This article is written by Aditi Deshmukh, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
“It is clear that you cannot stay in the top league if you only grow internally. You cannot catch up just by internal growth. If you want to stay in the top league, you must combine.”
This was correctly quoted by Daniel Vasella, Chief Executive Officer, Novartis. A very clear projection of what Daniel Vasella Pointed out is one of the topmost companies in the world “Google”. Google was invented as a search engine earlier and is now a $632 billion company, Alphabet being its Parent company.
You must have heard about Google’s acquisition of Android when android was not doing great as a company, but after acquisition android and google both together created a monopoly in the market, then google acquired various more companies to support it and expand its outreach such as Motorola, Nest labs, etc. There’s also another expected purchase from google for $2.1 billion of Fitbit. Who knows what will come of that — a Pixel Watch maybe?
The question is how google acquires these all companies by giving them cash? or does it buys stock? Or a combination of both?
When we come through deals like in 2013, Microsoft acquired Nokia’s devices, services, patents and licenses for €5.44 billion in cash, with so much of Nokia being used in its phones and patents the question to wonder is why didn’t Microsoft purchased Nokia company as a whole? What about the liabilities of the company which are being acquired?
Stock purchase and share purchase
“Mergers & Acquisition” is a term which is used to name the process of transactions of sale and purchase of either, assets of a business and the ownership of a company.
There are various ways by which a company can be acquired namely:
- Asset acquisition
- Share acquisition
- Slump sale
- Amalgamation
- Demerger
When a company purchases more than 50% stake in its target company, the company which acquires it gets the right to make decisions without the permission of the target company’s shareholders.
The acquiring company holds ownership by the way of either purchasing stock or assets.
What is stock purchase and asset purchase? How are they initiated? What are the advantages and disadvantages of acquiring a company by way of asset purchase and stock purchase? Is going to be addressed in this article.
What is a stock purchase
Stock purchase is when the acquiring company buys all or some part of shares of the target company. The target company continues to be a legal owner of his company however, the purchaser gets ownership of the company. The purchaser gets the majority of the sellers voting rights with purchase of stock. Liabilities and assets both are owned by share purchasers. In some circumstances buyer may want to pay all or part of M&A deal through stock purchase, seller can permit such transaction provided the seller has spoken with tax advisor for such arrangement of deal.
Examples
Microsoft and Linkedin
Microsoft acquired LinkedIn in 2016 for $ 196 per share with a $26 billion deal and were successful to fight with its competitor Salesforce.com. After the announcement of the deal shares of LinkedIn rose by 64%. The deal was an all cash deal which included LinkedIn’s net cash. Microsoft purchased LinkedIn at lower price by 25% than its normal price. They integrated products such as LinkedIn identity and network in Microsoft Outlook and the Office suite, LinkedIn notifications within the Windows action center, Enabling members drafting résumés in Word to update their profiles, and discover and apply to jobs on LinkedIn and many more.
The reason for this deal was the 433 million LinkedIn subscribers and professional clouds. The main idea of microsoft was to boost data productivity.
The share swapping deal
In a share swapping deal shares are acquired for shares i.e the acquirer exchanges their shares with the target companies shares. Let’s understand this with an example.
Ranbaxy acquired by Sun pharmaceuticals
What happened in the deal was ranbaxy shareholders received 4 shares for every 5 shares of sun pharmaceuticals. The deal was an all-share deal of $3.2 billion. Sunpharma with a turnover of INR 11,326 crore acquired Ranbaxy who was having a turnover of INR 12,410 crore. A unique acquisition of a bigger size company by a smaller size company.
The share price after acquisition was 457 per share with 18% premium.
Undertaking of share purchase
A share purchase agreement is used to undertake an acquisition of a company by shares. A share purchase agreement lists out:
- Terms and conditions of acquisition deal
- Value of shares
- Rights of acquirer and acquiree
A chartered accountant or registered valuer is appointed for valuation of shares in a share purchase agreement. If the company which is acquiring is a foreign company relevant FDI policy and additional compliance is to be checked.
A sample draft of share purchase agreement is here.
Pros
- Stock purchase allows the buyer to take everything readymade and as it is in a business there is no extra efforts for retitling of assets, assigning contracts, new bank account creation etc.
- The buyer will be benefitted by contracts already assigned, existing licenses and permits of the seller without worrying about third party consent.
- By doing a stock purchase, the buyer gets a benefit of the goodwill of the entity and credit history of the company.
- Stock acquisition is less complicated in terms of logistics.
- In a stock transaction sales and transfer taxes can be avoided.
Cons
- The acquiring company acquires debts and liabilities of the company along with stocks.
- All the liabilities may not be identified at the time of transactions and you never know what and how many liabilities may arise after closing of the transaction.
- Acquirer will not get benefited from the assets of the company as they are not acquiring assets.
