

Charles J. Morton, Jr.

© 2012 Venable LLP

30

Legal Considerations for Carve-Out Transactions A. Financial Due Diligence. Because the Target Business constitutes only part of a seller’s larger corporate structure, sellers often do not maintain stand-alone financial statements for that part of their business.

1.Which portions of the seller’s assets and overall expenses and revenues are attributable to the Target Business?

– Overhead expenses and other costs (e.g., insurance, marketing

expenses and human resources) are allocated among the seller’s overall corporate structure, and therefore do not provide clear insight into the costs in operating the Target Business as a stand-alone entity.

– Creates drafting challenges around reps and schedules

© 2012 Venable LLP

31


2. Similar challenges arise in determining the Target business’s revenues on a stand-alone basis.

– Parties must account for Intercompany sales arrangements, as well as the Target Business’s access to integral assets owned at the enterprise level (e.g., trade names and goodwill) and other intercompany benefits that will cease after closing.

– Target Business’s customer base may be skewed by favorable cross-selling

arrangements with the seller’s other business units and product lines. – Buyer will often supplement the stand-alone financial statements with additional due

diligence to approximate customer attrition after the Target Business is excised from the seller.

3. Bifurcation of other contracts

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Legal Considerations for Carve-Out Transactions B. Employees and Benefits. Seller’s employees may provide

services critical to the other entities within seller’s corporate structure or that exceed those services necessary to operate the Target Business as a separate business.

1. Employee Transition. Parties may negotiate a transition services

agreement through which the seller will provide core services to the buyer for a period of time and negotiated fee arrangement after closing to reach a mutually acceptable resolution with respect to employees.

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2. Benefits. Both parties will be required to spend considerable time and resources to understand the effect that the sale of the Target Business will have on their respective employee benefits plans.

– Buyer must determine whether it will be able to include the transferred

employees on its existing benefits plan. – Seller must examine whether the disposition of the Target Business’s

employees will result in the termination of its existing benefits plan in which its remaining employees are enrolled.

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III. Legal Considerations for Carve-Out Transactions

C. Intellectual Property. The intellectual property rights of the seller’s

parent company will be vital to the Target Business, both before and after closing.

1. Limited-use license often granted to the Target Business so that the

seller can maintain ownership of the intellectual property while granting the buyer use rights post-closing.

2. Similar issues arise with respect to software, license and ancillary maintenance agreements to which the seller is a licensee. • Is the license transferable? • Are there penalties for decreased user volume?

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Legal Considerations for Carve-Out Transactions D. Contracts and Business Records.

1. Is the carve-out transaction an asset sale? If so, parties will likely

discover logistical issues when assigning certain assets, namely customer contracts and seller’s books and records.

• Possible solutions are subcontracting and assignment once the logistics in obtaining any necessary consent from the customers given the timing of the transaction and other confidentiality concerns are determined.

2. Similar challenges may also arise if the carve-out is structured as a stock

sale if the relevant customer contracts contain “change of control” provisions requiring the customer’s consent for the seller to engage in the carve-out transaction with the buyer.

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3.Are the seller’s books and records maintained on a consolidated basis, thereby including confidential information specific to the seller’s remaining business?

– If the information pertinent to the buyer is inextricable, seller must weigh risks associated with providing access to the buyer or a confidentiality agreement will be negotiated with special attention to potential third-party acquirers.

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Legal Considerations for Carve-Out Transactions Today’s challenging economic environment requires M&A activity

that is carefully designed to achieve well-defined goals.

Carve-out transactions are a natural byproduct of this focus by enabling parties to pare down the business to be sold in order to optimize business efficiency while monetizing non-core operations.

An understanding of the unique and inevitable issues that arise when negotiating a carve-out transaction is essential to the success of the transaction.

Each issue creates drafting challenges that require precision

© 2012 Venable LLP

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Charles J. Morton, Jr. Partner Baltimore, MD 410.244.7716 Washington, DC 202.344.4499 [email protected]

© 2012 Venable LLP

Carve-out Diligence

Bill Steciak

Accounting Advisory Services

May 9, 2012

40 ©2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ('KPMG International'), a Swiss entity. All rights reserved.

