Alternative Structures for Life Sciences Companies: The LLC Holding Company

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

© 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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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



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.


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


Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Alternative Structures for Life Sciences Companies: The LLC Holding Company

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