deal, the term sheet should also include the major representations and warranties the parties are making.
The term sheet may be followed by a more detailed letter of intent (LOI). This letter delineates more of the detailed terms of the agreement. It may or may not be binding on the parties. LOIs vary in their detail. Some specify the purchase price, while others may only define a range or formula. It may also define various closing conditions, such as providing for the acquirer to have access to various records of the target. Other conditions, such as employment agreements for key employees, may also be noted. However, many merger partners enter into a merger agreement right away. So a LOI is something less than that, and it may reflect one of the parties not necessarily being prepared to enter into a formal merger agreement, For example, a private equity firm might sign a LOI when it does not yet have firm deal financing. This could alert investors, such as arbitragers, that the deal may possibly never be completed.
Before 1988, it was not clear what obligations U.S. companies involved in merger negotiations had to disclose their activities. However, in 1988, in the landmark Basic v. Levinson decision, the U.S. Supreme Court made it clear that a denial that negotiations are taking place, when the opposite is the case, is improper.8 Companies may not deceive the market by disseminating inaccurate or deceptive information, even when the discussions are preliminary and do not show much promise of coming to fruition. The Court's decision reversed earlier positions that had treated proposals or negotiations as being immaterial. The Basic v. Levinson decision does not go so far as to require companies to disclose all plans or internal proposals involving acquisitions. Negotiations between two potential merger partners, however, may not be denied. The exact timing of the disclosure is still not clear. Given the requirement to disclose, a company's hand may be forced by the pressure of market speculation. It is often difficult to confidentially continue such negotiations and planning for any length of time. Rather than let the information slowly leak, the company has an obligation to conduct an orderly disclosure once it is clear that confidentiality may be at risk or that prior statements the company has made are no longer accurate. In cases in which there is speculation that a takeover is being planned, significant market movements in stock prices of the companies involved – particularly the target – may occur. Such market movements may give rise to an inquiry from the exchange on which the company trades. Although exchanges have come under criticism for being somewhat lax about enforcing these types of rules, an insufficient response from the companies involved may give rise to disciplinary actions against the companies.
The choice of doing an asset deal as opposed to a whole entity deal usually has to do with how much of the target is being sold. If the deal is for only part of the target's business, then usually an asset deal works best.
One of the advantages for the acquirer of an asset deal is that the buyer does not have to accept all of the target's liabilities. This is the subject of negotiation between the parties. The seller will want the buyer to accept more liabilities and the buyer wants fewer liabilities. The benefit of limiting liability exposure is one reason a buyer may prefer an asset deal. Another benefit of an asset acquisition is that the buyer can pick and choose which assets it wants and not have to pay for assets that it is not interested in. All the assets acquired and liabilities incurred are listed in the asset purchase agreement.
Still other benefits of an asset deal are potential tax benefits. The buyer may be able to realize asset basis step-up. This can come from the buyer raising the value of the acquired assets to fair market value as opposed to the values they may have been carried at on the seller's balance sheet. Through such an increase in value the buyer can enjoy more depreciation in the future, which, in turn, may lower their taxable income and taxes paid.
Sellers may prefer a whole entity deal. In an asset deal the seller may be left with assets it does not want. This is particularly true when the seller is selling most of its assets. Here they are left with liabilities that they would prefer getting rid of. In addition, the seller may possibly get hit with negative tax consequences due to potential taxes on the sale of the assets and then taxes on a distribution to the owners of the entity. Exceptions could be entities that are 80 % owned subsidiaries, pass-through entities, or businesses that are LLPs or LLCs. Tax issues are very important in M&As. This is why much legal work is done in M&As not only by transactional lawyers but also by tax lawyers. Attorneys who are M&A tax specialists can be very important in doing deals, and this is a subspecialty of the law separate from transactional M&A law.
There are still more drawbacks to asset deals, in that the seller may have to secure third-party consents to the sale of the assets. This may be necessary if there are clauses in the financing agreements the target used to acquire the assets. It also could be the case if the seller has many contracts with nonassignment or nontransfer clauses associated with them. In order to do an asset deal the target needs to get approval from the relevant parties. The more of them there are, the more complicated the deal becomes. When these complications are significant, an asset deal becomes less practical, and if a deal is to be done it may have to be an entity transaction.
There are two ways to do an entity deal – a stock transaction or a merger. When the target has a limited number of shareholders, it may be practical to do a stock deal as securing approval of the sale by the target's shareholders may not be that difficult. The fewer the number of shareholders, the more practical this may be. However, when dealing with a large public company with a large and widely distributed shareholder base, a merger is often the way to go.
In a stock entity deal, deals which are more common involving closely held companies, the buyer does not have to buy the assets and send the consideration to the target corporation as it would have done in an asset deal. Instead, the consideration is sent directly to the target's shareholders who sell all their shares to the buyer. One of the advantages of a stock deal is that there are no conveyance issues, such as what there might have been with an asset deal, where there may have been the aforementioned contractual restrictions on transfer of assets. With a stock deal, the assets stay with the entity and remain at the target, as opposed to the acquirer's level.
One other benefit that a stock deal has over a merger is that there are no appraisal rights with a stock deal. In a merger, shareholders who do not approve of the deal may want to go to court to pursue their appraisal rights and seek the difference between the value they received for their shares in the merger and what they believe is the true value of the shares. In recent years the volume of appraisal litigation in Delaware has risen. This is, in part, due to the position the Delaware court has taken regarding the wide latitude it has in determining what a “fair value” is.9
One of the disadvantages of an entity deal is that the buyer may have to assume certain liabilities it may not want to have. One way a buyer can do a stock deal and not have to incur the potential adverse exposure to certain target liabilities it does not want is to have the seller indemnify it against this exposure. Here the buyer accepts the unwanted liabilities but gets the benefit of the seller's indemnification against this exposure. However, if the buyer has concerns about the long-term financial ability of the target to truly back up this indemnification, then it may pass on the stock deal.
Another disadvantage of a stock-entity deal is that all the target shareholders have to approve the deal. If some of them oppose the deal, it cannot be completed. When this is the case, then the companies have to pursue a merger. When the target is a large public corporation with many shareholders, this is the way to go.
Mergers, which are more common for publicly held companies, are partly a function of the relevant state laws, which can vary from state-to-state. Fortunately, as we will discuss in Chapter 3, more U.S. public corporations