Contents

Page

Overview of carve-out diligence 2

Three financial views of the carve-out business 6

Working capital carve-out considerations 7

Long lived assets carve-out considerations 9

Revenue and expense carve-out considerations 11

Post sale operations 13

Quality of earnings 15

Projections 16

General business considerations 18


Overview of carve-out diligence

Every carve-out is unique and comes with its own challenges

Diligence may take the form of

■ They can come in the form of:

– Segments

– Divisions

– Product lines

– Geographic Plants, Stores, Offices, etc.

■ Buy-side (buyer’s request during auction process)

■ Sell-side (seller’s request pre-sale/auction process)


Clean team

Synergies/upsides tracking

Integration planning assistance

Completion accounts process assistance Contract drafting assistance

Structuring assistance

Deal types and processes Illustrative buy-side timeline

Other

Performanceimprovement

Raising debt

Deal process assistance

Transaction evaluation

Pre deal/ no access

investigation

Market entry evaluation

Debt covenant reporting

assistance

Synergies/upside evaluation

Process Launch Non binding offer Confirmed offer Signing Closing Purchase price adjusted

Data-room investigation

Due diligence: financial (full access)

Completion accounts

investigation

Post closing Due diligence

Anti-trust filing Closing process

assistance

Debt syndication assistance

Securitization process

assistance

Purchase accounting and impairment test modeling

Project management assistance

Contract drafting

assistance

Fund flow improvement

Post closing interim management reporting

Financial model review

Modeling and sensitivity testing

Due diligence: commercial (full access)

Due diligence: operational (full access)


Separation planning and assistance Project management assistance

Clean team

Staple financing process assistance

Pre and Post closing completion accounts process assistance

Structuring assistance Contract drafting assistance

Illustrative sell-side timeline

Pre deal due diligence

Synergies/upside evaluation

Completion accounts investigation

Representations and warranties investigation assistance

Closing process assistance

Debt syndication assistance

Securitization process

assistance

Data room/Data book prep. assistance

Contract drafting

assistance

Q&A process assistance

Carve-out financials assistance

Vendor due diligence: financial

Vendor due diligence: commercial

Vendor due diligence: operational

Business plan development

Modeling and sensitivity testing

Performance improvement

Raising debt

Deal process assistance

Other

Process Launch Non binding offer Confirmed offer Signing Closing Purchase price adjusted

Transaction evaluation


Due diligence concerns

Valuation Cash flow ■ Investor relationships ■ Access to finance ■ Debt levels and covenants ■ Cash burn rates ■ Financial results Business model ■ Length of operating history ■ Product mix and pricing strategies ■ Revenue recognition ■ Cost cutting measures, especially labor Forecasts and projections ■ Expected timing and visibility ■ Backlog ■ Net operating losses and research and

development (“R&D”) credit carry-forwards

Market forces Macro trends ■ Cyclical business and consumer spending ■ Rapid technological change ■ E-business and web based services Industry structure ■ Fragmented business market compared to

Microsoft led consumer market ■ Packaged software market compared to

licensed software market Mergers and acquisition ■ Reduced levels of deal activity ■ Consolidation and alliances ■ Deal structure (stock vs. asset sale) ■ Integration of past acquisitions

Contingencies and commitments ■ Related party transactions ■ Litigation ■ Warrants and other potentially dilutive equity

instruments ■ Regulatory and political issues ■ Related reserves

Due diligence concerns

Intellectual property Patents, trademarks and licenses ■ Valuation ■ Royalties ■ Legal protection ■ Geographic location R&D ■ Level of R&D spending and status of current

projects ■ Product life cycles and timing of new introductions

Key relationships Customers ■ Customer relationships and reputation ■ Customer concentration ■ Sales and distribution channels Suppliers/outsourcers ■ Relationships and key terms with significant

suppliers and outsourcers Management and employees ■ Ability to attract and retain key employees ■ Stock based compensation ■ Use of independent contractors


Three viewpoints of financial statements

AS IS Historical Assets

Liabilities Revenues Costs

AS SOLD Conforms to PSA with certain additions and

subtractions

STAND ALONE Add certain revenues

and costs

To Buyer Operating

Reconciled Reconciled

Rec

onci

led

Parent Company


Accounts receivable

There are many things to consider when analyzing Accounts Receivable (A/R):

1. Have receivables been allocated or specifically identified?

2. Do current customers receive an invoice with commingled products?

3. Can the reserve for doubtful accounts be identified to the receivables of the carve-out business?

4. If customers invoices are commingled, who will collect post carve-out business sale and how will they be settled as part of the Purchase and Sale Agreement (PSA)?

