CHAPTER 3 ACQUISITION OF MINERAL INTERESTS INVOLVING THE PURCHASE OF A BUSINESS (A GUIDE TO BASIC CORPORATE ISSUES)
| Jurisdiction | United States |
(May 1991)
ACQUISITION OF MINERAL INTERESTS INVOLVING THE PURCHASE OF A BUSINESS (A GUIDE TO BASIC CORPORATE ISSUES)*
Pendleton & Sabian, P.C.
Denver, Colorado
TABLE OF CONTENTS
Page
I. OVERVIEW
II. TYPES OF TRANSACTION—GENERAL
III. MOTIVATION FACTORS
A. Motivation Factors—Seller
B. Motivation Factors—Acquiror
IV. PARTIES' APPROACH TO THE TRANSACTION
A. Acquiror's Viewpoint
B. Seller's Viewpoint
V. BASIC TRANSACTION STRUCTURES
A. Asset Acquisition
B. Stock Acquisition
C. Statutory Merger
VI. KEY NEGOTIATION ISSUES
A. Price
B. Indemnity Provisions
C. Warranties and Representations
D. Covenants
E. Securities Law Compliance
F. Bulk Transfer Act Compliance
G. Covenant Not to Compete
H. Dispute Resolution
VII. CONCLUSION
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I. OVERVIEW
The typical mineral property acquisition focuses with a relatively limited scope on the direct acquisition of the target mineral property and associated tangible and intangible personal property or on the earning of an interest in the property through an exploration and development joint venture agreement. Because these types of acquisition structures focus primarily on the specific property involved, the range of issues the advisor has to review and handle is limited to those inherent in the acquisition of the property.
When a mix of geographically disbursed mineral properties that constitute all or substantially all of the properties of a company is involved, it may be far more expedient to acquire them indirectly by acquiring the company. However, by reason of such a shift in focus from an individual property to the owner, a much broader range of transaction issues must be dealt with and accommodated. For the mining attorney who has dealt generally with the acquisition of individual mining properties, the negotiation and due diligence issues become exceeding more complex and are often driven by factors unrelated to title, property value, development potential or obligations and liabilities related only to the properties themselves.
Due to liability issues and capital considerations, most commercially feasible mineral properties today are owned and developed through the use of a corporate vehicle. The focus of this paper is on acquiring the corporate owner or, if not the corporate entity, the entire (or substantially all) business that is in corporate solution.1 This may involve acquiring the target's2 outstanding stock or acquiring the target's mineral properties and associated assets, including the business, management, labor force, etc., by using the acquiror's stock or
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other securities or some other mix of consideration. In either case, the need for an understanding of the general principles and issues involved in acquiring a company, the business assets of a company or business combinations come into play.
The purpose of this paper is provide such an understanding. However, it should also be understood that this paper at best scratches the surface of the range of principles and issues and attendant complexities involved in such transactions. As the size of the transaction increases, its complexity often increases geometrically, which stimulates the need for an increased level of awareness, sophistication and understanding concerning the range of acquisition issues and the possible alternatives for their resolution. The need for both the business attorney's and the mining attorney's knowledge and experience is apparent. However, if one person doesn't have the range of experience and knowledge attendant to both business and mineral property acquisition transactions then a team approach will be necessary. Hence, the collaboration of the authors for this paper.
II. TYPES OF TRANSACTION — GENERAL
In general, business acquisitions and combinations involving corporations are effected in one of three basic ways. They are:
o Asset Acquisition. In an asset acquisition, the acquiror purchases some, substantially all or all of the target's assets in exchange for cash, securities of the acquiror, other property or a combination of them.
o Stock Acquisition. In a stock acquisition, the acquiror purchases the stock of the target in exchange for cash, the acquiror's securities, other property or a combination of them.
o Statutory Merger. In a statutory merger, the target merges under state law with either the acquiror or a subsidiary of the acquiror and the target's shareholders receive the agreed consideration.
