By: Chris Way 

 

The Benefits & Risks in Buying a Business

Whether you are an enterprise looking to add a new line of business to your offerings, a company wanting to increase its size and scale by acquiring another, or an entrepreneur in waiting but not in love with the idea of starting from scratch, buying a business can be an excellent opportunity.

Buying a business can provide tremendous upside. Instead of spending years building brand recognition and customer loyalty, you can buy a business that already has both. You can obtain immediate cash flow, existing relationships with suppliers and customers, and a track record of performance. Perhaps you acquire proven, marketable products or services that you can now sell. Perhaps your purchase is for products or services that integrate into your own, so that you don’t need to buy them from third party vendors going forward.

You might obtain a strong business model with important operational systems, processes, and trade secrets that enhance your company’s skillsets. Conversely, you might be able to add your systems and processes to the operations of your acquisition target and unlock untold value in the newly acquired business. You may get a great team of employees with expertise and knowledge to run the operation, allowing you to be at least somewhat of a passive owner at some point. All of these combine to potentially offer returns on your investment faster than if you had started a new business from the ground up.

But it isn’t all sunshine and rainbows. You’re also taking on any problems the business might have. From outdated equipment to unhappy customers to legal issues, the burdens of the business follow the benefits. With some planning, a skilled team of lawyers can help distance you and protect you from the burdens.

But before we do that, let’s explore the two main ways to structure your purchase: an asset purchase or a stock purchase. I’ll use “stock purchase” as a label for all purchases of the ownership interest of a company (e.g., corporations have stock, LLCs have membership interests, partnerships have partnership interests). Each approach has its own advantages and disadvantages, and the choice between them can significantly impact everything from your tax bill to your legal responsibilities.

Understanding these two options is essential because the structure you choose will affect nearly every aspect of your business ownership experience. Let’s explore the key differences.

 

What’s the Difference Between an Asset Purchase and a Stock Purchase?

Before we dive into the details of what distinguishes an asset purchase and a stock purchase, let’s visualize how the two transactions work. That will make the rest of this much easier to conceptualize.

Think about a shoe. It’s a simple item we all interact with every day. But, according to Nike, a shoe has around 23 different parts. Let’s imagine a business as a shoe. When you buy all of the company’s stock, the owner takes their foot out and you slip your foot in. It’s the exact same shoe, just with a new foot in it.

When you buy a company’s assets, you’re buying parts of the shoe that you like (maybe the outsole, the laces, and a few other bits) and leaving behind the parts you don’t (maybe you don’t need the insole, maybe the tongue is worn out). You take the parts you want and rebuild the shoe around your foot. It’s not the same shoe, even though it has elements of the old one in it.

 

Asset Purchase vs. Stock Purchase: What You Need to Know

Who You’re Actually Buying From

• Stock Purchase:You’re buying directly from the current business owners (the shareholders). Think of it like buying someone’s car – you’re purchasing their ownership stake in the company itself.
• Asset Purchase:You’re buying from the company itself, not the owners. It’s more like going to a store and buying individual items rather than buying the entire store.

How the Transaction Actually Works

• Stock Purchase:This is the simpler route. You pay the current owners, and they hand over their ownership shares to you. The business continues operating exactly as it did before – same name, same legal entity, same everything. Only the ownership has changed hands.
• Asset Purchase:This process is more complex. You pick and choose which parts of the business you want to buy from the company. The company then takes your payment and distributes it to its owners. The original company might continue to exist (though often empty-handed) until the owners decide to shut it down.

What You Actually Get for Your Money

• Stock Purchase:You’re buying everything – the good, the bad, and the ugly. This includes all assets, all liabilities, all contracts, and all legal obligations. You can negotiate to have the sellers keep certain small items (like cash dividends or personal equipment), but you’re essentially buying the whole package.
• Asset Purchase:You have the power to pick and choose. Want the customer list but not the old equipment? No problem. Interested in the inventory but worried about those questionable accounts receivable? You can leave those behind. This selectivity helps protect you from nasty surprises, though you need to watch out for “successor liability”. This can still make you responsible for certain obligations.