Invoice

JD Company

Carve-out product 15 X $20 = $ 300

Non carve-out product

10 X $18 = $ 180

Total Due = $ 480


Accounts payable

Like Accounts Receivable, a buyer must also carefully analyze Accounts Payable (A/P):

1. Have payables been allocated or specifically identified?

2. Has the carve-out business received and tracked its own payables or are they commingled with parent?

3. If payables are commingled who will pay them post sale of carve-out business, and how will this be settled as part of PSA?

Invoice

Electric Co.

Power Supply = $ 500

Distribution = $ 60

Total Due = $ 560

Historically allocated


Fixed assets

Understand what is needed to run the business and what is being purchased under the PSA:

1. Historical operations may have required shared assets which may not be a part of the PSA (mainframe, office space, etc)

2. Consider the need for these shared fixed assets and whether a TSA or other replacement is necessary

3. Are the fixed assets in the carve-out business providing the same synergies on a standalone basis or do they lose value?

4. Are the plant sites commingled with other Parent company operations, if so, careful contracting dividing the real-estate may be required, or other lease arrangements may need to be reached


Intangibles

Are trademarks and trade names shared across Parent company and carve-out company? If so, may need to consider licensing arrangement as parent will likely be unwilling to part with trademark/names

Parent Company

Carve-out Company

Trademark® + Tradenames®


Revenues

How are revenues being reported?

Depending on how revenues have historically been reported buyers may have to adjust pricing/revenues to reflect their proposed customer base.


Corporate allocations

Divisions

Legal Entities

Businesses/Plants

Corporate Costs

Human Resources

Legal

Taxes Pension/Postretirement

Stock Comp Shareholder Services

Internal Audit

Insurance

Finance Dept

CEO

Treasury Dept IT Marketing

Board of Directors


How will the carve-out operate?

TSA (Seller Supplied)

Buyers In-house Resources

Carve-out operations purchased

3 months – 24 months

Integration


Complete operations?

Is the buyer acquiring all the pieces to operate the business?

Customer Service Centers

Warehousing

IT Environment

Manufacturing Operations

Back Office Functions –

(HR, Finance, etc.)

Office Space

Buyer needs to identify what it will take to run the business on a standalone basis. Thus, there is a need to understand what pieces are missing to fully operate the business.


Quality of earnings

Quality of earnings Working capital and cash flow

■ Revenue and profitability trends by project, customer, geography and type

■ Historical and current backlog/pipeline trends

■ One-time or non-recurring items (restructuring, impairment, etc.)

■ Potential customer concentration

■ Subcontractor cost trends and relationships

■ Value-add reseller agreements, if any

■ Major suppliers and related negotiated pricing

■ Insurance cost trends

■ Related party transactions and intercompany activity at arm’s length

■ Lease and occupancy costs

■ Employee union relationships and expected changes

■ Timing of cash payment by project including:

− Accounts receivable payment terms

− Supplier and subcontractor payment terms

■ Nature of deferred revenue

■ Warranty trends and related provisions

■ Existence of deferred expenditures (capital, R&D)

■ Legal and environmental commitments and contingencies

■ Inventory valuation


Projections

Projections for the carve-out business may receive additional scrutiny as these projections may not have been completed prior to the divestiture process.

Buyer’s Objective: Assess the reasonableness of major

forward-looking assumptions

Seller to Demonstrate Ability to frame key “drivers of value”

Buyer and Advisor Uncover “hard to find” commercial evidence

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07

Forecast

Projections

? ? ? ? ? ? ? ?

Volume Price Op Costs Wk Cap

x x x x x x x x x x x x

Financial Levers:

Business Drivers:

Key Metrics to Examine:

etc.

From interviews with: ■ Customers

■ Suppliers

■ Distributors

■ Expert analysts

■ Researchers

■ Academics

■ Trade associations

From sources such as: ■ Research databases

■ Market studies

■ Analyst reports

■ Company filings

■ Thought leadership reports

■ Press searches

■ etc.

