In the sale or purchase of a private company its still necessary to use best practices in order to have the parties feel good about the transaction.  Using the services of a corporate financial advisor, a tax accountant, a corporate lawyer who work together as a team from the beginning will provide you with the ability to see things that are often overlooked by purchaser in a company.

In a past transaction the sole shareholder(owner) of a private company sold his shares to an independent purchaser and the capital gain realized was eligible for the small business corporation shares capital gains deduction.  So far so good for both parties.

However, one of the most common issues which is misunderstood by both the purchase & seller is the “Due to/from shareholder” account.  On the surface it seems like a fairly straight forward liability account, the credit balance in the account is owed to the shareholder.  Here is where the 3 professional advisors, a corporate finance lawyer, the tax accountant, and the corporate financial advisor know that this is a liability like any other liability and is owed to the shareholder.  Some accountants have trouble understanding this because they assume that the company had sold its shares, but the shares are separate from its liabilities.

Another effect of this “credit balance” in the Due to Shareholder account is when the new owner decides to draw money out of this account he will have been deemed to have received a “taxable benefit” under Section 15 of the Income Tax Act. Why? The withdrawal transaction isn’t a return of capital it’s a debt owed to its the former owner.  The capital gain for the seller of the business in this situation is also overstated which the capital gains exemption the owner has here.

An example might help here: the seller of the business sells her business for $500,000 and the owner has a credit balance of $150,000 in the Due to Shareholder account.  In the sales agreement the buyer of the business should ensure that the agreement reflects an allocation of the purchase price of $150,000 to purchasing the debt of the Due to shareholder account and the remainder allocated to the purchase of the seller’s shares.  The reason is that the purchaser has a debt owed by the company to herself and when she wants to withdraw some of it, it will be tax free unlike the prior situation.

This unfortunate situation can be reversed, but if the parties use best practices and have a coordinated team of advisors working from the beginning  it will save time and money for both the buyer and the seller.  But sometimes, the transaction go through due to no advice for either party and the consequences are a tax project case resulting in more money spent on a tax advisor later.  In a case documented in CMA magazine an accountant figured they fixed this by exchanging the debt for more shares, but caused more tax problems in the allowable business investment loss  issues and failed to take into account subsection 80(2) of the income tax act which allows the debt to be settled for the fair market values of shares issued.

The lesson here is that it is easier to have a team in place before you decide to do a sale or purchase of a private business to advise you on the issues, because they’re not as straight forward as you may think.  You can’t substitute the expertise of a group of advisors to help you save you money and headaches in the long run.

Written by Richard Wong, CMA      rwong@firstchoicecapital.ca

Vancouver, B.C. based Cardiome Pharma shares skyrocket on a $700 million licensing agreement with Merck based out of Whitestation, New Jersey for Vernakalant, an investigational drug for treatment of atrial ibrillation. The agreement provides Merck with exclusive global rights to the oral formulation of vernakalant (vernakalant [oral]) for maintaining of normal heart rhythm in patients with atrial fibrillation, and provides a Merck affiliate, Merck Sharp & Dohme (Switzerland) GmbH, with exclusive rights outside of the United States, Canada and Mexico to the intravenous (IV) formulation of vernakalant (vernakalant [IV]) for rapid conversion of acute atrial ffibrillation to normal heart rhythm.

Cardiome to receive initial fee of US$60M and up to $300M in milestones.   Cardiome, a Canadian biotech which currently does not have any drugs approved for marketing, will get up to $200 million for achieving development and regulatory goals and another $100 million for approvals related to other heart conditions. And there’s $340 million available in sales milestones. Cardiome retains U.S. co-marketing rights in the deal and gets a $100 million credit facility from Merck that is available in 2010 in several tranches.

“Given Merck’s long-established leadership in the cardiovascular space, we believe there is no company better suited to advance Vernakalant,” said Bob Rieder, chairman and chief executive officer of Cardiome. “This collaboration places Cardiome in a strong financial position as we conclude our strategic review, and moves the Company closer to providing doctors with an important tool to address this critical unmet medical need.”

This deal also shows Merck continuing it direction of finding other external partners to help lead its drug pipeline for the future.

The effectiveness of the collaboration agreement is subject to the expiration or earlier termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, if applicable, as well as other customary closing conditions. The agreement between Cardiome and Astellas Pharma U.S., Inc. for vernakalant (IV) in the United States, Canada and Mexico is unaffected by this agreement.

Written by Richard Wong, CMA     rwong@firstchoicecapital.ca

Polaroid known as a maker of instant cameras and film was finally auctioned off for $59.1 million in a bankrupty protection.  This famous company had come upon hard times, but it’s interesting to note that the price tag was for the intellectual property, company, and digital and hard film collection.

Question is that does Patriarch think the company’s digital assets are worth more than the Polaroid name?  When you’ve had companies such a Sony, Hewlett Packard, and a host of camera phone makers enter in the space along with Polaroid and Kodak you would think that the Patriarch the private equity firm known for its reputation as a turn around artist it would try to leverage more of its digital assets than the previous management of Polaroid.

