The season of applications is upon us, which means it is time to refresh your understanding of commercial law and the landscape of the City (M&A Metropolis, Tax Town and Risk Ravine are some key locations to keep in mind). Today, we explore the important difference between ‘asset’ sales and ‘share’ sales, a favourite topic in assessment centres and interviews.
When considering the acquisition of a business, a buyer typically has two available options: an asset sale, in which the buyer will acquire the assets (and possibly liabilities) of the business; or a share sale, in which the buyer will acquire the shares of the company that owns the assets comprising the business. Two points can be made to illustrate the contrast. Firstly, an asset sale allows the buyer to ‘cherry-pick’ the assets it wishes to acquire, while in a share sale, the buyer will acquire all the assets and liabilities of the company (including those which it does not know about). Second, an asset sale does not typically allow the purchaser to begin running the business immediately, as various contracts will not necessarily carry over as part of the sale. In contrast, with a share sale, the company owning the business is acquired, meaning that things can continue ‘business as usual’ even once the company is acquired.
Given the differences between asset sales and share sales, a number of factors must therefore be taken into account by a would-be purchaser of a business when considering how to structure the purchase. The key factors to be considered are tax, third party contracts and consents, risk and overall strategy.
Tax is of significant importance to companies, particularly in the UK where corporation tax is set at 20%, levied on the net profits of a company. Naturally, a buyer will be seeking the most tax efficient arrangement for any acquisition. The general view is that a share sale is more advantageous for the seller while an asset sale is more advantageous for the buyer. This is primarily because in a share sale, a corporate seller enjoys the ‘substantial shareholding exemption’ (“SSE”) – a tax exemption for chargeable gains made by such sellers on the sale of shares under certain conditions – while in an asset sale, buyers can claim amortisation relief, that is, the reduction of tax obligations, regarding the purchase price of certain intangible fixed assets.
Focusing on the buyer’s point of view, there are potential advantages to be found in both share and asset sales, depending on the circumstances (though it is indeed the case that an asset sale will be more attractive). Under a share sale, a buyer may be able to acquire attractive tax assets, which could potentially be used in future to offset the business’ tax liabilities. Such assets include trading losses and capital losses which cannot be acquired as ‘assets’ per se under an asset sale. In addition, share sales are VAT-exempt and subject to only stamp duty (which is a low 0.5%) rather than the stamp duty land tax and land transaction tax imposed if the business’ assets include land and buildings.
Under an asset sale, the primary advantage to the buyer is the provision of corporation tax relief for intangible assets, such as intellectual property (though excluding goodwill and customer-related intangible assets). Furthermore, many such intangible assets are not subject to stamp duty at all and the cherry-picking nature of an asset sale means that tax liabilities can be excluded from the purchase. An additional point to note is the possibility of ‘roll-over relief’ on chargeable gains relating to business assets and income gains under certain circumstances.
Despite the vast importance of tax considerations in M&A, the Financial Times has been anxious to point out that the tax avoidance tail should not wag the business benefit dog (citing the example of Pfizer’s proposed merger with Allergan) – ultimately, a deal should be entered into only where a strong business case for it can be made out 1.
The transferability of third party contracts is also an important consideration and one which can add additional complexity to an asset sale. Under an asset sale, any contracts into which the target business has entered will not automatically be transferred. This means that if the buyer is interested in the surrounding contracts and agreements, it will be necessary to obtain third party consents so that the various agreements can be assigned or novated. Obtaining such consents could potentially introduce additional costs and may prove to be an a onerous process. If a buyer sees running the business as a going concern as a priority, it may be easier to structure the transaction in such cases as a share sale. Asset sales in general involve significantly more structural complexity – it is necessary, for example, to identify clearly what will be sold, meeting various transaction formality requirements and dealing with third party consents (as mentioned above).
Risk is another factor to be considered by buyers – in particular, the allocation of risk depending on whether an asset sale or share sale is chosen. Although careful due diligence must be undertaken for both asset sales and share sales, in share sales due diligence takes on an even greater significance, as the buyer is taking on all the assets and liabilities of the company, including historical and contingent liabilities. It is essential to identify, as far as possible, the full circumstances of the target business so that a well-informed risk assessment can be conducted. Both financial and legal due diligence will need to be undertaken.
While sellers may provide warranties and indemnities for both asset and share sales, in share sales this may become particularly important as a means for the buyer to allocate risk to the seller and limit its own potential losses. A particular feature of the warranties and indemnities extracted in share sales is that they are often required to extend into the future for what may be a significant period of time. Interestingly, parties may increasingly be turning to warranty and indemnity insurance, offered by providers such as AIG, who have noted that 18% of global M&A policies written by AIG between 2011-2015 resulted in a claim, a percentage which rises to 23% where the deal was worth more than $1 billion. This illustrates both the necessity of such assurances, and the ways in which the market can respond to provide solutions to these kinds of risk-related concerns2.
A buyer may pursue an acquisition for several reasons, which will likely shape its preferences and the type of transaction structure it decides on. Spatial metaphors provide a useful framework for understanding some of the motivations underlying a buyer’s acquisition strategy: vertical (e.g. acquiring a supplier or distributor somewhere in the commercial chain of activity), horizontal (e.g. acquiring a competitor or a business complementary to the existing business), diversificatory (e.g. moving into new markets), geographical (e.g. moving into new global regions), technological (e.g. acquiring particular research assets or infrastructure) and so on.
Where a buyer is more focused on making a vertical acquisition, it makes more sense to undertake a share sale so that the buyer can acquire a business as a going concern, which can then be more easily integrated into the buyer’s supply chain arrangements. An example of this can be found in Amazon’s acquisition of Whole Foods in 2017 for $13.7 billion, which some have analysed as an attempt to expand its business throughout the supply chain, from logistics to physical retail stores3.
Where, however, the buyer is more interested in acquiring specific technological or IP assets, it may be the case that an asset sale will offer a more focused, and therefore cheaper, option. This is not always the case – as McKinsey indicates, companies such as Cisco Systems have pursued a long-term strategy of acquiring smaller companies (71 between 1993-2001 at an average price of $350 million) to acquire key technologies that it then utilised to develop internet-orientated products4.
What makes the choice between an asset sale and a share sale particularly interesting, and indeed difficult, is the fact that the seller and the buyer tend to benefit from opposing transaction structures. As a result, although the factors outlined in this note remain relevant, the respective bargaining positions, financial heft and negotiating leverage available to the parties is also extremely important and should not be dismissed. In practice, combined with tax considerations, sheer negotiating power is often perhaps the deciding factor in determining whether a business is acquired via an asset sale or a share sale. Interesting questions arise as to how various trends may influence the balance of these factors in the future: increasingly rigorous tax regulation and anti-tax avoidance measures, new technologies improving the due diligence process, and the rise of gigantic global corporations will change the way businesses structure their transactions.