- Securities filing may arise at state and federal level.
- Minority shareholders may create a problem by not willing to sell their part of the share.
What is an asset purchase
This type of acquisition takes place when an acquiring company purchases one or more assets of the target company. In an asset purchase possession of legal entity remains with the seller and individual assets are purchased by the buyer. Such as Patents, Trademarks, goodwill, grade secrets, trade names, inventory, contact numbers, fixtures, leasehold, licenses etc. Asset sales normally do not include cash and the seller retains long term debt with him. Normal networking capital such as account receivables, account payable, prepaid expenses etc are included in a sale. Here the buyer doesn’t assume liabilities of the target company unless and until it has agreed to assume some liabilities of the company.
The use of asset acquisition strategy is made when the buyer wants to acquire selected assets and if feasible some liabilities of a bankrupt company rather than buying the whole company. It saves the cost of the buyer at the front while still the buyer benefits at the back. However as a strategy the acquirer company can gradually gain control of the seller as the target company has more dependency on the buyer company it becomes easy to acquire the whole business.
Examples
Disney and 21st Century Fox
A real shake up for the entertainment industry was the acquisition of 21st Century Fox by Disney for $71.3 billion. This deal brought together two major entertainment industry giants. Disney won this deal from competitor Comcast and took 9 months to get the necessary approval. It was an asset acquisition deal. The assets acquired were:
- 20th Century Fox
- Fox Searchlight Pictures
- Fox 2000 Pictures – Fox Family
- National Geographic Partners
- Fox Networks Group International
- Indian channels like – Star India
- Fox’s percentage interests in Hulu, Tata Sky, and Endemol Shine Group
Undertaking of asset purchase
An asset purchase can be undertaken with asset purchase agreement and business transfer agreement (BTA) however BTA is widely used for asset purchase deals. BTA should provide an outline of the type of sale, terms of the sale, details of assets and liabilities and consideration payable for each asset and liabilities.
You can check a sample draft of BTA here.
Asset purchase agreement is a legally binding agreement. Individual values of assets are assigned and the seller transfers assets to the buyer. Some essential things to be addressed in asset purchase agreement is value of assets transferred, representation and warranties, conditions precedents, purchase price, sale and transfer of specified assets.
You can check a sample draft of asset purchase agreement here.
Pros
- The buyer can obtain ordinary tax deductions for depreciation.
- Basis for most of the assets can be stepped up over their current tax values.
- The acquirer can specify liabilities they are willing to assume.
- By purchasing assets over stocks, the problem of minority shareholders not willing to sell their stocks is being eliminated.
- The goodwill can be amortized by buyer for easy tax calculations for a period of 15 years.
- Acquirer is not required to make any sort of securities filing as this is asset purchase not a stock purchase.
Cons
- The assets of the target company need to be retitled in the name of the buyer, this is not the case in-stock purchase.
- Tax free reorganization cannot be done in asset acquisition.
- Cost of asset acquisition is more than normal purchase of assets as it needs a lot of valuators to calculate the value of individual assets.
Which method to choose : stock acquisition vs. asset acquisition
There are different factors which need to be considered before deciding the manner of acquisition. The risk is normally shared between the target company and the purchaser or acquirer in a certain ratio. Based on the financial standing of the company the ratio can be decided. The acquirer company holds a strong position in deciding the terms and conditions for the deal. Due to different tax treatment in acquisition deals, acquirers prefer asset purchase because they get asset depreciation benefits whereas the seller prefers stock sale. It also depends upon size of business for eg. asset acquisition of larger business may make the process complicated and the depreciation cost may go high. Whereas in some cases the asset maynot be easily transferred to the acquirer then in this case stock acquisition is easy to make a deal.
Conclusion
Therefore, there are own advantages and disadvantages of asset acquisition and share acquisition methods. One should wisely analyze the target company’s business structure, cost implications and choose accordingly.
References
- https://www.cleverism.com/mergers-and-acquisitions-complete-guide/
- https://corporatefinanceinstitute.com/resources/knowledge/deals/asset-purchase-vs-stock-purchase/#:~:text=In%20most%20jurisdictions%2C%20an% 20ass et,an d % 2 0sale%20of%20common%20stock
- https://www.aranca.com/knowledge-library/articles/valuation/asset-purchase-versus-stock-purchase-which-one-suits-your-transaction-more
- https://www.findlaw.com/smallbusiness/starting-a-business/asset-purchase-vs-stock-purchase-advantages-and-disadvantages.html
- https://caryestateplanning.com/blog/buying-a-business-why-asset-purchases-are-the-key-to-success/
- https://www.wallstreetmojo.com/acquisitions-examples/
- https://www.dummies.com/business/corporate-finance/mergers-and-acquisitions/ma-financing-paying-for-a-company-with-stock/
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