Friday, April 15, 2011 9:37 AM
Verne, B. Michael
Subject: HSR Analysis Question
I hope all is well. Please let me know whethermy analysis of the transaction described below is correct.
Twocompanies, E (our client) and MC, want to create a Newco LLC that will acquireand invest in two related businesses, H LLC and T LLC. The acquisition would beeffected in three related contemporaneous transactions.
InTransaction 1, E and MC would create a Newco LLC ("Newco") and OpcoLLC ("Opco"), a wholly owned subsidiary of Newco. E would contribute$45 million in cash to Newco and MC would contribute $26 million in cash toNewco. In exchange Newco will issue three classes of membership interests, bothpreferred and common. Class A limits are preferred membership interests and aredivided into A-1 and A-2 units. A-1 units are senior to A-2 units. Class B, andClass C units are common membership interests. E would receive 60% of the ClassA units (in tile form of A-1 units), and MC would receive 40% of tile Class Aunits (in the form of A-1 and A-2 units) and 100% of the Class B units. TheClass C units would be distributed to the management of New co.
InTransaction 2, the owners of E LLC and T LLC, two affiliated LLC's, wouldcontribute all of H LLC's and T LLC's outstanding membership interests to O, anewly created LLC in exchange for membership interests in O.
Intransaction 3, Newco would acquire all of H LLC's and T LLC's membershipinterests from O for $60 million in cash (less the amount of outstanding debtassumed) and a potential earn-out of up to $30 million over five years.
Distributionsfrom Newco would be made pursuant to a waterfall arrangement, whereby the A-Iand A-2 preferred membership interests are paid first, before holders of commonclass B and Class C interests receive anything. Specifically, tile A-1 holderswould be entitled to an 8% cumulative preferred return and repayment of theircontributed capital, and then the A-2 holders would receive the same preferredrate of return and repayment of their contributed capital. Once the Class Aholders received this initial rate of return, any proceeds would then be splitamong all three membership classes. First, 70% of any proceeds from Newco wouldbe distributed to the Class A holders, 17.5% would be distributed to tile ClassB holders and 12.5% would be distributed to the Class C holders, until theClass A holders received an aggregate amount equal to 2 times their investedcapital. Thereafter, 43.75% of any proceeds from Newco would be distributed tothe Class A holders, 43.75% would be distributed to the Class B holders, and 12.5%would be distributed to the Class C holders, until the Class A holders receivedan aggregate amount equal to 5 times their invested capital. Thereafter, ClassA holders would be entitled to 17.5% of any proceeds, Class B holders wouldreceive 70% of any proceeds, and Class C holders would receive 12.5% of anyproceeds.
Stage 1 -E has no HSR filing obligationbecause the formation of New co is exempt under 802.4 because Newco does nothold non-exempt assets with an aggregate fair market value greater than $66million (the current HSR filing threshold).
Stage 2 -E has no involvement with theformation of O and has no filing obligation. The owners of H LLC and T LLC mayhave a filing obligation if the formation of O is not exempt.
Stage 3 -Newco's acquisition of H LLC'sand T LLC's membership interests from 0 for $60 million in cash (less assumeddebt) and up to a $30 million earn out is likely reportable if the fair marketvalue of the transaction is $66 million or more. Assuming that both the size oftransaction and the size of person tests were met, the question is who controlsNewco. It is our understanding that the payment of preferred units isconsidered debt and is thus not considered when determining who controls Newco.Indeed, a non-corporate interest is defined as a right to profits or assetsupon dissolution after payment of its debts. In this case, because Newco willnot be making regular profit distributions, the appropriate test for controlfocuses on whether anyone person or entity would have the right to 50% of theassets of Newco upon dissolution. The waterfall arrangement described above,indicates that after all of the Class A holders preferred rights are paid, theClass B holders would have the right to 70% of any remaining proceeds.Therefore, we believe that MC (not E) will control Newco, and E does not havean HSR filing obligation. MC will have a HSR filing obligation if the fairmarket value of the transaction is $66 million or more and no exemptions apply.