Buying & Selling a Business Part 1: Asset Deals vs. Stock Deals - Factors to Consider
When buying or selling a business, evaluating the alternatives for a deal structure that fits your current operations, tax attributes, and desired outcome is crucial. This three-part series discusses asset deals and stock* deals and highlights key considerations for business leaders who may be exploring a purchase or sale transaction of your business. In Part 1, we will provide you with an overview of asset and stock sales and weigh-in on their pros and cons.
In an asset deal, the buyer creates a new legal entity with which to acquire substantially all of the assets of the target business. Such assets may include the business name and trademarks, equipment, inventory, , real estate, intellectual property, and goodwill (such as company brand, reputation, customer relations, etc.). Only certain specified liabilities will be assumed, such as ordinary course trade payables and obligations under assumed contracts. Given that the buyer is creating a new legal entity, all employees would need to be terminated at closing by seller and rehired by the buyer. When the transaction closes, the seller entity continues its corporate existence (at least on an interim basis), although stripped of operating assets other than cash including the proceeds of the sale. The buyer controls the acquired business by virtue of owning all of the operating assets, often including the name and goodwill.
One of the main advantages of an asset deal for a buyer is the ability to limit the risk of unknown or unidentified liabilities by expressly assuming only certain liabilities. (Buyers should, however, be aware of the possibility of statutory or common law successor liability risks even with an asset deal. These risks may include certain taxes, products liability, and possibly employment-related claims.).
From a federal tax perspective, asset deals are also often favored by buyers because of the possibility of allocating a meaningful portion of the purchase price to depreciating/amortizing assets, and with an effective “step up” of the tax basis on those assets. This can result in future tax savings for a buyer through advantageous depreciation and amortization of those assets. The IRS requires the buyer and seller to allocate the sales price among assets in a consistent manner, so there can be some opposing considerations in this regard. Furthermore, in Washington, real estate excise tax is by statute a seller obligation whereas sales tax applicable to personal property is a buyer obligation, so attention needs to be given to the state tax impacts of a particular asset allocation.
Additionally, the parties will need to understand the assignability of key assets such as permits, insurance policies, leases and contracts. While third-party consents may still be needed where there is a change of ownership in a stock deal, an asset deal structure often requires multiple third-party consents, making the timing of each challenging given that the parties often want to maintain confidentiality until relatively close to the closing date.
In a stock deal, the buyer acquires all or most of the outstanding stock of the target company. When the transaction closes, the subject company maintains its corporate existence, but since the buyer now owns all of the stock of the target company, it controls the business by virtue of being its new owner.
Except in specialized circumstances (such as a 338(h)(10) election for S corps), the buyer in a stock deal steps into the shoes of the seller in terms of basis in the underlying assets. The buyer in a stock sale is also the successor to whatever liabilities exist, known and unknown, increasing the risk of successor liability issues. While the parties often negotiate representations, warranties, indemnities and other protections to attempt to mitigate these risks, stock deals are generally considered to involve a somewhat higher degree of liability risk for buyers.
As noted above, however, a stock deal may make ongoing relations with employees, insurance and contract counter parties easier.
Finally, most stock deals are predicated on the idea that all of the shareholders will participate as an organized block. If that is not the case, an asset deal may be easier to negotiate depending on the governance structure involved.
If you are considering buying or selling a business, the lawyers in Stokes Lawrence’s Business practice can assist with the transaction and answer questions regarding your specific situation.
Next up: Part 2 of this series will discuss the steps necessary to prepare for closing.
*For ease of reference, this post refers to “stock,” but the term stock should also be read as membership interests in a limited liability company.