Deal Structure Overview
Deal structure is as important as price. The right structure can bridge valuation gaps, allocate risk appropriately, and optimize tax outcomes for both parties.
Deal structure encompasses how the transaction is legally organized, how consideration is paid, and how risks and rewards are allocated between buyer and seller. This guide covers the fundamental decisions in structuring M&A transactions.
The Five Dimensions of Deal Structure
Legal Structure
Asset purchase vs. stock purchase vs. merger
Consideration
Cash, stock, debt, earnouts, or combinations
Timing
Payment at close vs. deferred vs. contingent
Risk Allocation
Reps & warranties, indemnification, escrows
Tax Treatment
Taxable vs. tax-free, basis step-up implications
Legal Structure Options
Stock Purchase
Definition: Buyer acquires the shares/equity of the target company
Mechanics:
- Buyer purchases stock directly from shareholders
- Target company continues to exist
- All assets and liabilities transfer with the entity
Pros:
- ✓ Simpler transaction (one entity purchased)
- ✓ Contracts and licenses typically transfer automatically
- ✓ No need to retitle assets
- ✓ Tax-free treatment possible (if structured properly)
Cons:
- ✗ Buyer assumes ALL liabilities (known and unknown)
- ✗ No step-up in asset basis (for tax purposes)
- ✗ Can't pick and choose assets
- ✗ Requires approval from all shareholders
Best For:
- C-corporations being acquired
- Clean companies with limited liability concerns
- Situations where keeping entity intact is valuable
- Tax-free reorganizations
Asset Purchase
Definition: Buyer acquires specific assets and assumes specific liabilities
Mechanics:
- Buyer picks which assets to acquire
- Seller retains the legal entity
- Each asset must be transferred individually
- Specified liabilities assumed
Pros:
- ✓ Buyer can cherry-pick assets
- ✓ Leave unwanted liabilities behind
- ✓ Step-up in asset basis (tax benefit for buyer)
- ✓ Can exclude problem assets/liabilities
Cons:
- ✗ More complex (every asset must be transferred)
- ✗ Contracts may require consent to assign
- ✗ Licenses and permits may not transfer
- ✗ Less favorable tax treatment for seller (ordinary income)
- ✗ Can trigger sales tax in some jurisdictions
Best For:
- Buyers wanting liability protection
- Targets with specific problem assets/liabilities
- Distressed situations
- Buyers wanting tax basis step-up
Merger (Forward, Reverse, Forward Triangular, Reverse Triangular)
Definition: Two companies combine into one legal entity by operation of law
Types:
Direct Merger:
- Target merges into buyer (or vice versa)
- One entity survives, one disappears
- Shareholders of disappearing entity receive consideration
Triangular Merger (most common):
- Buyer creates acquisition subsidiary
- Target merges with/into subsidiary
- Isolates buyer's liabilities
Pros:
- ✓ Automatic transfer of all assets and contracts
- ✓ No individual asset transfers needed
- ✓ Can structure as tax-free reorganization
- ✓ Minority shareholders forced out (if > certain threshold votes yes)
Cons:
- ✗ Assumes all liabilities
- ✗ Requires shareholder vote
- ✗ More complex structuring
- ✗ State law requirements vary
Best For:
- Public company acquisitions
- Tax-free reorganizations
- Situations where complete integration desired
- When automatic transfer of contracts is critical
Comparison: Stock vs. Asset vs. Merger
| Factor | Stock Purchase | Asset Purchase | Merger |
|---|---|---|---|
| Buyer Liability | Assumes All | Only Assumed | Assumes All |
| Asset Step-Up | No | Yes | No (Usually) |
| Seller Tax | Cap Gains | Ordinary + Cap Gains | Can Be Tax-Free |
| Complexity | Simple | Complex | Moderate |
| Contract Consent | Usually Not Needed | Required | Usually Not Needed |
| Shareholder Vote | All Must Agree | Corp Vote Only | Majority |
Types of Consideration
Cash
Characteristics:
- Most common in M&A
- Immediate, certain value
- Taxable event for seller
When to Use:
- Buyer has strong balance sheet or financing
- Seller wants liquidity and certainty
- Clean exit desired
Considerations:
- Requires financing or cash reserves
- No ongoing alignment with seller
- Fully taxable to seller immediately
Stock (Buyer's Equity)
Characteristics:
- Buyer issues shares to seller
- Value tied to buyer's performance
- Can be tax-free if structured properly
When to Use:
- Buyer wants to preserve cash
- Keep seller aligned post-transaction
- Public buyer with liquid stock
- Tax-free treatment desired
Considerations:
- Seller takes buyer risk
- May require registration (if public buyer)
- Dilutes existing shareholders
- Stock may not be liquid (if private buyer)
Earnouts / Contingent Consideration
Characteristics:
- Future payments based on performance
- Bridges valuation gaps
- Keeps seller motivated
When to Use:
- Valuation disagreement
- Uncertain future performance
- Want seller to stay and drive results
- Transition period needed
Considerations:
- Complex to structure and administer
- Potential for disputes
- Accounting complexity
- May reduce purchase price certainty
Seller Financing / Notes
Characteristics:
