Strategic commercial interventions: options and case studies

3. Types of Intervention Structures

3.1 Loan to Equity

Equity is a measure of ownership in a company. Most companies grow by issuing a mixture of debt and equity financing. In some cases, a company may have borrowed money containing a provision that allows the lender to “swap” the debt for equity. Alternatively, the lender may approach the company and ask to convert the loan amount to equity.

In some cases, a company may have borrowed money containing a provision that allows the lender to swap any debt for equity. Alternatively, the lender may approach the company and ask to convert the loan amount to equity. Finally a company may approach their lender and ask if they would be willing to swap the outstanding debt for equity.

Regardless of what option is taken, a portion of the company’s debt will be written off in exchange for a corresponding amount of ownership in the company. In the context or restructuring or refinancing, a company will award equity for shares. Before agreeing to this it is important that the following primary commercial considerations are made:

• How much debt will be swapped for equity?
• What proportion of total equity will the lender (SG) obtain?
• What rights will the company attach to the newly issued shares?
• Will there be any limitations on the lenders right to sell the shares to a third party?

3.2 Financial Guarantee

A financial guarantee is an agreement that guarantees a debt will be repaid to a lender by another party if the borrower defaults. Essentially, a third party acting as a guarantor promises to assume responsibility for a debt should the borrower be unable to keep up on its payments to the creditor.

Guarantees can be financial contracts, where a guarantor agrees to assume financial responsibility if the debtor defaults, it is a non-cancellable indemnity. Other guarantees involve security deposits or collateral that can be liquidated if the debtor stops paying for any reason. A financial guarantee doesn't always cover the entire liability. For instance, a guarantor may only guarantee the repayment of interest or principal, but not both.

A letter of intent (LOI) is also a financial guarantee. This is a commitment that states that one party will do business with another. It clearly lays out the financial obligations of each party but may not necessarily be a binding agreement.

LOIs are commonly used in the shipping industry, where the recipient’s bank provides a guarantee that it will pay the shipping company once the goods are received.

3.3 Purchase of a Company’s Assets

There are two ways a buyer can acquire a business, either by way of a share purchase or asset purchase. While both structures are capable of achieving broadly the same commercial objective, there are advantages and disadvantages to each, together with fundamental differences in both legal effect and the tax treatment. Although this section discusses asset purchase it would also be relevant to cases of asset sale if the government is the shareholder in the public body.

3.4 Asset Purchase

An asset purchase involves the buyer acquiring select assets and rights and sometimes assuming responsibility for certain liabilities relating to the business. The types of assets (both tangible and intangible) which a buyer commonly purchases include, for example, the business premises, lease of the premise, benefit of business contracts, intellectual property rights (signage and telephone numbers etc.), plant and machinery, goodwill and stock.

The buyer and seller will negotiate precisely which assets the buyer will acquire from the business upon completion. The assets which are not agreed to be purchased by the buyer under the asset purchase agreement will remain with the seller.

3.5 Share Purchase

A share purchase involves purchasing the shares of the company from the shareholders. A limited company has its own ‘legal personality’, separate from that of its owners. Therefore, the company as an entity owns its business, assets, obligations, liabilities and rights independently. A buyer purchasing the shares of a company essentially acquires everything owned by that company (including the liabilities). The only assets which change hands are the shares.

The principal document involved in the sale of shares is a share purchase agreement, which will set out the terms upon which the buyer shall purchase the shares. Share purchase agreements can often be quite lengthy based on the complexity of the business, and if the consideration being paid for the business is particularly high or paid over a deferred period of time.

The most significant difference between a share purchase and asset purchase is that with an asset purchase, the buyer has the ability to control and pick which assets are being purchased, allowing the buyer to choose only the best assets and leave behind any liabilities. In contrast, when buying the shares of a company, the company’s separate legal personality means that the buyer has no control over what is obtained and will need to carry out legal due diligence to ascertain all the assets and liabilities.

The flexibility of an asset deal means that this structure is often favoured by buyers and sellers, especially where a business has significant liabilities, which can be left behind.

Advantages of Asset Purchase

• Negotiating power – the buyer can decide what, if any, assets or liabilities it is going to assume in the transaction.
• Quicker sale – less due diligence for the buyer
• Balancing allowance – a sale of assets which have fallen in value, may give rise to a capital allowances that would not arise on share sale.
• Retained assets – the seller can choose which assets to sell and which to keep.

Advantages of Share Purchase

• Entrepreneurs’ relief – if the shares are sold for more than the seller paid for them there is likely to be a chargeable gain.
• No double tax charge – there is a potential double tax charge on an asset sale however with a share purchase, the proceeds of sale are paid directly to the company’s shareholders.
• Roll-over Relief – seller may be able to defer tax on chargeable gains.
• No Capital Allowances Balancing Charges