M&A Sell-Side Transactions: Legal, Financial and Operational Considerations

Mergers and acquisitions (M&A) are inherently complex, involving multiple layers of legal, financial and operational considerations. Understanding the legal issues and considerations for the target company is crucial to ensuring a smooth transaction and mitigating potential risks.

Structuring the Transaction: Asset Versus Stock Sales

One of the most critical early-stage decisions is whether to structure the deal as an asset sale or a stock sale. This decision has significant tax implications and affects the parties' liabilities and post-transaction control.

• Asset sales: In an asset sale, the buyer acquires specific assets and liabilities of the target company. This structure is desirable to a buyer if the seller owns assets that the buyer does not want, or if the buyer believes the seller has significant unknown liabilities that the buyer does not want to assume. It’s important to keep in mind that even when the buyer does not explicitly assume certain liabilities from the seller, there may be certain liabilities the buyer cannot avoid such as when the buyer is merely a continuation of the seller or the transaction is an attempt to defraud the creditors of the seller.
• Stock sales: In a stock sale, the buyer purchases the seller s ownership stake, acquiring the entire company, including its assets and liabilities. Sellers typically prefer stock sales for the simpler tax treatment and the ability to pass on existing liabilities to the buyer. On the flip side, buyers may be wary of the potential for unforeseen liabilities and may require robust representations and warranties or indemnification provisions to protect against these risks.

Understanding the tax and liability implications of these transaction structures is critical to ensuring that companies make informed decisions that align with their business goals.

Due Diligence: Uncovering Hidden Liabilities

For sell-side clients, due diligence involves preparing for a comprehensive review of their financial, operational and legal documentation. From a legal perspective, due diligence focuses on identifying potential liabilities that could impact the transaction s value or feasibility. Key areas of concern include the following:

• Pending or potential litigation: Legal disputes, even those that are seemingly minor, can be a red flag for buyers as they may lead to unforeseen costs or reputational damage.
• Regulatory compliance: Non-compliance with industry-specific regulations or general business laws can halt a deal in its tracks. A thorough review of licenses, permits and regulatory filings is essential.
• Real estate liabilities: If the target company owns or operates real estate, legal ownership, mortgages, leases and other related documents must be carefully examined. The key purposes of this review are to determine what rights the seller has in the subject property and to confirm the buyer s intended uses of the property will be permitted. 

Other areas of due diligence that could be critical depending on the type of companies and the industry include intellectual property, labor and employment, environmental and cybersecurity due diligence. Companies should be proactive in addressing these issues before they become stumbling blocks during negotiations.

Representations, Warranties and Indemnities

The seller will be expected to provide representations and warranties about the state of the business. These statements serve as assurances to the buyer regarding the company s financial health, compliance with laws, ownership of assets and more.

• Representations and warranties: These are detailed statements of fact that sellers provide to the buyer regarding the business’s operations, assets, liabilities and legal standing. Common representations include assertions about the accuracy of financial statements, the absence of undisclosed liabilities and compliance with applicable laws.
• Indemnities: Indemnification provisions protect the buyer in case any of the seller s representations or warranties turn out to be inaccurate or misleading. For example, if a seller misrepresents the company s tax liabilities and the buyer is later subject to a tax audit, the indemnification clause would require the seller to compensate the buyer for any resulting losses.

The scope and duration of these indemnities are often acutely negotiated parts of the deal, as sellers aim to limit their post-closing liability while buyers seek maximum protection.

Employee and Benefits Considerations

Another critical legal consideration during a sell-side M&A transaction involves the company s workforce. Whether the buyer intends to retain employees, integrate them into a larger organization or implement redundancies, employee-related issues need to be addressed early in the transaction.

• Employment agreements: For key employees, retention agreements can help ensure continuity during the transition. These agreements typically include financial incentives to retain critical personnel through the closing of the deal or beyond.
• Benefits liabilities: Employee benefit plans, including pensions, health insurance and stock option plans, may create liabilities that need to be addressed in the transaction documents. Understanding the legal and tax ramifications of these plans is vital to ensuring that the buyer is not inadvertently taking on significant financial obligations.

Post-Closing Obligations

The sale does not end at the closing table. Post-closing obligations, such as earn-outs, working capital adjustments and ongoing indemnification obligations, can have lasting financial and legal implications for sellers.

• Earn-outs: Earn-outs allow sellers to receive additional compensation based on the company s future performance. While attractive for bridging valuation gaps, earn-outs often lead to disputes post-closing as the parties may have different interpretations of performance metrics.
• Working capital adjustments: Working capital adjustments ensure that the company s working capital at closing is consistent with a pre-agreed target. Post-closing adjustments may result in the seller owing money to the buyer if the target is not met or vice versa.

Understanding these ongoing obligations and their potential financial impact is crucial for sell-side companies.

Collaboration is Key

M&A sell-side transactions require careful planning and a deep understanding of the legal issues involved. CPAs and tax professionals are in a unique position to help companies navigate these complexities, particularly when it comes to managing tax liabilities. By working closely with legal advisors, CPAs can help ensure that the seller achieves the best possible outcome in the sale of the company. 

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Len Garza Len Garza, Esq., is principal and managing attorney of Garza Business & Estate Law LLC. More content by Len Garza: Private Equity’s Role in Succession Planning