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Informational Articles Prepared by the DPA Law Group

The following articles have been prepared by members of the DPA Law Group and are based on the Firm's experience and expertise. To read about additional topics, and to receive copies of our informational newsletter, please call us today.

Mergers & Acquisitions: An Introduction

When buying or selling a business the transaction will generally be structured either as an acquisition (through an asset purchase or a stock purchase) or as a merger.

Asset Purchase: At least conceptually, the easiest structure for buying a business is to purchase the seller's assets, free and clear of any liabilities. The purchaser is not actually buying the business entity itself. Thus, an asset purchase is much like buying the seller's inventory and equipment without buying the store.

Often, a buyer may prefer an asset purchase agreement for one or more of the following reasons:

• The buyer has the ability to acquire assets only, without assuming any liabilities of the seller. More likely, the buyer will pick and choose which assets to acquire and which liabilities to assume. For instance, the acquisition of certain intellectual property (IP) rights or lease rights may be central to the buyer's desire to purchase. Acquiring such "rights," however, often entails a willingness to assume certain corresponding liabilities. And, conversely, from the seller's perspective the seller can choose which assets to sell and which to keep. For instance, it is not unusual for the seller to retain cash, certain receivables and sometimes some select IP rights.
• The buyer receives a "stepped-up" tax basis on the assets being acquired.
• The buyer usually has the option but not the obligation to hire employees of the seller's business.
• The buyer also has the ability to pick and choose which contracts to assume.

Stock Purchase: In simple terms, a stock purchase may require only that the selling shareholders swap their stock certificates for a check from the buyer. In contrast to an asset purchase, the buyer is actually taking over the seller's entity and everything it owns and owes, and not just purchasing its assets. In essence, the buyer steps into the shoes of the selling shareholders.

• All other things being equal, sellers will usually prefer a stock purchase agreement because of favorable tax consequences. They may be able to realize capital gains treatment on the sale of stock. This avoids "double taxation" that can result with an asset purchase where the business entity is first taxed on sales proceeds, and the shareholders are then taxed again on distributions that may then be made to them.
• The result can be a seamless change of ownership. The "business entity" may look like it is under new management but title to corporate assets and everything else can remain the same. Thus, there is a better chance of preserving the status quo. Employees can remain in place. It may not be necessary to change title to assets or assign existing contracts to a different business entity. Good will and other intangible assets remain with the seller's business.
• Buyers are wary of stock purchases because they end up assuming liabilities of the seller. Thus, a seller must anticipate that a buyer will expect some concessions. The buyer may, for example, insist on very strong indemnification language from the seller. The purchase price may also be adjusted accordingly.

strong>Merger: A merger is a combination of two or more business entities. It has many of the characteristics of both an asset purchase and a stock purchase. In its simplest form a "surviving" corporation will issue cash, new stock or a combination of cash and stock to shareholders of a "disappearing" corporation in exchange for their stock in the disappearing corporation. The surviving corporation then takes title to all the disappearing corporation's assets and liabilities, and the disappearing corporation ceases to exist. While mergers can proceed in various different forms (forward, reverse, forward triangular, reverse triangular etc.) depending on specific needs, objectives and circumstances, in general the following observations apply:

• A merger is the time-tested vehicle for recognizing the strength of combining two or more business entities into a single venture.
• A merger can allow for the recognition of economies of scale. While employees in duplicate positions may be laid off, the intent is often to improve the bottom line by cutting overhead and increasing efficiencies.
• Tax consequences can be neutralized or deferred. Properly structured, swapping stock will not result in any taxable gain to the shareholders of either of the merging organizations.
• A reverse triangular merger can be a particularly useful vehicle for the acquisition of the a target company in either a cash or stock transaction where certain contractual relationships of the target need to be preserved in order for the buyer and seller to realize full value from the transaction.

The Series Limited Liability Company or "Series LLC"

Many form an LLC to protect personal assets from a legal claim arising out of other assets. Segregating "dangerous" assets and businesses into separate entities away from other assets, especially "safe" assets, is a good idea from an asset protection point of view. Best practices would dictate that every distinct business or major real estate asset, be segregated into a different limited liability entity. In an ideal situation, someone with 10 commercial properties would have 10 separate LLCs, one for each property.

Theoretically, each LLC would be exposed to legal claims arising out the real estate asset owned by that specific LLC.

The primary problem with this strategy, however, is the cost and burden associated with properly forming, qualifying and maintaining each separate LLC. For instance if one had ten separately titled real estate investments, each in its own LLC, one would have to maintain ten checking accounts, register or, as applicable, qualify, each LLC to do business with the state where the property were located, cause to be prepared 10 separate partnership tax returns, and incur the legal and organizational fees and costs from forming 10 separate entities. Whether the theoretical benefits from trying to isolate liabilities to single asset LLCs out-weigh their associated costs and administrative burdens - which can be considerable - will vary from situation to situation.

There is, however, one very recent alternative to having to maintain 10 separate LLCs while trying to isolate liabilities among separate assets. This is the so-called "series limited liability company" or "series LLC" First called the "Delaware Series LLC" after the state whose statutes originated the entity, the statutes of a handful of states, including Nevada, but not California, now support this form of entity.

The Series LLC facilitates segregation by supporting separate subsidiary series of membership units in different assets. One can think of it as a master LLC that has separate divisions, where additional divisions or "series" can be added by simply amending the Series' "limited liability company agreement" (equivalent to an operating agreement for other LLCs). Thus, while each unit of a Series LLC can own distinct assets, incur separate liabilities, and have different managers and members, a Series LLC pays one filing fee and files one income tax return each year. And, in theory, liability incurred by one unit in a series does not cross over and jeopardize assets titled in other subsidiary units of the same Series LLC. The Series LLC is also intended to provide the ability to transfer assets among related subsidiary businesses without income tax on capital gains or real estate transfer taxes. So, in addition to liability segregation, a Series LLC may provide a method of transfer that avoids gain that would otherwise be recognized on a transfer between LLCs.

The problem with the Series LLC is the uncertainty that comes with its relative newness. While the statutes of Illinois, Iowa, Oklahoma and Nevada now support the formation of Series LLCs modeled after Delaware's, the series LLC is not more widely used as a liability segregation technique because its tax treatment has not been fully resolved and because its effectiveness has not been, in many practitioners' opinion, been adequately tested judicially. Currently, the state and federal tax standards for a Series LLC with multiple members remain less than clear. Some speculate that single entity federal tax treatment will require highly correlated members and managers (particularly the last two). And in fact, as of April 2006, the California Franchise Tax Board has determined that each series of a Delaware Series LLC with a taxable presence in California must report and pay franchise taxes as a separate entity in California. Further, since the asset protection and planning advantages of the Series LLC have not been thoroughly challenged in asset protection cases, they remain somewhat unproven - particularly where the assets at issue are held outside the handful of states with statutes that support their organization.

If you or someone you know in Silicon Valley, the Bay Area or throughout California needs the assistance of an experienced Northern California Business Law Attorney, please call the DPA Law Group today at (877) 408-6501, or complete the contact form provided on this site to schedule your initial consultation.