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M&A Fundamentals – Share Sale or Asset Sale?

This article explores some of the differences between completing an M&A transaction as a share sale or an asset sale, and the impact of these different legal deal structures on both the buyer and seller.

When you talk to a corporate development professional about a potential M&A transaction, the first question they will inevitable ask – “Is this an asset purchase or a share purchase?”

In a share sale the buyers acquire the shares of a limited liability corporation, and all the commercial assets and activities contained within the corporation.

In an asset purchase the limited liability corporation itself sells commercial assets and activities leaving the shareholders with an “empty” limited corporation.

Each method has its advantages and disadvantages for both M&A buyers and sellers.

M&A Issues Flowing from the Nature of a Limited Liability Corporation

The M&A implications of an asset sale and a share sale arise from the nature of a limited liability corporation.  Figure 1 illustrates the main issues:

 

 

The most important issue is that the company has a legal identity of its own.  In essence it is a legal ‘person’. This means that it is financially and legally independent of its directors and shareholders. The company is responsible for its own debts and liabilities, and its commercial assets belong to the business itself – not the shareholders. This means the business activities contained in the company can be sold in two ways.

In an M&A share sale the buyers can buy the shareholders’ shares and take ownership of the company.  In most cases they will now be entitled to appoint their own directors and take full control of the company’s business assets and activities.

Alternatively in an M&A asset sale the buyers can buy some or all of the commercial assets and activities of the company and move them into another limited liability corporation. This might be a newly established company or one of their existing legal entities. Assets in this case means everything necessary to run the company’s commercial activities – for example fixed assets, intellectual property, employment contracts, working capital and customer relationships.

We will look at each of these M&A transaction types in more detail.

M&A Issues Flowing from a Share Sale of a Limited Liability Corporation

At first sight a share sale is not a complex transaction, a straightforward exchange of shares for cash. The complexities for the buyer come from being the proud new owner of a shiny, new, second-hand company. A legal “person” with the baggage of a long and complex history perhaps littered with potential legacy liabilities. An M&A transaction for shares is a much more complex transaction necessitating extensive due diligence, and detailed legal protections from past actions of the directors through the company.

That said, there are genuine advantages to an M&A share sale for the buyer.  There should be minimal disruption to business.  Although ownership has changed the company will carry on business with the same name, legal identity, and trading conditions.  Most contracts to which the company is a party will continue undisturbed after the acquisition.  Staff will continue to be employed by the company, and in the EU and UK there will normally be no need for the transfer of undertakings consultations that apply only to an M&A asset transaction.  As there will be no change in the ownership of any land or property owned by the company there will be no need to register a transfer of ownership or pay any associated transaction taxes (UK Stamp Duty). If though the property is subject to a lease this will have to be reassigned which will involve costs for legal fees and in some countries transaction taxes.

Most of the downsides for the buyer relate to potential skeletons in the cupboard.  The company retains responsibility for all its past actions and undischarged liabilities, some of which might not be found in due diligence. To protect the buyer from these liabilities their lawyers will negotiate a long and complex contract making the sellers liable for any legacy issues. This is expensive for both sides.  A share sale contract will typically run to at least 80 pages of assurances by the sellers about the company and obligations to pay if undisclosed problems come to light.  Buyers are always aware that whatever the contract says it is difficult to get money back from a private seller after a sale. If a seller is unwilling to honour their obligations, all the contract gets you is the right to a lawsuit!

For the sell side of the M&A share sale transaction, and especially for private sellers, tax is the primary motivation for a share sale. Taxes on an M&A share sale in most countries are lower than for an asset sale. We will explore why in the next section on M&A asset sale transactions.  Unfortunately, despite the tax advantages, selling shares conflicts with one of the private business sellers other most cherished objectives – being free and clear with their money with no prospect of future claims by the buyer. There really is no such thing as a free lunch when it comes to selling a company, and a sale of shares will leave the seller with long term obligations to the buyer. Taxation, employment matters and regulatory compliance warranties can leave the seller exposed to future claims for many years. To protect themselves from a sellers’ likely reluctance to pay buyers will typically insist that up to 20% of the selling price is held back as a retention for up to two years. The retention can be used to settle any claims under the contract. A further 10% is often also retained for up to 3 months to protect the seller from last minute changes in working capital.

