CHAPTER 2 STRUCTURING ACQUISITIONS
| Jurisdiction | United States |
(Nov 1994)
STRUCTURING ACQUISITIONS
Parcel, Mauro, Hultin & Spaanstra, P.C.
Denver, Colorado
A business acquisition usually starts with an economic deal. A purchasing company ("P") decides that for any number of reasons it wants to acquire the business or assets of another company ("T"), and, after a period of courtship, the parties agree on a price. At that point the business people may regard the bulk of their work as done, and leave it to the lawyers to sort out the details. But from the practitioner's point of view, the parties' economic deal is only the tip of the iceberg; below the waterline are numerous issues that can have profound consequences. A small sampling of those issues would include whether P is willing to acquire all of the liabilities of T, known and unknown, whether T has tax attributes that P would like to acquire, whether T has assets that P does not want, whether the parties want or need a tax-free deal, and whether corporate or other laws impose any limitations on the transaction. Structuring an acquisition to account for all these factors is a major part of a transactional lawyer's job.
This paper will outline the major ways of structuring business acquisitions and will discuss the principal tax and business consequences of each form. A word of caution, however, is important at the outset: It would be impossible to list here, much less discuss, every legal nuance that might effect the structure of a business acquisition. Books have been written just on the tax aspects of acquisitions1 and a course on business acquisitions could easily consume a full year in law school. This paper therefore could not be, and does not presume to be, a comprehensive summary of the area, nor is it intended to provide the sort of technical analysis that would be of interest primarily to an experienced acquisitions lawyer. Rather, the purpose of this paper is only to provide a broad overview of the ways in which business acquisitions can be structured, without delving too deeply into the area in general or the byzantine complexities of the federal income tax laws in particular.
I. Basic Issues in Structuring.
Perhaps it is not too much of a simplification to say that, at root, there are two fundamental decisions that have to be made in structuring any business acquisition: First, will the transaction
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take the form of an asset acquisition or a stock acquisition?2 Second, will the transaction be structured so that it is a taxable event or will it be structured to qualify as a tax-free reorganization? Put differently, the transactional lawyer in a business acquisition has to make a decision at the outset between four basic kinds of transactions: a taxable asset acquisition, a taxable stock acquisition, a tax-free asset acquisition, and a tax-free stock acquisition.
This paper will begin with a discussion of taxable asset and stock acquisitions. It will then turn to the tax-free forms of these transactions.
II. Taxable Acquisitions.
A. Choosing between an asset deal and a stock deal.
There are a host of factors that might influence the decision to structure a business acquisition as an asset deal rather than a stock deal. These include the following:
1. Limiting assumed liabilities.
Maybe the biggest disadvantage of a stock acquisition is that P acquires not only all of the assets of T, but all of its liabilities as well. Thus, in a stock deal P runs the risk of paying a substantial price for T, only to discover that T is not as valuable as P thought (or, in the worst case, that T was worthless) because of unknown liabilities of T that come to light after the closing. Of course, good legal drafting of the warranties and representation in the purchase agreement, and a careful "due diligence" examination of T prior to the acquisition, can reduce the risk, but these are imperfect safeguards at best. Maximum protection against unknown liabilities can only be obtained through an asset acquisition in which P assumes only designated liabilities of T.
2. Nature of T's assets.
Not all assets can be bought and sold. For example, T may hold service contracts, patent or trademark rights, employment agreements, or other valuable intangibles that can not be assigned to P as a matter of law. When a substantial portion of T's value rests in assets that can not be transfered, an asset acquisition may be out of the question. An acquisition of T itself, i.e. a stock deal, may be the only option.
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3. Ownership of T.
If T is a closely held company an asset or stock acquisition can normally be done with equal facility. But if T is widely held, an asset acquisition may be preferable to a costly, and possibly unsuccessful, tender offer to all of T's shareholders.
