History and Causes of Merger Waves
Throughout history, giant companies have joined together through mergers but what causes merger waves? In the United States alone, there were six periods of high merger activity. These higher merger activities are often referred to as merger waves as well.
These periods of merger waves are characterized by cyclic activity. This means high rates of fusions followed by relatively fewer contract cycles.
A quick history recap for you: the first four waves of mergers occurred between the years 1897 and 1904, the next wave happened in 1916 and 1929, followed by the merger deals in 1965 and 1969, then again in 1984 and 1989.
After that, the merger trend began to decline in the late 1980s, but the third merger wave began again in the early 1990s. Between 2003 and 2007, a relatively short but intense merger wave happened too.
After the recession of 1883, the first wave of consolidation took place, occurred between 1898 and 1902, and ended in 1904. Although all major mining and manufacturing sectors were affected by these mergers, some industries clearly showed a higher incidence of mergers.
The second merger wave happened between 1916 and 1929 in which several industries were consolidated. This time, however, the result was often oligopolistic industry structure rather than monopolies. The consolidation pattern that was established in the first merger period continued into the second period.
A historically high degree of merger operation was featured in the third merger wave (1965-1969), and a booming economy brought about this in part. During those years, targeting larger companies for the acquisition was not unusual for relatively smaller firms.
What Causes Merger Waves?
So, you might be wondering what causes these merger waves and how they came about. According to multiple research, it shows that merger waves tend to be caused by a combination of different factors. There are changes in the environment, policy and innovation.
First, we have an economic shock factor. This usually comes in the form of an economic expansion which motivates different companies to expand in able to meet the rapidly growing aggregate demand in the economy. In short, a company mergers with another company is able to supply the demand.
Mergers and acquisitions are a faster form of expansion than internal, organic growth. Hence, a merger would be the most ideal way to go.
The second cause of a merger wave is the regulatory shock. These regulatory shocks can occur through the elimination of regulatory barriers that might have prevented corporate combinations. Take the changes in the United States banking laws for instance, these prevented banks from crossing state lines or entering other industries.
Ovtchinnikov found that the industry deregulation tends to occur whenever industries experience performance. He also found that industry merger partners tend to be poor performers prior to the merger. Not only that, but he found that these poor performers tend to have significant excess capacity.
Next, on the list of causes, we have the technological shocks. This one is tricky, as it can come in many forms. Technological shocks happen as technological changes can bring about dramatic shifts in existing industries. Additionally, these technological changes can even create new industries. For instance, the newspaper industry was once booming until technology happened. Most newspaper companies switched to websites instead of prints.
Harford shows that these various shocks by themselves are not generally enough to bring about a merger wave. He also looked at the industry waves instead of the overall level of merger and acquisition activity between the years 1981 to early 2000.
Harford did his research on 35 industry waves that occurred in the years mentioned above, and it shows that capital liquidity is also a necessary condition for a wave to take hold. This means that capital liquidity also contributes to creating a merger wave.
In his studies, Harford found that the misevaluation or market timing efforts by managers are not a cause of a wave, although they could be a cause of specific deals. The misevaluation findings, on the other hand, are contradicted by Rhodes-Kropf, Robinson, and Viswanathan. Their research found that misevaluation and valuation errors do, in fact, motivate merger activity.
In their research, they measured these by comparing the market to book ratios to true valuations. These brilliant authors do not say that valuation errors are the sole factor in explaining merger waves. However, they did say that they can play an important role that gains in prominence the greater the degree of misevaluation.
In contrast, between 1980 and 2004, Rau and Stouratis studied a study of 151,000 corporate transactions.This research included a broader variety of different corporate events than just merger and acquisitions.
In their research, they have found that corporate waves seem to begin with the new issue waves. It all starts first with seasoned equity bids, then initial public offers, followed by stock financed merger and acquisitions. This is later followed by repurchase waves.
This finding supports the neoclassical hypothesis of efficiency which indicates that when managers perceive growth opportunities, they will undertake transactions and then participate in repurchases if those opportunities fade.
There is also another view that may explain some of the mergers than can occur during a merger wave. This view focuses on defensive mergers. Defensive mergers consider situations where the management of a potential target wants to maintain their positions and the control that they may have over their company.
