Asset and stock purchases.

Dmitrii Shironosov © 123RF.com

Stock and Asset Purchase and Sales of Small Businesses

The acquisition of a small business is not a sport for the short-winded. If you are the buyer, once you have identified an acquisition target, you need to make an offer to structure the purchase.

This article summarizes the two main structures in purchasing a small business: asset purchases and stock purchases. Each has its advantages and disadvantages. Spoiler alert: in general the buyer favors an asset purchase, and the seller favors a stock purchase.

Consult with a lawyer before you sign a letter of intent.

The structure of purchasing a business is a major point of negotiation.  Which road you travel will affect other critical issues such as the purchase price and timing of the transaction. Although the structure may be changed, the parties should consider and address the structure of a sale of a small business as early as possible, even as they negotiate a letter of intent (LOI).

Related articles:

Checklist for Buying or Selling a Small Business
Lessons from Failed Business Acquisition 

Asset purchases favored by buyers.

The first approach is to purchase the assets of the small business. The assets may be comprised of tangible assets such as inventory and equipment and intangible assets such as intellectual property such as trademarks, patents and copyrights.

Usually, a major component of the purchase price is the goodwill of the business, which is considered an intangible asset. Goodwill may consist of the company’s name, brand reputation, loyal customer base, customer service, employee relations, and proprietary technology. The goodwill of the company is the difference between the fair market value of the other assets and the purchase price.

The seller of the assets is the small business, not its shareholders or members. And the purchaser is another company, sometimes one that is set up specially to purchase the assets of the selling company.

Most purchases of small businesses are structured as asset purchases.

Stock purchases favored by sellers.

In a stock purchase the buyer purchases ownership in the business.

The other approach to purchasing a business is a stock purchase. The seller is the owner, usually the shareholders in a corporation or members in a limited liability company. The buyer is usually an individual or other business who want to purchase the ownership, as reflected by the shares of stock in a corporation or membership interests in a limited liability company.

In a stock purchase, the buyer is buying ownership in the business—all of the assets and liabilities. And at the closing, the seller essentially hands over the keys to the business. The buyer steps into the shoes of the owner.

Why most buyers favor asset purchases.

There are several reasons that most purchasers prefer an asset purchase rather than a stock purchase. The most important reason is that the buyer wants only to buy the assets, and not assume the liabilities of the seller. And there may be certain assets of the business that the buyer wants to exclude from the purchase.

As a side note, there may be certain circumstances in which the buyer unwittingly can become responsible for the liabilities of the seller. For example, there may be some tax liabilities if the buyer does not comply with the bulk sales rules; or there may be environmental liabilities that may follow the assets.

The next reason is that an asset sale is tax advantaged for the buyer. The buyer gets a stepped up basis in the assets. What that means is that the assets of the seller are marked up to the fair market value, which is usually agreed on by the buyer and seller. If an asset has already been depreciated down to zero, but is worth $1000, the buyer gets to depreciate the asset all over again.

In addition, in an asset purchase the buyer can depreciate good will of the company.

Buyers may prefer a stock sale in limited circumstances.

A buyer may simply want to avoid the hassle of an asset sale. There is more legal work for your small business lawyer in an asset sale. In an asset sale, there may be several auxiliary agreements to transfer the intangible and tangible assets to the buyer in addition to the purchase and sale agreement. In a stock sale, these auxiliary agreements are not necessary.

Take for example, the business’ website. In a stock sale, the website is part of the business and no further transaction other the purchase and sale agreement is necessary. In an asset sale, the website needs to be transferred from the selling business to the buyer.

A common reason a buyer may prefer a stock sale is because the buyer wants to assume existing contracts without the need for an assignment. In the purchase and sale of a government contractor, the buyer may prefer a stock sale. There may be an issue with an asset sale whether the government contracts can be assigned to the buyer without renegotiating the contract with the government, known as a novation.

The buyer may be particularly interested in assuming the past performance and various registrations of an existing business.

Similarly, depending on the language in a particular contract, a contract may or may not be assignable. In a stock sale, depending on the language in a particular contract, a buyer may be able to assume what otherwise would be a non-assignable contract.

Asset sales involve more hassle after closing.

Even though buyers favor asset purchases, asset purchases are more of a hassle than stock purchases.

In an asset purchase, the selling company’s assets need to be re-titled in the buyer’s name. Any agreement, including vendor agreements, leases, employment agreements need to be assigned to the buyer or renegotiated.

In a stock purchase, the buyer takes the target’s assets and liabilities, lock, stock and barrel The buyer does not have to re-title or re-value any assets. Contract rights transfer automatically to the buyer.

Price in a stock sale may be discounted.

In general, because of the different structures and the tax advantages to the buyer from an asset sale, a stock sale may be sold at a discount in comparison with the same company selling its assets. You should do your homework. Speak with a valuation consultant about how much of a discount is appropriate for a stock sale.

Purchase agreements will reflect the structure of the transaction.

There are commonalities between a purchase agreement for a stock purchase and a purchase agreement between for an asset purchase. You will find representations and warranties in both agreements.

But there are some major differences. For example, the asset purchase agreement must identify all of the assets that are being purchased and any liabilities being assumed. This list of assets may be lengthy. The parties should go through in detail which assets are being transferred to the buyer.

Conclusion.

For most purchasers of small businesses, asset purchases are more advantageous. They provide greater safety in terms of liability and have tax benefits that stock purchases do not. There are limited circumstances in which a stock purchase may make more sense, especially because they are simpler. Before you commence your search, you should discuss with your M&A lawyer before making your decision.