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 of the target 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 the pre-emption rights of the other shareholders which may arise when purchasing shares in a private company. For example, there may be problems in locating missing minority shareholders of the target.
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 banking1, insurance2, securities and futures3, provident fund4, telecommunications5 or broadcasting6 sectors. Moreover, businesses in the telecommunications sector are also subject to the ‘Merger Rule’ under the Competition Ordinance7.
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 potential buyers, the disposal process may take the form of a controlled auction which typically involves:
- Drafting an information memorandum as the basis of marketing the target company, business or assets;
- Providing vendor due diligence report;
- Drafting of a sale and purchase agreement and other transaction documentation;
- Round one expressions of interest from potential buyers;
- Seller’s selection of potential buyers in round one who will then be permitted to undertake their own due diligence;
- Round two offers by potential buyers with definite bidding price and mark ups of the transaction documentation; and
- 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 Ordinance8 , or by ‘scheme of arrangement’ proposed by the company to be acquired in accordance with Part 4 of the Companies Ordinance9 .
Due diligence provides potential buyers and their financiers with the opportunity to evaluate the legal, financial, tax, commercial position and business prospects of a target 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;
- 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); and
- key members of management in the target business may enter into new employment agreements to secure their continued employment following completion of the transaction.
Consideration may be fixed or subject to post-closing adjustments. Payment of cash consideration may be in the form of a lump sum or several instalments. 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:
- 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;
- the scope of the due diligence exercise conducted can extend a transaction timetable prior to signing;
- 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;
- any delay might interrupt the buyer’s funding plan or increase its funding cost; and
- obtaining shareholders’ approval, regulatory approvals and/or third parties’ consents may impact completion of an M&A transaction.