As a result, the management may choose to pursue their own bid for a rival rather than lose control to a hostile bidder (these are often one of their competitors). The combined entity will then be significantly larger and more of a challenge to acquire and to raise the requisite financing to complete the deal. However, defensive mergers are another topic for another day.
To summarize, there are many different factors that contribute to able for a merger wave to happen. It is not just one single event or factor, there are different factors in play. There are also different types of mergers: short form and long form which you can read on our previous articles.
Type of Merger: Short-Form Merger
A short-form merger may take place in situations in which the stockholder approval process is not necessary. As a continuation of the previous article, we will discuss short-form mergers and how they are structured. We have previously established that there are different types of entity deals such as a stock deal or a merger.
In the previous article (Deal Structure: Asset Versus Entity Deals), we have discussed the difference between selling company assets and selling the company as a whole entity. Each of those options has its own pros and cons, which we have also discussed.
Mergers are often used by a large public company with a large and widely distributed shareholder base. In a merger deal, the company or corporation who survives the deal succeeds to all the liabilities of the company or corporation who did not survive.
Additionally, mergers can only happen if the majority of the shareholders agree to the deal. Voting approval needs between shareholders need to happen first.
Most giant companies use merger deals instead of asset deals. This is because a merger is much more beneficial to a seller in comparison to asset deals. You might have heard of giant companies merging with a similar company, this is done when a company or corporation is on the brink of bankruptcy. They merge with a similar company who will adapt all of their assets (including the liabilities), the surviving company will now own all of the non-surviving company.
There are different phases when it comes to mergers and acquisitions. It is also important to understand that there are different types of merger deals. First, there is what’s called the Forward Merger where the target merges directly into the purchaser corporation. In these types of deals, the target disappears while the purchaser survives. This is also known as a statutory merger sometimes.
Then we have the Forward Subsidiary Merger also known as a forward triangular merger. In this type of merger deal, the purchaser creates a merger subsidiary and the target merges directly into the subsidiary instead of the target merging directly into the purchaser.
Another type of merger deal is the Reverse Subsidiary Merger. This is also referred to as reverse triangular mergers sometimes. In these types of merger deals, acquirer subsidiary pays the target’s shareholders and receives the shares in the target exchange. This type of merger improves upon the forward subsidiary merger by reversing the direction of the merger.
Now that we have those three covered, it is time to focus on the Short Form Mergers.
This means that the stockholder approval may be bypassed when the corporation’s stock is concentrated in the hands of a small group. The said the small group could be the management who are advocating the merger.
However, all of that still depends on the state where the company is located. There are some state laws that may allow this “small group” to approve the transaction on its own without soliciting the approval of the other stockholders. Then, the board of directors simply approves the merger by a resolution. This law varies from state to state.
Furthermore, a short-form merger may also happen only when the stockholdings of insiders are beyond a certain threshold stipulated in the prevailing state corporation laws. Again, there are different state laws for this type of deal, so the percentage varies depending on the state in which the company is incorporated.
For instance, under Delaware state law, the short-form merger percentage is 90%. However, it could be different in other states. The 90% is the relevant percentage for most states with the exception of a few states such as Alabama, Florida, and Montana in which these states have an 80% threshold.
It is also important to mention that a short-term merger may follow a tender offer as a second-step transaction. This is where shareholders who did not tender their shares to a bidder who acquired substantially all of the target’s shares may be frozen out their positions. To know more details about tender offers, read our article about Tender Offers vs. Long-Term Mergers.
You might realize that the word “law” popped up quite a few times in this article. This is why it is important to have some great attorneys and law firms by your company’s side during merger deals and any type of deals. Look for law firms who specialize in mergers and acquisitions.
Once the short-form merger is approved by the company’s board of directors and they decide to take that route, it is typical that the board will also create a plan with a detailed definition of how the merger will proceed. This merger plan will also state the effects that the board of directors anticipates the transaction will have on the company.
Next, the plan will be distributed to the shareholders to allow them to determine whether or not they want to proceed with the transaction. Once the majority of shareholders approve of the short-form merger, the legal proceedings begin. The company will combine everything – including financial statements, business operations and legal rights with the parent company.