■ Alliance partners

■ Competitors

■ Technicians

■ Consultants

■ Functional specialists


Projections

Concerns with projections ■ …assumptions appear to be ambitious

■ …assumptions lack a sufficient level of granularity/support

■ …assumptions are overly reliant on a few factors/variables”

■ … it is difficult to obtain required information and evidence (to test assumptions)

■ …tough approval standards must be met (i.e., validation)

■ …future uncertainty exists, due to fast-changing market conditions

■ …assumptions are dependent on major “intangible” factors (e.g., reputation, brand, relationships, etc.)

■ …the subject matter is overly complex (or foreign)

■ …lack of internal resources exists


General business considerations

Market ■ What is the size and structure of the market in which the business operates? ■ At what rate has the market grown historically and how is this expected to change going forward? ■ What are the main drivers and trends underpinning market growth? ■ What are the key risks and obstacles to market growth? What is the business‘s response to these? ■ Is there pricing pressure in the market? How has this affected the business’s pricing strategy? Competition ■ How is the business positioned, in terms of product and service portfolio, versus key competitors? ■ What is the business’s market share versus competitors? How is market share likely to change going forward? ■ Is the business’s competitive position sustainable? ■ What are the barriers to entry and is there a threat of new entrants? ■ Are there any potential substitute products which may pose a threat to the business and what is the business' response to this? Customers ■ Who are the business‘s key customers and what is the strength of key customer relationships? ■ Are there key customer dependencies? ■ What is customers’ feedback on the business (e.g. quality, range, service levels, price etc)? ■ How likely are customers to renew their contracts? What would cause them to switch suppliers? ■ Has the business recently lost key customers and why? Suppliers ■ How many suppliers does the business have and what is the length of key supplier relationships? ■ How reliant is the business on a single supplier? ■ Are suppliers capable of growing in line with the business‘s projections? Projections ■ How do the business’s projections compare to forecast market growth? ■ How feasible do the business’s sales projections appear in light of market and competitive pressures, and historic performance? ■ What are the potential upsides or downsides?

Key Buyer Questions And Concerns

Thank you

Bill Steciak

Principal

Accounting Advisory Services

T: +1 312 665 8975

E: [email protected]

©2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ('KPMG International'), a Swiss entity. All rights reserved.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).

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EMPLOYMENT ISSUES IN CARVEOUT TRANSACTIONS

John A. Wilhelm

May 9, 2012

61

I. EMPLOYMENT ISSUES IN CARVEOUT TRANSACTIONS

A. Transfer of Employees in a Stock Sale or Merger. In a stock sale or merger of a subsidiary with a buyer entity, all employees and employment agreements transfer to the buyer group unless terminated.

B. Transfer of Employees in an Asset Sale.

1. U.S. In the U.S., employment of those who will continue with buyer will be

terminated by the seller in an asset sale and employees will be hired by buyer. Some employees may be terminated and not hired by buyer.

2. Foreign Jurisdictions. In some foreign jurisdictions, employment of employees in an asset sale will by law automatically be transferred to buyer, unless the employees choose otherwise. These laws may require that notice must be provided of the sale and the right to choose not to transfer. See, for example, the Transfer of Undertakings Protection of Employment Regulations of the United Kingdom. Need to consult with counsel in the foreign jurisdiction.

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I. EMPLOYMENT ISSUES IN CARVEOUT TRANSACTIONS, continued

C. Functions which buyer is not prepared to handle. In some transactions, buyer will need temporary assistance from seller for functions such as human resources, payroll, benefits management, etc. which were previously provided by a parent organization. Seller may even need to continue providing employee benefit plans for a short period. Means of doing this include the following:

1. Transition Service Agreement. The parties can enter an agreement providing for

such services from seller on an interim basis. The agreement can provide for continuing participation in seller’s benefit plans of employees transferred to buyer for a short period. Parties need to consider whether the plans become “multiple employer” plans and the implications.

2. Leasing Employees. Seller can lease employees to the buyer temporarily, meaning seller will continue to pay wages and provide benefits and be reimbursed by buyer.

3. Secondment. This is analogous to leasing employees in a foreign jurisdiction.

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I. EMPLOYMENT ISSUES IN CARVEOUT TRANSACTIONS, continued

D. FICA Taxes. The wage base as to FICA taxes ($110,100 in 2012) need not start anew on the sale of a trade or business. See Treas. Regs. Section 31.3121(a)(1)-1(b). Rev. Proc. 2004-53 provides one of two ways for reporting wages in an asset sale of substantially all property of a trade or business.

