When buying a business, should you structure the transaction as a purchase of the assets of the business or as an acquisition of the stock of the selling corporation?
Most transactions involving the sale of a business can be structured either as an asset purchase or a stock purchase.
Asset Purchase
An asset purchase is the sale of all or nearly all of the individual assets of a business, as well as the assumption of certain specific agreed-upon liabilities. The selling entity continues to exist (although it may eventually dissolve), while the buyer takes over the purchased assets which may include equipment, contracts, intellectual property, customer accounts and inventory. Asset purchase transactions generally do not include the transfer of long-term debt obligations, although it may require the buyer to assume certain such obligations tied to secured assets that are part of the transaction. Net working capital (for example, accounts receivable, inventory, and accounts payable) is often but not always, part of an asset acquisition.
Stock Purchase
A stock purchase, on the other hand, is the transfer and assignment of the ownership of the business entity itself, including all existing assets and liabilities.
Tax and Accounting Issues
The decision between the two alternatives can include detailed analysis of accounting and taxation. But, for purposes of this discussion, we’ll just touch on some key tax issues, which include:
Stepped-up Basis
In an asset purchase, the buyer is able to “step-up” the basis of the assets to the amount paid rather than the value on the seller’s books. This enables the buyer to take tax deductions for the depreciation of those assets on the stepped-up basis. If the buyer later sells those assets, the tax liability from that sale is the sale price less the stepped-up basis (minus applicable depreciation) and any taxable gain is reduced accordingly. Also, in an asset purchase, goodwill (and any other “intangible” assets) is amortized for tax purposes over 15 years on a straight-line basis. In a stock purchase, goodwill is not deducted unless and until the stock is subsequently sold by the buyer.
Section 338 Election
An election under Section 338 of the Internal Revenue Code enables a stock purchase to be treated as an asset purchase for purposes of taxation. The IRS refers to a stock transaction involving a Section 338 election as a “deemed asset sale.” Both the buyer and seller must agree to the election. The buyer must pay any taxes that are accrued from the step-up in basis of the assets. Thus, the difference between the seller’s tax basis and the buyer’s new stepped-up tax basis results in an immediate tax liability, however, the buyer still gets the advantage of the amortizing goodwill over 15 years. Thus, the decision whether to consider a Section 338 election can involve complex financial analysis.
Advantages of an Asset Purchase
Liabilities
In addition to the tax advantages described above, a key reason to buy a seller’s assets instead of its stock is that buyer can choose what, if any, liabilities it is going to assume in the transaction and those which it wants no part of. In a stock purchase, the buyer is exposed to liabilities that are either unknown to the seller or otherwise not disclosed or discovered during due diligence. In an asset purchase, therefore, due diligence, while still important, is not nearly as vital and as a result is less costly and time-consuming. It should be noted that careful drafting of the terms of the asset purchase agreement is critical to prevent post-closing “successor liability” issues for the buyer, particularly for employment-related issues.
Shareholders
The buyer in an asset purchase doesn’t need to be concerned with minority shareholders who refuse to participate in the transaction. That’s the seller’s problem if it’s a concern at all.
Employees
Most often in an asset purchase, the seller’s employees are terminated (unless the seller has a continuing need to employ them post-transaction). The buyer is able to select and rehire the specific employees they want to employ, if any. The seller is responsible for any costs of termination, including any effects on unemployment insurance rates as well as any legal claims and statutory compliance.
Disadvantages of an Asset Purchase
Contracts and Accounts
Most often, the reason for acquiring a business whether through an asset purchase or stock purchase is the revenue that comes with the transaction. But, in many cases that revenue is inextricably tied to written contracts with its customers and/or suppliers. Therefore, acquiring the physical assets without acquiring the contractual rights is not usually desirable. It must be determined during due diligence whether customer agreements are freely assignable or if permission must be obtained from the customer to assign the account to the buyer. If the customer must permit assignment, is the customer likely to grant such permission unconditionally or use the assignment request as a basis for terminating or renegotiating the terms of the contract?
Government contracts are generally not freely assignable and therefore if government contracts are a significant reason for undertaking a transaction, a stock purchase may be the only option. The same analysis must be undertaken with regard to any key supplier relationships that are intended to be assumed as part of an asset purchase, as well as any office or other space leases and software licenses. Some of those agreements may not be freely assignable, or assignment may be conditioned on something such as proof of creditworthiness.
NOTE: In some cases, permission must be obtained from customers and/or suppliers on a change of control which is triggered by a stock purchase transaction. This means that a key advantage of a stock purchase would be negated. This is very common with government contracts.
If any transferred assets are subject to financing, such as real estate and motor vehicles, the finance contract or mortgage must be assigned to the buyer or replaced with other financing (unless it is paid in full as part of the purchase price). Commercial leases must also be assigned to an asset buyer, unless the space is not needed. In those cases, consent from the lenders and/or landlord is necessary.
Taxes
As discussed above, the buyer may be able to take advantage of favorable tax treatment in an asset purchase. However, conversely, the seller may have to pay taxes on the sale of assets and therefore may require additional compensation. Thus, a negotiation may be required to resolve these potential inequities.
Employees
While retaining only select employees is often considered an advantage, the flip side is that there may be key employees who are not willing to work for the buyer or who use the transaction as an opportunity to renegotiate the terms of their employment, knowing they have leverage.
Advantages of a Stock Purchase
Complexity
While due diligence is generally more costly and time-consuming in a stock purchase, in other respects, a stock purchase is often a less complex transaction. The buyer becomes the new owner of the stock. There generally isn’t as much need to be concerned with assignments of contracts or leases, title issues, employees or other issues affecting the continuity of the business.
Asset Purchase vs. Stock Purchase In Summary
Choosing between an asset purchase or a stock purchase transaction is not a simple decision. There may be significant tax ramifications and other considerations for both parties. There may be substantial advantages for one party that are offset by disadvantages to the other party in either case. The issues mentioned in this article are just an overview of some of the key concerns but are by no means an exhaustive list. Professional tax and legal advice are highly recommended to anyone considering the acquisition or sale of a business or business assets.
Widerman Malek Attorneys
If you have any questions about the information in this article or other legal issues related to buying or selling a business, please contact me.
