Are you thinking of structuring your next deal as a stock purchase or an asset purchase? Why does it need to be either or? Occasionally deals are structured as both an asset purchase and a stock purchase — like Kennametal did on Monday with its acquisition of ATI’s Tungsten Materials Business.
Axial Member Leib Orlanski, of K&L Gates, recently completed a similar transactions for one of his clients. He explained, “Our tax department created a two-stage transaction. In the first stage, or the asset purchase, the assets of the company were transferred to a wholly owned subsidiary. Then, for the second stage, we bought 80% of the stock of the subsidiary. This two-part structure allowed for both an asset purchase and for the owner to retain 20%.”
A visual of the structure is included below:
1. Target forms wholly owned subsidiary and transfers its assets to its subsidiary pursuant to an asset contribution agreement in return for 100% of the stock of the subsidiary.
Ensuring that you remain in legal territory and avoid piercing the corporate veil is critical to this step of the transaction. Orlanski explained, “as long as (a) the subsidiary is adequately capitalized for the business in which it is engaged or proposed to be engaged (b) maintains good corporate records. Minute book,etc, (c) does not commingle accounts with target and deals with target on arm’s length basis (d) does not engage in fraudulent activities, then there is no pass through of liabilities or piercing the corporate veil.”
2. Buyer purchases from target 80% of the stock in the subsidiary pursuant to a stock purchase agreement.
Orlanski explained that the joint stock-asset purchase was created in an effort to accommodate the interests of both the buyer and seller. A purchase of either stocks or assets usually leaves one of the involved parties with a slight disadvantage.
Most buyers prefer asset purchase for tax reasons. “If the deal is structured as an asset purchase, the firm can write up the assets for depreciation purposes. Although some assets may have been written off by the seller — and no longer have tax shelter from them — the buyer can create new basis for depreciation based on purchase price allocated to the assets.”
To further weigh the scales in favor of an asset purchase, a stock purchase can also add additional risk to the deal. Orlanski explained, “In a traditional stock purchase, the acquiring PE firm assumes all liabilities associated with the company — even those they didn’t know about. Buyers tend to prefer an asset deal where they can clearly specify which liabilities they are assuming.” While these extra risks can be accommodated in the final deal paperwork, it can add unwanted details and burdens.
However, a stock purchase is not all downside for the buyer. “In many cases, a PE company doesn’t have a management team to step in and they will rely on the owner that is selling to stay onboard. In these cases, the owner should have a stake in the company. Retaining some ownership will keep the owner invested in the company and incentivized,” explained Orlanski. In addition to making the mechanics of the deal simpler, a stock purchase can eliminate the proceedings required to transfer permits, leases, utilities, etc. As a result, most buyers are fairly compliant on the transaction structure — “Often deal professionals would prefer to have an asset deal than no deal.”
Despite the trade offs, few deal professional opt for a joint stock-asset purchase. “Some deal professionals feel they can deal with unknown liabilities via the seller indemnification in the stock purchase agreement; others are not concerned with a step up in basis for tax purposes because in some cases that can be achieved via a special tax election; others feel it’s too complex to structure the transaction as a two step asset drop down to a subsidiary followed by a stock purchase,” explained Orlanski. “However, I think the main reason it is not common is that, in most cases, the buyer is seeking 100% of the target and this technique is primarily suited where a buyer is seeking less than 100%.”