Mergers and Acquisitions of Businesses: What to Examine Before Buying, What to Protect in the Agreement, and Why Most Disputes Arise from the Same Source

1. Share acquisition and asset acquisition are two entirely different transactions from a legal and tax perspective. In a share acquisition, the buyer steps into the shoes of the existing company, including its undisclosed liabilities. In an asset acquisition, the buyer selects what to take and what to leave behind.
2. Representations and warranties are the heart of the agreement. If the seller presented a misleading picture of the business, they are the tool for claiming compensation after closing.
3. Due diligence is not bureaucracy-it is the only way to uncover debts, claims, licensing issues, problematic contracts, and employees holding rights you were unaware of.
4. Employees of the acquired company are entitled to continuity of employment even after the merger-they cannot be dismissed and re-employed under inferior terms on the grounds that it is a “new” company.
5. Mergers meeting certain thresholds of sales turnover and market share require approval from the Commissioner of Competition. A transaction closed without approval may prove costly.

Two transactions that appear similar but are not

The choice between share acquisition and asset acquisition is one of the first and most significant decisions in any M&A.

Share acquisition: The buyer purchases the company itself-all its assets, contracts, licenses, and clients. But also all its liabilities, including those not disclosed in due diligence. A claim filed one month after the acquisition for an event that occurred a year before may become the buyer’s problem. On the other hand, in a share acquisition, contracts and concessions generally transfer automatically, without requiring third-party consent.

Asset acquisition: The buyer selects which assets to take-equipment, goodwill, clients, intellectual property, specific contracts-and leaves behind the remaining liabilities. Simpler in terms of exposure to past debts, but more complex in terms of required consents from third parties.

Due Diligence: What to Look for and Why It Matters

Professional due diligence examines the business in all its aspects before signing the agreement:

Legal status: Existing and potential claims, agreements incompatible with the acquisition (such as change of control clauses allowing a third party to terminate a contract upon change of ownership), licensing issues, liens.

Employees: Who is essential to the business and what is the likelihood they will remain? Are there personal agreements with senior employees? Are there undisclosed commitments regarding bonuses, options, or pensions?

Intellectual property: Are the technology, brand, and development software actually registered in the company’s name? Could former employees claim ownership?

Clients and attrition: What is the historical attrition rate? Are there clients likely to leave upon learning of the acquisition?

Financial picture: Do the reported revenues reflect actual reality? Is there “one-time” income presented as recurring revenue?

Representations and Warranties: The Tool That Protects After Closing

Every acquisition agreement contains a chapter of representations and warranties by the seller. The seller represents that the balance sheet is accurate, that there are no claims, that licenses are valid, that employees are lawfully employed, and dozens of other representations concerning different aspects of the business.

Alongside the representations operates the indemnification mechanism: if a representation was false and the buyer suffered damage as a result, the seller is liable for compensation. This mechanism is what enables closing a transaction without knowing everything, while knowing there is a safety cushion if matters surface later.

Drafting the representations is a meticulous craft. A broad representation provides greater protection for the buyer. A narrow representation protects the seller. Each party has a conflicting interest. An attorney drafting this chapter without M&A experience may leave gaps costing millions.

When Representations Do Not Match Reality: What the Law Determines

The Contracts Law (General Part), 5733-1973, establishes in Sections 14 and 15 the principles of misrepresentation and fraud. One who entered into a contract due to misrepresentation is entitled to rescind it. If the misrepresentation was made fraudulently, the injured party is also entitled to compensation for the damage caused, beyond restitution.

The Supreme Court held in CA 10582/02 Ben Abu v. Hamdiya Doors Ltd. (2005) that personal liability may be imposed on shareholders and directors who managed a business while presenting false representations regarding its financial condition to the contracting party, even beyond the separate legal personality of the company. In other words: the corporate veil does not protect when the director himself presented the false representations.

The Point from Which Most Disputes Arise

Experience in the field teaches that most disputes following a business acquisition arise not from intentional deception but from expectations not supported by the agreement. “We understood I would also take the major clients.” “It was agreed the seller would remain for a year.” “I knew the inventory delivered was worth more.” All of these, if not anchored in writing in the agreement, are open to dispute.

The way to avoid a dispute after closing is to manage all “understandings” before closing and ensure they are written, clear, and binding.

In a case represented by our firm (TA 32084-06-13 Kaufman v. Barosh et al.), the Tel Aviv District Court was required to address the question of what an agreement “for the purchase of equipment” includes when the parties actually intended to transfer an entire business operation. The court held that the title of the agreement is not determinative-interpretation depends on the entirety of the provisions and the circumstances of the transaction. It was further held that oral agreements not reflected in the written agreement are not binding, particularly when the agreement contained an express provision that any amendment must be made in writing only. The lesson: what is not written does not exist.

Tax Planning: An Integral Part of the Transaction

An M&A transaction in Israel encounters a host of tax considerations: capital gains tax on the sale of shares, income tax on the sale of assets, taxation of the goodwill component, taxation of employee options, and the possibility of obtaining tax deferral in a merger transaction under certain conditions pursuant to Part H’2 of the Income Tax Ordinance.

Tax planning that begins after an agreement is signed is too late. Planning must be part of the negotiation, not an addition after it.

Considering a business acquisition or strategic partnership and want to know what to examine before proceeding?

© Tidhar Tzur Law Firm | This article is for general information purposes only and does not constitute individual legal advice.