Introduction
When two companies decide to merge their activity by the purchase of one company by the other, there are a number of ways they can take, when the two main ones are (1) purchase of shares of the target company (namely, the purchased company) (2) purchase of the activity and/or the assets of the target company (naturally, there are additional ways to perform the transaction by way of merger, which we will not refer to in this article).
Both ways set forth above, despite having a similar goal, are different in many aspects, when the main ones are the type of the agreement and the corporate actions required for the purpose of executing it.
In this article, we will review the two types of purchase transactions: purchasing shares and purchasing business activity/assets, the approvals which are required for each of these transactions as well as the considerations which may affect the selection of the type of transaction.
Share Purchase Agreement
In a share purchase agreement (or SPA), the surviving company (namely, the purchasing company) actually purchases the shares, most or all of them, of the target company. Thus, the surviving company becomes the owner of the target company as a legal entity in and of itself.
Agreements of this type will usually require an extensive process of due diligence investigation, in light of the fact that by the very purchase of the shares of the target company, the surviving company becomes the owner of all of the assets, the employees, the rights and the undertakings of the target company, namely: any debt or undertaking which existed toward the target company, shall be, after performing the transaction, the responsibility and the duty of the surviving company, even if there is no change directly to the identity of the purchased company, which shall continue to be responsible for upholding all its undertakings directly.
Asset Purchase Agreement
In an asset (or business activity) purchase agreement (or APA), each party can choose the specific assets it is interested in selling or purchasing from the target company, such as reputation, intellectual property, business inventory, customer list and such. Thus, the surviving company does not become the owner of the entire target company, but rather an owner of some or all of its assets, all as will be agreed upon by the parties in the framework of the transaction.
This type of transaction constitutes a relatively simpler process than the process of share purchase, since there is no corporate interaction between the companies and/or between the shareholders of the target company. However, a transaction for purchasing assets is not automatically an easy or simple transaction, and even in this case there may be obstacles, which are worth considering.
The Approvals Required for Performing Each of the Transactions
When dealing with a transaction for the purchase of shares, the shareholders of the target company are a party to the transaction, and they need to approve the sale process, a fact which may thwart or delay the transaction, if there is no agreement by the required majority among the shareholder.
As a footnote, we shall state that there are regulation/agreement mechanisms intended to handle situations where there are shareholders who object a sale process, when the majority is interested in promoting it. These are naturally bring-along and tag-along mechanisms, which may be anchored in a founders’ agreement or in the articles of association of a company, and they are even expressed in the Companies Act[1], which provides a mechanism with similar purpose and nature, namely, in the framework of which, a party interested in purchasing the shares of a company, will be able to purchase, in a forced manner, the shares of objecting shareholders as well (under the terms set forth in the law or the company’s article of association).
This is also problematic in a situation in which there are different types (classes) of shares in the target company, and therefore there is a need to convene a class meeting for each type of the classes of shares. Under these circumstances, each class meeting must approve the sale process of the shares to the surviving company, so that if there are shareholders who hold a certain type of shares which the transaction may damage their interests, they will probably not approve the sale process and this will prevent it from being completed.
On the other hand, when dealing with a transaction for the sale of activity, the body which is responsible for approving the transaction is the board of directors of the target company, and there is no need to raise the subject for the vote of the shareholders. It is clear that the approval of a transaction via the board of directors is supposed to be theoretically simpler than its approval by a shareholders’ meeting, but even this mechanism is not free of potential problems.
Thus, inasmuch as there one or members of the board of directors who were appointed as such pursuant to a personal appointment, and this director that objects to the transaction and their approval its necessary to pass the resolution required to approve the transaction, then it will not be possible to approve it as it will be even difficult to replace such director/s for the purpose of completing the transaction, since, as stated above, their appointment is personal and not general pursuant to holding shares or pursuant to an appointment by a group of shareholders.
The Considerations which may Affect the Selection of the Type of Transaction
The purpose behind the desire of the surviving company to purchase the target company (whether by purchasing its shares or by purchasing its assets), is that which usually dictates the type of transaction which the surviving company will want to perform. In direct context to the stated in the previous chapter with regards to the required approvals, when there is a pre-known difficulty in passing a decision via the board of directors or the shareholders’ meeting of the target company, this difficulty may route the surviving company to advance with a transaction which may be easier to complete internally within the target company.
Another consideration may be in case the target company has reputation, tenders or licenses in which the surviving company is interested in. In such case, the surviving company will want (and in fact will be forced to) purchase the shares of the target company, since this way it also purchase the company’s registration number of the target company, and can continue to enjoy the reputation, as well as to use licenses or act in accordance with the tenders. In the framework of an asset/activity transaction, the company registration number of the target company is not transferred to the receiving company, and therefore the reputation of the target company remains in its possession. Naturally, in an agreement it is possible to purchase the trademark and such. In addition, in the framework of an asset/activity transaction the validity of the licenses in the ownership of the target company would have expired, and the surviving company would not have met the required criteria in order to submit offers for tenders which the target company would have submitted regularly. In parentheses we will state that even a transaction for the purpose of shares would not necessarily have solved the problem, since in many agreements (such as distribution agreements or franchise agreements) there is usually a provision which states that a change in the shares of control in the target company, constitutes a violation of the agreement or enables the other party to terminate it.
Another possible consideration is when the target company is in considerable debt or has legal problems whatsoever. In this case, the surviving company will prefer to purchase the assets of the target company, and in fact choose carefully the specific assets in which it is interested (cherry picking), without taking upon itself the debts of the target company or intervene in its legal problems.
Summary
As we can see above, there are material differences between a transaction for the purchase of shares and a transaction for the purpose of activity and/or assets. These differences usually constitute some of the considerations of the parties (and mostly of the surviving company) with regards to the most appropriate type of transaction for its needs, in combination with other considerations.
In this article, we tried to demonstrate how different situations and interests necessarily affect the type of transaction which will be executed, when the specific circumstances of each company are those which will dictate the type of transaction which will be selected. Therefore, prior to deciding to engage in any agreement whatsoever, it is recommended to carefully examine which type of transaction (and respectively, which type of agreement) will benefit the parties and has high chances of receiving the required approvals from the relevant organs in both companies, emphasizing the target company.
[1] The Companies Act, 5759-1999