- Seller loans portion to buyer
- Deferred payment over time
- Seller has downside risk
When to Use:
- Buyer needs financing assistance
- Seller confident in business
- Bridge financing gap
- Show seller confidence to lenders
Considerations:
- Seller bears credit risk
- May be subordinated to bank debt
- Can be beneficial for seller's taxes (installment sale)
- Creates ongoing relationship
Payment Timing Structures
💵 All at Close
Structure: 100% paid at closing
Pros: Simple, certain, clean break
Cons: Buyer takes all risk, seller has no ongoing stake
Common In: Smaller deals, financial buyers
⏱️ Deferred Payment
Structure: 70-80% at close, 20-30% deferred 1-3 years
Pros: Preserves buyer cash, keeps seller interested
Cons: Seller credit risk, ongoing relationship
Common In: Leveraged deals, cash-constrained buyers
🎯 Earnout
Structure: 60-80% at close, 20-40% based on performance
Pros: Bridges valuation gap, aligns incentives
Cons: Complex, potential for disputes
Common In: High-growth companies, valuation uncertainty
🔄 Equity Rollover
Structure: Seller rolls 10-40% into buyer's equity
Pros: Alignment, tax deferral, upside participation
Cons: Seller retains risk, liquidity constrained
Common In: PE roll-ups, strategic platforms
Common Deal Structures by Situation
Structure 1: Clean Strategic Acquisition
Total Value: $100M
Structure: Stock purchase, all cash at close
- $100M cash at closing
- $10M escrow (12 months) for indemnification
- Standard reps and warranties
- Clean break, no earnout
Best For: Clean company, strategic buyer with cash, seller wants liquidity
Structure 2: High-Growth with Uncertainty
Total Value: $80-120M
Structure: Stock purchase with earnout
- $60M cash at close
- $20M earnout over 2 years (revenue-based)
- $40M potential upside if extraordinary performance
- Seller CEO stays for earnout period
Best For: Fast-growing company, valuation disagreement, keep management
Structure 3: PE Platform Acquisition
Total Value: $75M
Structure: Asset purchase with rollover
- $50M cash at close
- $25M seller equity rollover (33% of new company)
- Seller becomes co-investor in platform
- Management stays, participates in future exits
Best For: PE buyer, management wants upside, building platform
Structure 4: Leveraged Acquisition
Total Value: $50M
Structure: Asset purchase with seller note
- $30M cash at close (debt financed)
- $15M seller note (5-year term, 8% interest)
- $5M escrow (18 months)
- Seller note subordinated to bank debt
Best For: Smaller buyer, limited capital, seller confident in business
Structure 5: Tax-Free Reorganization
Total Value: $200M
Structure: Reverse triangular merger
- 100% stock consideration (buyer shares)
- Tax-free to seller shareholders
- Target becomes subsidiary of buyer
- Seller shareholders become 20% owners of buyer
Best For: Public buyer, seller wants tax deferral, strategic rationale for stock
Key Structuring Decisions
The 8 Critical Choices
- Legal Structure: Stock, asset, or merger?
- Consideration Mix: Cash vs. stock vs. earnout?
- Payment Timing: All at close vs. deferred vs. contingent?
- Escrow/Holdback: How much and for how long?
- Earnout Terms: Revenue? EBITDA? Other metrics?
- Reps & Warranties: Scope, survival, caps, and baskets?
- Indemnification: Who bears what risks?
- Tax Treatment: Optimize for buyer? Seller? Both?
Factors Influencing Structure Choice
| Factor | Implications for Structure |
|---|---|
| Target Entity Type |
C-Corp: Stock purchase often better for tax S-Corp/LLC: Asset purchase typically preferred |
| Liability Concerns |
Clean: Stock purchase acceptable Risky: Asset purchase to limit liability |
| Buyer Type |
Strategic: Often stock, focus on integration PE: Usually asset purchase, tax benefits |
| Seller Goals |
Liquidity: Cash at close Tax Deferral: Stock or tax-free reorg Upside: Earnout or rollover equity |
| Valuation Gap |
Small Gap: Negotiate to middle Large Gap: Use earnout to bridge |
| Financing |
Cash Rich: All cash possible Leveraged: Use seller note, earnout, or stock |
Best Practices in Deal Structuring
1. Start with Tax Analysis
Engage tax advisors early. Tax implications often drive structure more than any other factor.
2. Balance Buyer and Seller Interests
Best deals work for both sides. Don't optimize only for yourself.
3. Keep It Simple When Possible
Complexity creates execution risk and ongoing headaches. Use simple structures unless complexity is necessary.
4. Model Multiple Structures
Run financial analysis on 3-4 different structures. Understand trade-offs.
5. Consider Integration Implications
Some structures (asset purchases) are harder to integrate. Factor this into decision.
6. Document Everything
Clear, written terms prevent disputes. Don't rely on handshakes.
7. Use Market Standards
Unless there's good reason, stick to market-standard terms. Exotic structures slow deals and create risk.
8. Think Through Edge Cases
What happens if seller breaches? If earnout target not met? If business declines? Plan for contingencies.
References
Last updated: Wed Jan 29 2025 19:00:00 GMT-0500 (Eastern Standard Time)