Mergers are pivotal strategic transactions that can shape the trajectory of businesses, whether they are Fortune 50 companies or local mom-and-pop establishments. Understanding the different types of mergers is essential for business owners and legal professionals alike. This comprehensive guide will delve into the intricacies of general mergers, parent-subsidiary mergers, triangular mergers, and multi-entity mergers, providing you with valuable insights into each type and their respective legal implications.
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Before discussing the types of mergers, it is helpful to discuss briefly how mergers are different from other business combination types, specifically stock acquisitions, asset acquisitions, and (especially) consolidations. Having some specially defined terms (a common vocabulary) can help, since the topic can tend to become a bit opaque otherwise.
There are terms that are used interchangeably in colloquial speech, but which, in the professional ecosystems of business transactions, have their own legal definitions and consequences. For example, often the terms "merger," "acquisition," consolidation," "combination," and even "amalgamation" are all used colloquially (even in business media) to refer to one business buying or taking over (acquiring) another.
In some cases (or, in some jurisdictions), this can be made a bit more confusing, even when referring to the legal definitions ... because the corporate and LLC laws of some states use the term, "merger," to refer to what is distinguished in other states as a "consolidation." An additional confusion can exist also because one business can, in fact, take over (acquire) another by means of a merger transaction.
So, to assist us in this discussion, some simple, defined terms for this post:
- Acquiror—In a Stock Acquisition or Asset Acquisition, the company that is buying the stock or assets of the Target. An Acquiror can also be a Surviving Entity in a merger (or the parent the Surviving Entity).
- Acquisition—A business takeover transaction in which the Acquiror takes ownership or control over the Target or its business either by means of an Asset Acquisition or a Stock Acquisition.
- Asset Acquisition—A business takeover transaction in which the Acquiror takes control of the Target's business by purchasing all or most ("substantially all") of the Target's assets used in the operation of its business.
- Constituent Entities—The legal entities participating in the Merger, Acquisition or Consolidation. Constituent entities can be corporations, limited liability companies (LLCs), partnerships, or other legally recognized entities.
- Consolidation—A business combination transaction in which neither of the Constituent Entities survives the transaction, but a brand new Entity takes over the businesses of all Constituent Entities.
- Consolidated Entity—In a Consolidation, the Consolidated Entity is the successor Entity, succeeding to the assets, rights, liabilities, and obligations of the Constituent Entities (all of which cease to exist when the transaction closes).
- Entity—A corporation, limited liability company, partnership, a limited partnership, or other legal entity (not a human being).
- Merger—A business transaction (described in more detail below) in which (generally speaking) a Merged Entity or Entities are merged into and "absorbed by" the Surviving Entity. A Merged Entity ceases to legally exist as soon as the Merger is done.
- Merged Entity—A Constituent Entity in a Merger. It is the entity that ceases to exist once the merger is completed. The Merged Entity is absorbed into or combined with the surviving entity. There can be more than one Merged Entity in a merger.
- Stock Acquisition—A business takeover transaction in which the Acquiror takes control of the Target by purchasing at least a majority of the the Target's voting stock.
- Surviving Entity—The Constituent Entity in a Merger that continues to exist after the Merger is consummated. It can be an Entity that was specifically formed for the purpose of surviving the Merger, or it can be a business that had a long operating history beforehand.
- Target—In an Acquisition, the Entity whose shares of stock or assets are being acquired by the Acquiror. A Target can also be a Merged Entity or a Surviving Entity in some Merger types.
Merger vs. Consolidation vs. Acquisition: Examples
Distinguishing mergers and consolidations can be somewhat of a head-scratcher to some folks, since the essence of each can be generally summarized in the same way: two or more companies "combine forces" to take advantage of business synergies or economies of scale to create a leaner and more competitive business when the deal is done and the dust has settled. The two have been explained in different ways by many others, but I think the simplest generalization is the most helpful for purposes of this post. Lets use a hypothetical transaction involving two Entities (A and B). We will use these Entities in this section for examples of the other types of transactions, also.
- Direct Merger—If A and B were to combine forces by means of a Merger, one of them would continue to exist after the Merger (the Surviving Entity), and the other (the Merged Entity) would cease to exist. For example, upon effectiveness of the Merger, B merges into and is absorbed by A. Entity B ceases to exist automatically (by "operation of law"), and A survives. A is the successor Entity to B, and as such A now owns all of the former assets of B, and A is now responsible for all of the former liabilities and other obligations of B. In this hypothetical, A "acquired" (took over) the business of B, but the legal transaction was a Merger, not an Acquisition.
