UNDERSTANDING TRANSACTION STRUCTURES IN M&A

In its most fundamental form, one can generally describe Mergers and Acquisitions(M&A) transactions as transactions that involve the purchase (acquisition) and sale/disposition (divestment) of a part or whole of a business. Acquisitions and divestments are basically two sides of a coin, in a relevant transaction, while one party acquires the whole or part of a target, the counterparty divests from the same target. The motivations that drive such decisions, whether strategic or financial, will be explored further in this article. But at the heart of every acquisition or divestiture lies the fiduciary duty of a company's board and management to act in the best interest of shareholders, with the overarching aim being the maximization of shareholder value. Irrespective of the reasoning behind these transactions, the choice of deal structure primarily boils down to two avenues: either a share deal or an asset deal. All other technical and fanciful terms like merger, takeover etc are, in essence, variations that build upon these core structures. In this article, we deep dive into the rationale for M & A transactions, the potential transaction structures, and key considerations for structuring them effectively.

Common Rationale for Divestments & Acquisition.

In M&A transactions, business acquirers generally fall into two primary categories: strategic acquirers and financial acquirers, each driven by distinct motivations and value propositions. Strategic acquirers pursue acquisitions with the intent to achieve specific, long-term business objectives that align closely with their operational and market goals. For these acquirers, the value of a transaction extends beyond the immediate financial return, often focusing on creating synergy, enhancing capabilities, or strengthening competitive positioning. Financial acquirers, however, focus on investment returns, treating acquisitions as assets to manage, optimize, and eventually exit profitably. Private equity firms, hedge funds, and family offices typify this group, targeting businesses with steady cash flows, growth potential, or undervalued assets. Their approach centers on capital appreciation, often with defined exit strategies, such as resale or IPOs.

A similar distinction applies to divestors. Strategic divestors aim to refocus on core activities or enhance operational efficiency, divesting units that no longer align with their primary goals. For example, a tech company might divest a manufacturing arm to sharpen its focus on software innovation. Financial divestors, on the other hand, seek liquidity or balance sheet optimization, divesting underperforming or non-core assets to boost profitability or financial flexibility. The following are some common strategic & financial rationale of acquisition/divestment:

1.???? Synergy Realization: A primary driver of acquisitions is the strategic pursuit of synergies. Through operational integration, companies streamline processes, reduce redundancies, and create more efficient structures, often unlocking significant cost savings. These synergies may be operational, such as through facility consolidation or function elimination, or financial, like enhanced access to capital markets. This integration supports the rationale behind many mergers, where the value of the combined entity exceeds the sum of its parts. Likewise, divestments can release latent value in business units that could achieve better performance independently.

2.???? Accelerated Growth and Market Positioning: Acquisitions enable swift expansion, particularly where organic growth is limited. By acquiring a competitor or complementary entity, companies can rapidly increase market share, solidify industry standing, and mitigate competitive threats. This approach allows immediate access to broader customer bases, new product lines, or expanded geographic reach. Conversely, divestments can enhance growth strategies by reallocating resources from non-core assets to focus on high-growth or profitable areas.

3.???? Strategic Diversification: Companies often pursue acquisitions to diversify, spreading risk by entering new markets, industries, or product lines. This approach reduces reliance on single revenue sources or geographic regions, buffering against market volatility. Conversely, divestitures can streamline operations, focusing on core strengths by shedding non-core or underperforming segments, thereby enhancing operational efficiency and long-term profitability.

4.???? Liquidity Optimization: For companies facing liquidity constraints, divestitures offer a vital means to generate capital by selling non-strategic or underperforming assets, which can then be used to reduce debt, strengthen balance sheets, or fund core operations. In acquisitions, financially robust companies may capitalize on liquidity challenges in other businesses, acquiring undervalued assets at favorable terms.

5.???? Operational Optimization and Strategic Realignment: Companies aiming for operational excellence may divest segments that no longer align with their strategic objectives or are underperforming. This refocuses resources on higher-margin, profitable areas. Acquisitions, on the other hand, may enable a company to acquire new capabilities, technology, or talent that enhance efficiency and competitiveness.

6.???? Regulatory Compliance and Strategic Positioning: Regulatory environments can drive acquisitions or divestments, especially in heavily regulated industries. Regulatory bodies may mandate divestitures to ensure fair competition or approve acquisitions that help companies meet specific market participation requirements. Companies may also acquire to achieve compliance-related scale or meet industry standards.

7.???? Market Entry Strategy: Acquisitions serve as a strategic pathway for entering new geographic markets or sectors, providing immediate access to established customer bases, distribution networks, and local expertise. This approach mitigates entry risks and costs. Similarly, divestments in less advantageous markets can free capital for reinvestment in more favorable regions or sectors, optimizing the company's strategic portfolio.?

