Public mergers and acquisitions (“M&A”) transactions often receive a lot of publicity. Nevertheless, there is no shortage of activities in private M&A. In Hong Kong, there are two main types of acquisition in the private M&A space: (1) purchase of shares of a private company and (2) asset purchase. The sale and purchase of shares is a common form of corporate acquisition in Hong Kong. By acquiring all or the majority part of a target company’s share capital, the buyer can exercise control over the target company as well as all its businesses and assets. Yet, some parties choose to acquire assets because it allows cherry-picking the suitable assets in the target company. This article provides some of the key legal issues involved in a private M&A and considers the differences between a share purchase and asset purchase.
Share purchase versus asset purchases
Whether to proceed by way of a share purchase or asset purchase will depend on the objectives of the buyer and circumstances of the target entity and its business. Some of the key considerations are set out below:
In a share acquisition, all the assets, liabilities and obligations of the target company will in effect pass to the buyer. By contrast, in an asset acquisition, the buyer acquires only specific identified assets and liabilities.
In other cases, a transaction may involve the sale and purchase of a division of a wider business. Unless the relevant division is neatly contained within one target entity owned by the seller, it would probably make sense for the transaction to be structured as an asset sale whereby the buyer can cherry-pick the assets it requires and house them in an appropriate entity in its own group.
Another potential avenue in this case is for the buyer to implement an intra-group reorganization so that the assets of the relevant division are transferred into one dedicated entity, followed by the acquisition by the buyer of the shares in such entity. In short, an internal asset transfer followed by a share purchase.
There may be certain tax advantages or disadvantages, depending mainly on the nature of the target’s assets, which may drive the structuring decision in favor of one option over the other.
Advantages of share purchases
A share purchase has the effect of transferring the target’s entire business, although sometimes prior consents of third parties are required. This is in contrast to an asset purchase, which requires each piece of target asset and liability to be individually identified and transferred.
Effect on existing contracts
Existing contracts (i.e., supply agreements, customer contracts etc.) are generally unaffected by a share purchase (subject to any change of control provisions and commercial risk that counterparties may cease their contractual relationship with the target). However, under an asset purchase, such contracts must be specifically novated or assigned to the buyer under the consents of the contract parties.
Effect on licenses and permits
The target’s existing licenses and permits remain in place, subject to any change of control requirements.
In general, stamp duty on transfer of shares of a property holding company is likely to be lower than the stamp duty on a direct transfer of its underlying properties, assuming that company does not own any other assets.
Advantages of asset purchases
The buyer can pick and choose the target’s specific assets and liabilities that it wishes to acquire, leaving behind any undesired assets and liabilities with the seller. An added advantage of cherry-picking assets is that the buyer has a reasonable degree of comfort that it needs not deal with any unwanted liabilities following the completion of the transaction. Under a share purchase, the buyer acquires all the target’s assets and liabilities unless these are specifically carved out from the transaction.
Asset purchases avoid any problems in relation to pre-emption rights which may arise when purchasing shares in a private company. For example, there may be problems in locating missing minority shareholders.
The most common Hong Kong corporate form is a private company limited by shares. Under the Companies Ordinance Cap. 622, Laws of Hong Kong (“Company Ordinance”), a private company is a company that restricts the right to transfer shares, limits the number of members to 50 people and prohibits any invitation to the public to subscribe for shares in the company.
Shares in private companies are subject to transfer restrictions set out in the company’s articles of association or shareholders’ agreement. For purchases of shares from an existing shareholder, the consent of the other shareholders may be required to waive pre-emptive rights, tag-along rights or other restrictions on transfer that are usually specified either under the articles of association of the target company or the relevant shareholders’ agreements. In general, there are no legal, regulatory or governmental restrictions on transfers of shares in a Hong Kong incorporated company unless the target business belongs to the banking , insurance , securities and futures , provident fund , telecommunications or broadcasting sectors. Moreover, businesses in the telecommunications sector are also subject to the ‘Merger Rule’ under the Competition Ordinance .
