One method of acquiring a company is through buying the stock of the shareholders. Naturally, this requires the approval of the shareholders. If a company is managed by officers and directors who are not shareholders, then a buyer can obtain control of as company through buying the stock directly from the shareholders, even if management is against the sale. Normally, this will not be the case in the purchase of a privately held corporation, where the deal is normally negotiated by the principals.
If the deal is a stock for stock or cash for stock deal, then after the agreement has been negotiated with management, the board of directors must approve it, followed by shareholder approval. Normally this is not a problem for most privately held companies because the shareholders serve as officers and directors. If there are a number of shareholders who are not officers and directors, then management of the selling corporation must prepare and mail a copy of the agreement and a notice of the shareholder meeting to approve the deal. Absent a higher requirement by the board of directors or the articles of incorporation, of the company, at least two thirds of each class of the acquired corporation’s shareholders must approve the plan.
How to Pay the Purchase Price.
There are several common structures for payment in a stock transaction. The simplest is cash at closing. An installment sale spreads the payments and may offer tax advantages to the seller. Another alternative is a deferred payout. In this structure, post-closing payments are usually tied to the seller’s profits, and are often called an “earn-out.”
Dissenters Rights.
If a majority of the shareholders voluntarily sell their shares to a purchaser, the minority shareholders generally have no right to complain, absent some contractual restrictions among the shareholders. On the other hand, the objecting minority will have the right to complain and exercise their dissenters’ rights in the event of a merger or a sale of assets. Before the shareholder meeting to consider the exchange, the objecting shareholder must file with the corporation a written notice of objection. Once the sale has been approved, then the corporation must notify each dissenter. After that, each dissenter must file with the surviving or new corporation, as the case may be, a written demand for payment for such dissenter’s shares at a value estimated by the shareholder, together with the number and class of shares. Then it is up to the corporation to either accept the amount claimed by the dissenting shareholder and pay that amount, or set out the corporation’s estimate of the fair value of the shares and an offer to pay that amount. If the dissenting shareholder and the corporation do not arrive at an agreed value, then either can file suit and ask for a hearing to determine the value of the dissenting shareholder's shares. At this hearing, the court will determine the value of the shares and order payment of such amount, plus interest to the date of the judgment.
Liabilities of Selling Corporation.
In a stock purchase, the target corporation remains subject to not only its existing debts and liabilities, but also to all unknown, contingent, or undisclosed liabilities. Naturally, if any turn up after the sale, they can reduce the value of the target and correspondingly, the value of the shares acquired. To protect against this concern, the buyer may ask that the purchase be restructured as an asset purchase. If that is not feasible, normally because of the double taxation potential, then the buyer may protect against overpayment by obtaining personal warranties and an indemnification agreement from the selling shareholders, holding part of purchase price in escrow, or deferring and paying a part out over time, with a right of offset for any pre-closing liabilities that surface after the closing.
Stock Sale Compared to Asset Sale.
Tax considerations usually affect the choice between buying the stock and buying the assets of a corporation. In taxable acquisitions, the target corporation will have to pay taxes on its gain, if the purchase price is greater than the corporation’s basis in its assets. When the net amount is distributed to the shareholders, then they also will be taxed if the amount distributed is greater than their basis in their stock. For this reason, many purchases are structured as stock purchases rather than asset purchases.
From the buyer’s point of view, in taxable transactions, the purchasing corporation's basis in the newly bought assets will equal the purchase price. If the transaction is structured as tax-free sale of assets or stock, the tax consequences are virtually identical.
Often other considerations will cause one party or the other to be in favor of an asset sale. It may be easier to accomplish an asset purchase than a purchase of stock if there are many shareholders, often requiring individual negotiation. Sometimes the parties will prefer a stock sale because of their flexibility in dealing with unwanted assets with the transaction remaining nontaxable. A larger number of tracts of real property or many items of titled personal property may make a stock sale preferable.
For additional information, please see the accompanying articles: How Do You Buy a Company, Some General Considerations in Buying or Selling a Business, Asset Purchase, Mergers, The Acquisition Agreement
THIS INFORMATIONAL MEMORANDA FROM THE LAW OFFICES OF THOMAS D. SOLOMON, P.C. is provided as a courtesy to our friends and clients to provide them with items of interest in the corporate acquisition area. It is not and is not intended to be an exhaustive treatment of its subject matter, but rather an overview of some of the elements of such subject. It is not intended to be legal advice or a legal opinion and should not be relied on in making legal or business decisions. If you have any questions, please call us.
