Purchase and Sale of Business
Buying or selling a business can be a complicated process that should not be undertaken on your own. If you are a buyer, you must analyze the business you want to acquire and determine what sale terms are acceptable to you based on your investigation. As a seller, you must decide whether to sell assets or stock and at what price. You’ll also need to prepare the documentation that buyers will need to evaluate the company. Then comes the negotiation and drafting of the relevant agreements. Throughout this process, an experienced attorney is invaluable to help you make informed decisions and structure a deal that protects your interests.
What Is the Difference between an Asset Purchase and Stock Sale?
Among the first decisions a seller must make is what to sell from the business. That decision affects how the deal is structured as well as the price for the sale. The two most common ways to transfer ownership of a business are: an asset purchase and a stock sale. Each has its advantages and disadvantages for buyers and sellers.
An asset purchase involves the purchase and sale 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, copyrights and other intellectual property. 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.
Sellers benefit from this approach because they can choose to retain certain assets, such as copyrights or intellectual property. However, they also may face the prospect of retaining current and future liabilities related to the business which would otherwise be transferred in a stock sale.
Generally, buyers prefer an asset purchase because they can negotiate which assets and liabilities they receive in the sale. This allows the purchaser to avoid paying for things they do not want and taking undesirable liabilities.
However, asset purchases may be more time consuming and complicated than stock sales because each significant asset may need to be individually valued and transferred. If this is not done correctly, a party may have problems enforcing contracts or have other related issues.
A stock sale (sometimes called an equity acquisition) involves the sale of the company’s ownership interests rather than specific business assets.
Generally, sellers prefer stock sales because they sell the entire business including its current and future liabilities. Buyers may object to this type of sale for the same reason – they do not want to accept liability.
Stock sales tend to be faster and less expensive in comparison to an asset sale since the business is valued and sold as a whole.
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, some of this can be mitigated through the use of appropriate representations, warranties, and indemnities in the contract.
Federal Income Tax Consequences
An important consideration in whether to pursue an asset or stock sale is the tax consequences. Stock sales favor sellers with significant tax advantages. If a shareholder sells stock for more than the purchase price, the income is taxed as capital gains which have a lower tax rate than the ordinary income rate which would apply to an asset sale.
Asset sales offer more tax benefits to buyers. They receive a stepped-up tax basis in the assets, resulting in future depreciation and amortization tax deductions. Throughout the process, both buyers and sellers should speak with tax counsel and/or their accountants, in order to protect their interests from a tax perspective.
Why Is Due Diligence Necessary?
Before buying or selling a business, it is essential that the parties learn more about each other to avoid unnecessary risks and ensure fair terms. This investigative process is known as due diligence. While typically, the buyer investigates the seller, due diligence is valuable to both parties. It enables them to assess potential risks by examining the other side’s assets, liabilities, operations, legal documents, and business relationships. Buyers want to minimize the chance of unknown risks and sellers want to ensure the buyer’s willingness and ability to perform and protect against a purchaser trying to gain confidential information about the seller.
During due diligence, various types of information will be requested by the buyer, including documents related to the seller’s corporate structure, financials, contracts/legal documents, intellectual property rights, and compliance with relevant laws. Sellers must cooperate but buyers should independently verify information received when possible. A qualified attorney is invaluable and can assist with this process.
What Provisions Should Be in the Purchase Agreement?
Once the parties have agreed in principle on the basic terms of the purchase/sale, a more extensive Purchase Agreement (either a Stock Purchase Agreement or an Asset Purchase Agreement) will be drafted. This agreement will contain all of the terms and conditions of the transaction, including what is included and excluded from the deal, as well as representations and warranties, restrictive covenants, and other provisions.
Essential provisions include:
- Identification of the parties
- Assets/stocks to be included
- Purchase price and method of payment
- Closing terms or conditions that must be met
- Representations and warranties
- Limits on liabilities assumed by the buyer
- Restrictive covenants (non-competition, non-solicitation, confidentiality/non-disclosure)
Representations and Warranties
Both the seller and buyer make representations (“reps”) and warranties in the agreement. The buyer’s reps and warranties typically relate to its ability to comply with the agreement. The seller’s encompass various items, including that the seller has the right to sell the stock/assets free of any encumbrances, the business is solvent, and there are no outstanding contracts regarding the business.
These statements if found to be untrue, can lead to major disputes between the parties. The repercussions are why the reps and warranties are so important, and often so heavily negotiated. Buyers typically want extensive reps and warranties of the seller, to protect themselves with a remedy if anything the seller has said turns out to be untrue. On the other hand, sellers typically want the reps and warranties to be as narrow as possible. This helps to limit their risk of liability after the deal closes. An experienced attorney should be consulted to ensure that the reps and warranties are comprehensive, accurate, and reasonable in scope.
There are many business and legal issues that need to be addressed to help ensure a successful transaction. Not getting good legal advice can result in significant expense and loss of the benefits of the deal. Buyers and sellers should work with experienced attorneys to help ensure they obtain the best terms with the least risk.
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