03 Apr Buying a Business: Stock Purchase vs. Asset Purchase?
You can buy a business in one of two ways: asset purchase or stock purchase.
In asset purchase, the buyer purchases “the business” by purchasing every single asset used by, necessary for or “making up” the business. By doing so, the buyer ends up in effect owning the entire going concern. A business, after all, is simply a bunch of assets brought together and used by the owner and employees to produce goods and/or services.
Purchased assets include desks, computers, pencils, calculators, staplers, tools, equipment, furniture, fixtures, cars, trucks, inventory, etc., including the rights to software, customer lists, accounting packages, vendor lists, web domains, websites, trade names, logos, marketing materials, phone numbers, etc. Purchased assets are listed on pieces of paper. The purchase agreement stipulates that the buyer purchases all assets and that they “make up” the business of X.
Of course, the buyer also must hire all the employees and employ them to continue to “work the business” just as they did before the purchase. This is not difficult to accomplish. Similarly, whether the facilities are leased or owned, the buyer needs to reach an agreement, or agreements, to secure use of the facility – assuming the buyer does not intend to immediately relocate it. Furthermore, to the extent there are other important agreements or contracts that the buyer wants to continue to enjoy or work under, such will need to be provided for – whether by assumption, transfer or negotiation and execution of entirely new agreements. Common items are phone service, utilities, sale representative agreements, supply agreements and credit agreement.
In stock purchase, the mechanics are much easier. The buyer simply buys the stock (or LLC units or S-corp shares, whichever is the case) of the legal entity that owns all of the business assets. This, of course, assumes the business is in fact held in – or owned by or within – a legal entity (i.e., is not a sole proprietorship).
Stock purchase virtually eliminates the need to transfer title (i.e., purchase) to all of the many different assets used in or by the business. It also can eliminate the need to transfer, renegotiate or reapply for things such as permits, utilities, facilities leases and employment agreements. Of course, some contracts may have so-called “change of control” provisions that will require special attention.
Tax matters. Taxes are a major consideration in business purchase transactions. This is because taxes cost real money and impact cash flow and rates of return. Business purchases effected by the asset method almost always provide for lower taxes for the buyer going forward. This is because the asset purchase allows for a step-up in the tax basis of the assets and, in turn, generates depreciation deductions. Business sellers, on the other hand, typically have to pay higher taxes on asset sale transactions, so these issues become points of negotiation – even contention – between buyer and seller.
Liability Considerations. Business purchases effected by stock can be more challenging for the buyer from a liability containment standpoint. It can be more difficult for the buyer to avoid assumption of unwanted, or unknown, liabilities of the purchased business. For this reason, stock purchase transactions can be riskier and also require higher levels of due diligence.
Of course, virtually any liability may be transferred back to (or retained by) the seller by contract (i.e., in the purchase agreement), so just because a purchase is effected by stock does not mean that all pre-purchase liabilities will be borne by the buyer, but it would require considerable seller cooperation and skilled crafting of the definitive agreement.
IRC Section 338 Election. Although there can be some advantages (mainly ease of title transfer) to the business buyer who effects a purchase by stock, most prefer the asset method for the reasons mentioned above (liability containment and tax advantages). Similarly, in some unique instances, the seller is indifferent as to method, but most often the seller prefers a sale by stock (for tax reasons).
Sometimes in these situations, Internal Revenue Code (IRC) Section 338 is useful. This federal tax law allows parties to elect a stock-method business transfer taxed as if it were an asset purchase. The trick is the buyer has to pay the tax bill that arises from the step-up on the basis of assets, which occurs under asset purchase transactions (or, of course, stock purchase transactions taxed as asset transaction by an IRC Section 338 election).
Why would a buyer agree to this and also take on the stock sale liability issues? Well, only if he, she or it has incentive to do so. For one, the buyer would have to get comfortable with the liability issue. Two, the buyer would have to feel okay about the tax bill. Such can occur if or when the seller provides the buyer with incentive to do so, for example, a reduced purchase price. The tax bill issue also can “go away” in instances where either the purchased entity or the purchasing entity has tax losses that can be used to shelter the gains.
Buying a business is a very serious, complex matter. Seek the advice of legal, tax, and merger & acquisition experts such as Acquisition Advisors (www.AcquisitionAdvisors.com).