Abstract:
Embodiments of an investment structure that avoids the earnings and ownership dilution related to an acquisition of a target company by a subsidiary company while providing attractive capital treatment are provided herein. In one embodiment, a method for creating an investment structure includes the steps of receiving investment capital from an investor in a subsidiary company; issuing convertible preferred shares from the subsidiary company to the investor; purchasing the target company by the subsidiary company with the investment capital; receiving at least one of target company common shares or target company assets in the subsidiary company; writing a first call option from the subsidiary company on the target company common shares or target company assets to the investor; and writing a second call option on the target company shares or target company assets from the investor to the parent company that at least partially owns the subsidiary company.

Description:
CROSS-REFERENCE TO RELATED APPLICATIONS  
       [0001]     This application claims the benefit of U.S. provisional patent application Ser. No. 60/642,282 filed Jan. 7, 2005, which is herein incorporated by reference. 
     
    
     BACKGROUND OF THE INVENTION  
       [0002]     1. Field of the Invention  
         [0003]     The present invention is generally related to investment structures and, more particularly, to an investment structure that avoids ownership, earnings and capital ratio dilution to a parent company that is purchasing a target company through a subsidiary company using investment capital supplied by a third party investor.  
         [0004]     2. Description of the Related Art  
         [0005]     In deciding how to finance an acquisition, companies have several choices, each with different pros and cons. If an acquiring company funds an acquisition with new equity, it may dilute the ownership and share of earnings attributable to existing shareholders. If the company uses new debt, it increases leverage measured by the ratio of debt to equity and equity to assets. Some acquirers or their corporate parents—financial institutions, for instance—may have constraints regarding leverage. In such cases, an acquirer may be compelled to issue equity in order to maintain certain capital ratios. Issuing equity avoids the dilution of important capital ratios, however, as discussed above it comes at the cost of diluting the existing owners&#39; stake in the business and share of earnings.  
         [0006]     Therefore, there is a need in the art for an investment structure that minimizes ownership, earnings and capital ratio dilution simultaneously.  
       SUMMARY OF THE INVENTION  
       [0007]     The present invention is an investment structure that avoids the earnings and ownership dilution related to an acquisition by a subsidiary company when purchasing a target company while providing attractive capital treatment. The investment structure involves a parent company, a subsidiary company, a third party investor and a target company. Third party investors invest cash into the subsidiary company in return for contingent convertible preferred shares issued by the subsidiary company. Since these convertible preferred shares are contingent, they are not currently dilutive to the ownership of the parent company in the subsidiary company. Because the convertible preferred shares have equity-like attributes, they are generally treated as equity. For instance, if the parent is a bank, and the preferred shares have a thirty year term, they may qualify as Tier 1 capital, a regulatory definition of high-quality equity, of which a minimum ratio must be maintained against assets. The subsidiary company uses the cash that is provided by the investor to purchase a target company. The subsidiary company receives common shares or assets in exchange for the cash used to purchase the target company. The subsidiary company will then write a call option on the target company&#39;s shares to the third party investor. The investor then writes an option on the target company&#39;s shares to the parent company. These call options are exercisable at a future time at a strike price that is below the expected value of target company shares in the future. The investor&#39;s call has a strike price that is lower than the strike price of the parent company&#39;s call option. As such, it is quite likely both the investor and the parent will exercise their call options. This means there is a high likelihood of the investor receiving fixed return, which serves to entice the investor to participate in the transaction. The contingency and conversion price of the convertible preferred shares may or may not be attained. If both are attained, the investor may convert the preferred shares to common shares in the subsidiary. If both are not attained, the preferred shares remain outstanding until the end of their term or some subsequent change agreed to by the parties. Since the contingently convertible preferred shares are classified as equity, the new capital acts as equity in capital ratio calculations but without the ownership and earnings dilution of a common equity issuance. 
     
    
     BRIEF DESCRIPTION OF THE DRAWINGS  
       [0008]     So that the manner in which the above recited features of the present invention can be understood in detail, a more particular description of the invention, briefly summarized above, may be had by reference to embodiments, some of which are illustrated in the appended drawings. It is to be noted, however, that the appended drawings illustrate only typical embodiments of this invention and are therefore not to be considered limiting of its scope, for the invention may admit to other equally effective embodiments.  