Should there be any shareholders who disapprove, the parent company will try to buy their shares out. There are also cases where shareholders disapprove of the short-form merger simply because they are not interested in the transaction. Either way, the parent company will have full control of the subsidiary.
As previously mentioned, there are a lot of options when it comes to the types of mergers. The type of merger deal you should take depends on the state of your company or corporation, and the agreement between shareholders. Again, a law firm who specializes in these cases is crucial for you and your company.
There you have it, a quick overview of short-form mergers and how it happens. In the next article, we will discuss more mergers and merger waves. To learn more about mergers and acquisitions, explore our website. We offer free articles regarding mergers and acquisitions as well as detailed guides on corporate restructurings.
Do Diversified or Focused Firms Do Better Acquisitions?
Planning to change or renew your business structure, there are a lot of factors to consider: Do Diversified or Focused Firms Do Better Acquisitions? Additionally, there are also plenty of questions to ask so you can lead your business on the right path to success.
One of those questions is whether or not diversified firms do better acquisitions than focused firms? If this is one of the questions you had in your mind, then you are in the right direction. To better answer this question, let us first discuss the difference between diversified and focused firms.
Diversified firms
A diversified firm or company runs multiple unrelated businesses and/or products. This means that while you’re running your company, you are also running multiple other businesses or selling other products.
Usually, these unrelated businesses require unique expertise in management. These also have different end customers than your primary business’ customers. An unrelated business under a diversified firm can also produce different products or provide different services.
To make it short, a diversified business is not focused and needs a lot of management. Because you have different products and services, you also have different consumer markets.
The idea is to spread or smooth financial operations or geographic risk concentrations. It is time-consuming and requires a lot of effort. But at the end of the day, what type of business doesn’t, right?
There are good sides and silver linings to running a diversified business, too. One of the main advantages of operating a diversified business is that it helps protect a company from drastic volatility in any market. This means that one business under a diversified firm can do bad at the stock market without affecting the others, or vice versa.
Another silver lining is that you can run multiple businesses, therefore, multiple sources of income without affecting the others. With multiple businesses, you also have the ability to create more jobs for people and help improve your local economy.
A company may diversify by entering into a new type of unrelated business on its own, combining with another company, or buying another company operating in a very different field or service sector.
There are plenty of diversified firms that are very successful at what they do. Some great examples of these types of diversified companies are General Electric, Motorola, 3M, Toshiba, Hitachi, and Siemens and Bayer. But do they have better acquisitions than focused firms?
Focused Firms
On the other hand, you have a focused firm that focuses on one specific brand or type of business. These focused firms immediately eliminate the complexity of running a diversified business.
It creates opportunities for simplification. Virtually every area of the business is simple enough. You no longer have the need for several management teams, and you don’t have to diverse your focus on other businesses.
You have your clear objectives, and you have a precise understanding of who your customer base is. This comes in handy especially when you are trying to focus on giving your customers the best products or services you can possibly provide.
This allows a businessman to focus more on other areas of the business such as determining which products or services will most appeal to the customers. It also helps you understand what your customers like or don’t like.
A focused firm helps you create a focused strategy. It helps with effective decision making and execution because you have the time and energy to focus on one specific niche. Therefore, it is easier to achieve your business’ objectives.
Throughout the companies’ lifespan, a focused firm is not interested in expanding, merging or entering into a new type of business. It focuses on one specific business model. But is it a better business model than a diversified firm?
Which One Did It Better?
An examination of the benefits and costs between a diversified and a more focused business structure has revealed a lot of information on which structure does better. Another separate question is which of the two business models are better at merger and acquisition.
For a period of two decades from 1981 to 2010, Cihan and Tice analyzed and studied a large sample of 1,810 deals. They found in the study that diversified firms had announcement returns that were 1.5 percent higher than single-segment bidders.
But that is not all that they found out. Cihan and Tice also went on to try to find the source of the higher value for diversified acquirers. They have conducted a regression analysis in which post-merger performance measures reflecting the profitability and costs were regressed against bidders’ diversification status and premerger performance.
What they found was that for firms with diversified acquirers, the Selling, General and Administrative is 1.8% to 2.6% lower than those firms with focused acquirers. Furthermore, the study that was conducted concluded that the combined companies where the bidder was diversified had higher profit margins and lower costs.
