When two companies are considering an M&A transaction, an important initial consideration is the legal structure that the transaction will take. Determining the transaction structure may be challenging as the buyer and target often have competing interests and different perspectives. The following explains some of the differences among the three most common transaction structures—asset purchases, stock purchases, and mergers.
In an asset purchase, the buyer purchases only those tangible and intangible assets—and assumes only those liabilities—that are specifically identified in the purchase agreement. Buyers often favor this structure for its flexibility. They can pick and choose the assets they wish to acquire and the liabilities they wish to assume, and leave the rest behind. Because the liabilities assumed by the buyer are specifically identified in the purchase agreement, this structure may allow a buyer to avoid contingent or unknown liabilities, although some laws (for example, environmental and tax) and certain doctrines (successor liability) may nonetheless impose liability on the buyer.
The asset purchase structure is often used when the buyer is looking to acquire a single division or business unit within a company. It can be complex and time consuming, however, due to the extra effort required to identify and transfer every important asset. While some assets, such as equipment, may easily be transferred by a bill of sale or other instrument of title, other assets, such as intellectual property or real estate, require a separate assignment or deed with different mechanics and formalities. Some assets, including many permits, are not transferable at all.
Third-party consents will often be required in order to transfer certain contracts from seller to buyer, as many contracts specifically state they are not assignable or require consent to assign. Since the process of identifying and obtaining consents may take considerable time, the parties should identify all required third-party consents at an early stage of the transaction to avoid delay at closing.
In a stock acquisition, the buyer acquires the target company’s stock from its stockholders. The target company stays exactly the same—its assets and liabilities unchanged—but with new ownership. It is critically important in a stock purchase transaction that the buyer negotiate representations and warranties concerning the target’s business, assets, and liabilities so that it has a complete and accurate understanding of the target company.
One consideration for the buyer is that it will not get 100 percent control unless all stockholders agree to sell their stock. A high number of stockholders increases the risk of hold-outs, protracted negotiations, and other complications. A buyer unable to acquire 100 percent of the stock will be left with minority stockholders who may prove difficult. To combat this risk, a buyer may condition the transaction on 100 percent participation by the stockholders, or on at least 90 percent participation and undertake a statutory “short-form merger,” a state law mechanism that allows a buyer to acquire the remaining minority interest in an expeditious manner and without a stockholder vote.
Since the target company is simply moving to a new owner, the assets of the target remain unchanged in a stock purchase, and most of the assignment and third-party consent procedures that can cause complications or delays in an asset purchase may be avoided. A stock purchase does, however, involve a “change of control,” so the buyer must identify contracts that require consent. For example, many real estate leases contain “change of control” provisions requiring landlord consent.
In a merger, two companies combine to form one legal entity, with the stockholders of the target company receiving stock of the buyer, cash, or a combination of both. The surviving entity assumes all the assets, rights, and liabilities of the extinguished entity by operation of law. Mergers are often structured as “triangular,” where the buyer uses a subsidiary (typically one that is newly formed) that will be merged into the target company (a reverse triangular merger) or into which the target company will merge (a forward triangular merger). An advantage of the triangular merger structure is that the buyer is able to shield itself from the liabilities of the target company.
A merger transaction is similar to a stock purchase in that the buyer will acquire all of the target company’s assets, rights, and liabilities (known and unknown) and will be unable to specifically identify which assets and liabilities it wishes to assume. Similarly, third-party consents are required only for those agreements requiring consent upon a “change of control.”
One key advantage of a merger is that it typically requires consent of only a majority of the target company’s stockholders (subject to any additional requirements existing in a target’s organizational documents). This makes merger a good choice (and often the only practical choice) where the target company has numerous stockholders or has stockholders opposed to the transaction. Under state laws, target company stockholders who are opposed to a transaction may have the right to dissent and exercise appraisal rights to receive “fair value” for their stock as determined by a court. Most public company acquisitions are effectuated through a merger.
Selecting the best structure to effectuate an M&A transaction is critical to the success of any acquisition. Transaction structure may be complicated, and the benefits of a structure for one party may work to the disadvantage of the other party. Therefore, both the parties and their attorneys must weigh the competing legal, tax, and business considerations and creatively construct the most mutually advantageous transaction structure.