You have identified an Israeli target company to purchase. Now the question is – how to structure the acquisition? There are two traditional routes in Israeli private M&A transactions. The first is to purchase the shares of the target company, and the second is to purchase its assets. Each structure has benefits and disadvantages for the purchaser.
When purchasing all the shares of a company, there is usually a plethora of sellers – the various shareholders of the company. The purchaser will need to consider the position of, and negotiate with, these various voices. Although in practice this process is typically centralized by the company’s legal counsel, all of the sellers will need to be aligned, as they are required to sign the share purchase agreement and potentially waive rights in the company. While the Israeli Companies Law provides a drag/bring along mechanism (often fleshed out and entrenched in the target’s articles of association), whereby the shareholders holding a significant majority of the company’s shares can force the minority shareholders to sell their shares in an acquisition, this statutory process takes at least three months and allows for an appeal to the courts. Accordingly, the purchaser would not want to rely on this option unless it is unavoidable.
On the contrary, in an asset deal there is one seller – the target company. Therefore, procuring the seller’s consent is arguably much simpler. That said, a sale of all of the assets of a company would require board and shareholder approval and may trigger shareholder veto rights, with the consequence that at least the majority of the members of the board and likely at least the holders of the majority of the shares of the company would need to be aligned. However, this is a significantly lower threshold than the 100% approval necessary in a share deal, and thus mitigates the risk of a minority shareholder seeking to exert leverage or frustrate the deal.
What is being bought?
In a share deal, the purchaser acquires the target company and with it all of the company’s assets, liabilities and history, including the unknown. To try to reduce this risk, in addition to conducting due diligence, the purchaser will demand indemnification for breach of the sellers’ representations and warranties in the share purchase agreement, and specific indemnitees for known risks. However, these compensation mechanisms are a product of vigorous negotiations between the parties and are subject to caps and carve-outs, with the consequence that they may not cover the full risk of inheriting the target company’s past.
Select Assets and Liabilities
On the contrary, when purchasing the assets of a company, the purchaser can cherry-pick. It can select which assets or business lines it is willing to acquire and which liabilities it is willing to assume and those which are to be retained by the seller. For example, the purchaser may exclude a piece of litigation, a lease agreement, or certain employees. In addition, as the purchaser would not be acquiring the target itself, corporate and tax risks would automatically be excluded. In other words, the purchaser is able to further limit its exposure to the target company’s past, liabilities and debts.
The Transfer of Ownership
In a share deal, the purchaser acquires the whole package. In Israel, in order to transfer title and ownership of a company, the sellers simply need to provide appropriate share transfer deeds and an updated company’s register of its shareholders to reflect the new ownership.
If the target company is subject to contracts that include change of control provisions, typically leases and loans, it will also be required to procure the counterparties’ consents to the deal.
In contrast, in asset deals, the transfer of title is more complex. For example, real estate transfers require registration with the appropriate land authority, patents need to be duly and formally assigned, contracts that do not include the right of assignment, require the counter party’s consent.
If the assets include employees, the purchaser has two options. The first is to transfer the employment of the employees to the purchaser (which would require a tax ruling), and the second is to “fire and hire”. The second is a cleaner and more favored option for the purchaser, where the target terminates the employment of the employees and pays their accrued benefits and severance, and the acquirer enters into fresh new agreements with the employees, with no liability for the past, only recognition of the employee’s accrued seniority. However, a consequence of entering into new employment agreements is that employees can use this process to leverage their position. In order to employ employees in Israel, the purchaser 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 share deals, while employment is not affected by the sale itself, the purchaser will demand that key employees enter into new employment agreements, to align with the purchaser’s corporate policies, to remedy defects in the current agreements and to seek to ensure retention.
In an asset deal, if the target company holds regulatory licenses necessary for the operation of the acquired assets, such as export licenses, encryption licenses, FDA approvals etc., the purchaser would have to apply for new licenses. This may be more complicated than any requirement to update the relevant authorities of the new controlling shareholder as a consequence of a share deal.
