Small business acquisitions and sales are monumental transactions for the average entrepreneur. The process will be filled with dozens of important decisions, discussions, documents, and logistics.  Some deals are negotiated and closed within a month, while others can drag on for a year or more.

One of the early decisions to make is how the transaction will be structured. Will the buyer be purchasing the stock or equity of the target company, or will it purchase its assets? The decision involves time and attention as both the buyer and seller will have various reasons to prefer one structure over the other. Here is a quick summary comparing and contrasting the two deal structures.

A Stock (Equity) Sale

A stock or equity deal refers to the acquisition of the stock or ownership interests in the target company (i.e., a limited liability company, corporation, etc.). Equity purchases result in the transfer of the ownership of the target company, but the target continues to own its assets and liabilities after the deal closes. Same company, new owner.  If given their choice, sellers typically will prefer a stock sale, and here are some reasons why:

Fewer Complexities. Equity deals are relatively straightforward as the assets and contracts of the target (e.g. leases, permits, vendor agreements, purchase orders, etc.) remain with the target company without additional need for renegotiation. However, because this structure necessarily involves the offer and sale of a security, the parties should be sure to consider the possible application of federal and state securities laws before selecting this method of acquisition.

Lower Transaction Costs. An equity deal is generally less expensive to execute as the buyer does not have to revalue or retitle individual assets. The need for negotiating with third parties on contracts is also less likely unless the document includes a provision prohibiting a change in control of the target.

Taxes. In most situations, an equity deal is less advantageous for a buyer from a tax perspective. A buyer will not receive the benefit of a tax basis step-up nor will goodwill be tax deductible. However, in most states a buyer can avoid paying transfer taxes on assets assumed in an equity deal. Depending on the value of the real estate and other assets involved, this could be a significant savings.

Risk. A buyer often assumes more risk in an equity transaction because the buyer is assuming the historical liabilities of the target company (known and unknown).  It is important to ensure that a buyer performs proper due diligence during the process and that appropriate protections are negotiated into the purchase agreement such as representations and warranties and corresponding indemnification language to protect the buyer from liability for claims based on the operations of the target company’s business prior to closing.

An Asset Sale

In an asset deal, a buyer can pick and choose specific assets of the target company and exclude taking on liabilities of the target unless specifically assumed. In the small business world, asset deals are far more common than equity deals; however, pros and cons still exist in an asset sale.

More Complicated. Asset purchases are typically more complex than an equity deal as most contracts, especially those with employees, customers, and vendors, will require the consent of the other party to the contract to assign them to the buyer or in some cases the contracts will have to be renegotiated in their entirety. Certain assets of the target (e.g., automobiles, airplanes, real property, etc.) will also have to be retitled in the name of the buyer.

Higher Transaction Costs. Because of the additional complexities inherent in an asset deal, asset deals are generally more costly from both the buyer’s and the seller’s perspective. Additionally, a seller may need to sell off any assets not purchased and will have to settle any outstanding liabilities not explicitly assumed in the deal. However, due to the tax implications discussed below, sellers may be able to command a higher purchase price in an asset deal to offset higher tax costs.

Taxes. Buyers generally prefer an asset deal because the buyer can “step up” the basis of the acquired assets to fair market value. This results in additional depreciation/amortization deductions over time. Furthermore, a buyer can amortize goodwill over 15 years for tax purposes. Sellers commonly bear higher tax costs in asset deals, as assets can be subject to higher ordinary income tax rates. In some cases, if the target happens to be a C corporation, a seller may even face double taxation.

RiskBecause a buyer may pick and choose the assets and liabilities it wishes to acquire, an asset deal is relatively less risky from a buyer’s perspective. Nevertheless, it is still important to ensure adequate diligence is performed on the target’s business.

Conclusion

By now it should be plain to see that the transaction structure of a small business acquisition can have important legal, tax, and business implications for both buyers and sellers. Working closely with your business attorney, accountant, insurance and financial advisors will help ensure that your deal is structured and documented properly and closes in a fashion that allows both parties to accomplish their objectives. 

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