- Consolidation—But, in a Consolidation, A and B combine in such a way that when the transaction is complete, neither A nor B exists any more. Instead, at the closing of the transaction, a third company (C) is created to take over the consolidated businesses of A and B. The Entity we are calling C is the successor Entity to both A and B, and as such C now owns the former assets of A and B, and is responsible for the former liabilities and other obligations of A and B.
- Stock Acquisition—On the other hand, A and B instead could pursue a Stock Acquisition. For example, if A were to pay the holders of all or a majority of the voting stock issued by B, A would acquire Entity B itself. As the result of this Stock Acquisition, both A and B continue to exist, but there would be a parent-subsidiary relationship between them, and A could direct the operations of B that way. (A could pay cash for the stock, in which case A would be the sole owner of B. Or, A could pay them (entirely or partially) with A's own stock, in which case A would still be the sole owner of B, but now the former owners of B would become additional owners of A. In each case, though, A and B continue to exist and A owns B.)
- Asset Acquisition—Or, A and B could enter into an asset purchase agreement. In an Asset Acquisition, A purchases all or substantially all of the business assets of B. A, of course would continue to exist after the Asset Acquisition is done; it would have to. B, on the other hand, would not automatically (not "by operation of law") cease to exist. B would still exist immediately after the closing of the Asset Acquisition, though it would no longer own its former business assets. (Usually, the deal documents require the owners of B to either dissolve B as an Entity, and/or to comply with the provisions of a non-compete agreement.) Also, unless the Acquisition documents provide for A to assume any of the liabilities of B, B will remain on the hook for all of its former liabilities and other obligations.
In the rest of this post, we will discuss Mergers ... their key legal effects of closing a merger and the four different kinds of mergers.
Legal Effects of a Merger
When two or more companies merge, it triggers a range of legal effects and implications.
- Ownership—Ownership of the surviving entity immediately after the Merger typically includes the owners (some or all) of the Surviving Entity immediately before the merger, as well as the owners of the Merged Entity immediately before the merger. This process can be complex depending on the number of owners, and on the mechanism by which ownership interests are exchanged and evidenced. All owners of the surviving entity are subject to its charter and its other internal governance provisions.
- Internal Governance—The certificate of incorporation (or other charter document for other entity types) of the Surviving Entity typically continues after the Merger. The same goes for the bylaws. In some cases, an amended or fully restated charter or bylaws will have been prepared as part of the merger documents to become effective simultaneously with the Merger's consummation. But, in either case, the former owners of the Merged Entity will be subject to these documents.
- Successor Obligations—Among other things, the Surviving Entity, by operation of law, assumes all obligations and liabilities of the Merged Entity. The Surviving Entity will be responsible for all of the obligations that the Merged Entity had to third parties under their contracts; for all payments to employees and contractors; for all taxes; for all rent and utilities to facilities the Surviving Entity takes over; for all license royalty payments; for all regulatory compliance requirements of the former Merged Entity; for all judgments from lawsuits; and for all other obligations and liabilities of every kind of the former Merged Entity.
- Successor Rights—By operation of law, all of the property, rights, privileges, franchises, patents, trademarks, licenses, registrations, and other asset of every kind that belonged to the Merged Entity immediately before the Merger was completed are transferred to and become owned exclusively by the Surviving Entity. The Surviving Entity continues the operations and activities of the Merged Entity, but the Surviving Entity has the right to modify, expand, retract, or cease any of those business operations of activities (unless any of the merger agreements provides otherwise).
- Employees—One of the business reasons for a Merger is to create synergies, or economies of scale. That is, the Surviving Entity can carry on both its own business operations and those of the Merged Entity at less than the combined cost paid by both of them before the merger. This often means that, although some employees of the former Merged Entity will become employees of the Surviving Entity, there are usually also layoffs due to redundancy.
- Management—This is both an employee matter and a governance / control matter. The merger documents will normally state who the management team will comprise immediately following the Merger. Sometimes, in larger corporate mergers, but sometimes in smaller companies, too, the Surviving Entity will have co-presidents or co-CEO's.
Types of Mergers
If you spend any time searching the Internet to read about Mergers, you will soon find there are numerous approaches to categorizing and describing types of mergers. Here, I am specifically categorizing Merger types based on the legal mechanics of the transaction, the legal relationship of the Constituent Entities to each other, and the organizational structure immediately before and after the Merger is consummated.