Written by Richard Wong, CMA     rwong@firstchoicecapital.ca

Short updates on Life Sciences funding for March 2009.

BiOptix Diagnostics, Inc.: Series A $3M

BiOptix (Boulder, CO) a commercial focused developer of an array-based biomolecule detection system that addresses many markets that currently cannot obtain the needed sensitivity and throughput in a single solution, closed a $3M Series A finacing.

NeoVista, Inc.: Series D $18M

NeoVista (Fremont, CA) a clinical-stage device company focused on epimacular beta radiation for the treatment of wet age-related macular degeneration, closed a $18M Series D financing.

Neuraltus Pharmaceuticals, Inc.: Series A $17M

Neuraltus Pharmaceuticals (Menlo Park, CA) a preclinical-stage developer of small-molecule drugs focused on Amyotropic Lateral Sclerosis and dyskinesia, closed a $17M Series A financing.

Nexstim, Oy: Series C $7.9M

Nexstim (Finland) a commercial-stage developer of non-invasive brain imaging technologies focused on cortical mapping prior to surgery, closed a $7.9M Series C financing.

Atritech, Inc.: Series E $30M

Atritech (Plymouth, MN) a clinical-stage medical device company focused on developing minimally invasive technologies designed for the prevention of atrial fibrillation related stroke, closed a $30M Series E financing.

Ikano Therapeutics, Inc.: Series B $9M

Ikano Therapeutics (Lexington, KY) a clinical-stage nasal delivery platform company focused on seizures and pain, closed a $9M Series B financing, the final tranche of a $18M round.

GetWellNetwork, Inc.: Series C $10M

GetWellNetwork (Bethesda, MD) a commercial stage telemedicine provider of interactive patient care solutions, closed a $10M Series C financing.

GlycoVaxyn, AG: Series B $22M

GlycoVaxyn (Switzerland) a preclinical-stage company developing vaccines focused on bacterial caused disease, closed a $22M Series B financing.

Surface Logix, Inc.: Series E $15M

Surface Logix (Brighton, MA) a clinical-stage small molecule company focused on metabolic and cardiovascular disease, closed a $15M Series E financing.

Proteon Therapeutics, Inc.: Series B $38M

Proteon Therapeutics (Waltham, MA) a clinical stage biopharmaceutical company focused on renal and vascular disease, closed a $38M Series B financing.

The economy has caused a credit crunch for businesses large and small so the one thing that all businesses should do is to get cozier with your banker.  This can take the form of calling more often, visiting, inviting your account manager to your business premises, anything which will provide more real world contact with your banker.

The one thing that is definite right now and that account managers are under more pressure to ensure their clients are worthy credit risks and are up to date in their monthly bank reports.   So now more than ever, its important to better your relationship with your banker, even if you don’t need more financing at this time, but very important if you think you may need to re-finance,  get waivers, or get amendments to their current financing.

Banks through their own databases, but also through credit bureaus have statistics on every industry and if you’re an underperforming company compared to the average in your industry, you may have already gotten a call to ask you whether you really do need for example a $4 million credit line, when you’ve only used $1 million for the past 3 years, yet your debt to equity ratio is higher than the industry average.  Not a good sign, but manageable if you take the time to provide comfort to your banker.

It’s hard to think of your banker as a partner, but they really are, they want to see you succeed, not fail, so having them understand your business and your competitive advantage compared to your competition is very much smart business.  So here are some steps to take to improve your banking relationship:

1. Make Verbal Contact with Your Banker
   - Call your account/relationship manager at least once a month or even better twice.
   - If your company isn’t doing well it’s even more important to outline your strategy to your banker to improve and give them comfort in what’s your business direction.
2. Build Trust with Your Banker
   - Private companies have quite often reported the bare minimum information to their banks, because they have wanted to remain private in all respects.  In today’s economy, in order to get help either re-financing or potentially finance acquisitions its time to bring down the curtains and let the bank see what you’re doing well.
3. Prepared Detailed Forecast Information
   -  Public companies are used to sharing information with their banks so for them this less of an issue because of the quarterly presentation done by CFO’s for their public companies, but some have gotten away from this practice in the last few years but should think about re-instituting it only for the confidence it shows to stakeholders about their business direction.
   - These forecasts should include various scenarios of financial, operational, and employee headcount variables.
   - The forecasts should include worst to best case scenarios going out at least 2 years.
4. Hire Reliable, Knowledgeable Financial Advisors
   - Today its a good practice to ensure that information is presented accurately and consistently by advisors who understand your industry, your business, and advisors who have gone through economic downturns before where maybe your current management haven’t.  In today’s times, you better know you’re making decisions on good reliable financial information.
5. Communicate, Communicate, Communicate!
   - Now is the time to be proactive, treat your banker as your partner in business, keep them informed of major milestones, and what you’re doing to beat the current economic environment.  Be a leader, manage your banker rather than have the bank manager you!

