RESOURCES

Structuring the Transaction

Once you have determined much of the background of the company you wish to acquire, and you ahev begun assembling your team, it's important to look at how to take the next steps in completing the transaction.

Asset Versus Stock Transactions

The purchase and sale of a company can be structured in one of two basic formats: (1) purchase of the assets of the selling corporation or (2) purchase of the stock of the selling corporation.

Asset Transactions

In an asset transaction, the assets to be acquired are specified in the contract. Practices vary from industry to industry but, in general, all assets of the company except cash convey to the buyer. None of the liabilities, except perhaps accounts payable, convey.

The selling corporation uses the proceeds from the sale to liquidate short-term and long-term liabilities. This means that the buyer purchases all of the company's equipment, furniture, fixtures, inventory, trademarks, trade names, goodwill and other intangible assets.

An asset transaction is generally advantageous to the buyer. The buyer may acquire a new cost basis in the assets which allows a larger depreciation deduction. The seller must pay taxes on the difference between the basis in the assets and the price paid for the company.

The buyer may prefer an asset transaction for liability reasons. By purchasing assets, the buyer may avoid the possibility of becoming liable for any of the selling corporation's undisclosed or unknown liabilities. The most common liabilities of this type are federal and state income taxes, payroll withholding taxes and legal actions against the company that are contemplated but as yet uninitiated.

Stock Transactions

In a stock transaction, all of the shares of stock of the selling corporation transfer to the buyer. Therefore, all of the assets and liabilities also convey. In some cases, the buyer and seller may choose to exclude certain assets or liabilities from being conveyed. The seller must pay taxes on the difference between the seller's basis in the stock and the price paid by the buyer.

Sometimes stock deals are more expedient for both parties. Stock transactions provide for continuity in relationships with suppliers. They may also preclude the necessity of obtaining a lease assignment when there is no such provision in the lease in the event of a change in the controlling interest of the corporation. The risk of inheriting undisclosed debts of the seller in a stock transaction can be minimized by providing for the buyer's indemnification and the right of offset to future payments due the seller.

In choosing to structure a deal as a stock transaction, the seller should be aware that the sale of stock in a closely held corporation falls under the umbrella of federal securities laws. This places a greater burden on the seller in a stock transaction to fully disclose all material information about the company. Failure to do so exposes the seller to the risk of securities fraud litigation.

Seller-Financed Transactions

Sales of most smaller businesses and some larger ones, particularly corporate divestitures, are partly seller financed. Typically this arrangement calls for the seller to receive some cash at settlement, but for the bulk of the purchase price to be seller financed. Such transactions are a form of leveraged buyout. For smaller privately held companies, the down payment often ranges from 10 to 50 percent of the selling price and the buyer executes a promissory note (secured by the assets of the business only) for the balance. Such notes are typically for a period of three to ten years at an interest rate that varies with the prime rate but is most often 9 to 12 percent.

Leveraged Buyouts

Just as in a seller-financed sale, in a leveraged buyout the assets of the company are used to collateralize a loan to buy the business. The difference is that in a leveraged buyout, the buyer typically invests little or no money and the loan is obtained from a lending institution.

This type of purchase is best suited to asset-rich companies. A company lacking the assets needed for a completely leveraged buyout may be able to put together a partially leveraged buyout. In this structure, the seller finances part of the transaction and is secured by a second lien security interest in the assets. Because leveraged buyouts place a greater debt burden on the company than do other types of financing, buyer and seller must take a close look at the company's ability to service the debt.

Earn-Outs

An earn-out, or contingent payment sale, as it is also called, is a method of paying for a company that helps bridge the gap between the positions of the buyer and seller with respect to price. Because the payment of money to the seller under the provisions of the earn-out is predicated on the performance of the company, it is important that the seller continue to operate the company through the period of the earn-out. An earn-out is usually calculated as a percentage of sales, gross profit or net profit. It is not uncommon to establish a floor and/or ceiling for the earn-out.

Earn-outs do not preclude the payment of a portion of the purchase price in cash or installment notes. Rather, such payments are normally made in addition to other forms of payment.