4. Management attitudes.
There are occasions where T's management is not wholly receptive to an acquisition by P, but the shareholder's of T would be delighted to sell, at least for the right price. In such hostile takeover situations, a tender offer for T's shares is often the only way to get the deal done.
5. Tax attributes.
In addition to assets, T may have tax attributes, such as net operating loss carryovers, that T would also like to acquire. In a taxable asset acquisition those attributes will remain with T; in a stock deal they will travel with T and therefore be available to P, albeit indirectly.3
6. Debt acceleration.
If assets of T are encumbered by debt, the relevant debt instruments will frequently provided that the full amount of the indebtedness is due and payable upon sale of the encumbered asset. Typically, although not always, such acceleration does not occur upon a sale of T's stock. In these situations, a stock deal may be the only viable alternative.
7. Unwanted assets.
It is not uncommon for T to have assets that P is not interested in purchasing. In these situations, an asset deal may be more attractive to P because it makes it easy for P to acquire only those assets that it wants and leave the rest behind.
8. Continuity.
In some circumstances T may have substantial name recognition, goodwill, or going concern value that P would like to benefit from. Although these problems are not unsolvable in an asset acquisition, they are much more easily addressed by structuring the transaction as a stock purchase.
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9. Mechanical issues.
Last but not least, an asset acquisition can be mechanically cumbersome. Every asset of T needs to be conveyed, which may involve considerable time and expense, and, in some cases, may be a practical impossibility. Stock conveyancing, by contrast, is usually simple and cheap.
B. Asset acquisitions.
1. Form of the acquisition.
A taxable asset acquisition can take a couple of forms. First, and most obviously, P can come to the closing with cash or other property that it delivers to T in exchange for the assets being acquired. T then has the option of (i) holding the cash or property received from P and continuing on, (ii) distributing the proceeds of the sale to its shareholders as a dividend and continuing on, or (iii) liquidating and distributing the proceeds to its shareholders as a liquidating distribution.
Second, the acquisition can be structured as a cash merger. In a cash merger, T is merged into P under applicable state merger laws. Under the terms of the merger, T's shareholders receive cash in exchange for their T shares and T is absorbed into P. Such a transaction is treated, at least for tax purposes, as a sale of all of the assets of T for cash, followed by a distribution by T of the proceeds of the sale in complete liquidation.4
Cash mergers have both advantages and disadvantages. The main advantage of a cash merger as a form of asset acquisition is that all of the assets of T become assets of P as a matter of law. The mechanical problems associated with multiple assets conveyances are therefore avoided. On the other hand, cash mergers have many of the problems of a stock acquisition. For example, all of the liabilities of T are transferred to P, along with the T assets, as a matter of law.
2. Tax consequences of taxable asset acquisitions.
From T's standpoint, the major tax consequence of a taxable asset acquisition is the recognition of gain or loss on the sale equal to the difference between T's basis in the assets sold and the amount of cash and the fair market value of the other property received from P. Prior to 1986, T might have avoided most or all of this gain by structuring the transaction so that it would qualify under section 337 of the Code. In essence, that section permitted T to sell substantially all of its assets to P without recognition of gain or loss, provided T liquidated within one year
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of the sale. Section 337 was, however, repealed in 1986 as part of Congress's broader repeal of the so-called "General Utilities doctrine."5 That doctrine basically held that a distribution of appreciated property from a corporation was not a taxable event at the corporate level. Section 337 had been enacted into the Code so that a sale of corporate assets in connection with a liquidation would be taxed the same way regardless of the order of events. With the repeal of the General Utilities doctrine, the theoretical underpinnings of section 337 were lost and the section was also repealed.
When the sale of a business is structured as an asset sale the purchase price must be allocated to each of the assets, and the tax consequences of each individual sale then computed.6 Gain or loss will be recognized by T depending on the difference between its basis in each asset sold and the amount of the total purchase price (including the amount of any debt assumed in the transaction) allocated to that asset. The character of the gain or loss will depend on the nature of the asset. For example, sales of...
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