Asset vs. Equity Deals: Why it Matters
Mergers and acquisitions (M&A) are a big part of the inorganic growth strategy for companies looking to expand, streamline operations, or gain a competitive advantage. While there is a plethora of intricacies involved in coming to a final agreement, one of the fundamental characteristics of any M&A deal is the decision between an asset or equity deal. For both buyers, and sellers alike, it is important to understand the difference between these two approaches. So, for this month’s blog, we will examine the nuances of both asset and equity deals, explaining why these differences matter.
Asset Deals: A Granular Approach
In an asset deal, the buyer purchases specific assets and liabilities of the target company, rather than its stock. This approach provides the buyer with greater flexibility and control. Looking into the key features of asset deals can provide additional context.
1. Selective Acquisition: In an asset deal, buyers can hand-pick the assets and liabilities they wish to acquire. This can be beneficial for the buyer, especially in cases where the target company has certain assets that are more valuable or strategic than others, or if there are liabilities the buyer is looking to avoid that can be advantageous in mitigating risk.
2. Liability Mitigation: Since the equity of the company is not being purchased, potential hidden liabilities (e.g., lawsuits, patent infringement claims, etc.) would not carry over to the buyer, limiting their risk. This something that is very valuable to buyers, especially if they are buying an older company with a lot of history.
3. Tax Implications: Upon completion of an asset deal, the buyer can depreciate the goodwill portion of the purchase price, potentially resulting in significant tax benefits. However, this can also lead to higher taxes on the seller, who often has to pay regular income tax rates, rather than capital gains tax, on the transaction proceeds. As a result, sellers may negotiate for an increase to the purchase price to offset the amount of any additional tax liabilities incurred by an asset sale.
Equity Deals: A Comprehensive Approach
In an equity deal, the buyer is purchasing the stock or equity of the target company, and effectively acquiring the entire entity in the process, including all its assets and liabilities that come with it. The key features of equity deals can outline the core characteristics that distinguish them from asset deals.
1. Liability Carryover: As mentioned above, an equity deal implies that the buyer is acquiring the target company as a whole. This comes with a different risk profile for the buyer, due to all the unknown liabilities that could potentially come with the equity (e.g., unpaid taxes, unknown lawsuits, etc.). This often requires extensive legal, financial, tax and HR due diligence in order to uncover any potential areas of risk.
2. Tax Implications: Equity deals can be more tax-efficient for the seller, as the proceeds from the sale of stock are typically taxed at capital gains rates. For buyers, there is less favorable tax treatment, as they are unable to have an immediate step-up in the tax-basis of the assets and depreciate the goodwill.
3. Continuity: At the conclusion of an equity deal, the target company continues to operate as it did before, which can be important for maintaining relationships with customers, suppliers, and employees.
An Impactful Distinction
From the points mentioned above, there are distinct advantages and disadvantages to each strategy. In the case of an asset deal, the selectiveness, and tax implications are generally enjoyed by the buyer. Compared to equity deals, where the tax implications liability carryover lend itself to favour the seller.
Conclusion
The finalized structure of any M&A deal will ultimately come down to the negotiation period, and arriving at terms that are acceptable for both parties. But, having a foundational understanding of the differences between asset and equity deals can be very useful before undergoing any M&A process. Additionally, consulting with experienced M&A advisors that have dealt with varying deal structures and are comfortable working on both asset and equity deals can ensure that you are well positioned to realize a successful M&A transaction.