Structuring M&A

A threshold issue to address in any M&A transaction is the structure of the deal. The three principal ways to acquire a business consist of (i) an asset acquisition, (ii) a stock acquisition, and (iii) a merger.

As a simple example, imagine that you incorporate a company to operate a lemonade stand, which you then decide to sell in its entirety for cash. In an asset acquisition, the buyer would acquire all of the balance sheet assets of your business (i.e. the lemons, sugar, water, physical infrastructure, goodwill, etc.) and its liabilities, but you would retain ownership of the company itself (as well as the cash paid to you by the buyer), which you would liquidate following the closing of the acquisition. In a stock acquisition, the buyer would acquire 100% of the stock of your company (and thus all of the company’s assets and liabilities), and you would no longer own anything (other than the cash paid to you by the buyer) following the closing. In a merger, the buyer would combine its company with yours in order to create one surviving company that owns all of the assets and liabilities of both companies, and you would no longer own anything (other than the cash paid to you by the buyer) following the closing.

In any event, you should consult with your legal counsel and tax advisors to determine which structure is best for your transaction given the numerous commercial, process/consent and tax issues that each structure poses.

Asset Acquisition

In an asset acquisition, a buyer acquires specific assets and liabilities of the selling company as listed in the acquisition agreement, an asset purchase agreement. After the deal closes, the buyer and seller maintain their corporate structures and the seller retains those assets and liabilities not purchased by the buyer. Asset acquisitions are a common way of structuring a talent acquisition (often referred to as an “acquihire”), especially in a distressed-type situation, whereby the buyer acquires certain limited assets of the selling company (i.e. IP, brand, goodwill and potentially certain contracts) and offers new employment agreements to some or all members of the selling company’s team.

Buyers may favor asset acquisitions for a number of reasons, including: (i) the flexibility to pick and choose specific assets and liabilities; (ii) no wasted money on unwanted assets; and (iii) a lower risk of assuming unknown or undisclosed liabilities (however, even when a deal is structured as an asset sale, a buyer may sometimes become liable for assets not specifically listed in the asset purchase agreement under a concept known as successor liability).

On the other hand, asset acquisitions are typically more complicated and time-consuming than stock acquisitions because: (a) assigning specific assets requires separate transfers with different mechanics and formalities; and (b) numerous third party consents are often required since most of a selling company’s agreements likely contain anti-assignment clauses (whereas stock acquisitions only require consents when change of control clauses are present, which are generally much less common).

From a tax perspective, buyers generally prefer asset deals because they acquire a basis in the acquired assets equal to the purchase price paid plus certain other items, which is often higher than the basis that the selling company had in those assets (i.e. a “stepped-up basis”). This stepped-up basis enables a buyer to take greater depreciation and amortization deductions on such assets, and reduces the amount of taxable income or gain (or increases the amount of loss) on a later sale or other disposition of the assets.

On the other hand, when the selling company is taxed as a C-corporation, it generally recognizes taxable income, gain, or loss on the sale of its assets and its stockholders generally recognize taxable income, gain, or loss on the distribution of any proceeds from the sale (i.e. there is potentially double taxation in an asset deal), and thus such companies generally prefer to structure a transaction as a stock acquisition (which results in a single level of taxation at the stockholder level). However, if the selling company is a partnership, limited liability company (i.e. taxed as a pass-through entity), or an S-corporation, any taxable income, gain, or loss realized from the sale of the assets generally passes through to (in other words, would be taxed directly to) the company’s partners, members, or stockholders as a single level of taxation, and thus such companies are more likely to be willing to structure a transaction as an asset acquisition.

Finally, in addition to potential double taxation, many asset acquisitions are subject to sales, use, and other transfer taxes under state law. Although the selling company generally is responsible for these taxes as a matter of law, they may be shifted to the buyer by contract.

Stock Acquisition

In a stock acquisition, a buyer acquires the target company’s stock directly from the selling stockholders through a stock purchase agreement and thus acquires all of the target company’s assets, rights, and liabilities (the target company maintains its corporate existence and becomes a subsidiary of the buyer). Although this additional liability creates some risk for buyers, a stock acquisition is good for buyers desiring to acquire a going concern, particularly if the target company has a relatively low number of stockholders. Moreover, to shield themselves from target company liabilities, buyers often: (i) maintain the target company as a separate subsidiary; and (ii) negotiate certain contractual protections into the stock purchase agreement, such as indemnities and escrow provisions.

Stock acquisitions are usually simpler than asset acquisitions and mergers—for example, unless a target company agreement specifically contains a change of control clause, there is generally no need for third party consents, and unlike with mergers, there are relatively few statutory requirements applicable to stock acquisitions. However, negotiations can get cumbersome and time consuming if the target company has a relatively high number of stockholders. Stock acquisitions generally result in a single level of taxation for a target company’s stockholders, and thus are the generally preferred transaction structure for sellers. Stock acquisitions generally do not result in sales, use, or other transfer taxes.

Merger

A merger is a stock acquisition in which two companies combine into one legal entity pursuant to the terms of a merger agreement, as a result of which the surviving entity assumes all of the assets, rights, and liabilities of the disappearing entity. The merger process itself is governed by the laws of the states of formation of the entity parties to the merger, and it generally involves more statutory requirements (including detailed filings and appraisal processes), and thus more time and expense, than either an asset transaction or a stock transaction. However, mergers generally only require majority consent from the target company’s stockholders for the buyer to obtain 100% of the stock (subject to any additional requirements that may exist in a company’s constituent documents, such as class voting rights for a series of stock), and thus may be a preferable option for buyers that want to acquire sole control of a going concern that has many stockholders, especially when some of them may be opposed to selling their stock. Depending on the exact structure of the merger, third party consents generally may or may not be required, and the transaction may be treated as an asset acquisition or a stock acquisition.

Proper structuring of an M&A transaction is a critical initial step in the deal process. Given the numerous commercial, process/consent and tax issues that each type of structure poses, due consideration should be given by all transaction parties and their advisors to this issue, ideally at the outset of the process.

Assaad Nasr, Guest Writer, is a Corporate Partner and Co-Head of the M&A group at Buhler Duggal & Henry LLP

The information in this article is provided solely for general educational purposes and is not intended as legal advice. This article should not replace competent legal counsel from a licensed attorney in your state. 1984 and its affiliates expressly disclaim any and all responsibility and/or liability for any consequences resulting from the use of this article or any other document found on 1984’s website.