The need to obtain consents, licenses and enter into new agreements in an asset deal, renders it more challenging to maintain the secrecy of an acquisition before its completion.
The Israel Innovation Authority
An important Israeli specific matter to consider is whether the target has received financing from the Israeli Innovation Authority (IIA). The IIA offers non-dilutive financing to Israeli R&D companies, by way of grants that are repaid in 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 high-tech companies and start-ups commonly take up these grants. However, one of the conditions of the grants is the need to obtain the IIA’s consent before transferring the funded intellectual property abroad or transferring the manufacturing of such funded intellectual property abroad. Such consent is contingent on the payment of exit fees to the IIA, ranging from up to three times the amount of the original grants for the transfer of manufacturing and up to six times the amount of the original grants for the transfer of the funded intellectual property.
These exit payments would not be triggered by a share deal itself (irrespective of whether the purchaser was a foreign entity), or an asset deal where the purchaser was an Israeli entity (though this would trigger payment of the ordinary royalties). It would be triggered by an asset deal where the purchaser was a non-Israeli entity (save in limited circumstances), and this should be factored into the purchase price.
On the tax front, the post-closing goal for the target is a pivotal factor. If following the acquisition, the aim is to transfer the company’s intellectual property out of Israel (for internal structuring purposes or otherwise) then there are important tax considerations, as the subsequent transfer would be a tax event.
In the Israeli high-tech space, the Israeli Tax Authority has challenged valuations of exported intellectual property that do not reflect the price paid for the company in the prior share deal.
Accordingly, it would be tax efficient to directly transfer the ownership of the assets (particularly the intellectual property) out of Israel as part of an initial asset transaction rather than a share deal.
While an asset deal may be beneficial for the purchaser for various 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 an asset deal, the target company itself will have to pay corporate tax at the rate of 23% and an individual or foreign shareholder will be subject to an additional level of income tax, at a rate of 23-33% on the dividend distribution of the sale proceeds, unless an applicable tax treaty provides relief. The answer here may be an adjustment to the purchase price in an effort to reduce the gap for the sellers.
When purchasing a company, the purchase price is allocated to one asset, the shares. When purchasing various assets, the purchase price must be appropriately allocated among the assets, and the different tax treatments need to be considered (i.e., real estate is subject to betterment tax and sales tax, intellectual property is subject to capital gains tax and inventory is subject to income tax), adding a further layer of analysis to the transaction.
On the other hand, in an asset deal, there is no need to engage a paying agent to take responsibility for the purchaser’s obligation to withhold tax on the consideration paid to each of the various sellers in a share deal.
On the closing of a share deal, the company continues to operate; it is largely business as usual. However, in asset deals, while the purchaser is preparing to run the business independently, including obtaining necessary regulatory licenses, leasing new office space, opening bank accounts etc., and in order to smooth the transition with its main customers or suppliers, it may ask the seller to provide it with transition services.
If any liabilities are left with the target company, the purchaser may be required to provide a grant-back license to the seller. This will allow the seller to use the intellectual property purchased by the purchaser in order to fulfill these retained obligations. If the retained liabilities include a piece of litigation, the manner in which such litigation is to be handled by the seller will need to be agreed in advance, to ensure it does not prejudice the purchaser.
All these elements will need to be negotiated in conjunction with the asset deal.
An asset deal provides the purchaser with a fresh start for the business, mitigating risks arising from the target’s past and in certain cases offering a more tax-efficient structure than a share deal. On the other hand, the select acquisition of assets and assumption of liabilities, rather than a package share deal, adds a level of complexity to the transaction. This complexity can translate into time, money, and the potential risk that the deal may not close. The answer as to how to structure an acquisition in
Israel, will depend on the individual variables of a particular deal, the nature of the assets being acquired and the purchaser’s post-closing plans.