We continue to see transactions where shareholders retain a portion of their equity (generally referred to as an equity roll or rollover transaction) in cross-border M&A transactions. These transactions often present unique challenges, including tax issues, questions of fairness to non-rolling shareholders, regulatory scrutiny and, particularly with respect to a US target, judicial scrutiny. Additionally, ongoing Canadian-US trade tensions may impact the attractiveness and structuring of rollovers. This insight explores key aspects of cross-border rollover transactions in both public and private M&A deals.
What is a rollover?
For purposes of this insight, a "rollover transaction" refers to apartialrollover arrangement in a public or private M&A transaction, where one or more (but not all) of the target shareholders (theRolling Shareholders) exchange (roll) all or part of their equity in the target for equity in the buyer (theBuyer) or an entity controlled by the Buyer. In a purely Canadian context, typically this share-for-share exchange can be accomplished on a tax-deferred basis. However, in a cross-border context, achieving this tax deferral may be complicated and is subject to applicable Canadian and US tax laws. The form of consideration paid to the Rolling Shareholders is typically a combination of cash and shares. The non-Rolling Shareholders generally receive cash consideration for their shares and have no involvement with the post-closing entity.
In the majority of cases, Rolling Shareholders consist of management shareholders that the Buyer wants to retain for continuity in managing the post-closing entity. The most common type of Buyer that requires a management rollover is a private equity buyer (or an operating company that is owned by a private equity buyer) that wants the management team (or certain key individuals) to remain with the company to drive ongoing business success. In thePartial Rollover Transactions in Canada - Morrison Park Advisors2024 survey of 13 recent rollover transactions (theSurvey), over half of the buyers were private equity firms, the vast majority of whom were US-based.
While rollovers have traditionally been associated with public M&A transactions, they are prevalent in private transactions as well. Unlike public rollovers in Canada, which are subject to regulatory scrutiny under Multilateral Instrument 61-101 -Protection of Minority Security Holders in Special Transactions(MI 61-101), private deals typically are not subject to regulatory oversight and therefore benefit from greater flexibility, though fairness issues may be even more relevant and could create issues for target boards to consider, particularly in the exercise of their fiduciary duties. With respect to US targets, rollovers may be subject to US judicial scrutiny of the target board's exercise of its fiduciary duties and, in certain circumstances, rollovers could be reviewed to ensure that the rollover was the result of a fair process and resulted in a fair price.
Key considerations
The first consideration for the various parties is whether they want (or are willing to have) a rollover at all.
For Buyers, the benefits of a rollover transaction include (i) the management team having "skin in the game" after the M&A transaction, (ii) reducing the amount of equity financing and debt financing that the Buyer needs for the transaction and (iii) obtaining a deal that may not otherwise be obtainable without a rollover. However, the downside is having minority shareholders (and the minority protections they are typically afforded) going forward, thus giving up some degree of post-closing control, as well as economic dilution.
For target companies, the benefits include obtaining a deal that may not otherwise be available without a rollover. The downsides include potential issues of fairness, as only a select group of shareholders are offered the rollover, which puts some negotiating power into the hands of the Rolling Shareholders. In addition, this disparity in treatment and potential unfairness can attract judicial or regulatory scrutiny with respect to the target board's exercise of its fiduciary duties.
For the Rolling Shareholders, a rollover means receiving less cash up front while balancing the benefits and risks of retaining equity in the post-closing entity. Further, the Buyer may impose vesting conditions on the Rolling Shareholders' new equity that were not in place on their existing equity of the target. The desire to roll, and the amount that a Rolling Shareholder may want to roll, will depend on the specific circumstances of the Rolling Shareholder and the deal. For example, does the Rolling Shareholder believe that there is upside in the combined entity? In addition, what is the cash position of the Rolling Shareholder? A Rolling Shareholder with significant wealth outside of the target may prefer a larger roll, given that they have little need for cash. Finally, and especially in a cross-border context, there is added complexity associated with achieving a tax-deferred rollover, and the parties' appetite for this added complexity may vary.
What has led to an increase in rollovers?
Several factors have driven the rise in rollover transactions involving Canadian targets in recent years, particularly in cross-border deals:
- Private equity activity:US private equity firms continue to deploy significant capital into Canada, often preferring structures that include management rollovers.
- Canadian IPO market:A few years ago, there was increased activity in the Canadian IPO market that created an increased pool of founder-controlled businesses. The businesses are now ideal candidates for rollover transactions because many have depressed valuations and the founders may be seeking exit opportunities with future potential upside through a rollover.
- Canadian legislative framework:The Canadian legislative framework works well for rollover transactions. While the framework of MI 61-101 imposes requirements on parties to rollover transactions, it also creates a bit of a roadmap in which the transactions can be completed. In addition, regulators and courts have addressed transactions involving insiders and further set out what parties should or should not do in such cases1. MI 61-101 and these decisions provide US Buyers with a flexible and sanctioned roadmap to complete rollover transactions in Canada.
- Tax efficiency:Rollover structures may allow sellers to defer capital gains taxes in both Canada and the US. Comfort around using "exchangeable share structures" to achieve tax deferral for Rolling Shareholders resident in Canada in a cross-border M&A transaction has increased recently. Though a detailed discussion of exchangeable share structures is outside the scope of this insight, such structures can provide Rolling Shareholders resident in Canada with a tax deferral that would not otherwise be available when receiving shares of a non-resident corporation as part of the proceeds of disposition received on a sale transaction. Similarly, Rolling Shareholders resident in the US may be able to obtain tax deferral depending on the ultimate structure chosen.
