Buying a Business: Asset vs Stock Purchase

06 September 2021

Asset purchase or stock purchase: When buying a business – or when selling one, for that matter – which of these two general categories are better for structuring the deal?

There are, of course almost countless ways to structure the deal within both those categories but one or the other approach must be chosen first; and each enjoy both pros and cons for both buyer and seller.

The Small Business Conundrum

In many small business sales, buyers are advised to use an asset purchase approach, primarily to shield them from undisclosed or undiscovered liabilities, the most common of which is unpaid taxes.

Many small business owners either operate on slim margins or spend the cash flow like drunken sailors. In the former instance, they need to keep the employees paid and the vendors current. Or in the latter they might like livin’ large and the payments – and insurance! – on that F8 Tributo current  As such, the last person or organization that gets paid is usually the government taxing authorities.

In such instances, the business may have an enormous back tax liability that, unless the buyer is extraordinarily savvy or represented by a knowledgeable business broker, may not become evident until months or even years after the deal closes and a panic-inducing “Dear Business Owner” letter arrives demanding the immediate payment of tens of thousands of dollars in back taxes, interest and penalties.

Of course, one possible solution to this issue is for the buyer to demand from the seller proof that all taxes have been paid – and confirmation from the taxing authorities that such proof is accurate – during the due diligence period. But in our more than 20 years experience, this is often overlooked – and just as often, does not provide iron-clad protection.

How the buyer chooses to acquire the business – asset purchase or stock purchase – will make all the difference for the potential of a “Dear Business Owner” arriving.

Why? Because an asset purchase is when the buyer acquires the assets of a business – and sometimes certain liabilities. An asset purchase give the buyer a choice about which aspects of the business will be bought.

A stock purchase is when the buyer purchases the owner’s ownership in the business entity – if a corporation, the owner’s shares of stock; if a limited liability company (LLC), the owner’s membership interest in such LLC. In a stock purchase, the buyer buys the proverbial whole nine yards. There’s rarely any choosing in a stock purchase.

Asset Purchase

As a rule, potential legal liabilities and tax implications are usually the parties’ primary concerns in an asset purchase. Aside from the example of the tax liability that I touched on above, there is the potential for additional tax liabilities – based on how the parties allocate the purchase price and a tax professional should be consulted to avoid potentially mistakes in this area.

But potential legal liabilities can be just as onerous – and sometimes more so.

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For example, in the case of a small manufacturer or distributor of chemicals – or of products that contain chemicals – the potential for lawsuits can be significant. This is particularly true in the United States where suing everybody in sight seems to have become a national pastime.

An asset purchase protects the buyer from most of these types of liabilities if they arise from the business’ practices prior to the transfer.

But an asset purchase also has some disadvantages.

For starters, for the buyer to be able to keep the employees, the seller must fire them and the buyer must then re-hire them. This can be an immense challenge especially if some of the employees have employment contracts with the company.

Another issue is the cost and time required to re-title certain assets.

For example, if the business in question owns a small fleet of delivery vehicles, each would have to be re-titled into the name of the new entity. Yes, this may be little more than a minor hassle but in most areas, this will include not only a re-titling fee but also a sales tax given that the seller is selling the vehicles to the buyer.

And finally, there is the question of contracts. Each existing contract that binds the company will have to be assigned or renegotiated. In some cases – especially of the company has dozens of supply agreements, some with customers, other with vendors – this can be a hassle of the first order.

Some vendors may recognize that they stand in the way of the seller and buyer completing a deal and realize that they all of a sudden have a degree of leverage that would be difficult to imagine under day-to-day circumstances. One or two hold-outs can gum up the works in a heartbeat.

Stock Purchase

In a stock purchase, the buyer takes over the business entity lock, stock and barrel. The transaction is simpler and more straightforward but includes all the liabilities, known and unknown.

Rarely will contracts – employment, vendor, customer or any others – need to be dealt with. They transfer automatically and seamlessly to the new owner.

Some of the advantages of a stock purchase include no need to value or re-title any assets. That small fleet of delivery vehicles stays in the name of the business.

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Employees stay employed by the company and no employment contracts are breached or need to be renegotiated.

The same is true for vendor and customer contracts. They, like all other assets and liabilities, simply pass with the business entity to the buyer; UNLESS there is a change-of-control provision in any of them.

As with asset purchases, stock purchases have their own disadvantages.

A big one is that the buyer can’t pick and choose what assets and liabilities to include. They’re ALL included – the good, the bad and the ugly.

For example, if the business is a building supply or auto supply, there is almost certainly going to be obsolete inventory – stuff that the business has been carrying on its books for the last 10 years such as a transit level in the age of laser models or a muffler assembly for a ’79 Pinto.

All the payables and past-due receivables are part and parcel of the deal. And if any receivables are 90+ days past due, there would be some serious doubt as to their collect-ability.

In fairness, some of these issues might be able to be resolved by creating a side agreement wherein the sellers retain responsibility for certain liabilities. This, however, requires a reasonable seller.

The Bottom Line

The vast majority of deals are asset purchases rather that purchases of the stock of a corporation (or the membership interests of a LLC). The main reason is that knowledgeable buyers generally are not comfortable with the potential of acquiring liabilities that they don’t even know exist.

So, which type of sale is the right one for a particular buyer? The answer to that question requires the input of talent – a tax advisor, a financial planner and an experienced business broker.

If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

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This week we received an inquiry from a small private equity fund looking for B2B opportunities, with recurring revenue and low capital intensity located anywhere in the United States. If any of you know of something that might fit, please let me know.

I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.

Joe

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The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com