         [0009]      FIG. 1  depicts a block diagram of an investment structure in accordance with the present invention;  
         [0010]      FIG. 2  depicts a flow diagram of a method for creating the investment structure of  FIG. 1 ; and  
         [0011]      FIG. 3  depicts a flow diagram of a method for unwinding the call options between the parties issued in the investment structure of  FIG. 1 .  
         [0012]      FIG. 4  depicts a flow diagram of a method for unwinding the investors preferred share position in the subsidiary issued in the investment structure of  FIG. 1 . 
     
    
     DETAILED DESCRIPTION  
       [0013]      FIG. 1  depicts a block diagram of an investment structure  50  in accordance with the present invention. The structure  50  comprises four entities: a parent company  100 , a subsidiary company  106  (or subsidiary  106 ), a target company  112  and an investor  120 . The parent company  100  controls and consolidates the subsidiary company  106 . The parent company  100  may be a bank or other financial institution that wholly or partially owns the subsidiary  106  that will be used to purchase the target company  112 .  
         [0014]     The investor  120  will invest cash (investment capital) along path  116  in return for contingent convertible preferred shares that are provided along path  118 . The contingently convertible preferred issued to the investor  120  by the subsidiary  106  are consolidated into the capital ratio calculations of the parent company  100  and are counted as equity.  
         [0015]     The subsidiary company  106  uses the cash received along path  116  from the investor  120  to purchase some or all of the common shares of the target company  112 . The cash is exchanged along path  110  for common shares provided along path  108 . As represented by path  114 , the subsidiary company  106  then writes a call option on the target company&#39;s shares to the investor  120 . The investor  120  writes a call option on the target company&#39;s shares to the parent company  100  along path  104 .  
         [0016]      FIG. 2  depicts a flow diagram of a method  200  for establishing the investment structure of  FIG. 1 . At step  202 , the investor  120  provides cash to the subsidiary  106 . At step  204 , the subsidiary  106  provides contingent convertible preferred shares to the investor  120 . The preferred shares may or may not pay dividends, and the shares have a term that is predefined, e.g., 30 years. In addition to a fixed term, the preferred shares may be putable to the subsidiary  106  upon the parent company  100  spinning off or otherwise selling or liquidating the subsidiary company  106 .  
         [0017]     At step  208 , the cash provided by the investor  120  to the subsidiary  106  is used to purchase the target company  112 . At step  210 , the subsidiary company  106  writes a covered call option against the target company&#39;s shares or assets and provides the option to the investor  120 . At step  212 , the investor  120  writes a call option for the target&#39;s shares to the parent company  100 . If the parent company  100  still controls the subsidiary  106  at the time the parent company  100  elects to exercise its call on the target  112 , the parent company  100  agrees to make the investor&#39;s preferred shares putable to the subsidiary  106 .  
         [0018]     In an alternative embodiment of the invention, the parent company  100  may additionally sell put options to the investor  120  on the common shares of the subsidiary company  106  to improve the attractiveness of the structure to an investor. The put options have a strike price that is substantially “out of the money”. This is indicated in method  200  as step  206 .  
         [0019]     Using the above-described investment structure  50 , the subsidiary  106  retains all of the earnings of the target company  112 . If the subsidiary  106  is consolidated into the parent company  100 , the parent company  100  receives Tier 1 capital credit for the contingent convertible preferred shares issued to the investor  120 .  
         [0020]     The contingency on the convertible preferred shares is not necessarily based solely on time and a dollar value. Generally, the contingency may be based upon revenues of the subsidiary  106  or other financial indicators of the financial health of the subsidiary  106 . If the contingency is not triggered, the preferred shares are not convertible even if the conversion price is reached.  
         [0021]     The call option created by the subsidiary  106  for the investor  120  in the target company&#39;s common stock has a strike price that is much less than the expected value of the target company&#39;s common shares at some period in the future. The time in the future in which the option is exercisable can be set at any duration, but is typically set at five years. Typically, the call option written by the investor  120  to the parent company  100  has a higher strike price than the option to the investor  120 . This arrangement of call options provides a vehicle to lock in a return for the investor  120 . This enables the investor  120  to be provided sufficient return to entice investors to participate in such an investment structure.  