1. The seller and the buyer can each report on Form W-2 the wages it pays

to the employees of the business. In this case the buyer must obtain Forms W-4 from each of the business employees it hires.

2. Under an alternative procedure, if agreed by seller and buyer, the Forms W-4 for business employees hired by buyer are transferred to buyer and buyer reports all wages from the business for those employees for the calendar year of sale. Special reporting by successor will be required to explain discrepancies between wages paid and wages reported.

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II. EMPLOYEE BENEFITS ISSUES IN CARVEOUT TRANSACTIONS

A. Overview of Handling if the Business Has Its Own Employee Benefit Plans.

1. Buyer conducts due diligence to determine if any liabilities or problems with the plans.

2. Corrections and/or special indemnifications are obtained in purchase agreement as to any discovered problems.

3. If no unresolvable problems, the plans can be transferred to buyer providing a smoother employee transition.

4. Buyer can generally maintain certain plans requiring coverage testing, such as 401(k) and cafeteria plans, for a grace period until the end of the next plan year before taking into account the buyer’s employees. See, for example, Section 410(b)(6)(C) of the Internal Revenue Code of 1986, as amended (“Code”).

5. Seller may be resistant to due diligence on parent’s plans in this case, but certain plans impose liabilities on whole group. See Section II(H) below.

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II. EMPLOYEE BENEFITS ISSUES IN CARVEOUT TRANSACTIONS, continued

B. Overview if Business Participates in Parent’s Employee Benefit Plans.

1. Buyer conducts due diligence on plans and requires corrections and/or special indemnifications as to any discovered problems.

2. Either (i) plans must be split-off or newly created for the business employees, (ii) employees must be enrolled in buyer’s plans or

(iii) an agreement must be entered for continued participation in seller’s plans temporarily while buyer implements plans.

3. Special rules facilitate participation in seller plans for limited periods after closing. See, e.g., Rev. Rul. 2002-32 as to flexible spending accounts and Labor Regulations 2520.101-2(h), Example 7, as to Multiple Employer Welfare Arrangement status.

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C. Impact of Carveout on a Parent 401(k) or Other Retirement Plan.

1. Vesting. Should ascertain whether there will be a partial termination (i.e., generally a termination of at least 20% of plan participants). See Treas. Regs. Section 1.411(d)-2; Rev. Rul. 2007-43.

– If so, 100% vesting of affected participant will result. – If not, consider requiring seller to amend plan to provide 100% vesting of business

employees.

2. Distributions. Should determine whether distributions will be permitted under the plan following closing.

– If so, employees can generally rollover accounts to buyer’s plan or an IRA or take a

taxable distribution. – If not, consider plan-to-plan transfer to a buyer plan.

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3. Plan Loans. Should ascertain whether employees of business have outstanding plan loans; if so, they will generally become payable upon closing unless plan is being transferred with the sale. If the plan is not being transferred:

– Consider whether the plan will permit participants to rollover loans with any

distribution rollovers to buyer’s plan.

– Otherwise, buyer may want to consider bridge loans to participants or a plan-to-plan transfer of participant accounts to effectively allow transfer of loans to buyer’s plan.

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D. Impact of Carveout on a Parent Health Insurance Plan.

1. COBRA. COBRA continuation coverage must generally be offered to

those who lose coverage in seller’s health plan in connection with an asset sale and those who lose coverage because of a termination of employment in a stock sale. Treas. Regs. Section 54.4980B-9 A-4.

2. Responsible Party. The seller must offer the COBRA coverage unless it

no longer maintains a health plan; in that case, the buyer must offer the COBRA health coverage in a stock sale or, if the business is continued without interruption or substantial change, an asset sale. Treas. Regs. Section 54.4980B-9 A-8.

3. Existing COBRA Beneficiaries. Also, employees or their beneficiaries

entitled to COBRA based on events prior to the sale closing must continue to be offered COBRA by the same ‘responsible” party.

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E. Impact of Carveout on Stock Options and Stock Appreciation Rights (“SARs”). 1. Termination. Should determine whether and as of what date cessation

of employees from seller’s group results in a termination of seller stock options and SARs per the plan and agreements.

