The difference between a Merger and an Acquisition
In an asset purchase, the purchaser buys particular resources of the target that are recorded within the trade documents. Buyers may choose an asset purchase since they can avoid buying unnecessary or unwanted assets and liabilities. Typically, no obligations are assumed unless expressly transferred under the transaction documents. Since the obligations remain inside the selling company, buyers may remove or reduce the chance of assuming unknown liabilities. Further, buyers typically get better tax treatment when buying assets instead of stock. If buyers have the ability to bring a stepped-up price basis in the assets that are acquired, they may lower their taxable profit, or increase their loss, when they later sell or dispose of their assets.
The principal risk to buyers in an asset purchase transaction is that a purchaser may fail to buy all the resources it needs to effectively operate the organization. Additionally, there are various elements of an asset sale which could be time consuming and push transaction costs: such as list particular assets and determining their worth; for some resources, third-party approval may be required before the assets can be transferred into the purchaser; and the way title of an asset is passed to the purchaser will change depending on each sort of asset, and name to each bought asset must be transferred separately. Finally, there’s a risk that the seller could retain sufficient assets to continue as a rival going concern. This risk is usually mitigated by requiring the vendor to covenant not to compete with the purchaser.
Sellers generally disfavor asset trades because the seller is left with possible obligations without significant resources it could otherwise use to meet those obligations. Additionally, the tax treatment of an asset purchase is generally less favorable to sellers than a stock exchange. The company and its shareholders can each potentially incur taxable income, which could lead to double-taxation of the sale proceeds. Entities who have pass-through taxation (partnerships, LLCs and S-Corporations) can prevent the issue of double-taxation, and consequently may be more inclined to take an asset purchase arrangement.
Generally, only acceptance of the vast majority of the members or shareholders is needed for an asset purchase transaction. Nevertheless, in Washington state and other states (not including Delaware), shareholders who vote against the asset purchase may have the right (called dissenter’s rights) to request a court to get the fair market value of the shares in connection with the asset purchase.
In a stock purchase, the purchaser buys the stock of the target company straight from the target’s shareholders. The business remains an existing going concern following the purchase, and its business, assets and liabilities continue unaffected by the trade. A purchaser may prefer a stock buy once the buyer wants to continue the performance of the target company after the purchase. Further, absent unusual circumstances, approval from third parties wouldn’t be required to approve the trade.
However, by purchasing the whole business, assets and liabilities, the purchaser could be exposed to unknown risks. Buyers can reduce its risk by holding back some of their cost in escrow to meet any obligations that arise after closure. Additionally, obtaining approval for a stock purchase could be problematic if the target has a great number of shareholders. Unless there are agreements in place ahead, buyers can’t force shareholders to market, and so that a holdout Visitor could refuse to sell to the purchaser. This result can be quite undesirable for buyers and may wind up causing the price to fall apart.
Buyers may have less-preferential tax treatment in a stock purchase. Usually, buyers might prefer to get a stepped-up price basis in the target firm’s assets than a stepped-up price basis in the target firm’s stock. However, in certain conditions, buyers are able to make an election to treat the stock purchase as an asset purchase, thus preserving the favored tax treatment of an asset purchase.
In a merger, two different legal entities become one living thing. All the assets and obligations of each are possessed by the new surviving legal entity by operation of law. There are lots of structures that mergers may take. The easiest is a forward merger, whereby the selling firm merges to the buying company, and the buying company survives the merger. Often, buyers will want to maintain the target company as a separate legal entity for liability reasons, so the buyer will rather merge the target to a wholly-owned subsidiary business of the purchaser, known as a forward triangular merger. When complete, the subsidiary survives the merger, holding all the obligations and assets of the target business.
Both a forward and a forward triangular merger normally need third-party consents, since the target company ceases to exist following the merger and all its assets are owned by the surviving entity. A reverse triangular merger is like a forward triangular merger, except that the target company is the surviving entity, rather than the wholly-owned subsidiary of the purchaser. Under Delaware law, a reverse triangular merger doesn’t constitute an assignment, as the targeted business continues as the living entity, and so no third party consents are required.
In terms of corporate approvals, mergers generally require approval only of the seller’s board of supervisors and the majority of its shareholders (absent additional requirements in its charter documents). This lower threshold is especially appealing when a target firm has multiple shareholders. However, shareholders who vote against the merger will normally have appraisal rights under state law. Appraisal rights (or dissenters’ rights) enable dissenting shareholders to request a court to get the fair market value of the stocks. This can complicate transactions and increase the purchaser’s costs.
The way the merger is taxed depends upon its structure. Generally, forward and forward triangle mergers are taxed as asset purchases, while reverse triangular mergers are taxed as inventory purchases.