As I have written about succession planning for a family business, this also should include exploring the possibilities of selling your company and the implications of how to best structure an exit or sale. For most startups and emerging companies, being acquired is the most common form of exit. Having a business exit strategy is an entrepreneur’s strategic plan to sell his or her ownership in a company to investors or another company. An exit strategy gives a business owner a way to reduce or liquidate his stake in a business and, if the business is successful, make a substantial profit. If the business is not successful, an exit strategy (or “exit plan”) enables the entrepreneur to limit losses. An exit strategy may also be used by an investor such as a venture capitalist in order to plan for a cash-out of an investment. Why think about selling or getting acquired? Maybe something has changed in your industry that makes your company valuable to another. Such as when a 2018 Supreme Court decision: ruled to legalized sports gambling in the US, and has sparked a rush for media and gambling companies to capitalize on an online betting boom. Barstool Sports, a controversial digital sports publisher, agreed to sell a 36% stake in Barstool to Penn National Gaming, (a casino operator) for $163 million in cash and stock — valuing the company at $450 million. For many large companies, M&A and acquisitions is a big part of their growth strategies.
The law firm Cooley LLP has published several useful articles about the subject including Merger & Acquisition exit preparation, and negotiating M&A purchase offer term sheets but they also discuss the 3 most common acquisition structures in a post here that I would like to discuss the pros and cons of each type. As the author Kevin Tsai mentions the most common structures include:
- Merger deals
- Stock sales
- Asset sales
Merger deals
Businesses acquire other businesses for a variety of reasons. From a buyer’s perspective, an acquisition is often the quickest way to grow and/or diversify a business. It is also a surefire way to eliminate competition. In a merger and acquisition M&A deal, a merger consolidates two different legal entity companies into a single legal entity that will now hold the combined assets and liabilities of the original companies. Mr Tsai states in his article that most common type of merger is called a “reverse triangular merger”, where the acquiring company (buyer) creates a wholly-owned subsidiary company (a “merger sub”). Investopedia says that a “reverse triangular merger is more easily accomplished than a direct merger because the subsidiary has only one shareholder—the acquiring company—and the acquiring company may obtain control of the target’s nontransferable assets and contracts.” At the deal closing your company’s equityholders’ interests are cancelled in exchange for “merger consideration”, most commonly cash or stock issued by the buyer. The merger sub merges into your company and ceases to exist as a separate entity and your company “survives” – now as a wholly-owned subsidiary of the buyer. Below Mr Tsai goes over the pros and cons of selling a company in an M&A transaction.
Pros
- Mergers can be less complicated than asset sales since the merged entities collapse into each other by operation of law. In an asset sale, assets to be sold need to be specified and duly transferred.
- Merger consideration is typically paid directly to stockholders, whereas in an asset sale you have to take the additional step of distributing the sale proceeds to the stockholders. Your company will also still exist after an asset sale, and administratively you will still need to take steps to dissolve the company and deal with any remaining liabilities and assets.
- Unlike a stock sale, 100% of the interests of a company can usually be transferred without the consent of all of the stockholders. The actual stockholder approval requirement, whether a majority in interest of outstanding stock or some higher threshold, will depend on state laws, your charter and the contracts you have signed.
Cons
- A merger can require additional steps to be completed compared to a stock sale with a limited number of sellers. For example, the buyer may need to form a merger sub and a merger certificate will need to be filed with state authorities.
- Some types of mergers may result in your company’s ceasing to exist as a distinct legal entity. This can breach anti-assignment provisions in contracts your company may have entered into, so you will need to evaluate contracts and determine if any third party consents need to be secured before closing.
Stock Sale
In a stock sale, the buyer simply purchases the outstanding stock of your company directly from each stockholder. The legal status of your company remains the same and the name of your company, operations, contracts, etc., all remain in place unless otherwise contemplated by the acquisition agreement. There is two ways to sell to a 3rd party: An owner sells the company’s assets outright, or the stock in the company (or units if it is a limited-liability company). Stock sales usually benefit the seller, while asset sales benefit the buyer.
