Business like/ objective M&A Transactions

Business like/ objective M&A Transactions

Author: Joris Kersten MSc/ Owner Kersten Corporate Finance

Kersten Corporate Finance: Selling/ buying companies in The Netherlands (M&A). www.kerstencf.nl

Valuation training: 4th – 8th November 2024 @ Amsterdam South. Financial Modelling & Deal Structuring. www.joriskersten.nl

Source used: Onderbouwd waarderen is lucratief. C. Denneboom. Tijdschrift Familie Bedrijven. April 2022.

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Introduction

Lets imagine a company is sold for 1 million.

And the total purchase price is 100% financed with a loan, by the seller, for 10 years with an interest of 6%.

Here basically the tax authorities in The Netherlands say the deal is NOT “business like” or “objective”.

This because the buyer makes a crazy high return on equity.

The tax authorities could argue here that the interest and paying back of the principal of the 1 million should be discounted based on a “market interest rate”.

And not on the suggested 6%.

The tax authorities can also argue that the appropriate market rate should be the “cost of equity unlevered”.

This because the loan has the same characteristics as equity, because it functions as equity within the company.

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When we discount all the interest, and paying back of the principal, against the cost of equity, let’s assume that the present value of the loan would be 600k.

Then 1 million -/- 600k = 400k.

And this 400k would then be taxed, because buyer would have received this as un-legitimate, because it is not objective based on market conditions.

It basically is an equity stake received against too positive conditions.

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The financing perspective

The above view of the tax authorities actually is not fully correct.

Some nuances need to be made.

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Whether the transaction is business like/ objective should not be seen from the perspective of the buyer.

It should be seen from the perspective of the supplier of the loan.

And this on the basis of financing ratios like for example:

-DSCR (debt service capacity ratio).

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With a business like/ objective financing structure, the 1 million would for example have been financed with:

-60% bank financing,

-20% vendor loan,

-20% equity by the buyer.

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Let’s assume that the bank financing, and vendor loan, still make 6% in the mix, and that the DSCR is all reasonable.

Then we can conclude that the only part of the deal that is not business like, is the missing equity part !

So we need to focus on the 20% that should have equity, this would be 200k (0,2 * 1 million).

Let’s assume that when we discount the interest & principal on the 200k against the cost of equity, the present value would be around 100k.

Then not 400k is received un-legitimate on non business like grounds, but only 100k instead !!

(200k that should have been equity -/- the present value)

So only 100k should be additionally taxed, and not 400k.

And still it is very debatable whether to discount (the missing 200k equity) against the cost of equity, because it still is a loan from the seller in this example !

And this loan has another risk profile than equity, so using the cost of equity is also not fully correct, the discount rate should be a little lower.

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So when looking at the “business like nature”/ objectively of a M&A transaction, then make your calculations based on an alternative “synthetic credit rating”.

This way you can calculate what part of the deal might be classified as non “business like” for the tax authorities.

On top of that, take the financing conditions into account (e.g. security provided), also when they are not there.

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Hope this was helpful, see you next week again,

Best Joris???

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Source used: Onderbouwd waarderen is lucratief. C. Denneboom. Tijdschrift Familie Bedrijven. April 2022.