From these three basic structures any number of hybrid structures can be utilized or developed to meet the needs of the transaction or the parties, which will be driven by a number of factors. The principal factors involve tax considerations, corporate issues, the regulatory environment and often the accounting treatment that will be accorded the transaction, especially if a public company is involved.
The best structure (not necessarily the ideal structure) will be the result of balancing the advantages and disadvantages related to the alternative structures. The negotiator's or advisor's role on behalf of the relevant parties (target, acquiror
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or shareholders) is to come up with a structure that optimizes a favorable balance of the various factors whose resolution is often dependent on finding the response or compromise that accommodates on an overall basis the often divergent objectives of the acquiror and the seller.
For example, when structuring a deal, the tax objectives of the buyer and seller often will be in conflict on any number of points in arriving at an agreed acquisition structure.3 Generally, the seller's structure goal from a tax perspective will be to maximize the after-tax proceeds from the transaction.
In the corporate context, the desired result is to avoid the recognition of significant taxable income at more than one taxpayer level.4 Since the federal government currently has the ability to impose up to an aggregate 65% tax on the profits derived from the transaction,5 tax considerations are often the primary reason why sellers generally prefer to sell stock. However, on balance, if both sides do their homework, there may not be a significant difference in what a shareholder ultimately receives in terms of net after-proceeds whether the transaction is structured as a stock or asset sale. This is primarily the result of the legislative repeal of the General Utilities doctrine which previously engendered the ability to avoid tax at the corporate
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level if particular tax structures were utilized.6 Any knowledgeable acquiror should take this into account in coming up with a price for the company, but mistakes can be made and often there will be reasonable differences of opinion concerning how any adverse tax consequences should be borne by the parties.
In contrast, the acquiror is interested in accounting for the acquisition of any assets that have substantial appreciation and value in excess of their book value (usually historical cost) in the hands of the target at a "stepped-up" tax basis. This is especially true if the cost of the asset can be depreciated or amortized as a business deduction over a relatively short period of time. The increased basis also serves to offset subsequently realized taxable gains, which may be important especially if unwanted assets are to be disposed of following the acquisition.
However, there may be many non-tax considerations that dictate that the acquiror may not be able to acquire assets. For example, restrictions on such transfers contained in joint property development agreements and loan agreements may require third-party consents or renegotiation of such agreements. In such cases, it may be more expedient from time-frame and risk perspectives to purchase the stock of the owner.
The bottom line here is that the advisor must understand and be familiar with the multitude of issues that relate to the tax and non-tax factors inherent in acquiring a company or its assets. Also, he should understand what motivates buyers and sellers. Often the advisor's failure to understand or comprehend the parties' motivations in entering any transaction irrespective of the advisor's technical competence on the various legal and tax issues can result in a failed transaction or a structure that fails properly to accommodate the parties' non-tax and tax objectives.
III. MOTIVATION FACTORS
Each advisor needs to understand both the acquiror's and seller's motivations before beginning the planning process. What motivates an acquiror may not necessarily motivate the seller and vice versa. Finding the fine line between the often divergent motivations of the parties will be more art than science, but then that's what makes this part of the business all the more exciting even though the negotiation process may reach exasperating heights. If the acquiror's and seller's motivations are in sync
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or at least do not conflict to any material extent, the possibility of consummating a deal is enhanced greatly.
A. Motivation Factors — Seller. A seller may be motivated by any of the following:
o Ownership Wants Out. This may result from a retirement or death situation when the owners view existing management as inadequate or the owners may want the security of a larger organization.
o Capital Needs. The capital resources for future growth and expansion are considered inadequate and the owners do not have the capacity or capability to raise the capital necessary for future operations.
o Tax Considerations. The owners want to cash out on a tax-advantaged basis.
o Diversification. The owners want to be part of a larger more risk-diversified company.
o Take Over Defense. The sale will prevent a hostile takeover attempt.
o Industry Conditions. Technological or industry factors dictate a sale. Perhaps all-time high reserve prices are being realized within...
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