If you're buying or selling a business, the deal will almost always be structured either as an acquisition (through an asset purchase or a stock purchase) or as a merger.
In concept, the easiest way to buy a business is to purchase a seller's assets, free and clear of any liabilities. The purchaser is not actually buying the business entity itself. Thus, an asset purchase is much like buying the seller's merchandise without buying the store.
As a rule of thumb, a buyer will usually prefer an asset purchase agreement. Some of the reasons why are:
- The buyer has the ability to acquire assets only, without assuming any liabilities of the seller. The buyer can also pick and choose which assets to acquire. Conversely, the seller can choose which assets to keep.
- The buyer gets a "stepped-up" tax basis on the assets being acquired.
- The buyer usually has the option but not the obligation to hire employees of the seller's business.
- The buyer also has the ability to pick and choose which contracts to assume.
In simple terms, a stock purchase may require only that the selling shareholders swap their stock certificates for a check from the buyer. In contrast to an asset purchase, the buyer is actually taking over the seller's store and not just purchasing the merchandise. In essence, the buyer steps into the shoes of the selling shareholders.
- All other things being equal, sellers will usually prefer a stock purchase agreement because of favorable tax consequences. They may be able to realize capital gains treatment on the sale of stock. This avoids "double taxation" that can result with an asset purchase where the business entity is first taxed on sales proceeds, and the shareholders are then taxed again on distributions that may then be made to them.
- The result can be a seamless change of ownership. The "store" may look like it is under new management but title to corporate assets and everything else can remain the same. Thus, there is a better chance of preserving the status quo. Employees can remain in place. It may not be necessary to change title to assets or assign existing contracts to a different business entity. Good will and other intangible assets remain with the seller's business.
- Buyers are wary of stock purchases because they end up assuming liabilities of the seller. Thus, a seller must anticipate that a buyer will expect some concessions. The buyer may, for example, insist on very strong indemnification language from the seller. The purchase price may also be adjusted accordingly.
A merger is a marriage of two businesses. It shares a lot of the characteristics of both an asset purchase and a stock purchase. In most cases, a "surviving" corporation will issue new stock to shareholders of a "disappearing" corporation in exchange for their stock in the disappearing corporation. The surviving corporation then takes title to all the disappearing corporation's assets, and the disappearing corporation ceases to exist.
- A merger is the time-tested vehicle for recognizing the united strength of combining two or more business entities into a single venture. There is no "buyer" or "seller" in a merger so the "us against them" mentality tends not to get in the way.
- A merger will also allow for economies of scale. While employees in duplicate positions may be laid off, the intent is to improve the bottom line by cutting overhead and increasing efficiencies. Tax consequences can be neutralized or deferred. Properly structured, swapping stock will not result in any taxable gain to the shareholders of either of the merging organizations.
- There are many hidden pitfalls to any merger or acquisition, so it is essential to get good legal and financial advice before agreeing to anything.
Most acquisition agreements involve many of the same kinds of provisions, including the following:
- Introductory provisions. The agreement typically begins with a recital of the parties and a description of the transaction, and contains the definitions of terms.
- Terms of the transaction. Every acquisition agreement contains a description of the structure of the transaction, the purchase price, the time and method of payment of the purchase price, and other matters relating to the terms of the transaction.
- Closing. The acquisition agreement contains a provision as to the time and place of the closing and the documents to be delivered by the purchaser and the seller.
- Conditions to the obligations of the purchaser. After the acquisition agreement is signed, there are typically other steps that need to be taken before the transaction can be closed, such as filing documents with the Securities and Exchange Commission. There are also a variety of conditions that must be met for the purchaser to be obligated to close the transaction. For example, the agreement sets out representations and warranties made by the seller and states that the purchaser can terminate the agreement if those representations and warranties are not met. Also, the sale can be conditioned on the approval of the shareholders. Further, if there is a material change to the business or financial condition of the seller, the purchaser can terminate the agreement.
- Conditions to obligations of the seller. The agreement also includes conditions to the seller's obligations to close the transaction. While the purchaser typically makes very limited representations and warranties in a cash transaction, it makes significantly more if it is issuing stock or debt instruments to the selling company or the selling shareholders. These include many of the same representations and warranties made by the seller.
Questions for Your Attorney
- Why would a buyer prefer to buy just the assets of another business instead of the entire business?
- When a buyer purchases a business by buying its stock, does the buyer assume the liabilities of the business?
- If a buyer and seller of a business sign an acquisition agreement, do they have to follow through with the sale?