In the end, the results implied that the diversified acquirers are at a better position to implement post-deal efficiency improvements as opposed to those who are more focused bidders.
The results of this study play a major learning lesson for those who are running a business today. It has been a general guide for businessmen who are trying to do better at running and expanding their businesses.
We hope that this blog post has helped you understand the difference between a diversified business and a focused firm better. The data in this post aims to help you decide on which route to take to create a better business model.
Now that you have the data in mind, you can think about what type of business model you want to do, and whether or not you should enter a diversified business or stick to a focused business. At the end of the day, it all boils down to what risks you are willing to take, and how hard you are willing to work to help lead your company to a better path.
Types of Preventative Antitakeover Measures
Protecting your company from a takeover is one of the most main priorities when it comes to running a business. In reality, most shareholders and other competitors are looking towards a takeover or antitakeover to hold a majority stock share in a company. This is especially true for most giant companies.
As a CEO and a company owner, it is one of your duties to prevent this from happening, amongst many other duties a CEO needs to fulfill. Thankfully, there are certain preventative measures you can take to avoid takeovers.
In this article, we will discuss the two main types of preventative anti-takeover measures, and how you can implement them. Learning about these is crucial as it equips you with the knowledge on how to protect your company better.
Think of it this way, your company is a precious castle, and there will always be people who will try to take over. In order to protect your castle, you need big, gigantic walls to prevent intruders from barging in and taking over.
In simpler terms, learning and exercising these said preventative measures is basically a wall building task. The higher and more resistant walls you build, the better. You are not just protecting your company from hostile takeovers, you are also protecting it from the raiders and their investment banking, and legal advisors.
Keep in mind that your enemies’ main goal is to devote their energies to designing different ways and strategies of scaling the defenses you have put in place. Your defenses are sometimes referred to as shark repellents, and for good reason. You need to make sure that the walls you build around your company constantly improves and gets better.
Now, onto the most common preventative measures to prevent hostile takeovers. The first preventative measure is often referred to as the “Poison Pills.”
The poison pills are basically securities issued by a potential target which makes the firm less valuable in the eyes of a hostile bidder. If it looks like the company is less valuable, it deflects the bidder’s attention elsewhere, or they might think the firm is of no value to them.
Poison pills can be an effective defense that has to be taken seriously by any hostile bidder. In fact, there are times when this type of preventative measures are so effective that the shareholder’s rights activists have pressured many companies to remove them. That is how effective this anti takeover measure is.
The strategy of Poison Pills was invented by the famous takeover lawyer Martin Lipton. Initially, Lipton used them in the year 1982 to defend the company El Paso Electric against General American Oil.
Lipton used the strategy again in 1983 during the Brown Foreman versus Lenox takeover contest. There are different types of poison pills, and they can be effective in dealing with raiders who seek to acquire a controlling influence in a target while no acquiring majority control.
The firms or companies that are protected by these Poison Pills ultimately may receive higher returns as a result of the pill defense.
Next in the list is an anti takeover measure aptly called the “Corporate Charter Amendments.”
The corporate charter amendments is not the same as corporation bylaws, there are differences between the two. For instance, the bylaws are usually established by the board of directors, and they set forth important rules for how the company will operate. On the other hand, a corporate charter is a more fundamental document that sets forth the company’s purpose and the different classes of shares it may have. This preventative measure is also often referred to as the articles of incorporation.
In these cases, a shareholder vote is usually required to change the articles of incorporation. There are many more major changes in how a company operates that may have to be set forth in the corporate charter and not by the bylaws.
From an M&A perspective, an action as big as staggering the board of directors needs to be in the corporate charter. To further implement this in the charter, it needs the shareholder’s approval. If it is not in the corporate charter prior to a hostile bid, there is a higher chance that the shareholders will not approve it.
Keep in mind that the changes in the corporate charter are common anti-takeover devices. The extent to which they may be implemented depends on state laws which can vary amongst different stays.
In this preventative measure, the target corporation can choose to enact various amendments in its corporate charter that will make it more difficult for any hostile acquirer to bring about a change in managerial control of the target. For instance, some of the amendments that can be done are supermajority provisions, staggered boards, fair price provisions, and dual capitalizations.