Pros
- No need to take certain steps that may otherwise be required in a merger, such as forming a merger sub.
- Since the company still exists in its original form post-closing, anti-assignment provisions are usually not breached (though change of control provisions may still be problematic).
- Stockholders are paid directly for their shares.
Cons
- Your company may have a large number of stockholders, some of whom might be difficult or impossible to contact, such that it may be hard to coordinate action by all holders. Buyers typically want to own 100% of a target’s outstanding equity and a single absent holder or small holder opposing the transaction may frustrate that buyer from being able to achieve that goal. Therefore, unless your company is closely held and you are confident that all of the stockholders can be convinced to agree to the terms of the sale, a stock purchase may not be feasible.
Asset Sale
This business exit strategy involves shutting down the entire business and selling some or all its assets. For this strategy to be profitable the business needs to have certain value-adding assets it can sell, such as land, building(s) or equipment. In an asset sale, Mr Tsai states that a “buyer can buy some or all assets of your company.” Assets can be in all kinds of forms, including intellectual property rights or contracts. Asset buyers purchase the company’s physical equipment, facilities, and customers, as well as the intangibles like trademarks and goodwill, and they are generally protected from prior claims against the business. Similarly, the buyer may assume none, some, or all of the liabilities of your company, and any liabilities not assumed by the buyer will remain with your company post-closing. Your company will continue to exist, and potentially continue to operate, following the sale.
Pros
- Buyers like asset sales since asset sales allow a buyer to only acquire desired assets and leave unwanted assets (and liabilities, both known and unknown) behind with the seller.
- A buyer can often obtain significant tax benefits in an asset purchase, since the buyer will get a “step up in basis” with respect to assets it purchases.
- Limited asset sales might not require the approval of the stockholders of the selling company (though a sale of substantially all assets will still require stockholder approval).
Cons
- If only a portion of the company’s assets are being sold, it can be time consuming, expensive and impractical, to separate assets (and contracts relating to such assets) to be acquired from the rest of your company. Assets and contracts are not confined to a single line of business and many assets, including intellectual property assets, may be shared between business lines. While these challenges can sometimes be addressed through “transition services agreements” that allow assets to be shared between the buyer and your company for a period of time, such agreements may themselves be complicated and difficult to negotiate.
- If your goal is to sell the entire company, an asset sale will not automatically wind down the company. After the asset sale, you will still need to figure out how to deal with the company’s remaining assets and liabilities.
- Transferring contracts in an asset sale often will require third party consent since the party to the contract will change. Other desired asset transfers might be difficult or prohibited. For example, government filings or approvals may be needed to complete certain transfers of intellectual property or contracts and government permits may be non-transferable.
Conclusion
Figuring out the right transaction structure for your deal will vary significantly based on your unique circumstances. Each structure offers distinct advantages and disadvantages, including those many things not mentioned in this blog post. For instance, tax considerations can play a significant – or even major role – in determining what structure will most maximize value in a deal. Considering these structures thoughtfully can help you facilitate a smooth sale transaction and increase the value your stockholders get out of the deal (including, in some cases, by giving your buyer the benefit of a structure it prefers in exchange for more consideration to be paid to your stockholders). If your company is considering a possible sale or merger you should consult your outside counsel and accounting teams to help identify outstanding record keeping matters. Such as organizing and cataloging key contracts, financing documents, employee arrangements, intellectual property documents, financial information and other key diligence materials so they are ready for review. I have some experience with M&A advising, in 2015, my accounting firm acquired the client base and assets of the firm Witt & Associates, CPA’s Inc. If you are business owner in the San Diego area and have been thinking about selling your business or possibly purchasing one and want some advice on tax considerations Huckabee CPA is here to help. Feel free to contact us for a free consultation.
