9 From PLI’s Course Handbook Real Estate M&A And

9 from pli’s course handbook real estate m&a and reit transactions 2008: adventures at the intersection of main street and wall s

9
From PLI’s Course Handbook
Real Estate M&A and REIT Transactions 2008: Adventures at the
Intersection of Main Street and Wall Street
#14128
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8
bridge equity
W. Michael Bond
David Herman
Weil, Gotshal & Manges LLP
BRIDGE EQUITY
By: W. Michael Bond and David Herman
I.
What is Bridge Equity? Bridge Equity is a financing technique that
allows potential acquirers of companies or assets to commit to an
acquisition before the equity necessary for such acquisition is
raised. By obtaining a Bridge Equity commitment from a capital
source, the acquirer can proceed with a quick commitment, even
though the ultimate equity investors may not be located for a
substantial period of time. In essence, the Bridge Equity
commitment obligates the capital source to provide the required
equity to the acquirer and then locate syndication investors who
are willing to acquire such equity. Thus, the capital source bears
the risk that the syndication cannot be completed.
II.
Advantages to Acquirers:
A.
Less Equity. Bridge Equity allows acquirers the ability to
commit to a transaction by providing far less of the
acquirer’s equity than would otherwise be the case. In fact,
the acquirer may only be required to provide a fraction of the
equity that would be required if the transaction did not have
bridge equity.
B.
Timing. Bridge Equity allows Sponsors the ability to move very
quickly to commit to acquisitions. Since the Bridge Equity
provider is often the lender for the transaction as well, the
time required for underwriting, due diligence and funding is
not significantly increased.
C.
Unlike traditional Bridge Loans which often filled a gap in
the capital stack prior to Bridge Equity there is no
collateral for Bridge Equity and while there will likely be
economic consequences to acquirers if the Bridge Equity cannot
be timely syndicated (such as loss of promote and fees), there
is no ability of a Bridge Equity provider to foreclose and
wipe out the position of the acquirer.
D.
Representative Bridge Equity Terms:
E.
Bridge Equity Compensation. A Bridge Equity fee is charged
based on a percentage of the amount committed (plus a higher
percentage of any amount actually funded). The fee is
customarily capitalized into the cost of the transaction. The
Bridge Equity provider also typically receives a fixed
percentage accrual on any capital that is funded until such
capital is syndicated. This return is often paid by the
syndication investor who is then treated as having joined the
venture from inception for IRR calculations.
F.
Syndication:
1.
The time allowed for syndication may be up to one year
after closing in large transactions.
2.
There is great variation in the respective roles of the
acquirer and the capital source in the syndication
process. The larger and more experienced acquirers may
want significant control over the process before a failed
syndication. Less substantial acquirers may look to the
capital source to locate investors and run the process.
3.
Offering Materials - The sale of Bridge Equity will in
many cases qualify as the offering of a “security” and
therefore it must be offered under applicable “securities
law” requiring the acquirer and the capital source to
comply with applicable securities law and exposing the
acquirer and the capital source to securities laws
liabilities for, among other things, failing to adequately
disclose the risks of the investment. Thus, the parties,
will likely prepare a private placement memorandum in
order to make this disclosure. As a result, the
responsibility for preparation of the private placement
memorandum must be allocated between the parties and the
parties must also allocate responsibility and liability
for claims under the securities laws (whether based on the
contents of the private placement memorandum or
otherwise).
G.
Failed Syndication Remedies:
1.
If there is a failed syndication after a designated period
of time, there are usually consequences to the acquirer.
These may include:
*
Loss of promote
*
Loss of fees
*
Loss of control or decision making rights
*
Loss of control or influence of syndication process
*
Greater approval rights for capital source and/or syndication
investors
*
Subordination of acquirer’s equity
*
Increased returns to Bridge Equity provider
*
Buy/Sell rights for Bridge Equity provider
*
Forced Sale rights for Bridge Equity provider
H.
Transfer Rights. The acquirer would typically be prohibited from
transferring its direct or indirect ownership interest until the
syndication is complete.
I.
Indemnification for Transfer Taxes. Many Bridge Equity providers
will insist on an indemnity to protect it against any transfer
tax risk.
J.