By using these methods, a hostile acquirer will find it very difficult to bring or make changes in the managerial control of your company. It is a bigger task that requires more time, energy, money and effort for a certain hostile acquirer which can make them think twice before a takeover.
Some of the more common antitakeover corporate charter changes are as follows:
◾ Staggered terms of the board of directors
◾ Supermajority provisions
◾ Fair price provisions
◾ Dual capitalizations
Keep exploring these common antitakeover corporate charter changes and see how you can implement them in your own company. You can choose to do only one of these, or do all of them. As long as you see it fit, and you know it will help protect your company for the better, then it must be done.
There you have it, the most common types of preventative anti-takeover measures. We hope that this article has helped you learn more about how you can protect your company better. Now, it’s time to study these methods and the legalities on how can further implement them.
These measures will help prevent any hostile takeovers and protect you and your shareholders’ assets. Remember, a strong leader needs to put up walls of defenses to keep his company safe. With these strategies in mind and in effect, you will be able to do that, too.
Advantages of Tender Offers over Open Market Purchases
It is one of the biggest questions in the world of stocks and trades – what are the advantages of tender offers over open market? If so, what will it cost? Is there a higher success rate? Which one will cost me less and earn me more?
There are different types of tender offers in the corporate world, but that is another topic to discuss for another day. Today, we discuss the advantages of tender offers over open market purchases.
At first glance, it may seem like open market purchases provide more advantages as opposed to tender offers. For instance, open market purchases do not usually involve complicated legal requirements and costs that are often associated with tender offers.
This means that the bidder must be concerned that the open market purchases will be legally interpreted as a tender offer. However, there is more to this than meets the eye. You need a certain understanding of the difference between tender offers and open market purchases.
Yes, the costs of a tender offer may seem to be far higher than those brokerage fees that are incurred when it comes to attempting to take control through open market purchases of the target’s stock. It was previously estimated that the total cost of tender offers averages at approximately 13% of the post-tender offer market price of the target’s shares.
Additionally, there are certain drawbacks to open market purchases that are not usually in tender offers. Let us take a bidder for example. The said bidder purchases shares in the open market. He is not guaranteed that he will be able to accumulate a sufficient amount of shares to acquire clear control.
This can mean that if 51% of the clear control position is not achieved by the bidder, there is a possibility that he will become stuck in an undesirable minority position. If he is looking to acquire control, then he certainly does not want a minority position only.
On the other hand, a tender offer has a distinct advantage. One of these advantages is that the said bidder is not bound to purchase the tendered shares with the exception that the desired number of shares has already been tendered.
So, in this position, what should the bidder choose? Well, the bidder who becomes mired in a minority position can use the following alternatives instead:
Tender Offers for Additional Shares
The advantages of tender offers over open market purchases will give you options. The first option is to do a tender offer for additional shares. In cases like these, the bidder incurs the tender offer expenses. In addition to that, the bidder should also incur the costs of the open market purchasing program.
Proxy Fight
The second option would be to begin a proxy flight. Once again, this is another costly means of acquiring control. However, the silver lining is that after the bidder has already acquired a large voting position, he is now in a stronger position to launch a proxy fight. It may be a costly option, but it gets the job done.
Another option would be to sell the minority stock position. The sales of the minority stock position would cause significant downward pressure on the stock price. This means that it could result in significant losses for a company.
An additional drawback to open market purchases, especially the large-scale ones, is that it is very difficult to keep private. There are a lot of market participants who watch the stock purchases and regards it as a signal that the bidder may be attempting to make a raid on the target.
As a result, this may then change the shape of the target’s supply curve for its stock by making it more vertical above some price. Yes, this strategy can make a street sweep effective, however, it can be more costly and expensive.
In addition to that, the other shareholders may also have the idea that a higher price may be forthcoming. This can make the other shareholders even more reluctant to sell. That is, of course, unless a very attractive offer is made to them.
This threshold price may be reached quickly and swiftly achieved as the available supply of shares on the market, which may be relatively small in comparison with the total shares outstanding, becomes exhausted. Furthermore, stockholders can sense these things coming. As they come to believe that a bid may be forthcoming, they have the luxury and incentive to hold out for a higher premium.