For acquisition or disposal of assets, parties should inspect the provisions under the articles of association and shareholders’ agreement to see if there are any restrictions on the transfer and/or prior shareholders’ approval for the transfer. The parties should follow the procedures for transferring rights, permits, licenses and consents for the transition and continuous operation of the business in Hong Kong and/or for obtaining new permits and/or licenses when acquiring a business or assets. Consents from third parties may be required under previous agreements of the target company with its landlords, creditors, debenture holders, mortgagees or other contracting parties that may be affected because of a transfer of assets or upon a change in control of the target company.
The most common process is that the seller and the buyer, after bilateral negotiations, agree on the terms and conditions of a sale and purchase agreement on the transfer of the target privately-owned company or target businesses and assets.
However, where the seller wishes to solicit interest from several buyers, the disposal process may take the form of a controlled auction which typically involves:
1. Drafting an information memorandum as the basis of marketing the company, business or assets;
2. Providing vendor due diligence report;
3. Drafting of a sale and purchase agreement and other transaction documentation;
4. Round one expressions of interest from potential buyers;
5. Seller’s selection of potential buyers in round one who will then be permitted to undertake their own due diligence;
6. Round two offers by potential buyers with mark ups of the transaction documentation; and
7. Negotiation of transaction documentation with one or more buyers until definitive terms are agreed with one party.
In certain special situations, private companies can also be acquired by ‘contractual offer’ followed by a minority squeeze-out, provided that the offer is made in accordance with Part 13 of the Companies Ordinance , or by ‘scheme of arrangement’ proposed by the company to be acquired in accordance with Part 4 of the Companies Ordinance .
Due diligence provides potential buyers and their financiers with the opportunity to evaluate the legal, financial, tax, commercial position and business prospects of a company, business or asset. Legal due diligence conducted by legal advisers to the buyer typically covers the title to and encumbrances over the company or business, the legal structure, terms of financial obligations, licences and permits, material contracts, ownership and use of information technology, intellectual and real property, physical assets, employee arrangements, litigation and compliance with law.
Vendor due diligence reports are a common feature of controlled sale processes in Hong Kong, whereby the seller provides information on the target company or business in order to accelerate the sale process, minimize disruption to the target, and explain any complexities associated with the transaction. It is customary for a successful buyer, and its financier, to be able to rely on such vendor due diligence reports, although buyers may often also complete confirmatory due diligence to complete their evaluation of a transaction.
The typical documents involved in a private M&A include:
• a confidentiality agreement governing the exchange of confidential information relating to the transaction;
• a memorandum of understanding or heads of terms setting out key terms and sometimes earnest monies and negotiation exclusivity;
• a sale and purchase agreement setting out the terms and conditions of the transaction; and an agreement on transfer of a business or assets usually includes detailed provisions on the scope of the business, assets and liabilities that are to be transferred and the mechanisms to address the misallocation of assets and liabilities between the seller and buyer;
• a disclosure letter in which general and specific disclosures are made by the seller qualifying the warranties included in the sale and purchase agreement;
• documents to transfer the title (e.g., an instrument of transfer and a bought and sold note in the case of a share transfer, and an assignment in the case of real property and intellectual property rights);
• key members of management in the target business may enter into new employment agreements to secure their continued employment following completion of the transaction.
Payment by cash may be in the form of a lump sum or several instalments, and it may also be subject to post-closing price adjustments. Non-cash consideration may be in the form of shares in the buyer (where the buyer is a listed company) or other securities, such as loan notes convertible into the buyer’s shares. Non-cash transactions generally involve a more complicated payment structure.
Timetable and delays
To avoid deviating from the timetable, parties should first ensure they are prepared, both internally and externally (in terms of engaging advisers), to undertake an M&A transaction. In complex or cross-border transactions, or where the target has a complex financial or tax position, parties should understand that: (1) structuring discussions might dominate the early part of a timetable and result in a delay to processes which depend on the outcome of these discussions; (2) the scope of the due diligence exercise conducted can extend a transaction timetable prior to signing; (3) the preparation and negotiation of documentation is an integral part of any M&A process and the duration depends on the relative bargaining powers of the parties and the complexity of the transaction; (4) any delay to the buyer might interrupt its funding plan or funding cost; and (5) obtaining shareholder approval and/or regulatory approvals may impact completion of an M&A transaction.
Rossana Chu (Managing Partner)
Jacky Chan (Associate)