Buying or selling an existing small business can be an exciting endeavor. Purchasing an already-existing business also has multiple advantages for buyers. Buying a pre-existing business can reduce startup costs. Furthermore, if the business has had past success, the purchaser can also take advantage of customer goodwill and will likely have easier financing opportunities. However, purchasing or selling a small business can also be a challenging and daunting process. The purchasing cost and other legal issues can discourage prospective buyers. Luckily, our attorneys can help you navigate these transactions. This post will walk you through the two main types of business acquisitions: asset purchases and stock purchases and what is required to complete such transactions.
What Is an Asset Purchase?
An asset purchase is when a buyer acquires only the seller’s assets and liabilities that it identifies. Such assets can include real estate, equipment/machinery, certain stocks, goodwill, or existing contracts. The buyer does not obtain control of the entity as a whole. Title to the purchased assets will be transferred to the buyer’s name.
What Is a Stock Purchase?
A stock purchase, also known as an equity purchase, is when the buyer takes full ownership of a business’s outstanding stock. In other words, the purchaser acquires all of the business’s assets and liabilities, becoming the legal owner of the business entity as a whole. Because the purchaser acquires the business as an entity, the assets remain titled in the company’s name.
What Are a Purchaser’s Advantages for an Asset Purchase?
Overall, there are multiple benefits to entering an asset purchase instead of a stock purchase including: tax benefits, flexibility, and circumventing any negotiations with minority shareholders
One major advantage of an asset purchase is that it can lead to a tax benefit for the purchaser. For an asset purchase, the purchaser receives a cost basis in the acquired assets. In other words, when the purchaser acquires the asset, the new basis for the acquired asset is the price paid in the sale. In a stock sale, a purchaser is forced to take on the existing basis of the assets.
An asset purchase also offers greater flexibility compared with a stock purchase. The purchaser can selectively identify which assets and liabilities it wants to obtain. Furthermore, the purchaser will not be subject to any hidden or unknown liabilities, which can reduce its vulnerability in the future. On the other hand, in a stock purchase transaction, the purchaser assumes all liability even those that are unknown or undisclosed at the time of the transaction.
Bypassing Negotiations with Minority Shareholders
In an asset purchase agreement, the purchaser does not have to worry about minority shareholders agreeing to the sale. An asset purchase agreement does not require the consent of minority shareholders. On the other hand, a stock purchase agreement will require a buyout of the minority shareholders.
What Are the Purchaser’s Advantages for a Stock Purchase?
There are other circumstances where it might make more sense to engage in a stock purchase. Advantages of a stock purchase can include: simplicity, assignability, and dealing with periods of economic downturn.
Simplicity of the Transaction
The major advantage of stock purchase is that it usually results in a more stable change in ownership and management. In other words, transacting for a stock purchase is a simpler process than an asset purchase. Asset purchases require more formalities and documents because there must be transfer for each of the seller’s assets and liabilities.
Assignability of the Assets
A stock purchase does not require the company to title all of the assets in the purchaser’s name. This benefit should not be overlooked because re-titling assets can be a lengthy and difficult process; especially when dealing with complex assets such as trademarks or patents.
Navigating Economic Decline
Another advantage of a stock purchase is that during times of economic decline, the purchaser’s basis cannot exceed the fair market value of the purchased assets. On the other hand, for an asset purchase, if a purchaser acquires assets with diminished values, the asset purchase would result in a “step-down” basis of the purchased assets.
What are the Seller’s Advantages for an Asset Purchase?
One advantage of an asset purchase is that the seller may be able to demand a higher purchase price for the asset than that asset would have gone for in a stock purchase arrangement. However, such a price is usually demanded because the tax costs of an asset purchase are quite high.
Overall, for the reasons stated above, asset purchases generally favor purchasers as opposed to sellers.
What are the Seller’s Advantages for a Stock Purchase?
For sellers, the major advantages for a stock purchase include tax treatment and liability.
When sellers transfer their stock in the company, the proceeds are often taxed on their personal tax return at lower capital gain tax rates. Therefore, there are tax benefits to a stock purchase as opposed to an asset purchase.
Because a buyer in a stock purchase acquires the company as an entity, sellers can insulate themselves from liability. When the seller in a stock purchase executes the sale, they are free to walk away free of all of the company’s assets and obligations which are now imposed on the purchaser.
Pre-Purchase Activities: Conducting Due Diligence
Before purchasing any business, it is important that a purchaser engages in due diligence. Due diligence is the formal process by which a purchase must examine all information about the seller. Conducting due diligence can ensure that the seller can follow through with the transaction. Due diligence can also provide protection from any surprises that might arise after the deal is completed. Alternatively, due diligence can also lead to the uncovering of important information that leads to a renegotiation of the purchase terms.
Both asset purchases and stock purchases require the purchaser to conduct due diligence before finalizing a transaction. However, because the purchaser is assuming a greater amount of risk for stock purchases, an even greater amount of due diligence is usually required.
Drafting & Finalizing the Asset Purchase Agreement or Stock Purchase Agreement
After conducting due diligence, a purchase agreement can be drafted and signed by the transacting parties. General provisions of both an asset purchase agreement and a stock purchase agreement include: the identities of the buyer and seller; language that shows that there is an agreement to sell; the specific assets and liabilities that are being transferred and assumed; procedures for transferring assets; covenants; and any conditions for closing.
Overall, acquiring a small business can be legally complex. Counsel from a stellar business attorney is instrumental to deciding whether an acquisition is proper and completing the transaction. Dudley and Smith, P.A. has experienced business law attorneys, including Joseph J. Dudley Jr. and Steven C. Opheim, that can help you with multiple aspects of the business purchase including: drafting and review of purchase agreements, due diligence, and succession plans. If you have questions about a stock purchase or asset purchase, please contact Mr. Opheim or Mr. Dudley at 651-291-1717. Dudley and Smith, P.A. is a full-service law firm with offices in Blaine, Bloomington, Burnsville, Woodbury, Eagan, Eden Prairie, Roseville, Mendota Heights and White Bear Lake.
The law is continually evolving and Dudley and Smith, P.A.’s blog posts should not be relied upon as legal advice, nor construed as a form of attorney-client relationship. Postings are for informational purposes and are not solicitations, legal advice, or tax advice. A viewer of Dudley and Smith, P.A.’s blog should not rely upon any information in the blog without seeking legal counsel.