M&A Transaction Structure

Transaction deal handshake

By: J. Wesley Legg

If your company is considering buying or selling, it is important to understand the differences between the types of transactions and some key considerations when structuring a deal.

Stock vs. Asset vs. Merger

A stock sale is the purchase of the owner’s shares of a corporation. Usually, the selling organization and its assets are left in place and it’s more of a change in control. If the buyer is purchasing 100%, all stockholders need to sign the purchase agreement, which can be difficult if there are a large number of minority stockholders. A stock purchase structure will usually be less tax-advantageous to the buyer than an asset purchase structure.

An asset purchase is a purchase of the individual assets and liabilities, which can include inventory, equipment, real estate, leases, patents, and more. The selected structure has ramifications on the seller’s tax liability, ongoing liabilities, and the buyer’s tax benefits. Buyers typically prefer asset purchases, because they tend to be more tax-advantageous for them.

A merger is when the seller is merged into the buyer or the buyer sets up a subsidiary with which the seller is merged. Mergers are similar to stock purchases; mergers are usually (but not always) considered a change in control, and the buyer “becomes” the seller. Mergers can sometimes be tax-free to the seller’s stockholders, depending on the purchase consideration, and they typically don’t require all seller stockholders to sign the purchase agreement, unlike stock sales.

As noted above, all of these structures have nuanced tax and legal implications. Any buyer or seller should consult legal counsel and a tax accountant to understand their unique situation and the implications of structuring the deal different ways.

Earnout Payment vs. Cash at Close

An earnout is a mechanism used in M&A transactions whereby a portion of the purchase price is deferred and calculated based on the performance of the target company or another agreed upon metric. Earnouts can take different forms (e.g. contingent payment, seller’s note) and can serve multiple purposes, including mitigating buyer risk, bridging a financing and valuation gap between buyers and sellers, and providing ongoing incentive-based compensation to sellers. Cash at close is the most straightforward; however, a value gap between seller and buyer may need to be bridged, particularly when the company being purchased is experiencing rapid growth. Also, promissory notes or installment payments can be made, subject to future conditions, to bridge the gap.

Equity Rollover Contribution

An equity rollover is the exchange of stock in the buyer company for ownership of the seller company (resulting in less cash at close). This allows a seller to get some liquidity and minimize their financial risk, while also allowing them to participate in the upside of the company.  It can also serve to bridge financing and valuation gaps between buyers and sellers and to align the incentives of sellers who will remain with the business. With proper structure, the equity rollover can be a tax-free transaction for the seller. Key items to look at when considering an equity rollover are the types of shares exchanged (common vs. preferred), equity kicker, the performance and valuation of buyer company.  A tax accountant should be engaged to assess the individual situation.

Legal Considerations

Each transaction structure has advantages and disadvantages for each party, and it is vital for the objectives of both the buyer and seller to be in alignment for the deal to close. A variety of legal considerations such as escrows, indemnifications, and non-compete agreements are negotiated in an M&A transaction and can have impacts on deal structure, purchase price allocation, and overall valuation. An experienced M&A lawyer should be engaged to assist in the consideration and close of any transaction.

Most people only buy or sell a business once, if at all, during their life. It’s not something you want to fumble your way through, especially if it involves a company you’ve dedicated your life to. If you’re considering buying or selling a company, or if you just have questions, reach out to us. We would be happy to help.


About Founders Investment Banking

Founders Investment Banking (Founders) is a merger, acquisition & strategic advisory firm serving middle-market companies. Founders’ focus is on oil and gas, SaaS/software, industrials, internet, digital media and healthcare companies located nationwide, as well as companies based in the Southeast across a variety of industries. Founders’ skilled professionals, proven expertise and process-based solutions help companies access growth capital, make acquisitions, and/or prepare for and execute liquidity events to achieve specific financial goals. In order to provide securities-related services discussed herein, certain principals of Founders are licensed with M&A Securities Group, Inc. or Founders M&A Advisory, LLC, both members FINRA & SiPC. M&A Securities Group and Founders are unaffiliated entities. Founders M&A Advisory is a wholly owned subsidiary of Founders. For more information, visit www.foundersib.com.