The parties to M&A transactions often waver over what the purchasers will be acquiring in the transaction: will they acquire the stocks of the company they are purchasing and thus preserve the separate legal structure of the acquired company or will they purchase only the business operations and the assets of the acquired company ("Operations Acquisition") for the purpose of merging them into the purchasing company? Each party may have a different point of view regarding this issue, depending on the individual considerations of each of the parties to the transaction, as discussed below.
The Purchasers' Considerations
- Purchasing the stocks of the acquired company constitutes the acquisition of that company, lock, stock, and barrel, and includes the risk of the future undertakings and exposures of the acquired company, including exposures to lawsuits against the company, debts owed to the tax authorities, and so forth, which may have not been known to the parties at the time the agreement was signed. It may not always be easy in the future, to enforce sellers' indemnification undertakings with respect to such exposures. On the other hand, Operations Acquisition enables the purchasers to obtain only those specific assets in which they are interested and to have a fresh start regarding their business, without serious concerns about overexposure and risk stemming from past operations of the company, which was managed by others.
- In an Operations Acquisition, the employees of a company whose operations are acquired will terminate their employment at the company before the deal goes into effect and are entitled to receive their full rights with respect to such termination of their employment. The advantage for the acquiring company, however, is that it can employ those former employees as it chooses and in that way, it will not be exposed vis-?-vis the employees for the period of their employment prior to the transaction. This stands in contrast to a stock purchase deal in which the employees of the acquired company maintain the continuity of their rights from the date of the start of their employment at the company.
- In many cases, Operations Acquisition necessitates obtaining consent from third parties and permits from entities and authorities, as it involves a purchaser, which is a different legal entity from the selling company. On the other hand, in a stock purchase transaction, the only change is in the identity of the shareholders, which does not necessarily require the consent of third parties.
- From the taxation standpoint, the Operations Acquisition usually includes the acquisition of the goodwill, on which the Israeli tax laws allow amortization during a 10-year period. Additionally, in the case of the acquisition of assets that are included in the operations, the cost of the assets will be taken into account for depreciation purposes (with regard to depreciable assets) and for the purpose of capital gains tax at the time of future sale. That is not the case when acquiring stock, since the cost of the stock acquisition cannot be amortized under the Israeli tax laws. Such costs, however, can be taken into account for capital gains tax purposes in the future, when the stock is sold.
Nevertheless, one advantage when stock is acquired, of a company with business losses, is that the future operations profits of the acquired company can be offset against the past losses of the acquired company.
The Seller's Considerations
- The sale of stock obligates the sellers (the shareholders), to pay real capital gains tax on the sale at a rate of 25% for a company and for a "substantial shareholder" (with 10% or more of the control of the company). Alternatively, at a reduced rate of 20% for an individual who is not a "substantial shareholder" (less than 10% control of the company).
Additionally, in a stock purchase transaction, the calculation of the tax applying to the sale will be affected by the cost of the stock purchase and by the distributable profits accrued by the company.
However, when the operations are sold, the sellers' tax burden will, in many cases, be heavier. The proceeds received from the purchaser for the sale of the operations will be paid to the company selling the operations. Any asset sold as part of the sale of the operations will be subject to the specific tax that applies to it. For example, the real estate that is sold will be subject to property betterment tax and sales tax; the equipment that is sold will be subject to capital gains tax, and the inventory will be subject to income tax, and so on. - Moreover, in an Operations Acquisition, the transfer of proceeds from the company to the shareholders, if they are individuals, will be subject to additional tax for the dividend (currently 25%, if it involves a "substantial shareholder" and 20% if it involves a "non-substantial shareholder").
- An agreement to sell the operations actually requires the dismissal of all employees by the selling company and completion of all the severance pay and other amounts owing to them due to the termination of their employment by the company. These amounts are usually paid to the seller's account. In contrast, a stock sale transaction does not necessarily lead to the dismissal of the employees, and hence, in many cases, it means a reduction or postponement of the sellers' liability with regard to the monies due to the employees.
- The sale of all the company's operations requires a decision by the qualified organ of the company and does not necessarily require the consent of all the shareholders (unless established otherwise in the company's articles or in the shareholders' agreement). On the other hand, the sale of all the company's stock requires the consent of all the shareholders (subject to the right of shareholders who hold at least 80% of the company stock to force a sale to a third party on the objecting shareholders). From this standpoint, it is easier to sell operations.
In Summary
In many cases of acquisitions or mergers, each of the parties to the transaction will have different considerations when discussing the manner of implementing the transaction. From the sellers' standpoint, the tax consideration is usually the main consideration, since the sellers want, first and foremost, to maximize the net proceeds they will receive. On the other hand, from the purchasers' standpoint, the tax issue is important, but it is not their main consideration. From the purchasers' standpoint, the most important consideration is to minimize their exposure to past obligations and future claims against the company.
Therefore, in the absence of unique taxation considerations (such as the option of setting off losses), purchasers will be inclined to acquire only the operations and not the company stock that is up for sale, which will increase the tax burden on the sellers.
The way to bridge the gap between these opposites in such cases is either by adapting the price to increase the net amount that will remain in the hands of the sellers in the case of the sale of the operations, or, alternatively, by reducing the risks in cases of stock acquisition, while providing solid indemnification undertakings on the part of the sellers, i.e., the shareholders.
*Advocate Moshe Kahn from Tel Aviv, Israel, specializes in the field of business law. He is licensed to practice law both in Israel and in the U.S.
