Key deal structures

A buyer can acquire a private company through a purchase of equity, a purchase of substantially all of its assets or a state law merger or consolidation. The best method to use in any particular transaction depends on a number of factors, such as commercial considerations, tax considerations, third-party and corporate consents, and deal process and timing.

One method of acquiring a private company is through a purchase of equity (for a target that is a Corporation, that equity will be stock). In an equity purchase, the buyer will purchase the target company's equity from the selling equity holders. Most commonly, the buyer will purchase the target company's equity with cash, but the buyer may also exchange a portion of its equity with the equity of the target company's equity holders to effectuate the acquisition. Although less common than all-cash or equity-for-equity acquisitions, a buyer may also use a combination of cash and equity to acquire the target company.

A buyer can also acquire a private company through a purchase of assets. In an asset acquisition, the buyer will purchase all or a portion of the target company's assets and/or liabilities directly from the target company in exchange for cash or equity consideration. If all of the target company's assets are acquired, the target company is frequently liquidated simultaneously.

Equity consideration is less common than cash consideration in an equity or asset acquisition because it carries additional risks. Such risks include the possibility that the value of the buyer's equity may fluctuate between signing and closing, or that the equity may not be freely tradable. All state laws provide for the merger of corporations and most states now provide for the merger of limited liability companies and other entities (including mergers of different forms of entity). In a statutory merger, two entities are joined by operation of law, with all assets and liabilities becoming the property of the surviving entity (or a new entity) solely by filing a certificate of merger. Normally, one entity disappears and the other continues as the successor to both lines of business. The principal advantage of a merger is that it typically only requires a majority consent from the target company's equity holders for the buyer to obtain all of the target company's equity (although dissenting equity holders may have the right to obtain an appraisal of their equity and recover the appraised value in lieu of the amount offered to them in the merger). In a merger, the transfer of assets and the exchange of the target corporation's equity are automatic. No separate transfer documents are required. Additionally, valuable permits, contracts, etc., are easier to transfer in a merger than in an asset sale.

Auction processes

Auctions are typically used when multiple buyers are interested in the target company. The auction structure tends to favor the seller because it allows the seller to control the sales process. Sellers will ordinarily disclose information about the target in a favorable light and distribute a seller-favorable draft purchase agreement to potential buyers. Auctions also have the potential to generate a higher purchase price because the structure is designed to reach more buyers and maximize competition among them. However, there are also potential pitfalls for sellers. Auctions are costly and time-consuming and carry an increased risk that potential buyers will leak transaction information or use the disclosure process to glean competitive information about the seller or target company. That is why it is extremely important in an auction process (even more so than in single-buyer situations) for a seller to require each bidder to execute a confidentiality or non-disclosure agreement at the beginning of the deal process before the seller discloses any proprietary information.

Letters of intent

The parties to an acquisition transaction usually sign a letter of intent (sometimes also referred to as a memorandum of understanding or a term sheet) as a first step in the process. The letter of intent is usually non-binding and outlines the proposed key terms of agreement between the parties. It is used as a starting point for negotiating the definitive acquisition agreement of the transaction.

In the US, there are several types of entities used for business purposes, including corporations, limited liability companies and various forms of partnerships. The most common entities that tend to be acquired are corporations and limited liability companies.

The laws of all states in the US provide for the organization of limited liability companies (LLCs). LLCs have become a popular structure for privately held businesses in the US. An LLC offers the flexibility to describe the entire relationship of the parties by contract, while still limiting the liability of each of the members to their investment in the company. The owners of an LLC are its members, who are analogous to a corporation's stockholders. No minimum or maximum applies to the number of members (i.e., one member is acceptable). The members typically enter into a limited liability company operating agreement (or LLC agreement), which governs the operation of the LLC, including the members' contractual rights, obligations and restrictions relating to their membership interests in the company. The members may generally select any management structure they desire. They may operate the company directly or may appoint officers or managers to conduct the daily affairs of the LLC. The ownership interests of the members in an LLC are known as membership interests or membership units. There are no limitations on the transferability of ownership interests under statute; however, members may provide for restrictions in the LLC agreement. For US tax purposes, an LLC with more than one owner can be treated as a partnership, or 'pass-through' entity, which generally avoids taxation at the entity level and passes the company's profits and losses through to the members. As such, an LLC can be very advantageous to a non-US buyer.

There is no restriction on the number of shareholders or members that a Corporation or LLC, respectively, can have, but a Corporation must have at least one shareholder and an LLC must have at least one member.

The acquisition of shares or membership interests is generally simpler than asset acquisitions, especially if there are only a few equity holders and all are willing to sell. Where equity interests are acquired, all assets remain in the target company and few transfer documents are required. Retaining assets such as licenses, permits and franchises avoids the difficulties of obtaining consent from the issuing government agencies. Additionally, unlike in asset acquisitions, third-party consents for the assignment of important contracts and leases will generally not be required, unless they contain change of control clauses. In a share acquisition, the target company will usually retain its tax attributes, both favorable and unfavorable, assuming that the business of the company continues. There are, however, limitations on the future use of some attributes, such as net operating losses and tax credits. Additionally, the buyer retains the seller's tax basis in the target company's assets, even if the buyer paid a higher purchase price for the business, unless the seller consents to certain tax elections that permit recharacterizing the acquisition of the target as an acquisition of the assets of the target for US tax purposes only, which often become commercially negotiated deal points.

In an asset acquisition, the buyer or its subsidiary acquires specific assets and liabilities of the target company. This may comprise 'substantially all' of the target's assets or only a division or line of business. The seller retains those assets and liabilities not acquired by the buyer. An asset acquisition is more complex than a share acquisition because each asset must be transferred. Clear identification of the specific assets to be transferred and the specific liabilities to be assumed by the buyer (as well as the specific assets and liabilities retained by the seller) is critical in an asset acquisition. An asset acquisition will generally trigger 'anti-assignment' clauses in the target's key contracts, licenses and permits, necessitating third-party consents for the transfer of certain valuable assets of the seller. If assets are acquired, the buyer's tax basis in the assets may be increased to reflect the actual purchase price (i.e., the so-called "basis step-up"). However, favorable tax attributes of the target corporation will often be lost in an asset acquisition.