How many of you have had the fortune of being able to establish your own business? From great idea to entrepreneurship, the journey is full of ups and downs: Obtaining funding for a startup, worrying about making payroll, celebrating unprecedented profits.
But then life happens and you are ready to move on to something else. You start thinking about selling your business and wonder what mergers & acquisitions (M&A) are all about. Or maybe you learn that your company is being bought, and you have no idea of what comes next.
Although mergers & acquisitions happen all the time, the reality is that the subject is lengthy and complex. In the interest of making it easier to digest, we’re creating a blog series on it, so that you can browse for the topic you need, when you need it.
Today, we’re addressing the question of stock versus asset purchases.
Mergers and Acquisitions Basics: Stock Versus Asset Sale
In a nutshell, there are two types of acquisitions:
Stock acquisition: Typically, with stock acquisitions, the risk for the buyer is that they step into the shoes of the prior shareholder(s), and the buyer inherits all of the company’s liabilities. There are ways to contract around this by including indemnification and other risk mitigation clauses in the purchase agreement. However, ordinarily, the buyer becomes liable, and he or she would have to go after the seller if it turns out the seller committed fraud during the sale or if an indemnification trigger occurs. For this reason, and for tax reasons we won’t touch on today, most buyers strongly prefer asset purchases.
Assets acquisition: This type of purchase occurs when one company purchases all or most of a “target” company’s assets then owns those assets in its own new entity. Assets include goodwill, intellectual property, assignable contracts, physical assets, customer lists, etc. In contrast with a stock purchase, when a buyer acquires a company’s assets, these are transferred to the buyer; but he or she does not assume the liabilities unless there are liabilities the buyer contractually agrees to assume. For example, if the buyer is getting the benefit of accounts receivable as an asset, the buyer will typically assume all of the accounts payable that go along with the A/R.
So why would any buyer choose a stock acquisition when the risk is so high?
There are a few reasons why a buyer would choose the higher risk option. For one, if the company that is being acquired has a lot of unassignable contracts (where the consent of the other party is required to assign them), the buyer may not want to risk that those customers won’t agree to an assignment. By doing a stock purchase, the contracting entity stays the same so that no assignment is needed. In other cases, the buyer may want the benefit of the selling entity’s strong credit history and vendor reputation.
As an example, think about a buyer of a car dealership. It is extremely burdensome to obtain dealership approval to sell automobiles. If the buyer were to only purchase the assets, and the dealership could not be assigned, then the buyer is likely to prefer to step directly into the shoes of the existing entity as a shareholder and simply retain the dealership status.
How do the Parties Choose?
For both parties, there are numerous and fact specific considerations that impact how best to structure an acquisition, and many tricks of the trade. Even a stock purchase can, for example, be characterized for tax purposes as an asset purchase if the parties agree to make a special tax election under a special section of the tax code known as Section 338(h)(10). If you don’t know these nuances, you may make a less than ideal choice that can cost you hundreds of thousands of dollars. Make sure to engage an experienced M&A attorney and tax advisor when selling your business or buying a business.
This Blog was written by Hunter Business Law Founder, Attorney Sheryl Hunter. View her profile HERE.