I. TRANSACTION BASICS
There are three basic types of merger and acquisition transaction: (1) asset purchase, (2) stock purchase and (3) merger. Consideration paid for the acquisition may include cash, stock of the buyer, assumption of seller liabilities or a combination of them. Factors including tax and financial accounting considerations, impact on earnings and cash flow, risk management, transaction mechanics and required corporate, governmental and third-party approvals are taken into account in determining transaction structure and form of consideration. The tax treatment of the transaction is often the most important factor. If the selling shareholders are key persons (whether continuing as employees or not), a portion of the consideration may be allocated to future employment compensation, covenants not to compete, or “Stay-Put” arrangements.
A. Asset Purchase. In an asset purchase, the buyer acquires only identified assets and liabilities of a company, not the company itself. With successful negotiation, the purchaser can select which of the seller’s assets to acquire (such as inventory, equipment, contract rights and intellectual property) and which not to acquire (such as contaminated real estate or obsolete inventory). Within limits, the buyer can also negotiate which outstanding or contingent liabilities to assume and not to assume. Buyer need to assess applicable state laws and determine if “successor liability” may apply – a common law doctrine applied by some states and in certain conditions which imposes upon the buyer of a business liability for certain obligations of the seller, even in the case of an asset purchase.
For tax and liability reasons, it is often said that buyers prefer to buy assets and sellers prefer to sell stock. As a practical matter, in most cases the substantial tax disadvantages of an asset deal to stockholders of the seller (likely double taxation at the corporate and stockholder levels) lead to a stock or merger transaction. As a result, asset purchases are most common in the acquisition of divisions of companies or specific contracts via novation, rather than entire companies.
B. Stock Purchase. In a stock purchase, the purchaser buys the outstanding stock of a corporation directly from the corporation’s stockholders. The corporation need not be a party to the transaction and remains unchanged after the closing (other than having different ownership), retaining all of its assets and liabilities. Existing employment agreements and non compete agreements remain in place (though buyers often require that these be renegotiated to ensure the retention of key persons). Stock purchases are typically preferred by sellers because all liabilities are transferred along with the company, there is no double taxation, and there is no need to liquidate the company after the transaction.
C. Merger. In a merger, one corporation merges with another to become a single ongoing corporation. One company is designated the “surviving,” and the other the “disappearing” corporation. By operation of law, the surviving corporation acquires all of the assets and succeeds to all of the liabilities of the disappearing corporation, and the disappearing corporation ceases to exist as a separate legal entity.
As with the other types of transactions, in a merger, the stockholders of the acquired corporation typically receive cash, stock of the surviving corporation, or some combination of stock and cash. A merger may be taxable or non-taxable to the acquired corporation’s stockholders, depending on the mix of consideration received by such stockholders.
In most cases the merger must be approved by the boards of directors and stockholders of both corporations. While rarely exercised, stockholders of the acquired corporation who formally oppose the merger may “perfect dissenters’ rights” to have value of their stock determined by a judicial procedure involving an appraisal rather than accept the value negotiated as part of the transaction. As a result, many merger agreements give the buyer an “out” if more than a small percentage of the seller’s stockholders perfect their dissenters’ rights.
D. Variations. There are numerous variations on these structures, such as
• reverse triangular mergers, in which the buyer incorporates a subsidiary that merges into the target company, and
• two-step transactions, in which the buyer acquires a controlling interest in the target by a stock purchase, and follows that transaction with a merger in order to eliminate or “freeze out” the remaining minority stockholders.
E. Transaction Stages and Timing. The typical acquisition of a substantial business involves two preparatory stages from the seller’s perspective, followed by three key events for both buyer and seller. For a selling corporation, the preparatory stages are: (I) positioning for possible sale, and (II) marketing the company. For both buyer and seller, the three key events are: (1) a letter of intent or term sheet; (2) a binding definitive purchase or merger agreement; and (3) closing. In some cases, particularly those involving public companies or smaller targets, there may be no letter of intent, and the signing of the agreement and the closing may be simultaneous.
In most cases, completing a substantial transaction from LOI to closing in two months would be considered lightning speed, while a transaction completed in a heavily negotiated or regulated context may take six months or longer.