Structure of Bridge Equity Transactions. The goal of the Bridge
Equity provider is to structure the transaction in a manner that
provides the most efficient treatment to the maximum number of
potential investors. Thus, the structure of the acquisition
vehicle will be of utmost importance to the Bridge Equity
provider. The following is a brief overview of some concerns
that various classes of investors may have:
K.
U.S. Tax Exempt Investors.
1.
Non-Governmental Plans (Not eligible for Fractions Rule).
These investors will typically be concerned with unrelated
business taxable income (“UBTI”) and can generally avoid
UBTI by owning their interest through a blocker corporation
or a REIT. A REIT is a much more tax efficient tax blocker
as there is no imposition of a corporate level tax.
2.
Non-Governmental Plans (Fractions Rule Eligible). To the
extent the transaction structure can be compliant with the
Fractions Rule (which is very fact specific and beyond the
scope of this discussion) such investors can avoid UBTI
without the utilization of a blocker corporation or REIT.
3.
Governmental Plans. These investors will often take the
position that they are not subject to U.S. federal income
tax but if given a choice many would prefer to invest
through a REIT to avoid any risk of incurring tax or UBTI.
L.
U.S. Taxable Investors. These investors should be indifferent to
investing through a REIT (except for the potentially draconian
consequences of failing to comply with the REIT requirements and
the potential taxes or penalties that could be levied for
non-compliance).
M.
Foreign Investors
1.
Foreign Governments. Most foreign governments would want to
invest through a REIT (provided they own less than 50%) thus
allowing them to avoid Federal income tax (pursuant to
Section 892 of the Code) on the sale of shares in the REIT
(if the exit strategy is through a sale of REIT shares) as
well as on ordinary dividends received from the REIT. As a
result of a recently enacted notice by the IRS Section 892
cannot be used to exempt foreign governments from Federal
income tax on capital gain distributions or liquidating
distributions from a REIT if the exit strategy is not
through the sale of REIT shares;
2.
Other Foreign Investors. These investors would typically be
concerned with “effectively connected income” (“ECI”) and
the potential requirement to file U.S. tax returns. A
foreign investor in a REIT could recognize income from its
investment from three sources: ordinary dividends, capital
gain dividends and gain on sales of shares in the REIT.
Ordinary dividends will generally not constitute ECI but
will be subject to withholding at a 30% (or lower treaty)
rate. Capital gain dividends are subject to tax to foreign
investors under FIRPTA at a withholding rate of 35% and are
treated as ECI, taxable to the investor at U.S. graduated
rates in the same manner as U.S. investors are taxed on that
income. In addition, if the foreign investor is a
corporation it may also be subject to the 30% branch profits
tax. The incurrence of ECI also causes such investor to have
a U.S. federal income tax filing obligation. Thus, foreign
investors in a REIT will not avoid the requirement of filing
U.S. federal income tax return if the REIT disposes of any
of its underlying properties prior to the investors
disposing of their interest in the REIT. Note that because
REITs generally are not in the business of holding
properties for short durations, a filing requirement may not
arise for the first few years. Gain recognized by such an
investor upon a sale of shares of the REIT will not be taxed
under FIRPTA if the REIT is a domestically-controlled REIT
(more than 50% is owned by U.S. investors).
N.
Investment Company Act of 1940. All parties will typically seek
to avoid the obligation to register as an “investment company”
under the Investment Company Act of 1940. Since limited
partnership interests in a limited partnership (generally the
vehicle that would be used in connection with syndication) are
treated as an “investment security” the structure will need to
qualify for an exemption from the 1940 Act. Typically limiting
the pool of investors to “qualified purchasers” or limiting the
ownership to 100 or fewer beneficial owners would qualify for
such an exemption.
O.
Employee Retirement Income Security Act of 1974. The goal of the
structure will be to allow ERISA investors to participate
without subjecting the transaction to ERISA fiduciary rules or
prohibited transaction rules. This can be accomplished by having
the investment vehicle qualify as a VCOC or REOC.
P.
Summary
Bridge Equity was developed as a natural response to market conditions
that required investors to move quickly in order to be in a position
to outbid rival potential acquirers. It also provided capital sources
with product to distribute to syndication investors. While there are
myriad issues that must be solved in order to properly align the
incentives of acquirers and capital sources and to make the investment
attractive to a panoply of potential syndication investors, the
advantages of this product are apparent. How this product will
continue to evolve in light of over charging market conditions will be
important to all of the constituent parties to these transactions.