Terms like merger, acquisition and conversion are found in business articles but are rarely explained. As a small business owner, you may think they only apply to large corporations. In reality, many smaller businesses use these vehicles as well. You never know when they will come in handy.
Mergers and acquisitions are terms used interchangeably but they are not the same.
What Is an Acquisition and How Can It Help Small Businesses?
An acquisition is how a business is taken over by another party. The party being bought doesn’t always need to agree to be acquired. There are two types of acquisitions: stock and asset.
In the case of a stock acquisition, the purchaser needs to buy a controlling interest in the stock. This is generally thought of as 50% plus 1, but a large public corporation may have thousands of shareholders with only a few owning significant amounts. If the purchaser can get the shareholders to agree to sell their stock at a certain price, the purchaser can have a controlling interest in the company. This can occur with small and midsize businesses including limited liability companies, or LLCs as they are commonly called. For LLCs a purchaser can offer to purchase membership interests. A small business may have several hundred shareholders or members to whom a would-be purchaser can make their pitch.
Individuals have a right to sell their shares or membership interest at the highest price regardless of the opinions of management. It can be difficult to get the parties to decide on the value which is why acquisitions do not always work out. Valuing a business requires knowledgeable accountants and it can be hard to get everyone to agree. That is where asset acquisitions come into play.
In the case where a corporation or LLC only has limited items of value, an asset acquisition allows the buyer to purchase any of the assets it wants as long as it is not a sale in the ordinary course of business. For example let’s say a company produces a chemical disinfectant that has been recently banned in several states. Consequently, the value of the company is reduced and it may be headed for bankruptcy. In an asset acquisition, the purchaser may want to buy the equipment in the field, the building and other high-value production equipment. The purchaser has no need for the chemical formulas or the customer list as it will be using the facility and equipment to expand its existing manufacturing of another product. Asset acquisitions can be complicated as accountants, analysts and appraisers are needed to determine the value of the assets. Additionally, the seller is not obligated to enter into the agreement if it doesn’t think the price is fair.
What is a Merger and how it can Strengthen a Small Business?
A merger takes place when two or more businesses want to join forces and become a single entity. Many businesses may take part in a merger, but at the end of the day, there is only one survivor. The surviving entity owns all the assets, liabilities, and obligations of the companies that are party to the merger. Many smaller businesses engage in mergers when they are doing well but need to take their growth to the next level. The synergy between the companies allows for the sharing of certain assets, liabilities as well as scaling of operations.
There are three types of mergers that one may encounter: general mergers, entity mergers and parent-subsidiary mergers.
A general merger is enacted under the general merger statutes (laws vary by state). These mergers are general in the sense that they are not specific and potentially apply to all mergers. Any merger can be enacted under the general merger statutes, even where specific or specialty types of mergers may apply. Typically, interest holders in the entity that did not survive get interests in the survivor.
In a general merger, all boards of all constituent corporations must approve the merger. The shareholders of the corporation that is merging out of existence must always approve the plan since it involves such a radical and fundamental change in their ownership interests. The shareholders of the surviving corporation ordinarily need not approve the plan since their corporation is continuing in existence and the nature of their equity interests is not being fundamentally changed.
Entity types for example Limited Liability Partnerships can also merge with corporations and in most states, either party may be the survivor. Some other examples of entity merging may include one limited liability company merging with another or one limited liability company joining forces with a limited partnership or limited liability partnership.
In addition to mergers occurring between or among domestic entities, they may also happen between domestic and foreign (out of state) entities. For example, a Georgia corporation may pursue a merger with a Michigan LLC pursuant to statutes.
Parent-subsidiary mergers are often called short form mergers because they do not require as much work as regular mergers. In the case of such a merger, the parent may merge its subsidiary into itself or merge itself into the subsidiary. All states require a statutory percentage of ownership before the short form merger can be used. The majority of states require 90% but a minority of states require a larger or smaller percentage. The theory for allowing this procedure is that the minority block of shareholders cannot block the merger even if they wanted to. Unless specifically noted under state law, the short form parent/sub procedures apply only to situations where the subsidiary is merged into the parent. The benefit of this vehicle is that it avoids costly and time-consuming meetings and proxy solicitations of publicly held companies.
Converting a Business Entity and Re-Domestication to Other States
Conversions are another device enabling businesses to change when the need arises. Conversions are a single entity transaction where a business entity can change its entity type and/or move to another state. Some states call moving to another state re-domestication rather than conversion. The existing entity which wants to change is called the old or converting entity. The new entity is called the converted or resulting entity.
Conversions are like mergers in that the converted entity has all the duties, debts, obligations and resources as the old entity. The converted entity is deemed to have existed without interruption and will have the same formation date as the old entity with a new entity type or home state. There may also be tax consequences, so it is advised business owners consult a tax advisor before engaging in this transaction. In fact, some entities will convert to another due to tax-related issues.
Types of Small Business and Corporate Conversions
Some common examples of conversion include a corporation becoming an LLC; an LLC becoming an LP; a general partnership becoming a limited partnership; or an LLC becoming a corporation. There are also instances in which a business corporation may become a nonprofit corporation or vice versa.
Entities change what they are, because of the benefits that come with their newly found state of being. An LLC may convert to a corporation if it plans to go public (most publicly traded entities are corporations). That same LLC may also decide that it wants to escape from double taxation, which affects business corporations and have only pass-through taxation. Conversely, a small corporation may decide it wants to do away with the corporate liabilities in favor of an LLC which has more relaxed requirements for meetings, voting etc. In this case, a conversion, if agreed to by the members, would be a simple and easy way to achieve that goal. Lastly, a general partnership may determine that it is more advantageous to formalize its affairs by registering with a particular state's business filing agency as either a limited partnership or a limited liability partnership and enjoy the protection afforded by any of those entity types.
In today’s business environment which is rife with hurdles to growth and expansion, it is reassuring to know that there are tools available to help small businesses achieve a better state of being. Acquisitions, mergers and conversions are invaluable tools that businesses may employ to expand, strengthen liability protection, reduce tax burdens and improve profitability.