Share Deal Transaction Structure

The shares of a company fundamentally constitute the company by embodying its financial, legal, and operational identity within a defined legal structure. Shares embody the capital structure of the company, dividing the business's value into marketable units that can be transferred or acquired. The valuation of these shares reflects the company’s financial standing, assets, liabilities, and future earning potential, thereby encapsulating the business’s worth as determined by market forces or valuation models. Each share is a fractional stake, conferring specific rights and entitlements as stipulated in the company’s governing documents, such as the Articles of Association or Shareholders’ Agreement. Collectively, these shares constitute the entire ownership interest in the company. When someone holds a company’s shares, they effectively own a portion of the company’s assets, liabilities, and the profits (or losses) generated through its operations. This makes shares the most direct way to acquire a company’s cumulative economic value in a single transaction.

In a share deal, the buyer acquires equity ownership by purchasing shares, effectively assuming control of the entire legal entity, including assets, liabilities, rights, and obligations. This approach circumvents the complexities of individually transferring assets and liabilities, which could require third-party renegotiations and regulatory approvals. By obtaining shares, the buyer ensures continuity of the company’s operations, brand, contracts, and relationships without disrupting ongoing business—a seamless transition that maintains the company’s identity. However, this also means inheriting the target’s liabilities, known or unknown, such as debts, lawsuits, or environmental risks. Also, Compared to asset deals, share deals tend to involve simpler and faster negotiation processes. The buyer and seller primarily negotiate over the shares themselves, with fewer complexities related to the transfer of individual assets. This streamlining of negotiations can result in lower transaction costs and a shorter timeline to close the deal, making it an attractive option for parties seeking a faster process.

The Share Purchase Agreement (SPA) serves as the definitive legal document in share transactions, defining the terms and conditions of the share acquisition. This agreement is crucial as it formalizes the buyer's acquisition of the seller’s shares, transferring ownership of the company’s financial, legal, and operational identity. Through the SPA, the buyer acquires equity ownership by purchasing shares, effectively assuming control of the entire legal entity, including its assets, liabilities, rights, and obligations. The SPA delineates the responsibilities of both parties and includes provisions that safeguard against unforeseen liabilities, warranties, and indemnities, which are essential to mitigating risks associated with the transaction.

Ultimately, share deals are generally more favorable to the seller. By selling shares rather than individual assets, the seller effectively transfers all liabilities—both known and unknown—along with the business. This reduces the seller’s post-transaction exposure to liabilities related to the target business. The buyer, on the other hand, inherits all existing obligations, making due diligence a critical step to uncover any hidden risks.

Asset Deal Transaction Structure

An asset deal, on the other hand, involves the buyer purchasing specific assets from the target company. This can include real estate, intellectual property, inventory, equipment, and more, depending on what the buyer deems valuable. Unlike a share deal, the seller retains the company’s legal entity, along with any liabilities not explicitly transferred in the transaction. In an asset deal, the buyer has the advantage of cherry-picking which assets to acquire and which liabilities to avoid. This enables the buyer to exclude unwanted liabilities or risky aspects of the business, creating a cleaner slate moving forward. The ability to be selective makes asset deals particularly appealing to buyers looking to mitigate risk or focus only on high-value assets. However, this selective approach requires that each individual asset be identified and separately transferred, making the process more cumbersome.

Also, while asset deals offer buyers more control over what is acquired, they are often less tax-efficient, especially for the seller. In many cases, asset sales may trigger multiple layers of taxation—once at the corporate level when the assets are sold and again at the shareholder level when proceeds are distributed. This double taxation can make asset deals less attractive for sellers from a financial perspective. One of the significant downsides of an asset deal is the complexity of transferring ownership of each individual asset. The formalities associated with asset transfers, including securing third-party consents, registering ownership changes, and transferring title deeds, can significantly slow down the transaction. In certain industries, specific regulatory approvals or licenses may also need to be transferred, further complicating the process.

Another consideration is that asset deals often require third-party consents for the transfer of key contracts, licenses, or permits. Suppliers, landlords, and other stakeholders may have the right to approve or block the transfer of agreements, adding another layer of complexity to the transaction. Negotiating these consents can be time-consuming and might introduce unforeseen obstacles. While more cumbersome, asset deals are generally more favorable to buyers. By selecting only the assets they want and leaving behind unwanted liabilities, buyers reduce their exposure to potential risks associated with the business. However, the complexity of the process and the need for thorough due diligence make asset deals more resource-intensive from the buyer's perspective.

Ultimately the choice of structure depends on the parties’ objectives, risk appetite, tax considerations, and the nature of the target business. Where there is a conflict in the interests of the seller and buyer on deal structuring, the structure to be adopted will inevitably be a matter for negotiation and may depend upon the respective bargaining positions of the parties.

Acquisitions/Divestments: Structuring Considerations

In deciding whether to pursue a share deal or an asset deal in M&A transactions, both buyers and sellers must carefully evaluate a series of strategic, legal, and financial factors. These considerations directly affect the transaction's overall structure and are influenced by the overarching objectives of the acquisition or divestment.

