Transaction Advisory: Deal Structuring, Due Diligence, and Risk

In a stock sale, the buyer acquires the seller's entity directly, including all its assets, contracts, liabilities, and legal history. In an asset sale, the buyer selects specific assets and assumes only specified liabilities, leaving unwanted obligations with the seller. Buyers generally prefer asset sales to avoid inheriting unknown liabilities, while sellers generally prefer stock sales because the gain is typically taxed at capital gains rates. The optimal structure depends on the transaction's tax profile, the seller's legacy liabilities, and whether third-party consents are required. Companies evaluating transaction structure should engage corporate due diligence counsel early to assess the liability and tax implications of each structure.

Transaction pricing involves more than agreeing on a purchase price. A working capital peg establishes the target amount of net working capital at closing, and the purchase price adjusts if closing working capital is above or below the peg. Earnout arrangements allow a portion of the purchase price to be contingent on the target achieving specified revenue, EBITDA, or other performance milestones after closing. The earnout provisions must define the calculation methodology, any buyer obligations to give the earnout a fair opportunity to be earned, and the dispute resolution process. Buyers and sellers negotiating complex pricing arrangements should engage acquisition finance counsel to structure pricing mechanics and earnout provisions that are clear and defensible.

Legal due diligence examines the target company's corporate records, material contracts, litigation history, intellectual property, employment matters, real property, and regulatory compliance. Contract diligence focuses on change-of-control provisions, termination rights that could be triggered by the transaction, and contractual obligations that survive closing. IP diligence confirms the target's ownership of its core intellectual property and whether any technology incorporates open source code subject to copyleft obligations. Regulatory diligence identifies pending government investigations, compliance failures, and regulatory approvals required to complete the transaction. Buyers conducting legal due diligence should engage legal due diligence counsel to conduct systematic diligence across all risk categories and prioritize findings for negotiation.

Financial due diligence examines the quality and sustainability of the target's earnings, the accuracy of historical financial statements, and the reliability of the financial projections supporting the transaction valuation. Key financial diligence findings frequently include revenue recognition issues, unrecorded liabilities, customer concentration risks, and working capital trends that affect the pricing peg. Tax due diligence identifies prior-year tax exposures, transfer pricing issues, and state and local tax compliance failures. Section 338(h)(10) and Section 336(e) elections can allow a stock sale to be treated as an asset sale for tax purposes, which may benefit both parties. Investors and acquirers in complex corporate transactions should engage private equity and investment funds counsel to evaluate financial and tax diligence findings before finalizing the transaction structure.

Representations and warranties are the seller's factual statements about the state of the business, covering financial statements, material contracts, intellectual property, litigation, and regulatory compliance. When a representation or warranty proves to be false, the buyer's primary remedy is indemnification. Key indemnification terms include the survival period, the basket or deductible amount below which claims cannot be recovered, and the cap on the seller's total indemnification exposure. Representation and warranty insurance (RWI) is frequently used to bridge indemnification gaps and reduce the amount of seller exposure held in escrow. Companies negotiating representations, warranties, and indemnification terms should engage M&A litigation counsel to identify the highest-risk representations and structure indemnification terms that provide meaningful post-closing protection.

The purchase agreement must define the assets or equity being transferred, the purchase price and adjustment mechanics, and the closing conditions that must be satisfied. Closing conditions typically include the accuracy of the seller's representations and warranties at closing, the absence of a material adverse effect (MAE) on the target, and the receipt of required regulatory approvals. The MAE clause is frequently the most contested provision when market conditions change between signing and closing. Parties to a complex acquisition or divestiture should engage corporate fraud counsel to review the purchase agreement for misrepresentation risks and ensure all terms are enforceable.

The Hart-Scott-Rodino Antitrust Improvements Act requires parties to transactions above specified size-of-transaction and size-of-person thresholds to file premerger notification with the FTC and DOJ before closing. The HSR filing triggers a 30-day waiting period, though second requests for additional information can extend the review significantly. Transactions that raise antitrust concerns may require divestitures, behavioral remedies, or consent orders as conditions of clearance. Industries with high concentration, significant barriers to entry, and overlapping product lines are most likely to attract FTC or DOJ scrutiny. Companies with transactions that may trigger HSR filing requirements should immediately engage Hart-Scott-Rodino filing counsel to assess filing thresholds, prepare the HSR notification, and develop a regulatory strategy.

The closing process requires satisfaction of all conditions precedent to closing, delivery of closing documents, and payment of the purchase price. Disputes over the closing adjustment calculation are among the most common post-closing disputes in M&A transactions. Personnel and cultural conflicts, IT integration failures, customer attrition, and undisclosed operational liabilities frequently surface during the integration period. Companies planning or recently completing a transaction should immediately engage post-merger integration (PMI) counsel to manage post-closing obligations, resolve purchase price adjustment disputes, and address integration risks.