As more and more Chinese companies go abroad to participate in the competition in the US market, more and more Chinese companies realize that acquiring a US company as a subsidiary or merging with a US company is an effective way to expand the market. This allows Chinese companies to directly take advantage of the production lines, human resources, sales channels and popularity of acquired or merged American companies. This article will explain the issues that Chinese enterprises need to pay attention to when making acquisition or merger decisions, how to choose acquisition or merger targets, and how to formulate merger and acquisition strategies.
Mergers vs Acquisitions
The so-called “merger and acquisition” is actually a general term for two different investment methods of mergers and acquisitions. The so-called merger (Merger), as the name suggests, refers to the merger of two existing enterprises, usually of similar size, into a new enterprise. After the merger, the two previous enterprises no longer exist, and the new enterprise continues to operate. Acquisition means that the buyer obtains control over the seller, and the seller’s enterprise ceases to exist after being acquired. The acquisition includes two investment methods, one is the purchase of assets (purchase of assets), that is, the buyer directly purchases the main assets of the seller for production and operation, and the other is the purchase of stock, that is, the buyer purchases the seller’s company’s stock, thereby indirectly obtaining control over the seller’s company.
From the buyer’s point of view, the above three methods have their own advantages, and Chinese enterprises should choose the investment method that is most beneficial to them based on their actual needs. Generally, there is no tax liability for either party to the merger unless cash is used in the transaction (see Section 354(a) of the US Tax Code). The main advantage of asset acquisition is that the buyer can negotiate on how much to bear the seller’s debts, especially when the seller’s company has debts that cannot be determined in amount or liability. If the buyer adopts asset acquisition, the buyer can ask the seller to bear debt, so that the new company after the acquisition is free from debt. The advantage of the stock acquisition is that the transaction only requires the approval of the shareholders of the selling company, not the executives of the selling company. However, it should be noted that the stock acquisition needs to comply with the provisions of the US Securities Law and related regulations. In order to protect the interests of shareholders who do not agree to the acquisition transaction, a “second-stage” acquisition is often required.
Select M&A Target
There are two main considerations in choosing an M&A target: one is the economic aspect, whether the expected economic benefits brought about by the M&A are worth the cost. If it is a special industry (such as banking, insurance, airlines, radio stations, etc.), relevant legal regulations and industry norms need to be considered. The importance of investigating potential M&A targets as the first step in M&A is self-evident. If the investigation work is not done in the early stage, huge losses may incur if problems are discovered after negotiation has already started or after the negotiation is over. Investigating potential M&A targets is not only a heavy workload, but also requires strong professional knowledge. It is recommended to consult lawyers and accountants. Generally, the following needs to be investigated:
- In the articles of incorporation or other organizational documents, special attention should be paid to whether there are restrictions on the transfer of shares, and if it is a listed company, it is also necessary to pay attention to whether there are shares that have been approved but have not yet been issued;
- Business status, including products, markets, technology research and development, plant equipment, labor relations, patents and trademarks, and joint ventures with other companies;
- Financial status, including historical profit status, expected profit, accounting principles, tax returns and review status of the tax bureau, tax base of fixed assets, employee welfare funds that have not yet been paid, and the relationship between the company and lending institutions such as banks;
- Major contracts and leases;
- Past, present and threatened major litigation;
- For debt contracts such as loans, it is particularly necessary to pay attention to whether the loan contract stipulates that if the controller of the enterprise changes, the loan must be accelerated;
- Compliance with securities laws and all filings with the U.S. Securities and Exchange Commission within the past five years;
- Equity incentives and other employee benefit plans;
- Management’s employment contract;
- Relevant laws and regulations, such as anti-monopoly law, environmental law and foreign investment law, etc.
Formulate an M&A strategy
After deciding whether to merge or acquire, and choosing the target to be merged or acquired, the next important step is to formulate specific strategies to complete the transaction. As foreign companies invest in the US market, M&A transactions have some particularities that need to be considered by Chinese companies.
The first thing to consider is whether the Chinese company operates directly in the United States or establishes a subsidiary to operate in the United States. Establishing a subsidiary will cost a certain amount of money initially, but it also has many advantages. The first is that Chinese companies are only responsible for their operations in the United States within the limit of their investment in subsidiaries. In this way, even if there is a problem with operations in the United States, only the subsidiaries need to bear the corresponding debts and consequences, protecting the parent company’s business and interests in China. The second is that the subsidiary is subject to the jurisdiction of the U.S. courts as an independent legal person, and its accounts and taxation are also independent. If it is sued in the U.S., the accounts of the parent company in China and other countries in the world do not need to be subject to U.S. courts or taxation agency’s review. Third, subsidiaries can engage in business matters that are prohibited by U.S. law from participation by foreign companies but allowed by foreign-owned local companies.
Another consideration is the specific steps involved in executing an M&A. Common M&A strategies include the following. The next article will detail the specific steps of each M&A strategy and their respective advantages and disadvantages.
- Class A Tax-Exempt Reorganization (“A” Reorganization)
- Class B Tax-Exempt Reorganization (“B” Reorganization)
- Class C Tax-Exempt Reorganization (“C” Reorganization)
- Triangular Merger
- Reverse Triangular Merger
- Reverse Merger
In general, M&A is a major investment decision that requires professional investigation and prudent consideration. The professional team of Lei Jiang Law Firm has excellent mergers and acquisitions lawyers and rich experience in helping Chinese companies acquire American companies. If you have any needs, please contact us.