         [0022]      FIG. 3  depicts one embodiment of a method  300  of unwinding the investor  120  and/or parent company  100  of the call options in the investment structure  50 . The method begins at step  302  and proceeds to step  304 , where the investor&#39;s call option is analyzed to see if it is “in the money.” If the investor  120  deems the call option in the money, i.e., the price of the target company  112  exceeds the strike price of the option, the method  300  proceeds to step  308 , wherein the call option will be exercised by the investor  120 . If the investor&#39;s option is not in the money, the method  300  proceeds to step  306  and the call option is not exercised.  
         [0023]     The target company  112  is purchased by the investor  120  at step  310 . At step  312 , the parent company  100  decides whether it will exercise its call option. In some circumstances, since the call option for the parent company  100  has a different strike price than the call option for the investor  120 , the call option for the investor  120  may be in the money while the call option to the parent company  100  is out of the money. If the call option is to be exercised, the method  300  proceeds to step  316 , where the common stock of the target company  112  is provided to the parent company  100  (i.e., the parent company  100  purchases the target company  112 ). At step  318 , if the parent company  100  continues to control the subsidiary  106 , the parent company  100  makes the preferred shares issued to the investor  120  immediately putable to the subsidiary. If, at step  312 , the parent company  100  deems the call option unworthy of exercising, the method  300  proceeds to step  314  where the parent&#39;s call option expires unexcercised and the investor  120  is free to sell the target common shares to a third party.  
         [0024]      FIG. 4  depicts a flow diagram of a method  400  for extinguishing the preferred shares, if desired. The method  400  begins at step  402  and proceeds to step  404 . At step  404 , the method  400  queries whether the parent company  100  remains in control of the subsidiary company  106 . If the parent company  100  has liquidated its position or otherwise sufficiently lessened control over the subsidiary company  106 , the method  400  proceeds to step  410 . At step  410 , the subsidiary preferred shares become putable to the subsidiary  106  either because of a change in control or the parent&#39;s exercise of its call option to buy the target company  112  from the investor  120 .  
         [0025]     At step  412 , the method  400  queries whether the contingency on the subsidiary preferred shares has occurred. If the contingency has been triggered, then the method  400  proceeds to step  416  to determine if the value of the shares is above the conversion price. If the preferred shares are valued above the conversion price, the method  400  proceeds to step  418 , where the investor  120  converts the preferred shares to common shares of the subsidiary  106 . Otherwise, the method  400  proceeds to step  414 , where the investor  120  may retain the preferred shares or put the preferred shares.  
         [0026]     If, at step  412 , the contingency is not triggered, the preferred shares remain outstanding at step  414  where the investor  120  may retain the preferred shares or put the preferred shares.  
         [0027]     If the parent company  100  controls the subsidiary  106 , then at step  404 , the method  400  proceeds to step  406 , where the parent company  100  decides whether to exercise its call option. If exercised, the method  400  proceeds to step  410 . If not exercised, the method  400  proceeds to step  408 , where the preferred shares remain outstanding.  
         [0028]     Separately, the investor  120  may exercise the put option purchased from the parent company  100  on the common stock of the subsidiary  106 . It is generally envisioned that the put will be significantly out of the money at inception and would expire at the same time as the investor&#39;s call option on the target company  112 .  
         [0029]     Thus, by using the above-described investment structure  50 , the parent company  100  can achieve several objectives in an attractive fashion: it can facilitate an important acquisition by a subsidiary  106  with no current and possibly no future ownership dilution, little to no earnings dilution and little to no reduction in key capital ratios reduction.  
         [0030]     It is contemplated that the investment structure  50  described above may be used by other entities for similar transactions, i.e., any third-party funded investments in a target entity through a subsidiary of a parent entity. The parent company, subsidiary company, target company, and the investor may be any form of company, such as a corporation, partnership, sole proprietorship, and the like. In addition, although the terms “common stock” and “convertible preferred stock” are used above, the respective companies need not have formal shares of stock issued and may instead use contracts for a desired percentage ownership of the company having the same terms as desired for the particular portion of the transaction as detailed above. Furthermore, the investment capital need not be cash and may be any other asset having an agreed-upon value between the parties.  
         [0031]     While the foregoing is directed to embodiments of the present invention, other and further embodiments of the invention may be devised without departing from the basic scope thereof, and the scope thereof is determined by the claims that follow.