alternative structures for life sciences companies: the llc holding company
DESCRIPTION
Explores the following: - Establishing the LLC Holding Company - Benefits and Drawbacks of Using the LLC Holding Company Structure - Timing ConsiderationsTRANSCRIPT
Alternative Structures for Life Sciences Companies: The LLC Holding Company
March 8, 2013
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Presentation Outline
Overview Establishing the LLC Holding Company Benefits and Drawbacks of Using the LLC Holding
Company Structure Timing Considerations Summary
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Overview: What is Driving the LLC Structure?
Life sciences companies often have – or envision – multiple programs
Multiple programs offer possibilities Multiple exits
Different funding streams for different programs
Goal is to realize the maximum value for all programs
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The Drawback of the C Corp
Sale or license of a program results in double taxation if net proceeds are distributed to shareholders
Sale of the stock of the whole company results in a single level of tax Buyer gets all programs, not just the ones it really wants
Little or no value attributed to “other programs”
Buyer likely to shut down the unwanted programs
Seller and its shareholders cannot realize the value of the other programs
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What is the Alternative if Remaining a C-Corp?
Spin-off the other program(s) at the time of the sale Likely significant tax cost
Spin-off the other program(s) at an early stage Lower value results in limited, if any, tax cost
Independent companies
Required to finance each separately
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The LLC Holding Company Structure
Investors invest in LLC and programs are held in subsidiaries (typically c-corps; possibly LLCs)
LLC Holding Company
Program 1 Program 2 Program 3
Investor 1
Investor 2 Investor
3
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Establishing the LLC Holding Co. Structure Original Company Merges with Merger Sub (tax free). Some or all of the existing shareholders set up LLC Holding Company with a wholly-owned subsidiary corporation. The subsidiary then merges with and into Original Company with all of the shareholders of the Original Company receiving corresponding interests in LLC Holding Company. Merger is tax free.
LLC Holding Company
Merger Sub
Merge Original Company
Existing Shareholders
Pre-Merger – Some of Existing Shareholders Post-Merger – All of Existing Shareholders
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Establishing the LLC Holding Co. Structure Creating the Program Subsidiaries. If a new program will be pursued out of IP located in the Original Company, the Original Company contributes IP to a newly formed C corporation subsidiary and distributes stock of subsidiary out to LLC Holding Company. Process is repeated for each program. This is a taxable transaction.
Original Company
LLC Holding Company
Program Subsidiary
LLC Holding Company
Original Company
Program
Subsidiary
Existing Shareholders
Existing Shareholders
IP/ Assets
Stock
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LLC Holding Company
Original Company (Lead Product) Program Sub #1 Program Sub #2
Establishing the LLC Holding Co. Structure Operating and Scaling Up. The R&D employees, administrative employees and lease remain at Original Company, which provides R&D services, administrative services and sub-leases space to each program subsidiary under intercompany services agreements. If a new program will be pursued out of IP located in an existing C corporation, that C corporation contributes IP to a newly formed C corporation subsidiary and distributes stock of subsidiary out to LLC Holding Company.
Existing Shareholders
Outside investor a possibility
Holds only cash and stock of subsidiaries
Services contracts with non-exclusive licenses to conduct R&D, etc.
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Tax Benefits of LLC Holding Company Structure
LLC holding company is a tax “pass through” vehicle
If program sale and distribution of net proceeds is effected by sale of stock of subsidiary, just one level of tax Taxable gain is passed through to investors in LLC
Distribution of cash proceeds to LLC investors is tax free
Can provide management equity at LLC level through profits interest No cash payment required – zero cost equity
Capital gain rather than ordinary income
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Other Benefits of LLC Holding Company Structure
Facilitates “Pure Play” equity investment opportunities in individual programs (at program sub) as well as all programs (at LLC)
Enhances preparedness for exit transactions, including management continuity after exits
Provides convenient collection vehicle for contingent payments
Can be implemented incrementally and is scalable
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Drawbacks of LLC Holding Company Structure More complicated capital structure
Employees and some investors are not familiar with LLCs
Transfer of IP from Existing Company into program subsidiaries is a taxable event from original company Could result in current tax due by existing company and
shareholders
Expensive to establish and administer Create and operate multiple entities instead of a single
entity
Need to track and allocate management time and other costs
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Drawbacks of LLC Holding Company Structure Expensive to establish and administer, cont.
No consolidated tax returns • Undesirable if some subsidiaries generate income and others
generate losses
Complex tracking of tax capital accounts
Corporate filings and sets of books and records for multiple entities
More expensive financing rounds because all economic and management terms must be precisely set forth; no corporate law to backstop
Need for Intercompany agreements
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Drawbacks of LLC Holding Company Structure Foreign investors and VC funds with institutional
LPs may be reluctant to invest in LLCs C corporation subsidiaries avoid UBTI and ECI issues
Tax imposed on inter-subsidiary movement of cash License deals would be at subsidiary level Double tax problem persists
IP may need to be divided into fields in licenses to subsidiaries May be tricky to draw lines between fields
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Timing Considerations
Waiting until second program has matured means the tax cost to implement structure may be too high
Establishing Holdco structure early in company life means a lower tax cost but may be offset by the extra cost of operating within the structure over time Uncertainty as to likelihood of multiple exits
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Summary
Is it worth it? Do you plan to develop multiple programs,
monetize these programs creating multiple exit events and distribute the proceeds to the shareholders upon each exit event?
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Wilmer Cutler Pickering Hale and Dorr LLP
Bill Caporizzo [email protected]
617-526-6411
Rosemary G. Reilly [email protected]
617-526-6633
Stuart M. Falber [email protected]
617-526-6663
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