This type of holdout problem does not exist in tender offers. Why do you ask? This is because the bidder is not obligated to purchase any shares yet. That is unless that amount requested has been tendered.
If the requested amount has not been tendered at the end of the expiration date of the offer, the bidder can simply choose to either cancel the offer or extend it. Additionally, a street sweep may be more effective when a bidder has the ability to locate large blocks of the stack in the hands of a small group of investors.
Other Options
It is a well-known fact that in cases in which there have been offers for the company or any speculation of an impending offer, the stock often becomes concentrated in the hands of arbitrageurs. And while these investors are often too eager to sell, they will often only do so at a higher price. That is just the way it works.
The existence of large blocks of stock in the hands of arbitrageurs may enable the bidder to acquire a significant percentage of a target’s stock. In some cases, the bidder can acquire enough percentage of the stock to gain effective control of the company. However, this only happens if the bidder is willing to pay a possibly painful dip in his pocket. More often than not, the costs of this method of acquisition are prohibitively expensive.
Now that you have these facts and the advantages of a tender offer versus open market purchases, it will become easier for you to make large business decisions in the future. Hopefully, the ideas, facts, and examples presented in this article help you make large and significant business decisions you may face in the future.
Tender Offers vs. Long-Form Merger
Until August 2013, there have been two ways to acquire a public target, through a tender offer or through a long-form merger. The former has to do with a two-step transaction, while the latter is a statutory merger that requires the target’s shareholder vote in order to approve the deal.
If you’re planning to acquire a US company, this article shall help you by elaborating the difference between the two means
Tender Offers
It is ironic how the Williams Act, the key piece of federal legislation on the regulation of tender offers, does not even define the term. This vagueness led to cases of confusion about what constitutes a tender offer.
Basically, it is an open offer by a prospect to all stockholders of a publicly traded corporation to tender their stock for sale at a specific price and time. Usually, the acquirer’s offer is higher than the market price to induce the shareholder.
8 Characteristics of a Tender Offer
- Active and widespread solicitation of public shareholders for the shares of an issuer
- Solicitation made for the substantial percentage of an issuer’s stock
- Offer to purchase made a premium over the prevailing market price
- Terms of the offer firm rather than negotiated
- Offer contingent on the tender of a fixed number of shares, often subject to a fixed maximum number to be purchased
- Offer open only a limited period of time
- Offeree subject to pressure to sell his stock
- Public announcements of a purchasing program concerning the target company precede or accompany the rapid accumulation of larger amounts of the target company’s securities
Unlike the long-form merger, the tender offer is more complex. However, the process is relatively quicker since the bidder may be able to acquire control in 20-40 business days. Here, the buyer can bypass the management and the board of directors directly. Still, the purchase is a friendly transaction in which there are a few shareholders, accelerating the process by avoiding the otherwise required management vote.
The downside of tender offers is that the acquirer must convince 100% of the shareholders to sell their stocks in order to gain full control of a company.
Long-Form Merger
Another basic way for the bidder to acquire a company is through the long-form merger. Here, the acquirer seeks 100% ownership through a transaction where it wins the approval of shareholders on taking over the sale of shares.
One advantage of the long-form merger is that it is assured since it is agreed upon, involving additional filing and disclosure requirements.
The only drawback of this method is that it takes two to four months before the bidder achieves full control. This is because it’s more systematized and it needs approval by the SEC
Read also: Friendly Mergers vs. Hostile Deals; Type of Merger: Short-Form Merger
Conclusion
Every acquisition must be thoroughly analyzed first in order to know what strategy will work best for him or her. This includes a review of publicly available documents and a written summary of salient legal issues.
To be fair, the long-form merger has more distinct advantages than the other such as cooperation between the management of the two parties, faster closing, and reduce costs.
However, depending on the situation, a tender offer may be quicker but can only be pursued if the bidder understands the complexity and risk, and if he or she believes negotiation will be futile or alternatives have been exhausted.
Deal Structure: Asset vs Entity Deals
When it comes to structuring a deal, there are different factors you need to consider. For instance, you might ask yourself: Is an asset deal better than an entity deal?
In this article, we will discuss the difference between the two further and dwell deeper on how each one has its own purpose. First, let’s discuss asset deals.
