Mergers and Acquisitions

A merger or acquisition is one of the biggest and most important transactions a company can undertake. If the transaction is not done properly, that deal can have a profound effect on the health of the business and its prospects for future growth. We help companies find the right fit in another business and negotiate terms that minimize liability, are tax-efficient, and help them meet their strategic goals.

Types of Mergers and Acquisitions

There are three main techniques for buying all or part of another company – a merger or combination, a stock sale, or an asset sale. Each one of these can be executed as taxable or nontaxable transactions for the buyer and the seller.

Merger or Combination

A merger or combination refers to a statutory filing where two or more businesses combine into one business. The two companies need not be of equal size. One reason to choose a merger or combination is that it is generally easier for the seller to achieve tax-free status.

To be tax-free, the transaction must comply with the requirements of § 368(a)(1)(A) of the Internal Revenue Code which provides that the acquirer must use its stock as a significant portion of the consideration paid to the acquired company. In addition, the transaction must meet four conditions:

1. Continuity of Shareholder Interest (COSI): the proprietary interest after the transaction must rest in the same parties as immediately prior to the transaction.
2. Continuity of Business Interest (COBE): the acquiring corporation must continue the acquired corporation’s business or use a significant portion of the acquired corporation’s business assets in a business.
3. Valid Business Purpose: there must be a valid business purpose for the transaction beyond tax avoidance.
4. Step-Transaction: the transaction cannot be a part of a larger transaction that taken in its entirety, would constitute a taxable acquisition.

Regulatory reasons or loan covenants may also make a merger or combination more desirable compared to a stock or asset sale.

The downside of a merger or combination is the problem of successor liability. The newly formed company is liable for the debts and obligations of the prior two companies.

Stock Sale

A stock sale is a stock-for-stock transaction or a transaction where the purchaser buys the company’s stock for cash. One company (the target or seller) exchanges most or all of its equity for the equity of the purchaser or sells most or all of its equity for cash. The effect is to make the seller a subsidiary of the buyer and the equity holders of the parent company become equity holders of the subsidiary. As with a merger or combination, there is successor liability. However, the risks are limited to the subsidiary since the subsidiary becomes a separate entity.

Under § 368(a)(1)(B) of the Internal Revenue Code, the transaction may be tax-free if the parent company acquires at least eighty percent (80%) of the vote and value of the subsidiary. The entire eighty percent (80%) of target stock need not be acquired at once, but the acquirer must own at least eighty percent (80%) upon completion of the acquisition.

Asset Sale

In an asset sale, the target company sells the majority of its assets to the purchaser. The old entity dissolves and distributes shares to shareholders.

If the consideration is equity and not cash, the transaction may be tax-free under § 368(a)(1)(C) of the Internal Revenue Code. The acquirer must exchange its voting common and/or preferred stock for “substantially all” of the target’s assets. If other consideration is given, it cannot exceed 20% of the FV of the target’s pre-transaction assets.

Successor liability is less of a problem with this option, although the rules are complicated, and limiting liability can be difficult to accomplish.

Requirements for Mergers and Acquisitions

Typically, the target company’s board of directors and shareholders must approve any form of merger or acquisition. The buyer may also need to obtain approval depending on the size of the buyer. A very large company may not require approval to make a purchase.

In addition, if the entities are public companies, various filings with regulatory agencies may be required such as a proxy and Form TO.

Dispositive Mergers and Acquisitions

Sometimes, companies want to sell off parts of the business or certain assets, such as intellectual property. There are three options to accomplish this – a split-up, a split-off, or a spin-out.

In a split-up, the company splits into two companies and the shareholders choose which one they will own shares in. In a split-off, a group of shareholders become shareholders in the split-off company. Finally, in a spin-out a new company is created and all shareholders of the original company become shareholders of the spin-out company.

Taxable and Nontaxable Transactions

As discussed above, transactions can be structured to be tax-free. Taxes are an important consideration in any deal. Buyers and sellers can negotiate the tax effect of the sale as they would any other contract term. However, any advantage given to the seller is a disadvantage to the buyer. It is a bargaining chip that can be used to gain other benefits that a party may decide is more worthwhile. For example, the buyer may negotiate a lower price for the company in exchange for allowing the deal to be structured to save taxes for the seller.

How We Help

Our goal is to counsel businesses about their options and what is best for their company under the circumstances. We then help execute a deal that is tax and cost-efficient so they get the maximum benefit out of the transaction.

If you are considering a merger or acquisition, relying on experienced counsel is vital to a successful deal. Contact us to learn how we can assist you in achieving your business goals.