Mergers and Acquisitions are a multistep and time-consuming process that entails many additional challenges, and they need to be resolved as quickly as possible. Both parties involved in the transaction must consider many aspects. In this article, we will discuss the main issues during M&A transactions.
To successfully form a deal, a company has several options including buying stock, selling assets, and merging. Before starting to form a structure, a company must address the essential issues. Key considerations that relate to the structure include transferability of liability, third-party agreement requirements, shareholder approval, and tax implications, let’s look at them in more detail below.
- Transfer of liability – if something was not negotiated in the transaction itself, once the transaction is completed, the target’s obligations are transferred to the purchaser by operation of law. Likewise, after the merger, the “surviving” company assumes the liabilities and obligations of the other entity and will be liable to the law for them
- Third-Party Consent – If the contract prohibits the assignment, you need to get prior consent to the assignment. Such a consent requirement does not exist for a stock purchase or merger unless the relevant contracts specifically prohibit assignment upon a change of control or by operation of law, respectively
- Shareholder approval – a sale of stock cannot occur unless at least one shareholder consents. If unanimous consent is not possible, the merger would be used as an alternative
- Tax implications -a merger transaction may be taxable, but it also depends on its structure. If it has been properly structured, then the payment (at least on part of the proceeds) of tax can be deferred
Cash versus capital
Another legal issue in mergers and acquisitions is the method of payment, it has an important role in the transaction and can be done in two ways:
- Cash – this method of transaction is the least risky from a target standpoint, as it accurately ensures that there are no unforeseen and hidden payments. On the buyer’s side, it can come from working capital or excess cash, or unused lines of credit
- The Unbiased, it refers to the payment of the equity of the buyer’s company. This method allows the buyer to improve the debt rating and reduce future financing costs
Working Capital Adjustment
Working capital adjustment (W/C) is a common practice during an M&A transaction. The buyer needs to make sure that the W/C of his acquisition is at a sufficient level to cover all of the business’s requirements after closing. The target party wants to be rewarded for the asset infrastructure that allowed the business to operate and generate the profits that triggered the buyer’s desire to buy the business in the first place. An effective W / C adjustment protects the buyer from the target initiating an accelerated debt collection or deferred inventory purchase or selling the inventory for cash or payments to creditors.
Contingent profit escrow.
The letter of intent should clearly state any contingency for payment of the purchase price in the transaction, including any escrow and any profit. The purpose of the escrow is to provide recourse for the purchaser in the event of a breach of representations and warranties made by the target (or upon the occurrence of certain other events). Although escrow is standard for M&A transactions, the terms of an escrow can vary significantly. Typical terms include an escrow dollar amount of 10% to 20% of the total consideration with an escrow period of 12 to 24 months from the closing date.