M&A Deal Structure – Legal options and Strategies

M&A Deal structure

M&A deal structure activity is extremely complex and involves substantial efforts and risks associated with it.
After the business identifies the right target to be acquired based on the strategic rationale and for business development purposes, structuring the deal along with using an appropriate acquisition vehicle to acquire the target and how the target will continue to operate post closing is extremely critical to achieve success.The legal entity of the target company has an important effect on the tax structure and planning of the acquisition.
There is no right strategy for structuring the deal.This depends on how the deal is structured like whether it is an asset or stock acquisition along with the desired acquisition vehicle on how the target will be merged into the acquired company either as a holding company or through a subsidiary. The deal consideration whether it is paid through cash or equity also is equally important in deciding the right strategy that is favorable to both the buyer and seller.

M&A deal structure process

1. Ideally the buyer can look at acquisition either by acquiring the assets of the target company or its stock.The deal structure basically depends on the contours of the deal and what the buyer is looking to achieve.
2. In case of asset acquisition, the buyer only acquires assets that is important to its strategy and takes liabilities associated with these assets.The target continues to operate as legal entity and can use tax credits and net operating losses to reduce taxes on its future earnings.The only issue is the double taxation for the seller based on the capital gains on the sale of the asset.The buyer can step up the value of assets based on the Fair Market Value and can depreciate the same in future to avail tax savings.Due to double taxation involved along with approvals required to be taken by the buyer from target customers and partners for change of control provisions, the buyer and seller negotiates on the deal structure to share the financial risks equally.
3. The buyer can look at Stock acquisition where the buyer also inherits all the outstanding liabilities of the seller post acquisition.The buyer limits these risks by indemnification clauses that protects the buyer from future penalties and risks against third parties. The buyer also is not required to get approvals from customers and suppliers as all these relevant contracts are transferred automatically post acquisition.In the stock acquisition, the buyer and seller are required to get their boards and shareholders approvals to close the transaction. The buyer need not get approvals of minority shareholders to close the transaction but needs to compensate the minority shareholders of their holdings appropriately in case the minority shareholders oppose the transaction.
4. Statutory merger is also another way of an acquisition where the identity of the seller ceases to exist and the acquirer controls the assets and liabilities of the seller.This transaction also requires the approval of the boards of both the companies.The buyer does not automatically become the owner of all the contracts of the seller.In case of IP contracts, the buyer needs to assign the target contracts to its name and need to register the same with the patents office so that it can contest against any future litigations or claim against the IP.This structuring requires a detailed due diligence to be done by the buyer as the buyer inherits all the outstanding liabilities – known and unknown liabilities of the target.
5. M&A need not be the only tool for the buyer to leverage the resources of another company.Companies enter into Joint Ventures, Strategic Alliance and Partnership to benefit from one another.In these deals, there is no change in ownership of both the parties. In case of JV, companies participating can create a distinct legal entity with an equity structure that depends on the contribution of individual parties.The largest equity holder influences the strategy.As there is no control of one party over another, parties can exit the JV when it no longer aligns to their strategic objectives.Strategic Alliances are also rapidly structured between the companies where two companies come together to sell each other services or work on building a product.JV/Partnerships generally are a precursor and a stepping stone for acquisitions.As companies work together and understand their cultures /way of working, M&A becomes the logical step ahead.

Acquisition Vehicles for Deals

1. Once the deal structure is finalized by the company, the deal team works on how the target company would be merged with the acquirer.
2. Generally acquirers create a subsidiary that would acquire the target company.This will insulate the parent company of any liabilities and risks associated with this acquisition. This also prevents any approvals which is needed to be obtained from the acquirer shareholders as it is the subsidiary that is acquiring.The subsidiary would be funding the acquisition and acquires all the risks associated with the transaction.The target company would be merged into the subsidiary and hence the legal identity of the target company ceases to exist.This is generally knows as Forward Triangular Merger.
3. In many cases, the acquirer would not be able to leverage the target customers and suppliers relationships as these contracts stipulate that the contracts will be valid and operative only with target company.Hence these contracts dissolve once the target ceases to exit.
4. To ensure continuity in operations and leverage targets relationship, the acquirer creates a subsidiary and the target company acquires the subsidiary. Hence the target company becomes the direct subsidiary of the acquirer and continues to operate as a legal entity.This is known as Reverse Triangular Merger.
5. Reverse Triangular Mergers has courted controversy because the provisions can be misinterpreted by the companies. For instance, Company A acquires Company B.Company C is a customer of company B and a competitor of Company A.Hence Company C does not want to share its details with Company A.By resorting to reverse Triangular Merger, Company A can allow Company B to operate legally which obligates company C to continue its relationship with Company B due to contractual commitments.

Post Closing Operations of the Target

1. The acquisition vehicle used would determine the post closing operations of the target company.
2. If the acquirer wants to integrate with the target, then the acquirer buys the seller stock and then decides to operate the seller as a division within the subsidiary.The divisional structure is not a legal entity and the target becomes one of the business divisions of the acquirer without any shareholders.
3. If the acquirer wishes to retain the legal structure of the target post closing, then the acquirer can operate the target as a holding company and make it as a subsidiary to acquirer. The subsidiary has a shareholding structure and would operate independently. This is generally used when target brand is more reputed or when the acquirer does not want to inherit target liabilities or when there is an earn out provision for the target owners to meet the growth targets.

M&A dea structure – Consideration of the transaction

Based on the deal structure, the consideration could be cash for stock, stock for stock, stock for asset and cash for asset.The buyer and seller would generally use more than one combination to finalize the consideration based on the tax planning as well as sharing any financial risk as a result of the transaction.

Conclusion

1. M&A deal structure is a very important process in deal life cycle to ensure both the acquirer and target company are able to benefit from the transaction.
2. The deal structuring would ideally depend on the transaction structure and how the acquirer want the target company to operate legally post the acquisition.
3. There is no one size fit all strategy and would basically vary on how the buyer and seller wishes to structure the transaction.The negotiations are based on these.