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August 6, 2024
By Nicholas P. Flint

In the world of mergers and acquisitions, no two deals are alike. That is because no two businesses are alike. However, we can break M&A deals down into three basic categories when it comes to transaction structure: asset deals, stock deals, and mergers. Apart from basic business terms such as the purchase price, deal structure is the most important aspect of a transaction for the parties to agree upon in the first stage of negotiations.

Asset Deals

In an asset deal, a selling or target company sells some or all of its assets to a separate buying company in consideration of the buyer’s payment of the purchase price to the selling company. The buyer would typically also assume certain liabilities of the seller in addition to the assets, such as obligations under any contracts that are included in the purchased assets. At the end of the deal, the seller entity remains intact and with the same ownership, but without the assets that were sold and liabilities that were assumed. The principal transaction document in an asset deal is called an Asset Purchase Agreement.

Typically, asset deals are preferred by buyers for a number of reasons. First, from a post-closing liability perspective, buyers are able to pick and choose the assets and liabilities that they want to purchase. Any excluded assets or liabilities that are not part of the deal remain with the seller. Second, from a tax perspective, the buyer receives a step-up in basis to the value of the assets purchased, which allows for greater depreciation of the purchased assets following the deal.

The inverse is true for sellers. In asset deals, sellers retain any unwanted assets and liabilities post-closing, and the taxes payable in connection with an asset transaction are almost always higher for sellers than that of a stock deal. Typically, the portion of the purchase price that is allocated to the seller’s goodwill (if goodwill is included as a purchased asset) will be taxed at a lower capital gains tax rate, and the remaining portion of the purchase price would be taxed at the higher ordinary income rate. Furthermore, if the seller is a C-corporation, the proceeds from an asset deal would likely be subject to double taxation—once at the corporate level and again at the individual shareholder level.

Both parties to an asset deal must be mindful of the legal and logistical issues that can arise when transferring assets between two entities. Most commercial contracts or permits will contain standard “anti-assignment” language, which prohibits one or both parties to the agreement from assigning the agreement to a third party without the other’s prior written consent. This language may be found in contracts ranging from key customer or supplier agreements, to simple internet or phone provider agreements, to required licenses and permits. Failure to obtain a required consent could result in a default by the seller under the applicable agreement, which could have a significant impact on the viability of the business post-closing. The parties should carefully consider the extent to which material contracts and permits contain anti-assignment provisions and the likelihood that the other parties to these instruments will consent to the transfer.

Stock Deals

In a stock deal, the owners of a target company sell their ownership interests in the company to one or more buyers (whether individuals or corporate entities). The term “stock deal” refers not only to the sale of stock if the target company is a corporation, but also the sale of membership interests in an LLC, partnership interests in a partnership, etc. At the end of a stock deal, the target company continues to own the same assets and liabilities, but with new ownership of the corporate entity. This is also referred to generally as a “change of control” of the target company. The principal transaction document for a stock deal is called a Stock Purchase Agreement if the target company is a corporation, or Membership Interest Purchase Agreement if the target is an LLC.

Stock deals are typically preferred by sellers for similar reasons to why buyers prefer asset deals. From a post-closing liability standpoint, the majority of liabilities are usually left with the target company which is now owned by the buyer. From a tax perspective, sellers typically enjoy the lower capital gains tax treatment on the entire purchase price, and the issue of double taxation in the context of a C-corporation is usually negated. In contrast, buyers in a stock deal inherit all known and, more alarmingly, unknown liabilities of a target company. Unlike an asset deal, buyers do not have the ability to step-up the basis in purchased stock to subsequently depreciate.

Perhaps one of the most common reasons for choosing a stock deal structure is the circumvention of anti-assignment provisions in key commercial contracts or permits. Unlike an asset deal where contractual rights and obligations must be assigned from one party to another, a stock deal simply involves a change of ownership of the target company. This change of ownership or control does not trigger most anti-assignment provisions, meaning the parties would not be required to obtain the consent of the other party to the contract or permit. Although some agreements will contain what is called a “change of control” provision requiring the other party’s prior consent to a change of ownership (i.e. a stock deal), this is often a persuading factor for choosing the stock deal structure over an asset deal since such change of control provisions are not as prevalent.

Mergers

Mergers are similar to stock deals in that assets and liabilities are not transferred from one entity to another, but rather two companies combine with one another, resulting in a singular remaining entity called the “survivor”. After the merger of two companies, the merging or “disappearing” entity will no longer exist, and the owners or members of the disappearing entity will be paid a purchase price for their stock similar to a stock deal. The principal transaction documents in a merger are called the Merger Agreement and the Plan of Merger.

Generally speaking, mergers are classified as either “direct” or “indirect”. In a direct merger, the buying company and the target company merge with each other, with one party continuing as the survivor and the other disappearing as a matter of law. In an indirect merger, the buying company establishes a subsidiary, and that subsidiary is merged with the target company. In the case of an indirect merger, a “forward triangular merger” refers to when the buyer subsidiary is the surviving entity, and a “reverse triangular merger” refers to when the target company is the surviving entity (now a subsidiary of the buyer company).

The same general pros and cons applicable in a stock deal apply to mergers, including the issues of anti-assignment or change of control provisions in commercial contracts, but mergers typically involve more complex tax considerations. Also, because the process for merging companies varies from state to state, parties must consider and follow the steps prescribed by the state of domicile for each of the parties to the merger.

As one can see from the above, the parties to an M&A transaction typically have opposing interests when it comes to deal structure. How, then, do the parties agree on a path forward? Factors such as negotiation leverage, required third-party consents, purchase price allocations in an asset deal, and liabilities of the target company play pivotal roles in negotiating the structure of a deal. One thing is clear: there is no one-size-fits-all structure, because every transaction is different. Buyers and sellers should seek the counsel of tax experts and experienced M&A counsel at the outset of negotiations (i.e. before a letter of intent is negotiated) to ensure that the transaction is structured in the best manner from both a tax and legal perspective.

Nicholas Flint is a partner with Flint, Connolly & Walker, LLP who represents domestic and international clients in a variety of corporate and transactional matters, including mergers and acquisitions, joint ventures, private equity and venture capital transactions, financing and lending arrangements, and debt and equity offerings. In addition, Mr. Flint serves as a general business and legal advisor to his clients, counseling on matters such as corporate governance, executive compensation, regulatory compliance, and commercial contracts.