If you’re considering buying a business – or if you’re a business broker working with a client buying a business – it’s important to know the difference between an asset purchase and a stock purchase. The distinction is very important.
Why? Because each method entails its own pluses and minuses.
Though the term “stock purchase” might be thought to pertain only to businesses set up as corporations – because only corporations can issue stock – in our world it can also apply to other forms of business entities such as LLC’s, partnerships, etc., because the owners of such entities can sell their membership or partnership interests in these entities.
In a stock purchase, the buyer buys everything the company owns, including all its liabilities. In an asset purchase, the buyer may or may not
buy everything the company owns.
Sellers generally prefer a stock purchase because it gives them a quick, clean and simple break from the business with no future ties once the transaction is completed
On the other hand, we generally advise buyers to pursue an asset purchase because it allows them to choose what assets to buy.
That comment might imply that the business being bought is being broken up and sold off in pieces. While this is occasionally true, it generally means that the buyer has the option of determining whether any of the assets are outdated or of little or no use to the business.
Let’s look at each approach a little closer.
Buying a Business: A Stock Purchase
As its name indicates, in a stock purchase, the buyer isn’t buying any
assets, per se. Instead, he or she is buying the stock, or similar ownership interest in the business entity, along with the right to assume the prior owner’s role. This generally results in less legwork and paperwork for the parties because there is no need to re-title individual assets in the name of the buyer or perform valuations on all the assets.
As I mentioned above, sellers generally prefer this method because it’s cleaner; they can ride off into the sunset with no loose ends to worry about.
But a stock purchase can entail negative aspects, as well, and for both parties. In a stock purchase, the buyer assumes all the business’ liabilities. For the seller, if there is more than one stock holder or member, getting everyone to agree to sell and on what terms can be tantamount to herding cats.
It is not uncommon that a business will be owned by multiple individuals such as family members that invested in the early years of the business or managers that were given equity as motivation. In a situation like this, it’s possible that some shareholders will want to keep their stock. In this scenario, even one holdout can create an assortment of headaches that will delay the transaction’s closing and reduce the ultimate price received.
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Buying a Business: An Asset Purchase
Buyers prefer asset purchases because they get to evaluate the assets and determine which ones they want.
Have you ever driven past the home office of a large plumbing company or a specialty metal fabricator? The ones I’ve passed generally have all sorts of junk – from old plumbing fixtures and the rusting hulks of ancient trucks to piles of scrap metal – lying around. A buyer would realistically not want to pay for that – nor have to pay to haul it away.
A company’s assets might include outdated inventory or equipment. We handled the sale of a regional building supply business. The buyers didn’t want to acquire any inventory that had not turned in more than three months. We also handled the sale of a publishing company whose assets included the building the company operated in. The buyer did’nt want the real estate, so the deal was structured as an asset purchase that excluded the real estate. The seller kept the real estate and leased it to the buyer.
In some situations, a buyer may want only intangible assets such as the business’ intellectual property, brand names and websites or trademarks and copyrights.
Finally, this type of arrangement also allows buyers to forego the purchase of any assets (tangible or intangible) that carry certain risks. A good example here would be a business whose past operations involved underground storage of petroleum products; tanks, pumps, etc., may all involve potential liability down the road.
If you’ve been reading this blog for any length of time, you probably know that an asset purchase is the way most strategic buyers
would pursue a deal.
What About Taxes?
When it comes to tax implications, buyers and seller are impacted differently by each of these transaction methods.
In the most common method – an asset sale – the buyer will want to assign more value – a higher percentage of the purchase price – to the assets and a lower value to the goodwill. Doing so allows the buyer a higher basis for both depreciation (which lowers taxable income in subsequent years) and capital gains (which lowers capital gains taxes) when the buyer eventually becomes the seller down the road.
Conversely, the seller will want a lower value assigned to the assets which will lower the seller’s capital gains and, thus, taxes. The parties must consult with their respective tax advisors and then the broker or brokers must try to negotiate the values to be assigned. It can be a pain in the butt to get everyone to agree but we’ve seldom seen a deal fall apart because the parties could not come together on this issues.
But the big tax issue is a more immediate one, and that is withholding taxes.
Liability for withholding taxes goes with the company. If the transaction is a stock purchase, the buyer assumes this liability.
If the seller has not been sending to the tax authorities the money that has been withheld from the employees’ paychecks, the buyer
is responsible for paying whatever amount has been withheld but not remitted.
Imagine a business with a dozen employees. The owner has been withholding the appropriate amount of taxes from each employee’s paycheck but has not sent that money to the taxing authorities for three years. At some point, this is going to be noticed by the authorities and they will be coming after the new owner.
This situation is one of many reasons that buyers need
competent representation and should hire a professional business broker for that role.
The Bottom Line
When we’re working for someone that is buying a business, we always advise that they pursue an asset rather than stock purchase. They generally follow this advice.
But as most of you know, as business brokers, the vast majority of our clients are sellers – the owners of the business being sold. In these cases, we always advise our client on the difference between an asset and stock purchase and that most reasonably knowledgeable buyers will want the transaction to be an asset purchase.
Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
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If you have any questions, comments or feedback on this topic – or any topic related to business – I want 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.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
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