1. Direct Mergers
A Direct Merger (also called a "statutory merger" or a "forward merger") is the simplest Merger in concept and, usually, in execution, too. In a Direct Merger, there are two Constituent Entities, say corporation A and corporation B. One of the Constituent Entities (say, B) is the Merged Entity and the other (A) is the Surviving Entity. At the closing, when the Direct Merger becomes effective, corporation B merges with and into A, and corporation B ceases to exist. Immediately upon effectiveness of the Direct Merger, corporation A, as the Surviving Entity, succeeds to the assets, rights, liabilities, and obligations of B by operation of law (that is, as the automatic consequence of the Merger's effectiveness). Commonly, the shareholders of corporation B will receive shares of stock of A and join corporation A's shareholders as the owners of A as the Surviving Entity.
2. Parent-Subsidiary Mergers
Parent-Subsidiary Mergers occur when the Constituent Entities (say, corporation A and corporation B) are related by ownership. For example, corporation A owns all of the stock of corporation B, making B a wholly-owned subsidiary of A. Corporation A decides that the two companies should effectuate a Parent-Subsidiary Merger, thereby consolidating their operations. There are two types of Parent-Subsidiary Mergers: Upstream and downstream.
- Upstream Mergers—In an Upstream Merger, corporation B, the subsidiary, as a Constituent Entity, merges with and into its parent, corporation A. As a result of the effectiveness of the Upstream Merger, subsidiary corporation B ceases to exist as a separate Entity, and parent-corporation A, as the Surviving Entity succeeds to the assets, rights, liabilities, and obligations of B by operation of law.
- Downstream Mergers—In a Downstream Merger, the opposite occurs. Corporation A, the parent, as a Constituent Entity, merges with and into its subsidiary, corporation B. As a result, parent-corporation A ceases to exist as an separate Entity, and subsidiary-corporation B, as the Surviving Entity succeeds to succeeds to the assets, rights, liabilities, and obligations of A by operation of law.
Parent-Subsidiary Mergers can involve more than two Constituent Entities.
3. Triangular Mergers
Triangular mergers involve a unique structure of three Entities. One of these Entities desires to be the ultimate Acquiror to acquire the ultimate Target. This Acquiror forms a new subsidiary Entity (sometimes called a "shell company"). This shell company and the ultimate Target enter into a merger agreement and related documents by which the shell company and the Target effectuate a Merger between themselves. There are two primary forms of triangular mergers: forward triangular mergers and reverse triangular mergers.
- Forward Triangular Mergers—In a forward triangular merger, the Target merges with and into the shell company. The Target is the Merged Entity and ceases to exists on consummation of the Merger, and the shell company, as the Surviving Entity, succeeds to the assets, rights, liabilities, and obligations of the Target.
- Reverse Triangular Mergers—In a reverse triangular merger, the opposite is true. The shall company merges with and into the Target. The shell company is the Merged Entity and ceases to exists upon consummation of the Merger, and the Target, as the Surviving Entity, succeeds to the assets, rights, liabilities, and obligations of the shell company.
In either case, the parent of the shell company is the ultimate Acquiror, as it is the parent of the Surviving Entity and has either acquired full control over either the Target company itself (in the Reverse Triangular Merger), or over the Target's business assets (in the Reverse Triangular Merger).
4. Multi-Entity Mergers
It may be a stretch to consider these a "type" of Merger, but the complexities justify a quick mention. Mergers involving three or more companies (other than the triangular mergers discussed above, and other than Parent-Subsidiary Mergers involving more than two constituents) are even more complex, involving negotiations among multiple parties and addressing various legal and financial considerations. Multi-entity Mergers are often pursued to create synergies, consolidate market share, or facilitate industry consolidation.
Understanding the nuances of Acquisitions, Consolidations, and Mergers—Direct Mergers, Parent-Subsidiary mergers, Triangular Mergers, and Multi-Entity Mergers—is essential for businesses navigating these complex transactions. By comprehending these distinctions and engaging the expertise of business lawyers, corporate finance professionals, and CPA's, companies can make informed decisions and help to ensure a smoother and legally compliant transaction. Remember, these transactions are significant undertakings that require careful planning, negotiation, and legal guidance to maximize their potential benefits while minimizing risks. Whether you're a Fortune 50 corporation or a local mom-and-pop business, Mergers and other acquisitive business transactions can be transformative opportunities for growth and success.
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