Part 1 and Part 2 explained how to buy a company using the asset and stock purchase method. The last and probably the most complicated structure in buying a business is known as a “merger.” Mergers require a lot of planning and are ultimately more suitable for well-established companies. This article seeks to provide a simplified understanding of how to structure a merger.
1. Types of Mergers
There are two basic types of mergers: direct and triangular.
A. Direct Merger
A direct merger is a merger between the buyer and the target company or seller. The direct merger may be structured in one of two ways.
The first way is as follows: the target company can merge with the buyer, with the buyer surviving the merger. Once the merger is effective, the separate existence of the target company is extinguished and the buyer, as the surviving entity, automatically assumes all of the target company’s assets and liabilities.
Alternatively, the buyer can merge with the target company, with the target company surviving the merger. In this case, the separate existence of the buyer is extinguished and the target company, as the surviving entity, holds all of the buyer’s assets and liabilities as well as their own assets and liabilities before the merger. Upon completion of the transaction, the buyer’s stockholders hold shares of the surviving entity, in this case the target company, and the stockholders of the target receive the agreed-upon equity value from the buyer.
A direct merger typically requires the approval of the stockholders of both the buyer and the seller, which is one of the reasons why it is generally less popular than the triangular merger.
B. Triangular Merger
In a triangular merger, a subsidiary of the buyer’s company merges with the target company. It is common for the buyer to create a new subsidiary for this purpose. One benefit of this structure is that it allows the buyer to shield itself from the liabilities of the target company by holding them in a subsidiary separately. The structure also helps to avoid stockholder approval requirements on the buyer’s side because the buyer simply takes action as the sole stockholder of the subsidiary.
There are two types of triangular mergers:
Forward Triangular Merger: In a forward triangular merger, the target merges into the buyer’s subsidiary, with the buyer’s subsidiary surviving the merger. The target’s stockholders receive cash, securities of the buyer, other assets or a combination of the three in exchange for the target’s stock.
Reverse Triangular Merger: In a reverse triangular merger, the buyer’s subsidiary merges into the target, with the target surviving the merger. The target’s stockholders receive cash, securities of the buyer, other assets or a combination of the three in exchange for their stock. The buyer is issued shares of the surviving company. This structure generally minimizes the need to obtain new contracts or assign contracts and/or other rights of the target because the target is the surviving company. Therefore, this transaction structure is often used if the target is subject to contracts that require third-party consent before they can be assigned to a different party.
2. Benefits of a Merger
The merger structure has many of the same advantages and disadvantages as a stock purchase. One benefit of the merger structure as compared to a stock purchase is that in a merger, so long as the minimum required vote of the target’s stockholders is obtained, the merger can be effected, and the buyer will acquire 100% of the target. By contrast, in a stock purchase transaction, if a single stockholder does not sell its shares, the buyer will be unable to acquire 100% of the target. One benefit of the merger structure as compared to the asset acquisition structure is that a merger is less likely to cause the termination of contracts, permits and licenses.
3. Disadvantages of a Merger
A significant drawback of the merger structure is that the parties have little flexibility to select which assets and liabilities of the target will be transferred to the buyer, unless designated assets and liabilities are transferred to another entity prior to the merger. Thus, the buyer will seek to fully understand the liabilities that it is purchasing before it decides to structure an acquisition in this manner.
The merger structure is a complex structure that is suitable for larger businesses. It requires careful planning. These type of mergers have major tax implications as well as securities implications and if not done correctly, will have major consequences for all parties involved. Any attempt to use this structure requires an attorney or multiple attorneys.
Eric W. Ching is a real estate & business attorney with Ching & Seto, APC.