First off, I want to congratulate once more our Finnish Information Processing Association, FIPA. The occasion is their 60th birthday, so greetings go to Robert, Tiina and the rest of the team! They organized a very interesting seminar some days ago on recent developments in the Finnish ICT sector. There were plenty of great speakers, Mikko Hyppönen, Ari Rahkonen and Turkka Keskinen just to mention a few. The product of the decade in Finland was also elected and Linux won the category—perhaps not surprisingly. We can say so congratulations for that achievement as well!
Then, to our topic. I promised that this time I would continue our M&A blog but, as it happened, I got so much carried away from technology issues yesterday, so I thought that I’d write something about technology and M&A. More precisely, it would be corporate law. I decided to talk a bit about technology licensing and use of technology as a contribution in kind. This is actually a real-life situation with cross-border elements and we can imagine that the background is that a Finnish technology company (leader in its field) is doing an M&A arrangement with its competitor in one of the BRIC countries. The following gives to you an outline of the relevant sections of chapter 9 of the Companies Act:
Section 12 — Contribution in kind
(1) If, instead of cash, the subscription price is paid in full or in part with other assets (contribution in kind), the assets shall at the time of conveyance have a financial value to the company at least equal to the price thus paid. An undertaking to perform work or provide services shall not be used as contribution in kind.
(2) The share issue decision shall contain a mention of the payment of the subscription price in kind. In addition, the decision shall contain an account specifying the contribution in kind and the price covered by it, as well as the circumstances relevant to the valuation of the contribution and the methods of valuation. If the provisions in this subsection have not been complied with, the subscriber shall prove that the contribution had a financial value to the company equal to the subscription price. Any shortfall shall be paid to the company in cash.
(3) If the subscription price is paid in cash on condition that the company is to acquire assets against consideration, the provisions on contribution in kind apply correspondingly to the acquisition.
Section 14 — Registration of new shares
(4) If a share has been paid for in kind, also a statement by an auditor on the account referred to in section 12(2) and on whether the assets had a financial value to the company at least equal to the price thus paid shall always be attached to the registration notification. (461/2007)
Two alternative options for executing the deal were discussed at the beginning:
A. the company would issue new shares first to itself and then hand over such old shares (pay attention to word "old" so these are no longer newly issued) to the buyer. According to the CFO, the original intention presumably was to avoid some of the above Companies Act’s formalities, such as the above-mentioned accounts specifying the contribution in kind and the price covered by it, as well as the circumstances relevant to the valuation of the contribution and the methods of valuation, or auditor statements on valuation; or
B. the company would make use of an official Companies Act’s contribution in kind structure. In other words issuance of new shares in which the value of the technology is used as a payment.
The idea that the CFO originally had in mind with option A was that with this solution, the price for the handover of our technology and the price for the shares would be set off (“they give us shares with a value and we give the technology with a value and neither party pays anything”). However, under Finnish law, if you hand over your own shares (like in option A) it is technically the same as an issuance of new shares. The second point is that if you pay the subscription price under circumstances where a precondition is that the subscribing company will acquire assets or services from the issuer (or for example from its inner circle so in theory it could be anyone), then it is again technically a contribution in kind under the Companies Act.
Could we circumvent formalities of the Companies Act in this way like CFO planned in option A? Well, the issue was actually discussed when the Companies Act was implemented and the answer is no. Valuation of technology is difficult we all must admit especially nowadays when the technology can be seen in many cases to have strategic value (as opposed to mere calculations based on revenue flows and enforcement). In general the value of a technology-based company or valuation of mere technology as such is more connected with the time and place—what is the value needed to execute the deal?— rather than following statistics or making mathematical calculations regarding the “right price”. As the Board has a general obligation to work for the benefit of the shareholders, it is definitely something that they need to evaluate on their shareholders’ part whether the minimum value is at least equal to the value paid for the shares and circumvention is not unfortunately possible. As a general guidance, my recommendation to questions such as, “what is the right price?” is that it is not the right price that is relevant but whether the technology has “at least the claimed value”. Here the issue is to analyse the story behind the valuation, typically giving you an idea whether the pricing is correct or not. If you have any hesitation, consider requesting fairness opinion from a third party, such as the good people from KPMG who have a top notch team for this. It was also discussed how to value the technology in this kind of event, but I think it deserves another posting.
But this is not the whole story. Especially in a cross-border environment, the investment was about to be made to a BRIC country and therefore the applicable legislation was not Finnish. This makes the situation slightly different and one should evaluate whether local law says anything about these kinds of arrangements.
One also needs to evaluate the taxation elements in this deal. Are in-kind structures and sale of technology treated differently in taxation? Tax authorities do not recognize set-off as a legal construction and therefore issuance of shares and sale of technology would be treated independently. If you end up “selling” your technology, then you probably end up paying taxes as well, while contribution in kind is typically tax-neutral. I am not a taxation law expert and this is a generalisation that I will make even at the risk that this might be slightly incorrect. Also this tax issue was put forward for more detailed review to our local partner.
To sum up, we ended up recommending a traditional in kind structure unless the local applicable law would have brought to the table any new aspects. Please note that this story is simplified in a manner that not all cross-border elements and taxation issues are reviewed here, but hopefully this helps you forward in technology transactions!