Mergers and acquisitions, a primer

When businesses or professionals talk about engaging in mergers or acquisitions (M&A), what exactly might that entail?

In a general sense, M&A is a broad term to describe the various transactions available to gain control of, or consolidate, companies.

An acquisition is the scenario where a buyer seeks to purchase or acquire the ownership of a business or a piece of a business. A merger might be a structure for two businesses to come together, or it might be just a “merger” in name, but practically an acquisition strategy without the long-term goal of the company owners working together.

This column provides a primer to better understand the terminology and the options.

The purchase of an entire business is accomplished one of two ways. First, it can be a purchase of the assets of the business. So, if William wants to buy a sign company under an asset-purchase acquisition strategy, William would enter into an agreement to buy each and every asset of the sign company.

This would of course include the equipment and vehicles and the inventory. It also would include less visible assets of the sign company such as customer lists, the phone number, website and the company’s name. After concluding the purchase, William would own the entirety of the company.

The second way to accomplish the acquisition of an entire business is to purchase each and every evidence of ownership (i.e., stock or LLC interests). For simplicity, the second way is generally understood as a stock purchase.

Continuing the example above, William could instead enter into an agreement with the owner to buy all his or her stock to William. This would automatically transfer the sole ownership of the company to William along with all of the assets owned by the company — to include all the assets outlined above.

William may wish to buy only a portion of the business as well. For example, he might buy only the banner graphics portion of the business. This would likely be structured as an asset purchase usually combined with the seller’s promise to not compete.

Let’s fast forward and assume William purchased the company 10 years ago.

In those 10 years, William has turned the sign company into a highly successful company where the annual revenue has soared from $200K a year to over $2 million a year.

A national branding company (XYX Inc.) that is publicly traded wants to acquire William’s sign business.

William is intrigued by the offer to sell but is concerned about the tax associated with the sale. After all, William has grown the company so much that the tax hit could be huge.

A potential solution would be for XYZ to “purchase” William’s shares with its own stock rather than cash. This is a stock-for-stock transaction that would be a type of merger that could qualify as tax-exempt.

After the transaction, William would not own the sign company stock, but would own XYZ stock valued at the sale price of the business.

Then, William can choose when to sell the stock on a stock exchange allowing him to choose when he must pay tax (tax would presumably be imposed at the time William sold his shares in the national branding company).

And, if William is worried about the potential fluctuation in the price of XYZ shares, he can work with his financial advisor to implement a collar strategy to effectively mute the volatility of a position. 

What if instead, another local sign company approached William seeking to combine their businesses with the hope that the resulting company would be more profitable by leveraging each other’s talent and infrastructure while reducing redundant operating costs?

William could structure it the same as discussed in the preceding paragraph, but the eventual sale of William’s stock would be much more complicated without a publicly-traded option.

Accordingly, William might rightly demand some amount of cash up front and the rest paid in stock of the resulting corporation. This transaction might also qualify for a portion of the purchase to be tax-free (perhaps tax-delayed is better terminology as the tax is due at the sale of the stock).

There are specific rules that govern the amount of cash that William can receive and still qualify for this type of preferential tax treatment.

In either of the previous two examples, the deal could be structured so that William is involved (which might then look more like a merger) of so that William is no longer involved (which might then look more like an acquisition even though termed a “merger”).

These transactions can be very sophisticated with various tax and legal ramifications. Of course, anyone attempting to engage in these transactions should work with competent counsel. For those who merely have a passing interest, this column should suffice.

Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.

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