As a potential seller, you must understand that price or business valuation is not the only important term you will need to negotiate with a potential buyer. Another hugely important issue is M&A deal structure. You should understand that all business sales can be structured in one of five ways:
Each of these five methods of acquisition is illustrated below.
A direct statutory merger is a common merger in which the acquiring company acquires all of the target company’s assets and liabilities. The target company then operates under the surviving company’s name and is considered liquidated. All shareholders of the target company are either compensated for their shares or hold shares in the surviving company.
In a forward triangular merger, also known as an indirect merger, the target company merges into a subsidiary of the acquiring company. This M&A deal structure normally takes place when the merger combines both cash and stock. Because the target company is merging into a subsidiary, rather than directly into the acquiring company, the acquiring company is protected from the target’s liabilities.
With regard to shareholders, the acquisition subsidiary compensates the target’s shareholders with stock, but up to 50% of their compensation can be in the form of cash and other non-stock options.
The common reverse triangular merger, like a forward triangular merger, also shelters the acquiring company from the target’s liabilities, because it is not a direct merger. However, the acquisition subsidiary in this case is not the surviving company. Instead, it purchases the target company and merges into the target company as a wholly owned subsidiary of the acquiring company. The buyer’s stock or cash is issued to the target company’s shareholders.
Why is this such a popular M&A deal structure? It’s because the surviving target company is preserved, so it keeps its business contracts and does not have to transfer its assets to the acquiring company, which may not be possible otherwise with anti-assignment clauses. This allows the acquiring company to have access and control of the target’s business contracts, preserving the target’s business continuity.
A share sale is more straightforward than a merger. In a share sale, the acquiring company purchases the target company’s stock from its shareholders. Rather than merging companies and dealing with complex contract reassignments, the target company gets to retain its name and business contracts, but under a new owner.
An asset sale does not deal with the target company’s shareholders. Instead, the acquiring company chooses specific assets (and sometimes assumes liabilities) that it wants to purchase and finds valuable. The target company remains in operation and does not have to merge or liquidate.
As can be seen by reviewing the charts of each M&A deal structure, there are four methods to purchase the shares in a company, and one way to purchase the assets of a company.
The four share purchase methods include the three merger varieties plus the purchase of the shares of the target company from the target company shareholders. In contrast, there is only one acquisition method by which the acquiring company purchases the assets of the target company shown in the above diagrams.
Therefore, the question presented to you, the seller (as well as any buyer), is whether the four share acquisition methods should be employed, or whether the asset acquisition method should be employed to effectuate the sale of the company’s business.
Each deal structure comes with its own tax advantages (or disadvantages), business continuity implications and legal requirements. All of these factors should be considered when choosing the best deal structure for your business.
[Editor’s Note: If you want to read more about how to sell or otherwise exit a business, be sure to read “Business Transition and Exit Planning: Welcome to the Jungle!” It will lead you step-by-step through what you need to know.
To learn more about this and related topics, you may want to attend the following webinars: Structuring and Planning the M&A Transaction and The M&A Process: Understanding the Lifecycle of a Deal & Basic Deal Documents. This is an updated version of an article originally published on April 3, 2015.]
Additional Contributing Author: Tom Petrides
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