How Everything Gets Valued

• Stock Purchase:The business keeps using the seller’s carrying book values, but these might be modified for certain step-ups or step-downs. For example, if the business has fully depreciated a piece of equipment, that equipment is going on your books fully depreciated.
• Asset Purchase:Every single asset and liability is valued separately. This means more work upfront, but potentially more accurate pricing.

Dealing with Existing Contracts

• Stock Purchase:Here’s a major advantage – most contracts stay in place automatically because the business entity itself hasn’t changed. Your lease, supplier agreements, and customer contracts typically continue without needing anyone’s consent. However, some contracts might have clauses that consider ownership change to be an assignment requiring the counterparty’s consent. So even in a stock purchase, you’ll need to check each one.
• Asset Purchase:You’ll need consent from each counterparty to take over their contract. Want to keep the office lease? You’ll need the landlord’s approval. Planning to honor existing customer agreements? Those customers need to agree to work with you instead of the original company. This can be time-consuming and sometimes deal-breaking if key parties refuse to consent.

Tax Implications for the Seller

• Stock Purchase:The sellers get the tax advantage here. They typically pay capital gains tax rates on their profit, which are usually lower than ordinary income tax rates. It’s a single level of taxation – straightforward and seller-friendly.
• Asset Purchase:This creates a more complex tax situation for sellers. If it’s a C corporation, there’s double taxation – the company pays taxes on the sale gains, and then the owners pay taxes again when the money is distributed to them. Some of the sale prices might be taxed as ordinary income rather than capital gains, which means higher tax rates.

Tax Implications for the Buyer

• Stock Purchase:You step into the shoes of the previous owners, taking on their tax basis in the assets. This means you won’t get to write off as much depreciation in the future.
• Asset Purchase:You get a “step-up” in tax basis, meaning you can base your future depreciation deductions on what you actually paid for the assets. This can lead to significant tax savings over time.

Intellectual Property Rights

• Stock Purchase:You automatically own all intellectual property because you own the company that holds these rights. Patents, trademarks, and copyrights transfer with the business ownership.
• Asset Purchase:You’ll need to file paperwork with appropriate government offices (like the Patent and Trademark Office) to officially transfer intellectual property rights to your name.

Employee Considerations

• Stock Purchase:All employees come with the business – you inherit the entire workforce along with their employment agreements, benefits, and any issues.
• Asset Purchase:You have the flexibility to choose which employees you want to hire. This allows you to keep the star performers while potentially avoiding problem employees.

Other Important Factors

• Stock Purchase:You can usually keep non-transferable licenses and permits without getting specific approvals. There are typically fewer complications with bulk sales taxes, and you don’t need to retitle assets or transfer ownership documents.
• Asset Purchase:The seller can more easily keep cash and other assets they want to retain. However, you might need to renegotiate important contracts, deal with bulk sales tax issues, and handle the paperwork for transferring titles and ownership of physical assets.

The BIG One: What About Liabilities

• Stock Purchase:Because the business is the same business it was when the seller held it (remember, it’s just a new foot in the same shoe), the business remains just as liable as it was for all claims against it that occurred on the seller’s watch. This includes claims that you and the seller don’t know about yet. Due diligence is extremely important here.
• Asset Purchase:This is a new and legally distinct business (remember, it’s a new shoe built from parts of the old shoe), so this new business is generally not liable for claims that occurred on the seller’s watch. Successor liability can apply, but with good due diligence and planning, you can avoid this.

 

Making Your Decision

Sellers “generally” prefer stock purchases because they’re simpler and offer better tax treatment. Buyers, on the other hand, often favor asset purchases because they provide more control and protection from unwanted liabilities, along with better tax treatment.

These are just generalizations, though. The right choice for your situation depends on many factors: the type of business, your risk tolerance, tax considerations, and the specific circumstances of the sale. With great planning and design, you can design a deal that maximizes the upside for you, whether the transaction is a stock purchase or an asset purchase.

When you’re ready to buy (or sell) a business, you have many choices in how to build the best deal for your goals. At Way Law, we’ll show you how. Call us today!