Shares or assets?
A threshold question in M&A

On a share deal, the buyer will normally acquire the entire issued share capital of the target company (‘Target Ltd’) from the shareholders of Target Ltd (the ‘Sellers’).

Some of the principal pros and cons of this approach are set out below, and in setting these out we have assumed that we are looking at a cash only deal with no equity issued as consideration.

On an asset deal, the Buyer will acquire the assets of Seller Ltd if not also the Seller Ltd’s business as a going concern.

Since it is Seller Ltd that is selling the assets and business to the Buyer – and not Seller Ltd’s shareholders – an asset deal is fundamentally different to a share deal where it is the Target Ltd shareholders selling their shares to the Buyer.

The pros and cons of this approach are set out below, and in setting these out we have assumed that we are also looking at a cash only deal with no equity issued as consideration.

Either route will require a review of any existing financing and security arrangements, to confirm whether they permit the proposed sale of Target Ltd or of the relevant business / assets of Seller Ltd (as applicable) and/or what permissions will need to be obtained from lenders before the sale can proceed.  Depending on the financing arrangements of Target Ltd / Seller Ltd, existing debt may need to be paid off pre or post sale or existing security over shares and/or target assets may need to be replaced with new security post sale.

While a full discussion of this topic is beyond the scope if this piece, the following considerations commonly apply to share deals and asset (business deals) with regard to financing / security arrangements:

The parties to an M&A transaction might seek to structure it as a sale through a ‘hive down’ where Seller Ltd transfers the target assets or business to a newly established subsidiary (‘New Target Ltd’) which is then acquired by the Buyer.

This type of structure seeks to combine some of the main benefits of an asset / business deal (where assets can be ‘cherry picked’ and the Buyer does not acquire an existing company with its history) with some of the main benefits of a share deal.  It may be particularly attractive where Seller Ltd holds valuable tax assets, such as carried forward losses, which can be transferred to New Target Ltd and preserved for future use when New Target Ltd is part of the Buyer’s group.

The use of a ‘hive down’ structure usually relies on the availability of the SSE to Seller Ltd, to cover de-grouping charges that would otherwise be triggered by the sale of New Target Ltd shortly after (initially tax neutral) intra-group transfers of the target assets to New Target Ltd.  The changes made by the Finance Act 2019 to the tax regime for intangible assets (which now also prevent de-grouping charges being triggered in respect of pre-sale transfers of intangible assets in circumstances where the SSE applies, thereby achieving near parity of the tax treatment of intra-group transfers of assets under the intangible assets regime and under the chargeable gains regime) have also made ‘hive downs’ a more attractive option for M&A transactions involving intangible assets of significant value.

While a full discussion of ‘hive downs’ is beyond the scope of this piece, it should be noted that a ‘hive down’, and in fact any other type of pre-sale restructuring (such as a ‘hive out’ where unwanted assets are transferred to a different group company prior to completion), will need to be properly planned and thought through.  In addition to confirming the availability of the SSE, there will be a host of other tax issues to consider, from VAT and SDLT to anti-avoidance rules relating to the use of carried forward losses following a change of control.  The availability of relevant reliefs generally depends on a number of factors such as commercial motifs, trading status, order and timings.  And as always, tax is only one part of the deal and there will be many other parts and commercial matters to be negotiated between the parties. Above all, a complex structure requires cooperation and proper communication between the parties and their advisers.

Many of the considerations that a UK buyer would use to determine whether to make an acquisition by stock purchase[1] or asset purchase are similar to those that a UK buyer would analyze.  It is also important for a buyer to consider its negotiating leverage when choosing a transaction structure for an acquisition – in a highly competitive auction, a buyer might have no choice but to agree to a more seller-favorable deal structure to make sure it can win the bid.  Below are several issues for a US buyer to take into account with respect to transaction structure:

[1] When referring to a “stock purchase”, we are including statutory merger transactions under state law since they have the same legal and tax treatment as a stock purchase.

In a stock purchase, the buyer acquires the target entity’s stock (and as a matter of law, acquires all of the target entity’s assets, rights and liabilities). As such, the buyer would be fully responsible (because the buyer will then own the target) for all liabilities of the target after the deal is consummated.  In a stock purchase, the definitive agreement will allocate risk of being responsible for liabilities between buyer and seller as those terms are negotiated – a typical purchase agreement in a US transaction has extensive provisions around indemnification and liability for damages, losses, costs and expenses arising from pre-closing events and circumstances.

In an asset purchase, however, a US buyer can pick and choose what assets it wants to acquire and what liabilities it wants to assume from the seller.  As a general matter, the seller will retain any liabilities that the buyer is unwilling to assume and will be responsible for paying or settling such liabilities.  And on top of that, the asset purchase agreement will normally require the seller to indemnify the buyer for all costs, expenses and damages arising from liabilities retained by the seller.

Buyers and sellers in asset purchase transactions should also be cognizant of “bulk sales” laws in certain states that require notification to be provided to seller creditors to prevent sellers from avoiding creditor liabilities through asset sales. 

A word of warning, we are not tax lawyers and do not provide tax advice to any of our clients, but we are providing basic commentary on major tax issues that arise in US mergers and acquisitions.  Please always be sure to consult with tax advisors on any transaction.

