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Mergers and Acquisitions: Asset Versus Stock Transactions and Which is Best for Your Business

Mergers and Acquisitions: Asset Versus Stock Transactions and Which is Best for Your Business

Author: Kirsten Soneson, Director, Corporate Banking

Like many things in 2020, merger and acquisition (M&A) activity has seen significant fluctuations. Despite the current economic uncertainty, more than half of M&A executives expect M&A activity to return to pre-COVID-19 levels in the next 12 months, according to Deloitte’s Future of M&A Trends Survey.

For some companies, the current economic climate may provide strategic M&A opportunities, as undercapitalized businesses in certain industries may not have been able to weather the COVID-19 storm as well. For example, now may be an ideal time to buy out a competitor and increase market share or acquire your main supplier to provide more control over your product’s quality and pricing. You may also be able to acquire assets at lower than market prices if the seller is in the process of bankruptcy or liquidation.

Asset Versus Stock Transactions

When it comes to M&A, an acquisition occurs when a company takes control of another by either purchasing its assets or the majority of its stock. Whether an asset or stock transaction makes the most sense for your business depends on a variety of factors.

With an asset transaction, the sale typically doesn’t include the purchase of the seller’s cash or assumption of its long-term debt. Asset acquisitions have several advantages that include tax savings, as a buyer can step-up the basis of many assets over their current tax values, leading to tax deductions for depreciation. If goodwill is obtained, it can be amortized on a 15-year straight-line basis for tax purposes. The buyer also can decide which assets it will not purchase and if any liabilities will be assumed in the transaction. With limited exposure to liabilities, less time and money is generally spent on the due diligence process. This type of transaction is generally preferred by the acquirer.  

Conversely, a stock transaction results in a transfer of ownership of the business entity from the seller to the buyer and the acquired entity continues to own the same assets and liabilities. Stock acquisitions have many advantages. This type of acquisition is typically less complex, and most contracts of the target automatically transfer to the purchaser. The purchaser does not have to spend time with costly re-valuations and retitles of individual assets and non-assignable licenses and permits can typically be assumed without having to obtain specific consent. However, the acquirer does not have the same tax advantages as with an asset sale. This type of transaction is generally preferred by the seller as the equity sold receives treatment as a capital gain, typically with a much lower tax rate than ordinary income tax rates. 

Often, small businesses and privately held companies use asset sales more frequently when selling their businesses as the value of the business’s stock is less discernible without a public market. Additionally, how the selling entity is structured determines if a certain type of acquisition is even possible. For example, a sole proprietorship, partnership or a limited liability company (LLC) are not entities with stock that can be transferred to someone else. Instead, owners of these entities can sell their partnership or membership interests. Owners of incorporated companies (C and S corporations) generally look to sell their company through a stock sale with the buyer assuming the full business. Speaking with your business’s financial advisor, accounting firm and legal counsel can aid in determining which type of acquisition makes the most sense based on the target’s legal structure and the acquirer’s goals. 

Six Primary Structure Types to Consider

The type of acquisition a company should consider depends on the management team’s overall strategy and future growth initiatives. Below are six primary M&A structure types that may be considered.

  1. Horizontal – two companies that directly compete with the same product offering in the same market.
  2. Vertical – two companies that are in complimentary businesses along the supply chain or product cycle.
  3. Congeneric – two companies that serve the same customer but with different products.
  4. Market-extension – two companies that sell the same product in different markets.
  5. Product-extension – two companies that sell different but related products in the same market.
  6. Conglomeration – two companies that do not have overlapping businesses.

Is Now the Right Time to Consider M&A?

There are many considerations to take into account before making a significant investment in another company or its assets. Some important questions to ask include:

  • Is the purchase price warranted for your company’s objective or are you overpaying for something you could build organically?
  • How will the transaction be financed and does your company’s current balance sheet support assuming additional debt?
  • Does cash flow from the acquired entity support the increase in debt on the combined business?

In addition to financial considerations, you should also contemplate the company’s culture, brand reputation, talent and operations. You can learn more about finding the right fit for an M&A opportunity in our previous blog post.

As 2020 comes to a close, it’s important to have a well-defined strategy to support expansion prior to an opportunity arising. This allows management to stay focused on growth goals and value creation rather than entertaining potential strategic opportunities that may not fit within your business plan.

According to McKinsey & Company, the strategic rationale for an acquisition that creates the most value typically conforms to one of six archetypes, which you can learn more about here. Whether the purpose is for accelerating market access or obtaining skills and technology which can’t be built internally, the more detailed and tangible the strategy, the more likely of successful integration and long-term value creation for shareholders. If you’re considering an M&A opportunity, contact an FNBO commercial relationship manager for information on acquisition financing.

 

About the Author

Kirsten is a Director of Corporate Banking for FNBO, providing lending, treasury, and financial advisory solutions for corporations. Kirsten’s engagement with clients is based upon one overarching goal: to prepare them to meet challenges ahead, so they are positioned to take advantage of opportunities and create an environment of growth.