2. Vesting. Should also determine whether the sale will result in vesting of

stock options and SARs per the plan and agreements; if not, buyer should consider requiring this. The value of accelerated vesting may be a parachute payment. See Section II(F).

3. Alternatives. The sale agreement should provide whether seller stock

options and SARs are to be terminated at closing if not exercised, cashed out at closing for the “spread” or exchanged for options or SARs in buyer. Exchanges must follow certain rules to avoid adverse tax results. See Treas. Regs. Sections 1.409A-1(b)(5)(v)(D) and 1.424-1(a).

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F. Golden Parachute Rules Under Code Sections 280G and 4999. 1. Brief Overview. Deductions are denied and a 20% excise tax applies to

“excess parachute payments” made on a change in ownership or control of a corporation. See Code Sections 280G and 4999 and Treas. Regs. 1.280G-1 for details.

a. Parachute Payments. Parachute payments are compensation contingent on a

change in ownership or control payable to a “disqualified individual” which equal or exceed three times the average taxable earnings of the individual over the last 5 years (or shorter employment period with the company) (the “Base Amount”). Code Section 280G(b)(2)(A).

b. Disqualified Individuals. “Disqualified individuals” are certain officers, the highest paid 1% service providers and holders of at least 1% of the corporation’s shares. Code Section 280G(c); Treas. Regs. Section 1.280G-1 A-15-20.

c. Excess Parachute Payments. Excess parachute payments are the excess of parachute payments over one times the Base Amount. Code Section 280G(b)(1).

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2. Change in Ownership in Carve Out Transaction. For purposes of whether there is a change of ownership under these rules, all members of an affiliated group of corporations under Code Section 1504 (without regard to 1504(b)) are considered a single corporation per Treas. Regs. Section 1.280G-1 A-46. a. Therefore, for these purposes, a carveout transaction by an affiliated group of

corporations is generally considered an asset sale. Treas. Regs. Section 1.280G-1 A-29.

b. There is a change of ownership if there is a sale of one-third or more of the total

gross fair market value of the affiliated group’s assets, determined without regard to any liabilities. Treas. Regs. Section 1.280G-1 A-29.

c. In the case of sale of a corporate subsidiary by a partnership or limited liability, a

change of ownership generally means acquisition of stock which results in over 50% ownership of the total fair market value or voting power of all shares (although there can be a change of control with lower percentage acquisition in certain circumstances). Treas. Regs. Section 1.280G-1 A-27.

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3. Exceptions for Closely Held Companies. In the case of closely held corporations, there are two possible exceptions: a. S Corporations or corporations which are eligible to elect S Corporation status are

not subject to the golden parachute rules. Code Section 280G(b)(5)(A)(i). b. Shareholders of corporations whose shares are not readily tradable (and do not

have certain publicly held shareholders) who hold over 75% of voting power (other than the disqualified individuals) at or within 6 months before the transaction can approve the parachute payments after receiving adequate disclosures and thereby exempt them from the golden parachute rules. Code Section 280G(b)(5)(A)(ii) and (B); Treas. Regs. Section 1.280G-1 A-7(b)(2). The vote must establish the right to receive the payments.

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G. Section 409A of the Code Applicable to Nonqualified Deferred Compensation. 1. Brief Overview. Nonqualified deferred compensation which is subject to,

but non-compliant with, Section 409A is taxable when vested and subject to a 20% excise tax and interest. See Code Section 409A and Treas. Regs. Section 1.409A-1 through 6 for details.

a. Nonqualified deferred compensation is generally compensation to which there is

a legally enforceable right in the current year to payment in a future year. Treas. Regs. Section 1.409A-1(a)(1) and (b)(1).

b. With certain exceptions, an election to defer and to choose the method and date or event of payout must be made either within 30 days of initial eligibility or in the year before the compensation is earned. Code Section 409A(a)(4)(B).

c. Additionally, nonqualified deferred compensation can be paid only upon a specified date or schedule, separation from service, death, disability, change in control or ownership, or unforeseeable emergency. Code Section 409A(a)(2).

