Thinkific Labs Inc. THNC-T is trying to get rid of a problem that has irked its U.S. investors: It has too much cash.
The Vancouver software company has so much cash and equivalents – US$87.3-million on March 31, or 90 per cent of its assets – that it is at risk of being branded as a passive foreign investment by the U.S. Internal Revenue Service (IRS). That could be a headache for U.S. shareholders, who own 20 per cent of its 24.1 million subordinate voting shares.
So Thinkific is trying to make its balance sheet look more like that of a fast-growing tech company than an investment account. Thinkific, which provides a digital platform for entrepreneurs and businesses to create and run online courses, last week offered to buy 12.86 million subordinate shares for C$3.72 apiece, $47.83-million (US$35-million) in total, in a substantial issuer bid. That represents 16 per cent of shares and would use 40 per cent of its cash and equivalents.
Chief executive officer Greg Smith, brother and chief strategy officer Matthew Smith and inside investor Rhino Ventures have agreed to tender shares and sell between 16 per cent to 23 per cent of their holdings. For the CEO, that could mean 4.09 million to 5.82 million shares.
While the bid is well below the $13-a-share April, 2021, initial public offering price, “I think it’s good for a CEO to pay off the mortgage and just be 100 per cent worry-free to worry about the growth of the business,” Greg Smith said. From Thinkific’s perspective, “the stock is a good value buy so it’s a good use of funds,” he said.
The offer is set to expire June 21, four days before the federal government hikes the taxable portion of capital gains to two-thirds from 50 per cent for corporations and trusts, and for individuals with capital gains of more than $250,000. While BMO Capital Markets analyst Thanos Moschopoulos said in a note the looming tax change may have influenced the bid’s timing, tax considerations south of the border appear to be a bigger factor.
Under U.S. tax law, foreign companies with 50 per cent of their assets held to produce passive income are deemed to be “passive foreign investment companies.” PFICs are subject to strict, complicated tax guidelines aimed at deterring U.S. individuals from sheltering offshore investments.
Gains from PFICs are taxed as ordinary income, at a higher rate than capital gains, and holding them brings administrative headaches, said Ari Feder, a tax partner with law firm Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC in New York. Investors must fill out lengthy forms and can apply to have the investment taxed at a lower rate by filling out even more paperwork,
With cash accounting for 88.6 per cent of its US$97.8-million in assets at the end of last year, Thinkific discloses in its bid circular, “The company believes that it was a PFIC for its tax year ending Dec. 31, 2023,″ though it didn’t seek a legal opinion or ruling from the IRS, nor does it plan to. If it’s right, and doesn’t change its implied status, U.S. investors selling this year could be in for an unwelcome surprise.
That comes despite Thinkific’s improving operating performance thanks to cost-cutting efforts and revenue expansion. But that has also boosted its cash and equivalents as a share of assets.
“We have significant cash on the books and wanted to reduce the exposure investors have in Thinkific to being more of a cash investment,” Mr. Smith said. “By us using cash for other purposes, it helps prevent becoming a PFIC.”
Mr. Smith said U.S. investors have also told him Thinkific, which has a market capitalization of C$300-million, had too much cash for a “growth” company. While revenues have been expanding, reaching US$16-million in its first quarter, up 13 per cent year-over-year, much of the increase has come from selling payments services to existing users. The number of paying customers only crept up by 3 per cent in the quarter over the same period a year earlier, reaching 35,100.
Even after the bid – which interrupted another continuing normal stock repurchase plan – Mr. Smith said Thinkific will have plenty of cash to support its growth initiatives and even make acquisitions.
Editor’s note: A previous version of this article incorrectly stated Thinkific has launched a substantial issuer bid to buy back US$47.83-million of its shares, worth 55 per cent of the company's cash and cash equivalents as of March 31. The value of the shares is C$47.83-million (US$35-million), which amounts to roughly 40 per cent of the company's cash and cash equivalents. This version has been updated.