Acquisition: Structuring a Stock Purchase Deal
In a deal structured as a stock purchase, the buyer purchases either all or a controlling interest in the outstanding shares of the target company’s stock, which results in the target becoming a subsidiary of the buyer. Stock purchases differ from asset purchases in that the former leaves the existing target company intact, making a stock purchase a change of control rather than an assignment. The obvious implication of this difference is that fewer consents need to be obtained pursuant to the target’s contractual obligations and any applicable regulatory permits or licenses.
However, this greatly increases the buyer’s exposure to all liabilities, current and historic, of the target company. The only opportunity the buyer has to limit its exposure is by getting the target’s shareholders to promise indemnification as part of the purchase agreement. The more shareholders to persuade, the more difficult this task becomes. If the buyer’s goal is to acquire one hundred percent (100%) ownership of the target, the buyer must secure the signatures of every single stockholder, which can be a daunting task if there are abundant minority stockholders with little to gain from the acquisition.
From the buyer’s perspective, stock purchase structures can be less advantageous on a tax basis as well, unless the target has a specific corporate form. If the target is organized as an S-Corp, the target stockholders may make a Section 338(h)(10) election (assuming other requirements are satisfied) to step-up the tax basis of the target’s assets. That election allows the parties to treat the transaction as if it were an asset sale for federal income tax purposes.
The basic analysis whether to make such an election centers on whether the step-up benefit to the buyer exceeds the cost to the seller. However, the implication for companies hoping to be acquired is that dissolving the current entity to become an S-Corp in an effort to make the company a more attractive target does not necessarily guarantee any benefit to hopeful buyers. If the buyer becomes interested but determines the target would be more attractive in S-Corp form, the corresponding change in corporate form would then be justifiable and could just as easily be undertaken before any proposed transaction is consummated.
Acquisitions of privately held target companies almost always include indemnification provisions requiring the stockholders of the target to compensate the buyer for any liabilities incurred in relation to specific identified issues with the target and its stockholders. These provisions inject uncertainty into the deal, specifically the purchase price ultimately paid to the target’s stockholders, making them one of the most heavily negotiated points in any M&A transaction. Indemnification provisions are highly complex, including matters from scope of indemnification and duration of indemnity obligations to thresholds, deductibles, and caps. To preserve value and protect the interests of the company, it is essential for a company on either side of the deal to secure advice from a knowledgeable and trusted attorney who can provide guidance on how to successfully navigate the deal.