When you are looking at buying an existing business you need to understand your options. Should you purchase the assets (asset purchase) of the business or the stock (stock purchase)? There are advantages and possible disadvantages to each, and it is important to understand which may be better for you.
What is an asset purchase agreement?
An asset purchase agreement is an agreement between buyer and seller to acquire an organization's assets. A company's assets can include anything from computers and software licenses, machinery, buildings and furniture to product inventory. It is also important to consider that assets can include vendor information, domain names, websites, logos, and marketing materials. With an asset sale, only specified assets are transferred, and those assets must be re-titled to the new owner.
What is a stock purchase agreement?
A stock purchase agreement is an agreement between a closely held or private firm and its shareholders for the sale and transfer of firm's shares. This means that the buyer is obtaining ownership of the company through the purchase of the shareholder's stock. The assets and liabilities purchased are similar to an asset sale, the means of purchase is the difference.
What are the advantages and disadvantages of an asset purchase sale?
Advantages of Asset Purchase Sale
When you buy a company through an asset purchase, you are able to choose which assets and liabilities you are willing to assume. You can decide if you want to purchase the company's goodwill, trade secrets or trade names. Buyers can avoid inheriting potential liabilities including contract disputes, product warranty issues, or employee lawsuits. Net working capital is usually included in a sale, and if the purchase price is higher than the aggregate tax amount of the assets the buyer will receive value in assets equal to the purchase price. It is also worth considering that, for tax purposes, goodwill can be amortized over a period of fifteen years. This can reduce taxes in the short-term and improve the company's cash flow during the first years.
Disadvantages of Asset Purchase Sale
Asset sales can have possible problems for buyers. Some assets are more difficult to transfer because of legal ownership or third-party consents including contracts, leases, and permits. The buyer must re-title the company's assets in their name. Both of these issues may slow down the transaction process. Tax-free reorganization is not applicable to asset purchases. When there are liabilities that are not being included in the sale the parties have to ensure that the purchase is for the fair value of the assets, and that the company can pay its debts after the sale, otherwise the transaction could violate fraudulent conveyance laws. The buyer would need to get a solvency opinion, and that can add to the cost of the transaction.
What are the advantages and disadvantages of stock purchase sale?
Advantages of Stock Purchase Sale
When you buy a company through a stock purchase the process can be simplified as the sale will not require separate conveyances of individual assets because the title of assets are held within the corporation. If there are liabilities that the buyer does not want to purchase they can be paid off or distributed before the sale. The buyer can usually obtain the company's nonassignable contracts or licenses without first getting the consent of the other party. This can be especially valuable if the company has copyrights, patents, or significant government or corporate contracts because the company retains ownership. If the company depends on specific vendors or customers a stock sale may have less risk of losing those contracts.
Disadvantages of Stock Purchase Sale
There are some possible disadvantages of a stock sale. For example, buyers do not have the ability to gain a stepped-up basis in the assets, and therefore cannot re-depreciate certain assets. The value of the assets at the time of sale sets the depreciation basis, the lower depreciation expense may result in higher future taxes for the buyer. Buyers might accept more risk with a stock sale, including all contingent risk that may be unknown or undisclosed. The buyer becomes responsible for any future lawsuits, environmental concerns, and employee issues. Warranties and indemnifications can be included in the agreement to mitigate these liabilities.
Each sale is different, and therefore, there is no one-size-fits-all answer to which purchasing option is always best. Each sale should be evaluated on an individual basis, where pros and cons of each option are explored carefully. Since each business transaction is unique, buyers should always consult an attorney when considering a business sale structure. Contact us today for more information.
Julian Cordero is an Attorney, Music Producer, and Entrepreneur. Oh and he blogs too! Julian is licensed to practice law in New York and is the Managing Member of Cordero Law LLC, a New York City based law firm focusing on Business Law, Entertainment Law, and Intellectual Property.