Structure
Mechanics

DEFINITIONS

A merger is combination of two legal entities where (i) one entity is absorbed by the other and ceases to exist and (ii) the other survives as the go-forward business. Corporations, limited liability companies, and partnerships may merge together, though typically a merger is between corporations. A merger is a type of equity transaction.

An acquisition or disposition involves an exchange of equity or assets between two or more parties. An exchange of equity is a type of equity transaction, and an exchange of assets is a type of asset transaction.

TRANSACTION MECHANICS

If parties have chosen to structure a transaction as an equity transaction, it may be structured as either a merger or equity exchange. If parties have selected an asset transaction, the transaction will be an asset exchange.

• MERGERS

Mergers are completed via compliance with relevant statutory law and pursuant to the underlying transaction agreement, usually an agreement and plan of merger. It is executed by making a merger filing with the relevant authority.

One entity survives a merger, and the other entity (typically a target business) ceases to exist. The surviving entity, which is usually owned by a buyer, inherits the assets, liabilities, and workforce of the entity that it absorbed. That is how the buyer comes to own the target business in a merger.

A seller in a merger does not sell its equity in the target business to the buyer. Instead, its equity is automatically canceled and converted into the right to receive cash or other agreed-upon proceeds in exchange for the equity that was canceled. This is why a merger does not involve an exchange of equity between parties.

The key benefit of mergers in dealmaking is that approval of them usually only requires a majority (or in some cases, two-thirds) vote of a target business’s outstanding equity. In other words, they provide a way for buyers to acquire widely held businesses without obtaining unanimous approval from all equityholders, even in the face of dissenting minority holders.

• EQUITY EXCHANGES

In a purchase and sale of equity, the transaction parties directly or indirectly exchange equity pursuant to a transaction agreement—resulting in a buyer owning a target business following closing.

Generally, if the target is: (i) a corporation, the target equity will be shares of stock; (ii) a limited liability company, the target equity will be membership units or limited liability company interests; or (iii) a limited partnership, the target equity will be interests or partnership interests.

The exact terminology will depend on not only the target company’s domestic jurisdiction, but also the terms used in the documents that comprise its corporate charter. Getting these terms correct, which is an aim of legal diligence, reduces ambiguity, confirms deal terms, and lessens the probability of post-closing disputes.

• ASSET EXCHANGES

In a purchase and sale of assets, the transaction parties directly or indirectly exchange assets and liabilities comprising a target business—resulting in a buyer operating the target following closing.

An asset transaction involves transferring specified assets (i.e., purchased assets that are within the transaction’s perimeter) and the workforce to a buyer. Liabilities the buyer is responsible for—like those relating to the post-closing period—are called assumed liabilities. Liabilities that a seller is responsible for—like those relating to the pre-closing period—are called excluded liabilities, and any assets that stay with the seller are called excluded (or retained) assets.

The purchased assets should permit the buyer to operate the target business in the ordinary course, from day one after closing.

Assets frequently purchased in asset transactions include: (i) cash and cash equivalents, (ii) accounts receivable, (iii) inventory, (iv) contracts, (v) intellectual property, (vi) personal property, (vii) owned real property, (viii) permits, (ix) rights in lawsuits and under warranties, (x) insurance benefits, (xi) company books and records, and (xii) goodwill. The foregoing list is only illustrative. Legal, operational, and other diligence is required to derive and confirm the exact list of assets to be included in the relevant transaction.

Workforce transfer requires: (i) identifying the employees needed to operate the target business, (ii) terminating their pre-closing employment immediately prior to closing, and (iii) having the buy-side legal entity that will house the target business on a go-forward basis hire the employees immediately after closing. The fire-and-rehire process typically does not materially alter employment terms or benefits.

Key employees should sign, as applicable, offer letters or new employment agreements in advance of signing (if a staggered sign/close transaction) or closing (if a simultaneous sign/close transaction). Otherwise, they may be able to walk, leaving the buyer with core roles unfilled after closing.

IMPLEMENTING STRUCTURES

Once a transaction’s structure and exact mechanics are selected, parties then develop a structure deck detailing precisely how the transaction will be completed.

PITFALLS

• MERGERS NOT UNIFORMLY THE SAME OR AVAILABLE

Because mergers are completed pursuant to statutory law, their requirements and implications—and even whether they are available in the first place—depend on the relevant jurisdiction.

For example, in the United States, mergers are governed by state law and, accordingly, different procedures and implications exist. In Delaware, a certificate of merger is filed with the Secretary of State and may be pre-cleared (a best practice) prior to the closing date to ensure that the filing is ready-to-go when needed.

But in Canada, mergers do not exist. There, an amalgamation is a close (but not identical) relation to a Delaware merger.

Parties should not assume the worldwide availability and uniformity of mergers. Even if available, liability allocation, tax implications, filing requirements, and pre-clearance options vary.

• EQUATING TAX TREATMENT WITH TRANSACTION STRUCTURE

Tax treatment does not necessarily match a transaction’s legal structure.

For example, it is possible for a transaction to be structured as an exchange of equity, but treated as an asset transaction for tax purposes. Or for certain mergers to be treated as asset sales.

Careful attention should be paid to separating these concepts.

• NOT FOLLOWING STEPS PLAN

To achieve desired financial, legal, and tax results, the final structure deck should be followed to its exact letter. Even deviations that may seem trivial at first blush can jeopardize intended outcomes.

• WAITING TOO LONG

Deciding on a transaction structure and its mechanics should not hold up instructing lawyers to begin drafting legal documents and commence negotiations around provisions, like representations and warranties, that are largely unaffected by the transaction structure.

Waiting too long to begin negotiating these types of provisions can delay other workstreams, such as preparing and negotiating disclosure schedules, and create costly bottlenecks.