Global mergers and acquisitions in 2021 reached new heights. In fact, the number of deals announced publicly numbered 62,000, representing a 24% increase from the previous year. Cheap credit, high corporate profits, elevated share prices, and private equity cash were just a few of the contributors to the increase in merger and acquisition activity at the tail-end of the pandemic. And we are not done yet.
With the surge in deal-making expected to grow again this year, it is crucial for business owners to understand the most common deal structures to better understand what to expect when looking to sell a company and how to better achieve scale and growth when looking to acquire a company.
But what does “deal structure” really mean? In short, it is the term used to describe the ultimate agreement between a seller and a buyer for how a given business will be transferred. Additionally, the deal structure, and the terms therein, will also outline the specific conditions each party to the agreement must adhere to, which helps ensure a smooth transfer of business ownership.
Types of Deal Structures
Below you will find the information on the most common deal structures. And while there is no “right” structure, per se, it is important that you consult with your attorney, financial advisor, and/or accountant to determine which structure best aligns with your goals.1. Entity Transfer (Stock or Membership Interest Sale)
When a buyer intends to take over the company “turn-key” or has another reason to keep the entity itself in operation, then the transfer of stock (S-Corp or C-Corp) or Membership Interest (Limited Liability Company) is most common. This structure allows the new owner to “step into the shoes” of the exiting owner with, in many cases, minimal disruption to business operations. Unlike with an asset sale discussed below, all contracts remain at the entity level and with only certain exceptions will not need to be re-negotiated or re-assigned.
For example, it is common for real estate leases to have an assignment provision covering the change of ownership of a business, whereas employment agreements remain unimpacted as the employer is the company itself (not the exiting owner). In short, an entity transfer is minimally disruptive to a company’s daily operations. However, the most common objection to an entity transfer is fear of the unknown. Meaning, past liability coming back to roost in the future. While this fear is not without merit, clear and effective drafting of legal documents to account for future “issues” through funds held in escrow, for instance, can significantly mitigate risk and, in doing so, make this structure attractive.
2. Asset Purchase
Unlike the above structure, with an asset purchase, the buyer is acquiring only the assets of the company. All liabilities, including contracts, remain at the company level and only those transferred to the buyer’s new company will be assumed. For example, if a buyer wishes to remain in the same physical location, then a new lease would need to be entered into with the property owner (or assignment of lease depending upon the specific language of the lease itself). Additionally, all employees of the company would need to be hired by the new owner’s company and their employment with the selling company terminated. The purchase of assets is attractive to a buyer who already has a going concern and does not want to inherit any of the risk of the former owner’s business. At the same time, an asset purchase can be more administratively complex.
What are the steps in putting a deal together?
Though each deal structure is different, here are the main steps involved in most transactions:
- Develop a strategy. This step allows you to consider why you want to consolidate your company with another.
- Develop a search criteria detailing the company with which you are willing to join.
- Develop a list of the companies that meet your search criteria.
- Contact your target companies through an intermediary (or personally) to assess the owners’ willingness to sell their companies or join with yours.
- Perform an analysis of the operational and financial specifics of the companies that are willing to consolidate with yours.
- Negotiate the terms of your deal with the seller.
- Write a letter of intent outlining your deal’s terms and conditions, including the payment.
- Conduct due diligence with the company you want to acquire or merge with. This is an audit of the operations, taxes, legal structure, finances, and human capital, among other critical elements in your target company.
- Put together an informed purchase and sales contract based on the data you get during due diligence.
- Plan for the transition.
- Integrate with the target company.
Who Are the Stakeholders in a Deal Structure?
When thinking of a deal structure, it is prudent to know the stakeholders involved in the process and their responsibilities. Here are the main stakeholders:
- The buyer is the one who wants to acquire another company. He/she will want to pay as little as possible for the deal and get as much value as possible. The buyer’s primary responsibility is identifying attractive targets and ensuring he/she gets them at the best possible terms.
- The seller is a general term for the stakeholders who control the assets in a target company. A seller aims to maximize the value of a transaction and transfer ownership to the buyer after an agreement.
- Advisors and intermediaries include strategic consultants, lawyers, financial advisors, and bankers who seek to close a deal in their client’s best interests.
- Governments and regulatory bodies protect the public’s interests in a deal.
In summary, the deal structure provides a clear outline of terms that help enhance a smooth and efficient transfer of business ownership. Be careful when conducting your due diligence to ensure the deal works in your favor.
At Private Practice Transitions, we can assist you with the deal structure and all aspects of the purchase or sale. We are business brokers with the expertise, tools, and services to help you transfer your business ownership. Please contact us with queries about our services.