A stock deal or an asset deal in Israeli M&A?
You have identified an Israeli target company to buy. Now the question is: how to structure the acquisition? There are two traditional paths in Israeli private M&A transactions. The first is to buy the shares of the target company and the second is to buy its assets. Each structure has advantages and disadvantages for the buyer.
When buying all the shares of a company, there is usually a plethora of sellers – the various shareholders of the company. The buyer will have to take into account the position of these different voices and negotiate with them. Although in practice this process is usually centralized by the company’s legal counsel, all sellers will need to be aligned, as they are required to sign the share purchase agreement and possibly waive their rights in the company. While Israeli corporate law provides a pull-in mechanism (often fleshed out and written into the target company’s bylaws), whereby shareholders holding a significant majority of the company’s shares can force minority shareholders to sell their shares during an acquisition, this legal procedure takes at least three months and allows recourse to the courts. Therefore, the buyer would not want to avail this option unless it is unavoidable.
On the contrary, in an asset transaction, there is a seller – the target company. Therefore, obtaining the seller’s consent is arguably much simpler. That said, the sale of all of a company’s assets would require board and shareholder approval and could trigger shareholder veto rights, with the result that at least a majority of the board of directors directors and probably at least the majority holders of the company’s shares should be aligned. However, this is a significantly lower threshold than the 100% approval needed in a stock transaction, and thus mitigates the risk that a minority shareholder will seek to leverage or frustrate the transaction. .
What is purchased?
In a stock transaction, the buyer acquires the target company and with it all the assets, liabilities and history of the company, including the unknown. In an attempt to reduce this risk, in addition to exercising due diligence, the acquirer will seek indemnification for breach of the sellers’ representations and warranties in the share purchase agreement, and specific indemnities for known risks. However, these compensation mechanisms are the result of vigorous negotiations between the parties and are subject to caps and carve-outs, with the consequence that they may not fully cover the risk of inheriting the company’s past. target.
Select assets and liabilities
On the contrary, when buying the assets of a company, the buyer can choose. He can select which assets or trades he is willing to acquire and which liabilities he is willing to assume and which ones should be kept by the seller. For example, the acquirer can exclude a dispute, a lease or certain employees. Moreover, since the acquirer does not acquire the target itself, social and tax risks would automatically be excluded. In other words, the acquirer is able to further limit its exposure to the past, liabilities and debts of the target company.
Transfer of ownership
In a share deal, the buyer acquires the whole package. In Israel, in order to transfer title and ownership of a company, sellers simply need to provide the appropriate stock transfer deeds and an updated company register of its shareholders to reflect the new ownership. If the target company is subject to contracts that include change of control clauses, usually leases and loans, it will also be required to obtain the consent of the counterparties to the transaction.
On the other hand, in asset deals, the transfer of ownership is more complex. For example, real estate transfers require registration with the relevant land authority, patents must be duly and formally assigned, contracts that do not include the right of assignment require the consent of the counterparty.
If the assets include employees, the buyer has two options. The first is to transfer the employment of the employees to the acquirer (which would require a tax ruling), and the second is to “lay off and hire”. The second is a cleaner, more favored option for the buyer, where the target terminates the employees’ employment and pays their accrued benefits and severance, and the acquirer enters into new agreements with the employees, without any responsibility for the past, only recognition of the seniority acquired by the employee. However, a consequence of entering into new employment contracts is that employees can use this process to take advantage of their position. In order to employ employees in Israel, the buyer would need to incorporate a new local Israeli entity, if it did not already have one.
It should be noted that in practice in many equity transactions, while employment is not affected by the sale itself, the buyer will require key employees to enter into new employment contracts, to align with buyer’s company policies, to remedy defects in current contract agreements and seek to ensure retention.
In an asset transaction, if the target company has the necessary regulatory licenses to operate the acquired assets, such as export licenses, encryption licenses, FDA approvals, etc., the buyer will have to apply for new licenses. This may be more complicated than any requirement to update the competent authorities of the new controlling shareholder following a share transaction.
