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M&A Deal Makes Payment Partly Dependent on PPP Loan Forgiveness

Posted on Dec. 15, 2020

Mergers and acquisitions involving companies with a Paycheck Protection Program loan have been fraught with complexities, but a recently announced transaction reveals a solution for dealing with uncertainty and risks.

ZAGG Inc., a global mobile lifestyle company, and a buyer group led by Evercel Inc. announced December 11 that they have entered into a definitive agreement in which the buyer group will acquire all the stock of ZAGG.

According to the terms of the agreement filed with the SEC, ZAGG stockholders will receive $4.20 per share in cash upon closing and be entitled to an additional amount of cash up to 25 cents per share, contingent on the company’s PPP loan being forgiven and any related audit satisfactorily completed.

The PPP, created by the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136), generally provides small businesses with loans that are forgivable tax-free if a specified portion of the loan is spent on payroll costs over a covered period and the remainder is used for other enumerated operating costs. 

In the acquisition of ZAGG, which is effected by means of a reverse triangular cash merger, the contingent value right (CVR) depends on whether the company “timely deployed the proceeds of the loan for eligible expenditures,” Robert Willens of Robert Willens LLC told Tax Notes.

“While we have seen many deals involving the use of CVRs, their payoff usually depends on the success of a pharmaceutical that the target company is in the process of developing,” Willens said. For special purchase acquisition company deals, the payoff is sometimes “geared to the price of the acquiring corporation’s stock during a specified period following the acquisition,” he added.

“This is the first time — but won’t be the last, I’m sure — where the CVR’s maturity value is geared to the forgiveness of a PPP loan,” Willens said.

Regarding the tax treatment of the rights, Willens said, “the IRS almost never allows a transaction to remain ‘open,’ so it’s a safe bet that shareholders of ZAGG will have to include the fair market value of the CVRs in the amount realized when computing their gain or loss from the sale.”

According to the companies’ “PPP Loan Forgiveness Rights Agreement,” the contingent rights in the ZAGG deal are nontransferable subject to limited exceptions.

“It’s a shame these CVRs are not tradable or readily marketable,” Willens said, suggesting that “it would be an interesting investment for a trader who feels strongly that the PPP will, in fact, be forgiven.”

Willens said that if the rights were transferable, they could probably be purchased “at a discount to their face value, leading to a quick arbitrage-type profit for the purchaser when the CVRs mature.”

Rights for Deductibility?

In the Bipartisan Emergency COVID Relief Act of 2020, introduced December 14, a group of Senate and House lawmakers proposed making deductible the business expenses paid for with the proceeds of PPP loans.

If coronavirus relief legislation is enacted that provides for PPP deductibility, that would overturn Treasury and the IRS’s stance against making those expenses deductible, which they argue would allow businesses a double benefit by granting a deduction for expenses paid for with a tax-free forgivable loan.

Perhaps in M&A deals with CVRs, “additional consideration should be provided if legislation is enacted that allows the target to deduct the eligible expenses,” Willens said. “If I were negotiating one of these CVRs, I think I’d ask for additional consideration should those expenses wind up being deductible.”

PPP-Related Covenant

According to M&A practitioners, the PPP loan forgiveness feature has complicated the structuring and negotiations of deals in part because of the parties’ conflicting interests, unclear guidance, and potential for delay stemming from presumptions by the lender and the Small Business Administration.

In an October 2 notice, the SBA provided long-awaited guidance on the required procedures for changes of ownership of a PPP borrower, including when SBA preapproval of transactions is required. The SBA will review requests for changes of ownership and provide a determination within 60 calendar days of receiving the lender’s complete request, according to the notice.

The ZAGG transaction is expected to close in the first quarter of 2021. By January 31, 2021, the company must prepare and file all documents and applications required for obtaining the SBA’s and lender’s consent to the organization’s change in control. ZAGG must also take all PPP-related actions necessary “to permit the consummation of the Merger without violating any regulations of the SBA,” including making any required deposits with the lender or other party, according to the agreement.

Also by January 31, ZAGG must prepare and file its application for forgiveness of the PPP loan consistent with SBA regulations in effect at the time and “use commercially reasonable efforts to obtain forgiveness of the PPP Loan including complying with all deadlines, requests, inquiries and similar items with respect to any such application,” the agreement states.

If the conditions for payment of the CVRs — that is, the SBA’s audit of the PPP loan has been satisfactorily completed and forgiveness of all, or a portion, of the amounts outstanding under the PPP loan is confirmed — aren’t satisfied as of December 31, 2022, the rights will expire.

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