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Mergers & Acquisitions have many deal components, and one of the most crucial decisions lies at the foundation: should you opt for an asset or stock acquisition? It’s one of my frequently asked questions on consultation calls. While there isn’t a one-size-fits-all answer, understanding the intricacies and implications of each can help you better understand which may be the best option for you and position you for success.
1. The Basics of Asset Acquisitions
In an asset acquisition, a buyer typically acquires certain assets (generally, all assets, but not always) and possibly assumes certain liabilities of the seller (there are general and specific carveouts that are negotiated). This structure provides a cleaner break for sellers and tends to be the go-to method for various reasons:
Pros:
- Risk Mitigation: Buyers can often avoid inheriting unknown or undisclosed liabilities. This and the tax benefits tend to be the drivers of why most buyers prefer an asset acquisition.
- Flexibility: Buyers can be selective about which assets to purchase and which liabilities to assume. If not all assets are purchased, this may reflect in the purchase price as they buyer would only pay for what they’re purchasing.
- Tax Benefits: Some jurisdictions may offer depreciation advantages for tangible and intangible assets.
Cons:
- Complexity: Certain asset acquisitions may require numerous transfers of title (for instance a fleet of 100 vehicles) and consents for the transfer of contracts, which depends on the industry, business practices and operations. We recommend these be questions searchers ask pre-LOI.
- Potential for Higher Transfer Taxes: While less prevalent, depending on jurisdiction, transferring individual assets might result in higher taxes than selling company stock.
- Non-Transferable Assets: Certain assets or components of the business may be non-transferable, such as certain accreditations, licenses from the government, contracts, etc.
2. The Basics of Stock Acquisitions
In a stock sale, the buyer acquires the selling shareholders' stock, effectively stepping into the shoes of the seller. This means they acquire all assets, rights, and liabilities.
Pros:
- Simplicity: No need to transfer assets or reassign contracts. It’s a cleaner transition.
- Non-Transferable Assets: Ideal for businesses with government licenses, accreditations, non-transferable contracts, or other components that aren’t easily transferred, or aren’t permitted to be transferred.
- Rollover Equity: Generally, stock acquisitions come into play more where there is rollover equity involved in the structure. Under the new and evolving SBA rules and guidelines, certain banks have interpreted the permissibility of rollover equity to mandate that the transaction be structured as a stock purchase, while others interpret the rules more liberally and allow them to apply in an asset purchase as well.
Cons:
- Hidden Liabilities: The buyer generally assumes all known and unknown liabilities. While there are many solutions to this, (i) spin-off or resolve liabilities pre-closing, (ii) set-off provisions against an escrow or seller note, (iii) clawback provisions against an escrow or seller note, (iv) escrow account, (v) indemnification, (vi) representations and warranties, and (vii) thorough due diligence, it’s of course better to preclude this from being an issue in the first place through an asset acquisition particularly if there is greater risk or concern for unknown liabilities or a known liability.
- Due Diligence Intensity: Given the potential for undisclosed liabilities, buyers often conduct a more thorough due diligence process. From our cost perspective, the structure as an asset purchase vs. a stock purchase generally doesn’t drive cost as the additional due diligence for the stock purchase generally equals the added complexity to transfer assets under an asset purchase. For us, it’s generally other components that impact the complexity of the transaction that drive cost.
3. The Rise of Rollover Equity and Its Implications
Since the new SBA rules permitting rollover equity, we’ve seen a significant increase in rollover equity being a component of the deal structure. It’s a great tool to align both the seller’s and buyer’s interests post-closing. However, it's essential to structure this with precision, especially when considering SBA financing. The newer SBA rules have added complexity, allowing for rollover equity but leading to varied interpretations by banks, especially in the context of stock vs. asset purchases. To address the lenders’ interpretation uncertainty, we include terms in the LOI for our clients to permit them to elect a stock purchase if necessary. It’s not just a provision allowing the election, but also establishing how this election will impact key deal terms. We go through the deal and LOI line by line and consider how each component would need to be handled and typically include several clauses that only become effective if the election to pursue a stock acquisition is elected. This allows clients to move forward in dealmaking despite uncertainties in the martket place.
4. Navigating Non-Transferable Contracts and Approvals
Something important to note is that certain contracts may still require third party approval even in the event of a stock sale. While it’s less common in general, it is particularly more common where the contract party, or parties, are more sophisticated. This is especially true in industries where relationships are paramount and where the counter-party relies on the target company. You want to identify the need for third party approvals as soon as possible in the deal and generally cover this post-LOI in due diligence or pre-LOI if the parties know there may be approvals that are required. Even a deal that both parties want to close can come to a standstill if third party approvals become an issue.
Practical Tips:
When structuring an LOI, particularly if you're eyeing SBA financing and rollover equity, consider providing an option for the buyer to elect a stock acquisition if they plan to present an LOI with an asset acquisition. This optionality recognizes the unpredictability in bank interpretations and keeps pathways open. In addition, be sure your business due diligence pre-LOI digs into the need for third party approvals and transferability of the various components of the business.
Wrapping Up: The Essence of Strategic Acquisitions
The decision between asset and stock acquisitions isn't just legal or financial; it's fundamentally strategic. It requires a deep understanding of the business, its environment, and the nuanced needs of the transaction and all stakeholders involved.
Your Turn: Have you had experiences, challenges, or insights into choosing between asset and stock acquisitions? What strategic considerations did you prioritize? Let me know in the comments below!
If you have questions or are looking to delve deeper into this topic, feel free to reach out. Cheers to great, strategic dealmaking!