Five Thoughts for Mergers & Acquisitions Transactions

Mergers and acquisitions (M&A) are important and difficult transactions. A delicate transaction between a buyer and seller that must be contracted in minute detail. This requires contemplation of a multitude of issues from the beginning. Many issues must be addressed as early as the letter of intent stage. The following are some of the top issues to decide as early as possible in the M&A process.

1. How to Structure the Transaction

Deciding whether the transaction is going to be a merger, stock purchase or sale of assets is the defining element of any M&A transaction. Each type of transaction produces competing considerations between buyer and seller. The factors that determine the type of transaction are the transferability of liabilities, stockholder approval of the transaction, the tax consequences 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 rather than 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 such as stockholders, governmental authorities and third parties with existing contracts.

2. Financial Considerations

How is the deal going to be financed? Parties should know from the beginning whether the payment will be cash which is liquid low risk to the seller or equity which increases the risk and complications of the deal. 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 difficult 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 representations and warranties.

4. Indemnification and Joint and Several Liability

As with representations and warranties, indemnification is a thoroughly negotiated aspect of any M&A transaction. One aspect 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?

5. The Closing

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.

There are a numerous other considerations in an M&A transaction, but the ones listed above 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. Contact Jeff Roper to obtain any assistance in guiding you throughout the transaction process.