M&A deal structure: Basics for buyers and sellers
by Everyham & Kerr
Every M&A deal is unique, but they all involve one or a combination of three basic structures: stock purchase, asset sale or merger of companies. If your company is considering buying or selling, it’s important to understand the differences between these types of transactions. The wrong choice could lead to negotiation difficulties and tax disadvantages and could even prevent your deal from closing.
Stock purchase primer
In a stock purchase, the buyer acquires a control- ling majority, if not all, of the seller’s voting shares.
So the buyer essentially becomes the owner of all of the seller’s assets and liabilities. Stock purchases usually are advantageous for sellers. The proceeds of a sale generally are taxed at the lower, long-term capital gains rate. (See “The tax question” on page 3.) Also, such sales are less likely to disrupt the company’s day-to-day business.
For buyers, one advantage of this type of deal can be that the seller continues running operations, helping the buyer to avoid a lengthy — and expensive — integration. Yet the buyer owns all contracts, intellectual property and assets, making it easy to begin deriving value from the acquisition. Also, all-stock deal negotiations tend to be less contentious.
The downside is that, because a buyer acquires all of the seller’s outstanding liabilities, the buyer may inherit legal and financial problems that ultimately reduce the value of the purchase. And if the selling company has dissenting shareholders, a stock purchase won’t make them go away. In fact, dissenting shareholders (depending on the scope of their rights) can become an uncomfortable thorn in the buyer’s side once it assumes majority ownership.
The goods on asset sales
With an asset sale, the buyer acquires most of the seller’s assets — typically paying cash or offering its own shares — and assumes all liabilities associated with those assets. The selling company continues to legally exist after the sale, though in many cases it may wind down operations soon after the deal closes.
Buyers enjoy many advantages with this structure. An asset sale enables them to cherry-pick assets, choosing not to carry over certain liabilities that might prove burdensome, such as employee pension plans or unused assets. And by avoiding the rights of appraisal issues that typically surface in a merger, buyers can sidestep complaints made by dissenting shareholders. On the other hand, buyers may lose desirable nontransferable assets such as licenses or permits. What’s more, an asset sale can trigger a costly tax event, hindering the transaction or requiring both buyer and seller to agree on a price that takes tax implications into consideration.
Asset sales offer sellers some advantages — for example, quickly available funds. However, such sales can be time-consuming and it’s possible for sellers to get stuck with liabilities that the buyer declines.
Merger matters. The term “merger” is thrown around a lot, but strictly speaking a merger occurs when two distinct companies agree to legally become a new, combined entity.
A merger deal starts when one party buys the other’s shares or assets. Then the two combine to become a “new” company — either the buyer’s or seller’s company is reconstituted or they start with a fresh entity.
The upside to a merger for both buyers and sellers is simplicity. All contracts and liabilities pass into the new entity, thus requiring little negotiation about such terms. (Keep in mind that, as with a stock purchase, the buyer is on the hook for all seller obligations.) The downside: If they form a large enough block, disapproving shareholders on either side can thwart the merger by voting against it.
The tax question
Each of the three main M&A structures — stock purchase, asset sale and merger — has its own tax-related advantages and disadvantages.
Mergers and stock purchases generally enable buyers to transfer the seller’s tax benefits, such as net operating loss carry-forwards, and avoid having to pay bulk and sales taxes. Buyers may have to pay substantial taxes on an asset acquisition, but there are benefits to this structure:
The buyer has greater flexibility to step up appreciation of its assets and enjoy higher deductions.
For sellers, stock purchases generally provide the most favorable tax treatment, while asset sales are more likely to create tax burdens. With an asset sale, the seller’s proceeds are likely to be taxed as ordinary income. And depending on the legal structure of the entity, the seller might incur a “double tax” — first at the corporation level and again when proceeds are distributed to shareholders.
Working to the decision
Unfortunately, choosing a deal structure is complicated by the fact that buyers and sellers typically have competing legal, tax and other financial considerations. So, for example, a buyer preferring an asset sale may need to offer a higher price or other concessions to get a seller who wants a stock deal to play ball.
The kinds of concessions a company might be willing to make depend largely on its strategic endgame. If a buyer wants to acquire a seller’s reputation, business and best employees, a straight merger may be the best option — even if it isn’t the cheapest. If a selling owner is looking to cash out as quickly as possible, an asset sale could be more appealing than a stock deal.
Getting it right
Deal structure negotiations can be challenging, which is why it’s important to have experienced M&A advisors working with you. In the end, it often comes down to which party wants the deal more and is willing to compromise.
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