Asset Deals
There are plenty of advantages when it comes to asset deals. One of these advantages is that the buyer doesn’t have to accept all the target’s liability. This is a great advantage for the acquirer. It is the subject of most negotiations between the seller and the buyer.
In almost all cases, the seller will want the buyer to accept more liabilities, naturally, and the buyer will want a few liabilities. Buyers usually prefer an asset deal because of limited liability exposure.
Additionally, the buyer can pick and choose which assets they want and they don’t necessarily have to pay for assets that they are not interested in. This is an additional benefit for the buyer’s side.
Benefits of Asset Deal
Furthermore, an asset deal has potential tax benefits. Of course, all of the assets acquired as well as the liabilities incurred should be listed in the asset purchase agreement once the buyer and seller come to a mutual understanding.
There’s also what we call the asset basis set-up where the buyer can raise the value of the acquired assets to fair market value as opposed to the values they may have been carried at on the seller’s balance sheet. This way, the buyer can benefit from more depreciation in the future. As a result, the buyer may also lower their taxable income and taxes paid.
Whole Entity Deal
But what about the seller? Most sellers prefer a whole entity deal. This is because a seller may be left with assets they do not want in an asset deal. For instance, a seller wants to sell most of their asset, and that can’t be done immediately in an asset deal. Especially because the seller might be left with liabilities that they would prefer to get rid of.
Additionally, the seller may possibly get hit with negative tax consequences due to the potential taxes on the sale of the assets and then the taxes on a distribution to the owners of the entity. Keep in mind that tax issues are very crucial when it comes to Mergers and Acquisitions.
This is only one of the reasons why there is a lot of legal work that needs to be done in mergers and acquisitions. These legal works are not only done by transactional lawyers but by tax lawyers as well. When it comes to doing these deals, having attorneys who are merger and acquisition tax specialist are crucial.
More Drawbacks to Asset Deals
There are also more drawbacks to asset deals. For instance, the seller may have to secure third-party consents to the sale of the assets. This is especially necessary when there are clauses in the financing agreements that the target used to acquire the said assets. Or if the seller has a lot of contracts with nonassignment or nontransfer clauses that are associated with them.
In order to do these an asset deal, the target first needs to get approval from all the relevant parties. If there are a lot of relevant parties involved, the deal becomes more complicated. In these cases, the asset deal becomes less practical, and if it is necessary for the deal to be done, it may have to be an entity transaction. Which leads us to entity deals:
Entity Deals
For starters, you need to understand that there are two ways to do an entity deal. First is a stock transaction, second is a merger. A stock deal is ideal and more practical when the target has a limited number of shareholders. This is because securing the approval of the sale by the target’s shareholders may not be as difficult. The fewer shareholders, the more practical a stock transaction is.
In stock entity deals, the buyer does not have to buy the assets and send the consideration to the target corporation as opposed to an asset deal. In these cases, the consideration is sent directly to the target’s shareholders who sell all their shares to the buyer instead.
There are no conveyance issues when it comes to stock deals, this is one of its main advantages. There are no instances where they may have been the aforementioned contractual restrictions on the transfer of assets. The assets firmly stay with the entity and remain at the target when it comes to stock deals.
Another benefit of a stock deal is that there are no appraisal rights. As opposed to mergers where shareholders who do not approve of the deal may want to go to a court to pursue their appraisal rights. The shareholders may also seek the difference between the value they received for their shares in the merger.
Merger Entity Deal
On the other hand, we have a merger. Merger entity deals are more common for publicly held companies. These merger deals are partly a function of the relevant state laws which vary from state to state. In merger deals, constituent corporations are the companies doing the deal where one survives (called the survivor) and the other one ceases to exist.
In these type of deals, the surviving company succeeds to all of the liabilities of the nonsurviving company. In any case that there are assets that the buyer doesn’t want, these can be spun or sold off before the merger is complete.
Mergers also require the voting approval of the shareholders. The percentage of approvals can vary across different states. There are also cases where a corporation enacted supermajority provisions in each bylaw. For those shareholders who do not approve of the deal, they can go to court to pursue their appraisal rights.
There you have it, the difference between asset and entity deals. Take this information at heart, study each type of deals and decide which one is more suited for your company.