Stock Exchanges

In some instances the seller may want to accept the stock of the purchasing corporation in payment for the company. Typically, the stock received (if it is the stock of a publicly held company) may not be resold for two years. If the stock may not be freely traded, its value is diminished and should be discounted to allow for this lack of marketability.

There is an advantage to the seller in this kind of transaction, however. Taxes incurred by the seller on the gain from the sale of the company are deferred until the acquired stock is eventually sold. This kind of transaction is termed a tax-free exchange by the IRS. Several tests must be met to qualify for this tax treatment.

Employee Stock Ownership Plans

An employee stock ownership plan (ESOP) can be a viable way of structuring the purchase or sale of a company. For the owners of privately held companies, an ESOP provides an excellent way to sell the company but still control it. In this arrangement, the ESOP is established with less than 50 percent of the company's stock. For a buyer, an ESOP has some powerful financial incentives to recommend it.

Closing the Transaction

Closings are the final legal procedure by which a company changes hands. It is important to have good problem-solving attorneys representing all parties.

One of the many details of settlement is that of meeting the requirements of the Bulk Sales Act in the event the assets (not the stock) of the company are being sold. This law calls for the company's suppliers to be notified of the impending sale. The suppliers must respond within the allowed time if money is owed by the seller. Another function performed as part of settlement is a search, to determine whether any liens against the company's assets have been filed in the records of the local courthouse.

Meeting Conditions of Sale

After buyer and seller have entered into a binding contract, there may be several conditions to be met before the sale can be closed. Such conditions often address issues such as assignment of the lease, verification of financial statements, transfer of licenses or obtaining financing. There is usually a date set for meeting the conditions of sale. If a condition is not met within the specified time, the agreement is invalidated.

Documents

A number of documents are required to close a transaction. The purchase and sale agreement is the basic document from which all the documents used to close the transaction are created. The documents most often used in closing a transaction are described below. Other documents not described below may also be needed, depending on the particulars of the transaction.

The settlement sheet

-- Shows, as of the date of settlement, the various costs and adjustments to be paid by or credited to each party.

Escrow agreement

-- Used only for escrow settlements. It is a set of instructions signed by the buyer and seller in advance of settlement stating the conditions of escrow, the responsibilities of the escrow agent and the requirements to be met for the release of escrowed funds and documents.

Bill of sale

-- Describes the physical assets being transferred and identifies the amount of consideration paid for those assets.

Promissory note

-- Used only in an installment sale, this note shows the principal amount and terms of repayment of the buyer's debt. It specifies remedies for the seller in the event of default by the buyer. It is signed by the buyer, and the buyer often must personally guarantee the debt.

Security agreement

-- Creates the security interest in the assets pledged by the buyer to secure the promissory note and underlying debt. It also states the terms under which the buyer agrees to use those assets that constitute collateral. It is used only in an installment sale.

Financing statement

-- Creates a public record of the security interest in the collateral and therefore notifies third parties that certain assets are encumbered by a lien to secure the existing debt. The cost to record the financing statement varies by jurisdiction. It is used only in installment sales.

Covenant not to compete

-- Protects the buyer and the buyer's investment from immediate competition by the seller in his or her market area for a limited time. The scope of this document must be reasonable in order for it to be legally enforceable. The covenant not to compete is sometimes included as a part of the purchase and sales agreement and is sometimes written as a separate document. It is not required in every transaction.

Employment agreement

-- Specifies the nature of services to be performed by the seller after the sale, the amount of compensation to the seller, the number of times per week or per month the services are to be performed, the duration of the agreement and often a method for discontinuing the agreement before its completion. Employment agreements are not required in all transactions, but they are used with great frequency. It is not uncommon that the seller remain involved with the company for periods of as little as a week or as much as several years. The length of time depends on the complexity of the company, the depth of management and the experience of the buyer.

Contingent Liabilities

Contingent liabilities must be taken into account and provided for when a company is sold. They most often occur because of pending tax payments, unresolved lawsuits or anticipated but uncertain costs of meeting regulatory requirements. Contingent liabilities can be handled by escrowing a portion of the funds earmarked for disbursement to the seller. The sum escrowed can be used to pay the liability as it comes due and any remaining money can be disbursed to the seller.