Mergers and Acquisitions
Buying or selling a business can be emotional. The seller has devoted years to growing the business and wants to be compensated for its efforts. The buyer is concerned with the continued viability of the business. Balancing these interests can be difficult and problems can be prevented by getting advice early in the process. Regardless of the type of transaction, DeAngelis Legal can explain the risks of the transaction and assist you with the negotiations so that the documents properly protect you.
Letters of Intent and Confidentiality Agreements
If the material terms have not already been agreed upon, best practice is for the parties to enter into a non-binding letter of intent which defines the material terms and a confidentiality agreement to allow the buyer to begin due diligence. These documents can be drafted to protect both parties and set the parameters on the negotiations for the transaction documents. Even if the material components of a transaction are agreed upon, disputes can arise over the language of the documents because each side is angling to reduce their risk exposure. Having a well drafted Letter of Intent in place can sometimes prevent a transaction from getting derailed early
Asset Purchase Agreements
Business mergers and acquisitions fall into one of two broad categories asset sales and stock sales. The asset sale structure is the most commonly used, as it protects the assets purchased from the past liabilities of the seller. Third party buyers who are not familiar with the business will insist on this structure to protect their investment. Therefore, asset purchases usually involve small to middle market transactions to third parties. Under an asset purchase transaction the buyer only acquires the name, telephone number, website and other business assets of the business. In addition to the purchase agreement, the seller needs to provide assignments of each asset, lease and key contracts to the buyer’s entity. As most contracts contain limitations on assignability, the transaction becomes contingent on the approval of these parties. At closing, the seller terminates the employment of the employees and the buyer hires them. This category is used to insulate the buyer from the seller’s pre-closing obligations.
Stock (or Interest) Purchase Agreements
Stock or interest purchases are usually confined to large transactions and sales of minority interests in existing businesses to key employees or related parties who are familiar with the business. From the seller’s perspective these transactions are preferred because the buyer takes everything associated with an entity, assets and obligations. A purchase agreement and assignment are all that is needed to transfer the business. The seller receives capital gains in all the proceeds, but the buyer is not able to reset the basis of the individual assets and depreciate them from income, making the transaction less favorable for asset heavy transactions. If the entity has strong insurance ratings and history, the buyer can save operating expenses by taking stock instead of creating a new entity. However, the assets of the business remain exposed to claims resulting from the operations prior to closing, and even if the seller indemnifies the buyer from such liabilities, there is no cut off. These transactions require the buyer to perform a greater degree of due diligence on the seller’s business or at least negotiate stronger representations and warranties from the seller to protect the buyer’s investment.
The so-called F-Reorganization is the current preferred structure for private equity buyers of S-Corporations as the structure mimics the simplicity of the transfer of the assets, employees, leases and key contracts while resetting the basis in the depreciated assets to their current fair market value, thus giving the buyer some additional cash flow from the non-cash deductions from future income. The structure also solves the issues of a buyer (usually taxed as a partnership) not being qualified to own an S-corporation and not wanting the entity to be taxed as a C-corporation post-closing because the buyer can treat the transaction as an asset purchase for tax purposes. The F-Reorganization is a general term used to describe a series of three transactions: a tax-free re-organization to create a parent and subsidiary, a conversion of the subsidiary corporation to an LLC and the sale of the LLC interest by the parent. Several factors have contributed to the increase in the use of the F-Reorganization in Arizona, including:
- Arizona enacted the Arizona Entity Restructuring Act (the “AERA”) in 2015, which allows a corporation formed in Arizona to be converted to a limited liability company (LLC).
- The 2017 Tax Act created the 199A deduction reducing an S-Corporation owner’s effective tax rate from 43.5% to 29.5% making the tax hit on the depreciation recapture less significant.
- Strong economic conditions locally and nationally provide buyers with excess cash, lending facilities and investment opportunities.
Cash or Deferred Terms?
Sellers prefer their cash up front. However, buyers do not always have sufficient funds to close the transaction or desire to holdback a portion of the purchase price to cover unexpected obligations or insufficient performance post-closing. These terms must be carefully negotiated so that the seller understands the risk. If 100% of the purchase is not paid at closing, what are the terms of the loan (interest rate, term, default)? What is the security for non-payment? Can the buyer offset its damages caused by the seller’s breach of the purchase agreement against the payment owed to the seller? All questions which should be addressed in the transaction documents.
Closing the transaction is paramount. Otherwise the parties have wasted their time, energy and expense. The parties are often distracted with transaction and emotions are high. Explaining the transition to employees, vendors and customers is time consuming. However, it is at this moment that all the formalities of the transaction must be completed and signed so there is not a dispute in the future. Transfer documents need to be properly signed and delivered, the buyer must be given control over the assets and employees and of course the sale proceeds must be delivered to the seller. DeAngelis Legal can assist with the closing to insure you spend your time on the business aspects of the transaction.
Call DeAngelis Legal today at (480) 281-1512 for assistance with your transaction, or fill out the form to the right.