The complexities in any transaction are as broad as they are deep. Any single discussion about process, structure and timing in a deal will not fully do justice to anyone seeking a broad-stroke solution to the issue. The reason: there seldom is one. What follows is therefore helpful in understanding the process and structure when determining some of the disadvantages of a stock transaction, but may be too broad for some larger, more complex deals. Having been warned, we proceed with the nuances and downsides of pursuing an stock-based acquisition over an asset-only strategy.
The greater number of stockholders in the company, the more difficult it may be to “corral the cats,” so to speak. If we are under the assumption that the buyer desires to acquire 100% of the target company, a contract between each of the selling shareholders must be implemented. In the event that even one of the selling stockholders refuses to consummate a transaction with the buyer, the deal could implode. It’s an unfortunate truth that the entire deal could hinge on a single stockholder digging-in. There are, of course, ways to avoid this impasse. For instance, a merger transaction can eliminate the need for complete agreement amount the shareholders, but still result in the same desired outcome for completing the deal.
As always, tax considerations hold a huge weight in any deal, particularly when a stock transaction is involved. In many cases, an asset sale can help to avoid some of the sticky tax disadvantages of a stock sale. Typically stock transactions are most appropriate when the tax costs or other issues of doing an asset deal make the asset sale more tainted than it otherwise would have been. In many larger transactions, asset sales can produce much larger tax costs. In addition, stock deals are also helpful when the transfer of assets may require costly or difficult third party consents or where the size of the company makes an asset deal too burdensome.
Avoiding the tax disadvantages of a stock sale can often be accomplished through a Section 338 election. The 338 election provides the benefits of an asset transaction while avoiding some of the ancillary non-tax pitfalls of an asset transaction.
From the Seller’s Perspective–Most sellers prefer stock deals because the buyer will take with them all of the corporation’s liabilities, assets and everything in between. The seller can completely absolve itself from most liabilities. While this sounds good in practice, in principal it is more difficult as most acquirers will seek immunity through indemnification against undisclosed or unforeseen liabilities that may have resulted from previous management or shareholders. Reps and warranties can also be a boon to avoid some of the potential skeletons in the closet.
From the Buyer’s Perspective–The inverse is true in the case of a company buyer. Buyer’s typically prefer asset acquisitions for both tax and liability reasons, but the route taken typically depends on a number of factors, including some of the downsides of asset purchases, which we’ve discussed previously.
Stock sales do not always involve direct cash payment to the seller. When public companies elect to make purchases, they often do so using stock as consideration in the transaction. In rare cases, this can also occur with private companies as well, particularly if the private company has a good growth story or is expected to go public soon. Again, the structure of any transaction will require the trusted insight of attorneys, accountants and investment bankers to ensure the deal is structured in a way that makes sense for all involved.