1.???? Overarching Objectives of the Acquisition/Divestment: The primary objectives behind an acquisition or divestment play a critical role in determining the structure of the transaction. A company may pursue an acquisition to expand market share, gain strategic assets, enter new markets, or acquire specific intellectual property, while a divestment may be motivated by a desire to refocus core business activities, reduce debt, or exit underperforming business units. These objectives will influence whether an asset deal or share deal is more appropriate. For Acquisitions for example, if the buyer is primarily interested in the entire business (including its existing contracts, customer base, and operational setup), a share deal is often the preferred option. This allows the buyer to take control of the business without disturbing ongoing operations. Meanwhile, in a Divestments, if the seller wants to retain the legal entity but dispose of specific business units or assets, an asset deal may be more suitable. This allows the seller to offload underperforming segments while retaining control over the remaining business operations.

2.???? Liabilities Assumed: One of the most critical distinctions between share and asset deals is how liabilities are treated. In a Share Deal, the buyer assumes all liabilities of the target company, both known and unknown, since they are acquiring the legal entity itself. This includes financial obligations, outstanding litigation, and potential environmental liabilities. As a result, the buyer must conduct thorough due diligence to assess and mitigate any risk. Meanwhile in an asset deal,? the buyer can cherry-pick which assets to acquire and can leave behind unwanted liabilities. This is particularly beneficial if the target company has significant legacy issues, as the buyer can avoid taking on obligations such as debts, pending lawsuits, or problematic contracts.

3.???? Transaction Complexity, Ease, & Speed of Execution: The level of complexity and the ease of executing the transaction are important considerations. Share Deals are typically faster and less complex than asset deals because the buyer simply purchases the shares of the company, resulting in a seamless transfer of ownership. Contracts, licenses, and relationships with suppliers and customers remain intact, allowing the business to continue operating without interruption. The simplicity of a share deal often translates into reduced transaction costs and quicker completion timelines. Asset deals on the other hand tend to be more complex, as the buyer must identify and negotiate the transfer of individual assets. Each asset must be legally transferred, and this process may involve third-party consents and approvals. Additionally, contracts and licenses may not automatically transfer, necessitating renegotiation with counterparties. The cumulative effect of these processes makes asset deals more time-consuming and resource-intensive.

4.???? Employee Transfer and Retention:? Employment considerations are often central to the structuring decision in M&A transactions, particularly if retaining the workforce is critical to the success of the business. Where this is the case, share deals are more suitable than asset deal where employee transfer may not be automatic.

5.???? Complexity of Company’s Shareholding Structures: The complexity of the target company’s shareholding structure can heavily influence whether a share deal or an asset deal is preferable. In a Share Deal, if the target company has multiple shareholders or intricate shareholding arrangements (such as cross-holdings or shareholder agreements with restrictive provisions), executing a share deal may become legally and operationally challenging. The buyer may need to negotiate with several parties, obtain shareholder approvals, and navigate restrictions on share transfers. These hurdles can complicate the transaction and prolong the execution timeline. In asset deals, the complexity of the shareholding structure is not a factor. The seller can divest specific assets without the need for shareholder approval or renegotiating ownership rights, simplifying the transaction from a legal perspective.

6.???? Tax Considerations: Tax efficiency is a pivotal factor in determining the structure of an M&A transaction. The tax implications for both the buyer and the seller can vary significantly depending on the structure. In a Share Deal, the seller typically incurs capital gains tax on the sale of shares, which is often more tax-efficient than selling individual assets, especially in jurisdictions where favorable tax rates apply to share transactions. For asset deals, tax implications are more complex. The seller may face multiple layers of taxation—corporate tax on the sale of assets and further taxes when proceeds are distributed to shareholders. These tax burdens can reduce the net proceeds from the sale, making asset deals less attractive from a tax perspective.

7.???? Continuity of Contracts and Licenses: The ability to maintain continuity of existing contracts and licenses is often a key consideration in determining the structure of a transaction. In a Share Deal, all contracts and licenses automatically transfer to the buyer, as the legal entity itself remains unchanged. Unlike in an asset deal where Contracts and licenses generally do not transfer automatically. The buyer may need to renegotiate contracts with third parties, obtain approvals for the assignment of contracts, or reapply for regulatory licenses. This process can be time-consuming and may result in disruptions to the business if key contracts or licenses cannot be transferred or are subject to unfavorable renegotiation.

8.???? Regulatory and Third-Party Approvals: M&A transactions often require regulatory and third-party approvals, which can affect the transaction structure. In a Share Deal, regulatory authorities typically review the transfer of shares for compliance with competition law, anti-trust regulations, and other industry-specific rules. Depending on the jurisdiction and industry, obtaining regulatory approvals can delay the transaction. Additionally, the sale of shares may require shareholder or board approval under the company’s bylaws. In an asset deal, regulatory approval may be required for the transfer of certain assets, especially in regulated industries like Oil and Gas, Minning etc. Similarly, third-party consents from suppliers, customers, or landlords may be required to transfer key contracts or leases. The need for multiple approvals and consents can significantly slow down the transaction and increase the risk of failure if critical stakeholders withhold their consent.

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