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Mergers and Acquisitions: Five Early Considerations in any M&A Transaction
Mergers and acquisitions (M&A) can be tricky transactions, a delicate dance between buyer and seller that must be choreographed in minute detail. This requires contemplation of a multitude of issues at the outset, many of which must be addressed as early as the letter of intent stage. Below are some of the top issues that should be decided upon as early as possible in the M&A process, as doing so is paramount to a successful transaction.
1. The Structure of the Transaction
This issue alone could produce another top five list and constitutes the defining element of any M&A transaction. Is the transaction going to be a stock purchase, a sale of assets, or a merger? Each type of transaction produces competing considerations between buyer and seller (or acquiring entity and target). The factors that determine the type of transaction are the tax consequences, the transferability of liabilities, stockholder approval of the transaction, and any required consents to the transaction by third parties.
Tax consequences will occur with asset sales and stock purchases, but some mergers, reorganizations or recapitalizations can be structured in such a way that a portion of the proceeds from the sale can receive tax deferred treatment. Stock sales may be preferable to a seller/target because the gain is taxed as capital gain at the shareholder level, not ordinary income. Asset sales may be preferable for buyers because they may step up the tax basis of the assets to fair market value, with the seller/target paying the corporate tax on the sale. Transfer of liabilities is a key difference between asset sales and stock purchases as well, with a stock purchase typically transferring all liabilities while an asset purchase involves negotiation of particular items.
Finally, there are certain groups that may have to give consent: stockholders, governmental authorities and third parties with existing contracts. The deal may be structured in such a way as to do an end-run around the consent of these groups, such as an asset purchase, which can be approved without stockholder input.
2. Payment for the Transaction
How is the deal going to be financed? Parties should know from the outset whether the payment will take the form of cash, which is liquid and not as much of a risk to the seller, or equity, which will bring more flexibility to the structure of the deal and may improve the acquiring entity’s debt rating while adding such complications as a potential rejection of the deal by shareholders. Payment structures can be further complicated by earnout provisions, deferred compensation terms, escrow accounts subject to conditions, and more.
3. Representations and Warranties
The deal will ultimately include very detailed representations and warranties from the seller/target concerning issues such as capitalization, compliance, authority, tax, intellectual property, etc. The seller/target will need to review these closely, and all disclosure schedules (the exceptions to the list of representations and warranties) should be highly detailed. Representations and warranties are some of the trickier aspects of the deal, with both parties wanting the other to shoulder more of the burdens of the transaction through these provisions. As a consequence, a significant portion of the negotiations between the respective sides often takes place regarding the precise wording of the language in this section.
4. Indemnification and Joint and Several Liability
As with representations and warranties, indemnification is a thoroughly negotiated aspect of any M&A transaction. One piece of this negotiation is whether to cap certain indemnification claims at the escrow amount. Some deals may cap all claims, but it is a common practice to create some exceptions, as in the cases of fraud or intentional misrepresentation.
The parties must consider liability for indemnification among the owners of the seller/target. Will all stockholders be liable individually for the full amount of potential damages, as in joint and several liability, or will the liability for potential damages be applied only proportionally according to ownership, as in merely several liability? Stockholders will likely balk at the idea of full joint and several liability (where any individual stockholder could solely be on the hook for all damages), but this provides more avenues for the acquiring entity to pursue indemnification should damages arise.
5. Closing Conditions
All deals must include a list of conditions that must be met before the parties may close the transaction. These may include conditions such as the absence of pending litigation, stockholder approval (and the threshold for that approval that will ratify the transaction), board approval, legal opinions on the transaction, etc. These conditions will certainly be a part of the final agreement, but they have a place in the letter of intent as well.
There are a multitude of other considerations in an M&A transaction, but the ones listed here should be addressed early in the process. Understanding the larger issues and familiarizing yourself with the fundamental deal structure are the best ways to begin such a transaction. Towards that end, obtaining the assistance of an experienced and knowledgeable attorney is key at an early stage and will pay dividends in guiding you throughout the transaction process.
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This article does not constitute legal advice.