Written by Richard Wong, CMA    rwong@firstchoicecapital.ca

People tend to forget that Twitter is 3 years old and that it has tried to figure out the best way to develop its service to reach critical mass and lately to figure out the best way to turn the Web 2.0 service into cold hard cash.  I’ve spoken earlier that similar to bricks and mortar companies the valuation of a business is a difficult thing to tie down between 2 private companies where the majority of the value given ie. FaceBook proposing to give Twitter private stock valued at $500 million but here we have stock analysts questioning whether or not Twitter can really be valued as high as its investors had hoped.

Sanford Bernstein believes that historically companies have had a hard time trying to capitalize on this technology, whether through acquisition or building it from scratch, have overpaid for technology, especially in the Web 2.0 space.  The examples used are AOL acquired Netscape for $4.2 billion and Ebay buying Skype for $4.1 billion  We see these 2 examples they definitely haven’t paid off with AOL having written off their investment in Netscape a long time ago and Skype still struggling to become profitable.

Bernstein believes that its difficult to get people to pay for a subscription service after it being free for several years.  Case in point, would you have paid to use Google Search in the beginning?  I think the majority of people probably would have stayed using Yahoo or Ask.com search instead.

But people argue saying that Twitter might be purchased by FaceBook or Google, well we see that FaceBook has now their own newsfeed system and it looks more similar to Twitter, and they earn revenue from people buying the “Virtual Gifts, games, etc.” which has conservative estimates at over $50 million year, which is no slouch currently.  FaceBook has had its own pushback from its users for the types of advertising brought on by FaceBook.  Google on the other hand you would seem a better fit, but it has had its own failure in its Orkut social network experiment and its YouTube purchase has yet to make huge revenues yet.  I believe that Google with its recent strategic decisions to shut down products lines that haven’t done well.

Twitter can still make money from selling the data from the streams of information they get from its users as well as limited advertising, but the main selling feature about Twitter is that is a quick blogging service 140 characters and you’re out so how long can the advertising be that the advertisers would be willing to pay for it similar to a Google?  For the short term you’ll probably see continued losses at Twitter and maybe for a decade?

We’ll see is what I say, but I think that in today’s venture capital world more people are recommending caution rather than running to the bridle aisle.

Written by Richard Wong, CMA    rwong@firstchoicecapital.ca

Facebook’s initial failed attempts to takeover Twitter were because the most common reason why mergers & acquisitions fail, VALUATION differences. This is the main reason why other mergers or acquisitions fail because of the parties not being able to agree on what each brings to the table. That’s why Facebook’s attempted acquisition of Twitter didn’t materialize this time around, but don’t be surprised if this marriage of social media companies still happens.

Simply, Facebook believed that their private company stock value was worth a higher amount than what Twitter management believed and when you’re trying to purchase another company primarily with company stock it really is a moving target because there is no real 3rd party independent opinion of what the common stock is worth, like a public company stock.

Twitter was in active talks with Facebook for a takeover based on a value which is still a moving target just like any other private company where it is hard to put a independent value on its common stock. However, Facebook for stock option purposes where employees wouldn’t be taxed had valued its common stock at $3.7 billion after Microsoft’s investment which calculating backwards had Facebook’s stock valuation approaching $15 billion, but that was in a hot stock market over a year ago.

Problem with Twitter is that Facebook offered them $500 million for the company which apparently was a good number until Facebook pegged its own company value at $8 or $9 billion making Twitter shareholders’ worth of Facebook’s company less. This is a common issue in negotiations for many private companies who are looking to sell a share of their company or their company in whole. The sellers’ valuation is commonly based on the company’s best financial year and multiplying by a number to get a sales price value, whereas a buyer usually will try to use either the company’s worst year or projections to help bring the price closer to what they want to pay.

In high growth companies like Facebook who are continually trying to organically grow and through acquisitions don’t be surprised if they come back to Twitter and give them a higher dollar amount based on dropping technology stock values and Twitter has something Facebook wants is the micro-blogging technology, but most importantly growing user base of Twitter.

Mergers & acquisitions whether its for large private company like Facebook or your small business in downtown USA or Canada still have its issues trying to come to a mutually satisfying dollar value. However, for the smaller business be expected in this selling cycle to have purchasers ask for what’s called “Earnouts” and “Vendor Take Back Financing.” Earnouts are basically bonuses for the seller if the company reaches certain targets or milestones for anything from number of subscribers to EBITDA to Net Profit. Vendor take back financing is where the seller agrees to a price and will help the purchaser by financing a portion of the sell price which helps the purchaser get outside financing. These 2 negotiation tools were widely used before the last economic boom and expect them to come back if sellers want to sell their businesses quicker in this economic environment.

Written by Richard Wong, CMA      rwong@firstchoicecapital.ca