Structuring M&A Deals for Buyers and Sellers

Hi everyone, hope you’re having a great week. Today we’re going to talk about structuring M&A deals – how to structure the sale of your business or the purchase of a business. There are 3 primary ways to do it – we’ll get into that in a second. In my experience, deal structures are not covered or addressed well enough up front. By the time I get involved, and we’re putting together the documents, the structure’s already been put together without a whole lot of thought about the consequences. Not always, but often. So, you need to know all about it up front – we’ll get into that.

First, a little bit about me. I’m Brett Cenkus, I’m a business attorney. I do that from my law firm, Cenkus Law, based in Austin. I have an office based in Houston, and I have clients all over. I’m also a business consultant and I do that out of my brand, The Startup Shepherd. I’ve done M&A at a very high level – billion dollar deals. In this life I do half a million to about 20 million dollar deals. That’s kind of the size of the market in which I play. And, that’s considered the Main Street part of the market, the lower-middle market. Those are kind of terms of art, but, just so you understand what’s going on, these are smaller deals and this content is aimed at someone buying or selling in that space.

So, deal structures – there are 3 primary ways to structure the sale of a business. One is to sell the stock or equity interests. Two is to sell the assets. Third is a merger. We’re not going to spend a whole lot of time on mergers even though that’s half of the term M&A or mergers and acquisitions. Not a lot of the deals at this part of the market are done as mergers. Mergers are often driven by kind of high level tax issues, and that kind of deal just doesn’t show up down here. So, stock sales and asset sales are primarily what I see.

In a stock sale, the seller actually takes their equity interest and sells it to the buyer. They don’t touch the company. Similar to if you have a share of Microsoft, you could sell it to me and we didn’t touch Microsoft. Now someone else, I, own that tiny little piece of the company that you used to own. In an asset sale, you actually itemize all the assets of the business and you transfer those to the buyer. So those are two main ways deals get done in this part of the market.

Generally speaking, sellers want to sell stock, and buyers want to buy assets. Two main reasons: one is tax, the other is liability. On the tax side, sellers want to sell stock or equity interest because they can get favorable capital gains treatment. Sometimes they can get capital gains treatment depending on the assets, but stock is clearly going to be a capital gains item. And, if they held the stock for longer than a year, they get long-term capital gains treatment. And, if it’s qualified small business stock (a special type of corporate stock) they can potentially have no tax obligations. So, there’s usually a reason sellers want to be selling stock.

Buyers, on the other hand, want to purchase assets, they want to buy the individual assets. The main reason is because, if they buy the stock and step into the seller’s shoes, they take over the assets at the book value that are on the books of the company at the time of the sale. Now, if the assets have been held for a long time and have been heavily depreciated, there may not be a whole lot of depreciation left. Depreciation is write-offs against income. So, you want as much depreciation as you can get. A buyer who purchases assets gets to mark the value of those assets up to their fair market value and depreciate the assets again. So, generally interests are not totally aligned. Sellers want to sell stock, and buyers want to buy assets.

That’s tax – the other reason is liability. So, when the seller sells the stock, the whole company – all of it – goes over to the buyer, including the liabilities. There are ways to carve out certain liabilities or the seller could indemnify the buyer for things that are particularly sensitive items, but, generally speaking, the buyer is taking the whole thing – the good and the bad. If the buyer purchases assets, they could cherry pick the assets and leave behind the liabilities. There are exceptions, like there always are in law. It’s called successor liability and sometimes buyers can be responsible for liabilities even though they didn’t want them. But, generally speaking, if you’re concerned about liabilities, purchasing assets is a safer play.

A couple other things to think about. In my experience, a lot of the business brokers market assets, and , really, that’s because it’s an easier thing to market. Some of them are concerned about licensing issues because they are not investment bankers. They don’t have broker dealer licenses to market securities. They’re more comfortable just marketing the sale of a business as the sale of assets. So, sometimes that doesn’t get covered up front too much because brokers are used to just doing things a certain way.

Another thing to consider on both sides – interests are aligned, here – is that getting a deal done as a stock sale is a little easier. Assets, when you start looking at the individual assets, every contract – is it assignable, can we transfer that to the buyer? If the buyer steps into the shoes of the seller and just takes over the stock or equity interest, nothing changed at the company level. We didn’t transfer a contract. We just transferred the owner of the business. And, so there are what are called anti-assignment clauses in a lot of commercial contracts that say you can’t assign this contract without the counterparty’s consent, without their approval. And, an asset sale is an assignment or transfer that would trigger that. So, sometimes there are concerns around being able to transfer individual assets that make it more compelling to structure deals as stock sales.

Those are the main things to consider. There are always a lot of other nuances and reasons and thoughts, but hopefully this content gives you something to go on. Keep in mind when buying a company or selling your company, spend time up on these things front. Figure out what the consequences of each avenue.

As a seller, get with your CPA early on. Does it matter if I sell stock or I sell assets? As a buyer, you won’t really know much until you start to see the books of the seller, but you know enough now to at least ask the question and tackle the issue before the documents come out and the deal’s already put together.

So, hope you enjoyed that. If you want to dive a little bit deeper, I’ve got an article Ways to Structure Company Sales and Purchases  that goes into more detail about M&A deal structures. If you want to talk about this or have any other questions about M&A or business generally, please reach out and get in touch. Hope you enjoyed that. If you have a question, leave it in the comments. If you’re involved in M&A and agree with me or disagree with me, if you see a lot of mergers at this part of the market, I would love to hear about your experience. Different things happen differently in different parts of the country, so drop a comment in. Hope you enjoyed the content. Have a great week.