How to Acquire a U.S. Business

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Acquiring an existing US company is an advantageous method of entering the US market for many foreign and domestic businesses. The three most commonly used acquisition vehicles of US businesses are: 1) stock purchase; 2) asset purchase; and 3) statutory merger. This blog post outlines these types of transactions and basic tax consequences.

TRANSACTION TYPES

1. Stock Purchase. An existing company corporation can be acquired via a purchase of the company’s stock (shares in case the company is a corporation, or membership interest, in the case of an LLC).  The advantage of a stock purchase is that all of the assets of the target will be acquired, even if they are not all clearly identified. A major disadvantage to the buyer is that it may be assuming unwanted or unknown liabilities incurred by the previous owner.

A direct purchase of stock of the target will not require a formal vote of the target’s stockholders, but may not result in the acquisition of sufficient target stock to successfully complete the transaction. Target’s organizational documents (Certificate of incorporation, Bylaws, Shareholder Agr., Operationg Agr., etc.) must be examined carefully. These documents may provide for rights of first refusal, drag-along, tag-along right and other provisions that may limit acquirer’s ability to buy all (or any) stock in the target. Sometimes the aforementioned documents state that if any shareholder is offering its share for sale to a third party, then that shareholder must first offer its stock to other stockholders on the same terms as they are offered to the acquirer. Tag-along (“co-sale rights”).mean that if the acquirer is making an offer for any shareholder’s shares, target’s minority shareholders can insist that the acquirer purchases minority shares on the same terms.

2. Asset Purchase.  In this transaction, the buyer is buying only the assets of the target company, but not its shares. Advantages to buyer are:

a) The liabilities of the target company are not transferred in the transaction. The buyer only purchases assets. Avoiding liabilities is particularly crucial where there may be unknown liabilities or liabilities that could arise later because of the previous owner’s mistakes.

b) The buyer can pick and choose which assets it wants to buy while leaving the unneeded assets with the previous owner.

Buyer must be aware that governmental permits and any contracts with prohibitions on assignment will require the parties to obtain new permits and consents to assignments before the buyer can continue the target’s business as before. Buyer shall attempt to get consents prior to closing, although governmental permits sometimes cannot be obtained until after closing.

3. Statutory Merger is when two companies combine together and one of the companies survives while the other disappears. To accomplish statutory merger, the buyer can form a US company for the purpose of the transaction and merge it with the target company. Only one entity survives in this transaction. The surviving entity assumes all the assets, liabilities and contracts of the disappearing entity.

State law governs statutory mergers. Companies of different types can normally merge (e.g. LLC can merge with a corporation). A “simple” merger is when the acquired company merges with the acquiring company, normally target company’s shareholders receive stock of the acquiring company, cash or a combination of both. A “triangular” merger is when the acquiring company forms a subsidiary for the purposes of the transaction and the acquired company is merged with the subsidiary rather than into the acquiring company.  When the target merges into the acquirer or into its subsidiary, the merger is called a “forward” merger. A “reverse” merger is when the acquiring company merge into the target.

A merger will normally require the approval of the target’s shareholders/members. Such approval can normally be obtained by a majority vote of the target’s shareholders, unless a higher percentage vote is required by the target’s bylaws, Operating Agreement or Certificate of Incorporation/Formation. A triangular merger may be accomplished without a vote by the acquirer’s shareholders unless the transaction is sufficiently material that organizational documents or the necessity to authorize additional securities to be issued in the transaction mandate such a vote.

The advantage of a merger is that all of the assets of the target will be acquired, even if they are not all clearly identified. In a reverse merger, since there is no change in the assets or liabilities of the acquired company, in most cases its permits and contracts will not be affected, unless there is a “change of control” prohibition present.

Major disadvantage to the buyer here is the same as in the stock purchase transaction: the buyer may be assuming undisclosed or unknown liabilities of the old company.

TAX CONSEQUENCES

Section 368 of the Internal Revenue Code allows entities taxed as corporations to complete a transaction without an immediate recognition of gain or loss by equity holders in certain instances where there is a continuation of an equity interest in the resulting entity. This is called “tax-free reorganizations.” These transactions defer tax on any gain at the time of the transaction, typically allowing capital gains treatment of tax on the gain when the equity is ultimately sold. If the equity holders receive cash, or if the transaction fails to meet the specific requirements for tax-deferred treatment, tax on any gain to the date of closing may be due.
Section 368 does not apply to entities taxed as partnerships (as is the case in most LLCs and limited partnerships). Transactions involving entities taxed as partnerships may have taxable consequences.The tax impact will in large part depend on the tax basis of the target’s stockholders’. In the case of limited liability companies or partnerships, a transaction may also result in the recapture of losses previously recognized for tax purposes by the target’s stockholders.

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