One of the major advantages for a US buyer of assets is that, so long as the value of the assets exceeds the cost basis of such assets for the seller, the buyer will receive a “step-up” in the cost basis for the acquired assets – the purchase price will be allocated across the assets acquired.  As a result, if the buyer later resells those assets, any taxable gain will be measured from the purchase price allocated to those assets when the initial asset purchase closed which would cause a reduction in taxable gain.  If there is goodwill acquired in the transaction, this can also be amortized, and this amortization is tax-deductible.  Basis step-up with respect to seller assets is not available in a stock purchase.

Sellers that are sub-chapter C corporations, however, should try to steer the buyer away from an asset purchase in favor of a stock purchase because any gain on the sale of the assets is taxable to the corporate entity, and then distribution of the proceeds from such transaction from the corporation to its stockholders would be subject to an additional layer of tax, which is the so-called “double tax regime” of US C-corporations.  Prospera Law, like Humphreys Law, works very regularly with start-up and emerging growth companies that are backed by venture capital funds.  In the US, those start-ups and emerging growth companies are almost always organized as C-corporations as US venture capital funds require that their portfolio companies must be C-corporations.  So, the double-tax problem is a consistent issue when a venture backed company is forced into an asset sale.

In any M&A transaction, legal counsel must review any contracts that are being acquired by the buyer to determine if the contracts contain anti-assignment provisions or change of control restrictions.  If the contract requires consent of a third party to be assigned to a new contract party or acquired in a change of control, that is an additional condition to closing the transaction.  In an asset purchase, any contract being sold by the seller to the buyer must be assigned, so any form of anti-assignment language in the contract will necessitate consent from the counterparty.  In a stock purchase, on the other hand, an anti-assignment provision that does not specify consent in respect of a change of control, stock sale or merger will not require consent of the counterparty since the target company remains a party to the contract, i.e. there is no actual assignment of the agreement.  Consequently, an asset purchase is more likely to require third party consent to any transfer of a contract.

Similarly, if the buyer is acquiring registered intellectual property in an asset purchase, a filing will need to be made with the US Patent and Trademark Office to provide notice that ownership of the intellectual property has changed hands.  In a stock purchase, however, such filing is typically not required since the same entity continues to own the intellectual property.

If the seller has licenses, permits or other permissions provided by any governmental authority to operate its business, an asset purchase transaction will almost certainly require consent from such governmental authority for transfer of such license, permit or other permission.  That might also be the case in a stock purchase since governmental statutes and regulations could expand the definition of “transfer” or “assign” to include a merger, stock purchase or change of control, but each applicable statute or regulation would have to be reviewed.

In a stock sale that is not a merger, a buyer needs to get all stockholders to agree to the transaction, otherwise the buyer will not have complete ownership of the target.  This unanimous requirement in a non-merger stock sale creates a negative dynamic for getting a deal done if not all seller stockholders approve of the deal.  A merger or an asset sale can be consummated without unanimous consent of selling stockholders.  Subject to contractual and state law statutory consent rights, an asset sale generally requires consent of the holders of a majority of the voting securities of the selling entity.  A merger can be consummated with less than 100% of seller stockholders consent, subject to negotiation in the definitive documentation, as required by the buyer, as to what percentage of voting shares must approve the merger for the deal to close.

Given how broadly the terms “process” and “personal data” are defined under the UK/EU data protection regime, any acquisition deal would almost always involve the processing of personal data throughout the life cycle of the deal, including during initial negotiations between the Buyer and Seller Ltd, the due diligence process, and post-completion.

Regardless of whether the acquisition takes the form of an asset or share deal, in addition to the typical confidentiality undertakings found in an NDA, Seller Ltd would likely want to incorporate additional provisions addressing the Buyer’s obligation to comply with applicable data protection laws with regards any personal data shared during negotiations and due diligence. Equally, the Buyer may seek contractual assurances and warranties that Seller Ltd is lawfully entitled to share personal data with the Buyer for such purposes, with a view of ensuring any subsequent processing of personal data by the Buyer is properly authorised and compliant with applicable data protection laws.

Further, in the use of any data sites during the due diligence process, Seller Ltd should be aware of the data minimisation principle, which requires the processing of personal data to be limited to what is directly relevant and necessary to accomplish a particular purpose. Therefore, any personal data uploaded onto the data site should be limited to what is needed for the Buyer to reasonably conduct its due diligence and to evaluate Seller Ltd in connection with the proposed acquisition.

Asset deals may also pose additional considerations from a data protection perspective compared to share deals. As described earlier in this article, the integration of business assets pursuant to an asset deal is often a major exercise, and so the Buyer may well want to start the integration process some time between signing and completion in hopes of a smoother transition post-completion.  The parties ought carefully to consider if they have a legal basis for personal data to be processed in connection with any such pre-completion integration (i.e., query whether the interests of individual data subjects override any legitimate business interest of the Buyer and Seller Ltd).

On completion of a share deal, only Seller Ltd’s shares will be transferred to the Buyer, and so the controller of personal data remains the same. Conversely, in an asset deal, completion would involve the direct transfer of personal data from Seller Ltd to the Buyer, resulting in a change of controller of such data. The obligation to comply with the transparency principle and to keep data subjects informed (such as to inform data subjects of a change in legal entity that controls the processing of their data) thus arguably has greater weight in asset deals than share deals.