M&A Issues Flowing from an Asset Sale of a Limited Liability Corporation

As you might expect asset sales are often favoured by buyers as they can leave most legacy liabilities with the selling corporation.  Buyers in an M&A asset transaction are also able to pick and choose the assets they want to purchase.  This is useful if some of the assets in a corporation are less attractive to the buyer or associated with specific liabilities. One exception to this in the UK and EU is employees.  EU regulations, and the UK Transfer of Undertakings (Protection of employment) Regulations 2006, mean that any employees associated with a set of commercial assets automatically transfer to the new owners with their existing terms and conditions.

Inevitably there are some downsides for the buyer in an M&A asset transaction. If the assets are transferred into a newly formed limited company this company will have to apply for all the necessary governmental and regulatory registration it needs to operate.  Also, the new company will have no credit history which might lead some suppliers to offer restricted credit terms until a payment history can be established.  Many of the commercial contracts associated with the purchased assets may also have change of control clauses linked to the selling corporation.  It can be a sizeable administrative task to get these contracts signed over to the new limited company.  Some suppliers might even take the opportunity to renegotiate terms.

The main motivation for a private seller to oppose an M&A transaction by asset transfer is exposure to additional taxation.  In most jurisdictions a limited corporation will pay corporate income taxes on the difference between the selling price of the assets sold, and their value in the seller’s balance sheet.  After the sale completes the shareholders will be left with a limited liability corporation with a large cash balance and no assets.  When the shareholders extract the cash from the company these payments will be subject to personal income or capital taxes.  In most countries this “double” taxation will result in a higher overall tax bill than for a sale of shares.

One upside of an M&A assets sale transactions for both buyers and sellers is that the associated legal fees are substantially lower than for an M&A share sale transaction. As most legacy liabilities are left with the selling corporation the contract for the sale is much reduced.  Often no more than 10 pages in length plus a listing of all the assets to be sold.  Legal fees for both sides can be as little as a third of the cost of share sale agreement.

 

About The Merger Training Institute

We provide practical, in-career mergers and acquisitions training for boards, executives and professionals in global corporations.

Our short, intense M&A courses are designed for executives needing to understand best M&A practice or adding new M&A responsibilities to their existing roles.

The courses are taught by tutors with hands-on M&A experience gained as part of corporate management teams. As well as being academically rigorous they are rich with case studies and real-world examples based on our tutor’s practical mergers and acquisitions experience.

Our course participants come from a wide range of industries and roles including general management, business development, strategy, marketing, finance, human resources, operations and legal.

 

Our Mergers and Acquisitions Training Courses

Core Mergers and Acquisitions Skills Training Course

The Core Mergers and Acquisitions Skills programme (M&A training course) is a three- day programme that teaches all the commercial and technical skills you will need to confidently lead or support a successful M&A transaction.

Our expert tutors guide you through the M&A process from strategy and deal origination to valuation, due diligence, deal structuring, contract negotiation and post-merger integration.

M&A Due Diligence Training Course

The M&A Due Diligence Training Course is a two-day programme that offering a solid grounding in the techniques used by some of the world’s most successful companies to assess risks, evaluate synergies and confirm the strategic fit of an M&A target. The course is designed specifically for executives involved in corporate M&A.

Successful Post-Merger Integration Training Course

The Successful Post-Merger Integration Training Course is a two-day programme that provides a solid grounding in the post-merger integration techniques used by some of the world’s most successful companies to deliver value from their M&A transactions.

Across the two days of the course you move from the key decisions made in the pre-deal phase, through the critical first 100 days and on to full synergy delivery. The course covers the post-merger integration issues most likely to arise in each business function and the most important business processes.

Advanced Business Valuation Training Course

The Advanced Business Valuation training course is a two-day expert level business valuation training course that teaches participants how to prepare robust business valuations in the context of a corporate M&A transaction.

Our expert tutors move you past the stage of plugging numbers into a standard spreadsheet and help you explore how risk, synergies and the quality of the target company might impact its value.

 


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