The need to obtain consents, licenses and enter into new agreements as part of an asset transaction makes it more difficult to maintain the secrecy of an acquisition before it is completed.
The Israel Innovation Authority
An important Israeli-specific question to consider is whether the target has received funding from the Israel Innovation Authority (IIA). The IIA provides non-dilutive funding to Israeli R&D companies, in the form of grants that are repaid as royalties at the rate of 3-5% of future sales of the funded intellectual property, up to the amount of the grant plus interest. Israeli tech companies and start-ups usually receive these grants. However, one of the conditions of the grants is the requirement to obtain The IIA’s consent before transferring funded intellectual property overseas or transferring manufacturing of such funded intellectual property overseas. This consent is conditional upon the payment of an exit fee to The IIA, up to three times the amount of the initial grants for the transfer of manufacturing and up to six times the amount of the initial grants for the transfer of intellectual property. funded. .
These exit payments would not be triggered by an equity transaction itself (regardless of whether the buyer was a foreign entity) or an asset transaction where the buyer was an Israeli entity (although that would trigger the payment of ordinary royalties). It would be triggered by an asset transaction where the buyer was a non-Israeli entity (except in limited circumstances), and this would have to be factored into the purchase price.
Buyer’s point of view
From a tax standpoint, the target’s post-closing objective is a determining factor. If, after the acquisition, the objective is to transfer the company’s intellectual property out of Israel (for internal structuring or other purposes), then there are important tax considerations, as the subsequent transfer would be an event. tax.
In Israel’s high-tech space, the Israel Tax Authority has challenged valuations of exported intellectual property that do not reflect the price paid for the company in the previous stock transaction. As a result, it would be tax efficient to directly transfer ownership of assets (especially intellectual property) out of Israel in an initial asset transaction rather than an equity ownership arrangement.
Sellers point of view
Although an asset transaction can benefit the buyer for a variety of reasons, it is important to understand the interests of your counterparty. In Israel, the sale of shares is considered a capital gain, taxed at a rate of 23-33%. However, if the sale is structured as a disposal of assets, the target company will itself have to pay corporation tax at the rate of 23% and a shareholder, natural or foreign, will be subject to an additional level of income tax at the rate of 23%. -33% on the distribution of dividends from the sale proceeds, unless an applicable tax treaty provides relief. The answer here may be a bid price adjustment in an effort to reduce the spread for sellers.
When buying a business, the purchase price is allocated to an asset, the shares. When purchasing various assets, the purchase price must be allocated appropriately between the assets and the different tax treatments must be taken into account (i.e. real estate is subject to capital gains tax and sales tax, intellectual property is subject to capital gains tax, and inventory is subject to income tax), adding a level of analysis additional to the transaction.
In contrast, in a transfer of assets, it is not necessary to engage a paying agent to support the buyer’s obligation to withhold tax from the consideration paid to each of the various sellers in a transfer. of shares.
Upon closing of a stock transaction, the company continues to operate; it’s largely business as usual. However, in asset acquisitions, as the acquirer prepares to run the business independently, including obtaining necessary regulatory licenses, renting new office space, opening bank accounts, etc. , and in order to facilitate the transition with its main customers or suppliers, it may ask the seller to provide it with transition services.
If responsibilities are left with the target company, the buyer may be required to provide a reassignment license to the seller. This will allow the seller to use the intellectual property purchased by the buyer in order to fulfill these retained obligations. If the debts withheld include a dispute, the manner in which this dispute is to be handled by the seller must be agreed in advance, in order to ensure that it does not prejudice the buyer.
All these elements will have to be negotiated within the framework of the asset deal.
An asset sale offers the acquirer a fresh start for the business, mitigating the risks associated with the target’s past and, in some cases, providing a more tax-efficient structure than a stock sale. On the other hand, the selective acquisition of assets and assumption of liabilities, rather than an overall sharing agreement, adds a level of complexity to the transaction. This complexity can translate into time, money and the potential risk that the deal will not close. The answer as to how to structure an acquisition in Israel will depend on the individual variables of a particular transaction, the nature of the assets being acquired and the buyer’s post-closing plans.