Letter of Intent: Structure – Asset vs. Stock
While price is usually first issue on every seller’s mind, structure should be second. While there only two types of deals (asset deal vs. stock deal), there are numerous structural issues surrounding each deal. Rather than trying to address all the different issues, Jason and I decided to start by discussing the basics of an asset deal and a stock deal.
In general, all sellers want to do stock deals and all buyers want to do asset deals. Just to increase the confusion level, a stock deal can be done for cash and an asset deal can be done for stock – don’t confuse the type of deal with the actual consideration received (if you start getting confused, simply think of an asset deal as a “artichoke deal” and a stock deal as a “strawberry deal.”)
Sarcastic venture capitalists on the seller side will refer to an artichoke deal as a situation “when buying a company is not really buying a company” (kind of like eating the artichoke leaves but leaving the artichoke heart untouched.) Buyers will request this structure, with the idea that they will only buy the particular assets that they want out of a company, leave certain liabilities (read: “warts”) behind, and live happily ever after. If you engage lawyers and accountants in this discussion, they’ll ramble on about something regarding taxes, accounting, and liabilities, but our experience is that most of time the acquirer is just looking to buy the crown jewels, explicitly limit their liabilities, and craft a simpler deal for themselves at the expense of the seller. We notice that asset deals are more popular in shaky economic times, as acquirers are trying to avoid creditor issues and successor liability. One saw very few asset deals (in proportion) in the late 1990’s, but in early 2000 artichokes became much more popular and there is still a significant hang over today.
While asset deals are “ok” for a seller, the fundamental problem for the seller is that the “company” hasn’t actually been sold! The assets have left the company (and are now owned by the buyer), but there is still a shell corporation with contracts, liabilities, potentially employees, and tax forms to file. Even if the company is relatively clean from a corporate hygiene perspective, it may take several years (depending on tax, capital structure and jurisdictional concerns) to wind down the company. During this time, the officers and directors of the company are still on the hook and the company presumably has few assets to operate the business (since they were sold to the buyer).
In the case of a strawberry deal, the acquirer is buying the entire company. Once the acquisition is closed, the seller’s company disappears into the corporate structure of the buyer and there is nothing left (except possibly some t-shirts that found their way into the hands of spouses and the company sign that used to be on the door (oops – did I say that?) just before the deal closed.) There is nothing to wind down and the historical company is well – history.
So is an asset deal “bad” or is it just a “hassle”? It depends. It can be really bad if the seller has multiple subsidiaries, numerous contracts, employees with severance commitments, disgruntled shareholders, or is close to insolvent. In this case, the officers and directors may be taking on fraudulent conveyance liability by consummating an asset deal. It’s merely a hassle if the company is in relatively good shape, is very small, or has few shareholders to consider. Of course, if any of these things are true, then the obvious rhetorical question is “why doesn’t the acquirer just buy the whole company via a stock deal?”
In our experience, we see stock deals the vast majority of the time. Often the first draft of the LOI is an asset deal, but as sellers that is the first point we raise and we are generally successful ending up with strawberries except in extreme circumstances whereby the company is in dire straits. Many buyers go down a path to discuss all the protection they get from an asset deal – this is generally nonsense as a stock deal can be configured to provide functionally equivalent protection for the buyer with a lot less hassle for the seller. In addition, asset deals are no longer the protection they used to be with regards to successor liability in a transaction – courts are much more eager to find that a company who purchase substantial assets of another company to be a “successor in interest” with respect to liabilities of the seller.
The structure of the deal is also tied closely to the tax issues surrounding a deal and – once you start trying to optimize for structure and tax – you end up defining the type of consideration (stock or cash) the seller can receive. It can get complicated very quickly and pretty soon you can feel like you are climbing up a staircase in an Escher drawing (or running the Manhattan part of the New York Marathon – each time you turn you expect to get to go downhill and see the end, but instead you continue to wind uphill forever – even when you’ve turned 180 degrees and are running the other direction.) We’ll dig into tax and consideration is other posts – just realize that they are all linked together and usually ultimately impact price which is – after all – what the seller usually cares most about.