Fairness issues
Despite the safeguards provided by MI 61-101, relevant case law and market practice, some Canadian target shareholders and market participants believe that rollover transactions may not be fair. Non-Rolling Shareholders might feel that even if the cash offer made by Buyer is reasonable, if the Rolling Shareholders may be receiving a "sweetheart deal" (i.e., the value of the role is greater than the value of the cash offer), they could still be unhappy. This raises two questions: (i) does it matter what the Rolling Shareholders are getting, or should the non-Rolling Shareholders vote based on the fairness of what they are receiving, and (ii) if it matters what the Rolling Shareholders are getting, is there adequate disclosure to determine the value of the roll?
The answer to the first question, at least in the view of some non-Rolling Shareholders, appears to be that it does matter what Rolling Shareholders are getting and it is not enough to be able to vote the deal down through the minority vote if some non-Rolling Shareholders want the ability to participate in the roll. The Survey showed that nearly one quarter of the deals were formally contested by one or more shareholders.
Regarding the second question, public targets are required to mail management information circulars to shareholders and such circulars must not contain any misrepresentations (which includes omissions of material facts). Notwithstanding this requirement, it is standard for circulars to contain a very brief description regarding the existence, but not necessarily the substance, of a rollover agreement. The relevant disclosure is often one to two sentences and merely states something to the effect that the parties entered into a rollover agreement pursuant to which the value of the consideration to the Rollover Shareholders is not greater than that paid to the other shareholders and the difference is only in the form of consideration. There is typically little or no description of the combined entity going forward, nor any analysis that would assist in determining the value of the consideration to the Rolling Shareholders. Given that this style of disclosure has consistently been used, it suggests that it meets disclosure standards, even if non-Rolling Shareholders feel it is inadequate.
As noted above, with respect to US targets, rollovers may be subject to US judicial scrutiny to ensure that the rollover transaction was the result of a fair process and resulted in a fair price.
Cross-border considerations
In cross-border transactions, particularly those involving US buyers and Canadian target companies, additional complexities arise. Some key considerations include:
- Regulatory and securities regimes: In Canada, securities laws, as well as MI 61-101, will be applicable to public deals and will govern matters such as disclosure, certain aspects of fairness and minority protections. If the Buyer shares being issued are of a US entity or are being issued to US persons, US securities laws will be relevant. Buyers and Sellers will need to be mindful of available exemptions under theSecurities Actof 1933, as amended, and state securities laws.
- Tax implications: Cross-border rollovers must be carefully structured to address tax implications in all relevant jurisdictions, ensuring that the transaction is tax-efficient for all parties involved.
- Deal structuring: US Buyers often structure acquisitions using Delaware-based holding companies, which may offer tax and governance advantages but require specific structuring to accommodate Canadian target shareholders. For example, if a Delaware-based entity is used, a Canadian holding shares in a Canadian target will likely lose their tax deferral unless some form of exchangeable share structure is implemented. This creates additional costs and complexities. Additionally, management incentives and equity plans may need to be restructured post-closing to align with US corporate governance practices.
- Exchange rate risk:Rollover Shareholders who accept US dollar-denominated shares must consider currency fluctuations (see below) and hedging strategies. Exchange rate volatility can significantly impact the post-closing value of the rolled equity, potentially making it a key risk factor for Canadian Rollover Shareholders.
Impact of US-Canadian trade tensions
Current trade tensions, tariffs and regulatory disputes between the US and Canada may have significant implications for rollover transactions in cross-border deals. These potential impacts include:
- Valuation uncertainty:If tariffs or trade restrictions increase costs for Canadian target companies, their valuations may be negatively affected. This could make any transaction, including a rollover, less attractive to Rolling Shareholders who may have a lower risk tolerance and a preference for liquidity in an uncertain market, or more attractive to Rolling Shareholders who anticipate that valuations will eventually recover.
- Deal structuring complexity:If tariffs or new trade regulations increase operational costs of the target business, US buyers may demand adjustments to rollover structures, such as reduced equity consideration or alternative financing mechanisms.
- Regulatory scrutiny:Increased trade tensions could lead to increased scrutiny of cross-border M&A transactions by the Competition Bureau in Canada and the Committee on Foreign Investment in the United States (CFIUS), potentially causing delays or additional compliance hurdles.
- Financing challenges:Economic uncertainty related to trade conflicts may impact debt financing for US Buyers. In response, Buyers may push for larger rollover percentages to limit their upfront cash commitments, transferring more risk to the Rolling Shareholders.
- Currency volatility:Trade tensions can create fluctuations in currency exchange rates, impacting the value of rolled equity.
Conclusion
We expect to continue to see cross-border rollover transactions notwithstanding the current economic and trade environment. Structuring these transactions effectively requires a careful evaluation of tax, securities, business and governance considerations, particularly in the context of US buyers acquiring Canadian targets. Additionally, ongoing US-Canadian trade tensions introduce new complexities that must be considered in deal structuring. As these deals continue to gain traction, companies, shareholders and advisors must remain vigilant in balancing fairness, regulatory compliance and commercial objectives in an increasingly volatile market.
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