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2. Change in Ownership. Does the sale constitute a change in ownership that is a distribution event?

a. A change in ownership constituting a distribution event occurs if one person, or

more than one person acting as a group, acquires:

i. ownership of interests that, together with interests already owned, constitutes 50 percent or more of the total fair market value or total voting power of interests of the entity. Treas. Regs. Section 1.409A-3(i)(5)(v); or

ii. Assets that constitute 40 percent of the total fair market value of the assets of the

entity, without regard to liabilities associated with the assets. Treas. Regs. Section 1.409A-3(i)(5)(vii).

b. If there is a change in ownership for Section 409A purposes, a special rule allows

deferred payments based on equity ownership, rights or value to be paid out in the same manner and at the same time as equity holders are paid. Treas. Regs. Section 1.409A-3(i)(5)(iv).

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3. Change of Control. A change of control occurs for purposes of Section 409A if one person, or more than one person acting as a group, acquires interests that constitute 30 percent or more of the total voting power of the entity and a majority of the governing Board is replaced by members not endorsed by a majority of the existing Board. Treas. Regs. Section 1.409A-3(i)(5)(vi).

4. Separation from Service. Is there a separation from service in

connection with the sale that constitutes a distribution event?

a. A stock sale of a subsidiary would not result in a separation from service with employees who continue to render services to the buyer group after the sale. Section 409A Regulations Preamble, VII(C)(2)(F).

b. An asset sale would typically result in a separation from service, although buyer and seller may agree in writing before closing to treat employees uniformly to the contrary. Treas. Regs. Section 1.409A-1(h)(4).

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5. Vesting. Does the sale constitute a vesting event under the plan or agreement? If not, consider requiring that the business employees be vested. Such accelerated vesting may be a parachute payment. See Section II(F).

6. Plan Termination. Is the nonqualified deferred compensation being paid

upon closing to the business employees? If not, consider whether Section 409A permits termination and payout following closing. See Treas. Regs. Section 1.490A -3(j)(4)(ix)(B).

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H. Underfunded Single-Employer Plans. Liability for any underfunding of defined benefit pension plans sponsored by a single employer or a controlled group extends to all members of the controlled group. Section 302(b)(2) of the Employee Retirement Income Securities Act of 1974, as amended (“ERISA”). 1. Failure to make minimum funding obligations of $1,000,000 or more

results in a lien on assets of all controlled group members. Code Section 430(k)(1).

2. Code Section 4971 imposes a 10% excise tax on single-employer pension

underfunding which is a joint and several liability of all controlled group members.

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I. Underfunding of Multi-Employer Plans. Withdrawal liability is imposed for any underfunding of vested benefits on a withdrawal or certain partial withdrawals from multi-employer pension plans. Withdrawal liability may be imposed on any member of a controlled group. ERISA Section 4001(b). 1. A complete withdrawal occurs on cessation of obligation to contribute to

the plan. ERISA Section 4203. 2. A partial withdrawal can occur on cessation of the obligation to contribute

only at certain facilities or a decline in contribution obligations of 70% over a few years. ERISA Section 4205.

3. A buyer of assets does not generally inherit the funding obligation unless

it assumes the obligation. ERISA Section 4204. However, withdrawal liability may be imposed without regard to a transaction, if a principal purpose is to evade or avoid such liability. ERISA Section 4212(c).

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4. Some courts have held certain “successor” employers in an asset purchase may be liable for the Seller’s delinquent contributions to a multi-employer plan. Upholsterers’ Int’l Union Pension Fund v. Artistic Furniture of Pontiac, 920 F.2d 1323 (7th Cir. 1990).

This outline is just a brief summary of certain employment and benefit issues involved in carveout transactions and is not intended to constitute legal advice or to be relied upon as to the issues in any particular transaction.

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John A. Wilhelm, Partner [email protected]

Tysons Corner

T 703.760.1917 F 703.821.8949

John Wilhelm counsels businesses regarding employee benefits and compensation matters, including the establishment, operation, and tax and ERISA implications of qualified retirement plans including pensions, 401(k) plans and ESOPs, nonqualified deferred compensation plans and stock option, stock purchase and restricted stock plans. This includes advice regarding establishing and maintaining the tax-exempt status of VEBAs and profit-sharing, pension and welfare benefit trusts and the application of UBIT to any of their profit making activities. This also includes advice in structuring nonqualified deferred compensation plans to comply with Internal Revenue Code Section 409A.

© 2012 Venable LLP

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