There are many things to consider when buying a business. Typically, someone makes an offer to buy (or sell) an existing enterprise and the other side accepts. This seems simple enough, right? Not exactly.
Selling or buying a business requires strategic planning. The first step is to understand what exactly is being sold and whether the transaction should be structured as an asset purchase or stock sale. Understanding these basic elements will often help secure a better deal, whether you are the seller or the buyer.
The Asset Purchase
An asset purchase involves the purchase of some or all of the company’s assets and liabilities. These assets may include anything that the business owns, including inventory, equipment, vehicles, machinery, land, leases, and copyrights. The buyer and seller are able to negotiate exactly which assets will be part of the transaction and the specific terms of the deal – like whether payment will be in installments or a lump sum, liens and encumbrances on the assets, conditions to the closing etc.
Generally, buyers prefer an asset purchase, because it’s customizable – the buyer can be selective about which assets and liabilities to purchase. This allows the purchaser to avoid unwanted assets and, often more importantly, unwanted financial burdens. Don’t want to take responsibility for that mortgage on a building the target company owns? Then don’t include the building in the transaction! Typically, much can be negotiated. Another major advantage is that the buyer receives a stepped-up tax basis in the assets, resulting in future depreciation and amortization tax deductions.
An advantage to the seller is that the seller may negotiate to retain the company name and continue doing business under it, or retain any specific assets that the seller does not want to sell.
Asset purchases may be more time consuming than stock purchases, because each significant asset may need to be individually valued and transferred. Asset sales may also require consents and assignments from third parties. For example, the consent of a landlord may often be required prior to the transfer of a lease to a buyer. Without appropriate assignments, the buyer may have difficulty enforcing some contracts originally signed by the seller.
A clear disadvantage to the seller is the prospect of retaining current and future liabilities.
The Stock Purchase
A stock purchase (sometimes called an equity acquisition) involves the sale of the company’s ownership interests rather than specific business assets. Instead of picking and choosing what to buy, the acquirer essentially steps into the shoes of the seller. In a stock acquisition, the business operations continue on as normal as if the ownership had not changed.
Sellers tend to prefer stock purchases because they can hand over the entire business to the buyer and walk away from liabilities. This type of sale also tends to be faster and less expensive, since it is usually streamlined in comparison to an asset purchase. Rather than choosing and valuing individual assets, the business is valued and sold as a whole. Often, the sale will be also be taxed at the lower capital gains rate, which can be a significant tax advantage for the seller.
For buyers, purchasing an ownership interest means buying the business with all of its obligations and liabilities, even liabilities that are currently unknown or undisclosed. However, liabilities can be reduced through appropriate representations, warranties and indemnities negotiated into the stock purchase agreement. A tax disadvantage to the acquirer is that they are generally unable to obtain a stepped-up cost basis and a new start to the depreciation and amortization schedules.
These are just some basic points for purchasers and sellers to consider in the early stages of a deal. Several factors will affect whether a transaction should be structured as an asset or stock sale. It is important for buyers to perform appropriate due diligence prior to any purchase, so they know exactly what they might be buying. We strongly recommend that you consult an experienced business lawyer and accountant, on all aspects of selling or purchasing a business, to help you decide the best way to structure your deal.
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