Key factors to consider when buying or selling a business.    

Mergers and acquisitions (M&A) is a category of transactions involving the purchase and sale of businesses. This might happen when one company purchases another to achieve growth, gain a competitive edge, or enter new markets. These deals come in many forms, ranging from full company mergers to partial asset acquisitions and each type carries unique legal, financial and operational considerations.

The “M” in M&A is for mergers, which we will touch on briefly below. However, this article mainly deals with the “A”, which is acquisitions. At the heart of any acquisition is a fundamental choice: Should the buyer acquire the company’s assets or its stock? This structural decision shapes everything from contractual obligations to risk exposure. In this article, we’ll explore the key differences between asset purchases and stock purchases, helping you determine which structure is best for your deal.

A Brief Word on Mergers

A merger is when one company is absorbed into another company and then ceases to exist on its own. In some cases, the target company can merge into the  purchasing company, and in other cases the purchasing company can merge into the target company. Unlike a stock or asset purchase, where a buyer acquires specific assets or shares of another company, a merger usually involves the two separate companies being combined into a single company, which merges all of their assets, debts, contracts and responsibilities. Mergers require their own set of considerations, strategies and planning. As this articles mainly focuses on asset and stock sales, which are different versions of an acquisition, further details on mergers will be addressed in a separate article.

Acquisitions

An acquisition is when one company purchases and acquires another company. The end result of an acquisition is that the purchasing company will own and control the selling company. However, there are two primary ways to achieve this outcome and the transaction will usually be done under one of these structures: (1) stock purchase, or (2) asset purchase. Each of these methods has its own set of logistics, pros and cons, and should be considered as early as possible when considering an acquisition.   

Note: A business purchase or sale refers to the same transaction, just depending on whether the party is the buyer or seller (ie. the buyer purchases and acquires, the seller sells).

What is an Asset Purchase?

In an asset purchase, the buyer acquires specific assets of the selling business. This can include all or substantially all of the selling business’s assets (such as inventory, equipment, supplies, contracts, real estate, brand name, intellectual property, goodwill, customer lists, lease, etc.), or can be limited to a narrower list of specifically selected assets (such as a specific brand and product line). This really depends on what items of value the buyer wants to purchase.

In an asset sale, the buyer is typically operating under their own business entity, which purchases the assets from the selling entity. Those assets are transferred from the seller to the buyer, and at that point the buyer will own and control all of the assets of the business and would continue that business under its own entity. If purchasing all of the assets, the selling entity continues to exist though may be nearly empty of assets. If purchasing only select assets, the selling entity may continue to operate the rest of its business.

Because an asset sale involves the specific itemization of assets being purchased, the buyer does not automatically assume the selling company’s debts or other liabilities unless the buyer specifically agrees to acquire those debts or other liabilities. An asset purchase can be a great way to buy all the upside, and leave all the downside.   Due to the tax implications of an asset purchase (as described further below), an asset purchase tends to be more beneficial to a buyer.

A few examples of when an asset purchase can be used:

• An e-commerce company wants to sell only a specific brand and related product line, but continue to operate with its remaining brands.
• An entrepreneur buys an existing franchise location, but not the existing company that owns it or any of that company’s liabilities.
• An accounting firm acquires all of the assets of another accounting firm, to gain greater market shares and expand their clientele.

What is a Stock Purchase?

In a stock purchase, the buyer purchases the equity (shares or membership interests) directly from the owners of the  target company (whether shareholders or members). Under this structure the target company itself remains intact, and will continue to own all of its property, the ownership of the company just changes hands. The buyer essentially just steps into the shoes of the previous owner(s). At that point the buyer will own and control the target company as its primary member or shareholder, and would continue that business under its own ownership.

This means the buyer acquires the target company and everything that comes along with it, including its assets, liabilities (known or hidden), contracts, employees, licenses, permits, obligations, etc.). A stock purchase can be a great way to more efficiently take over a company and all of its contracts, licenses and other assets, since those items don’t actually change hands. This can be very advantageous for a company that relies heavily on ongoing contracts, regulatory approval or licenses that would be difficult to transfer. But it can be risky for a buyer since they would be inheriting all of the company’s liabilities as well.

Due to the tax implications of a stock purchase (as described further below), a stock purchase tends to be more beneficial to a seller. A few examples of when a stock purchase can be used:

• A tech company acquires a smaller startup with proprietary software and a strong engineering team.
• A hospitality company acquires a chain of hotels or restaurants with hundreds of existing vendor and lease agreements.
• A real estate company acquires another company that owns various parcels of real estate.

Key Differences Between Asset and Stock Purchases

The key difference between an asset purchase and a stock purchase lies in what is being acquired and how liabilities are handled. The result of either structure is that the buyer will own and control the business, but that result is arrived at through different methods.

In an asset purchase, the buyer selects specific assets and liabilities to acquire, allowing greater control and reduced risk exposure, but often at the cost of a more complex transaction requiring individual transfers and third-party consents. In contrast, a stock purchase involves acquiring ownership of the target company as a whole, including all assets, liabilities and contracts. This structure usually enables a smoother operational transition, since the business entity remains intact, but it also means the buyer assumes all existing and potential liabilities.

Pros and Cons

Pros of Asset Purchases

• Selective Liability: Buyers can avoid unwanted liabilities by purchasing only selected assets.
• Tax Benefits: Buyers may benefit from a “step-up” in the tax basis of the assets, allowing for higher depreciation and amortization deductions.
• Clean Slate: Buyers start fresh without being tied to the target’s corporate history, reducing legal and compliance risks.

Cons of Asset Purchases

• More Complex Transfers: Each asset may need to be individually itemized transferred, which can be time-consuming, exhausting and costly.
• Third-Party Approvals: Contracts, leases or licenses may require third-party consents before they can be transferred, which could jeopardize the transaction if the third-parties are not willing to provide consent.
• Potential Double Taxation: Sellers that are corporations may face double taxation. Once at the corporate level and again when distributing proceeds to shareholders.

Pros of Stock Purchases

• Continuity: The business continues operating as-is, without the need to transfer individual assets, employees, contracts or licenses.
• Simplicity: Often a simpler transaction from a legal and administrative perspective.
• Seller Preference: Sellers may prefer stock deals to minimize tax liabilities.

Cons of Stock Purchases

• Assumption of Liabilities: Buyers assume all liabilities, known and unknown, including pending litigation or tax issues.
• Limited Tax Benefits: Buyers may not receive a step-up in the basis of the company’s assets.
• Due Diligence Is Critical: Buyers must perform thorough due diligence to uncover hidden risks.

Frequently Asked Questions

1. What’s the difference between a stock sale and an asset sale? In a stock sale, the buyer acquires the ownership of the entire company, including all assets and liabilities. In an asset sale, the buyer usually starts their own company, and purchases only selected assets and liabilities from the seller.

2. Why might a seller prefer a stock sale? Stock sales often provide favorable capital gains tax treatment and can be simpler since individual assets don’t need to be transferred.

3. What are the tax benefits of an asset sale for buyers? Buyers can get a step-up in asset basis, allowing larger depreciation deductions, though some assets may trigger recapture taxes.

4. Do buyers assume liabilities in an asset sale? Buyers usually avoid the seller’s liabilities unless specifically agreed, protecting them from unwanted debts.

5. Which type of sale is better for the buyer? It depends on the buyer’s goals: asset sales limit liability and allow selective purchases, while stock sales are simpler but include all company obligations.

Conclusion

There’s no universally “correct” structure or “standard operating procedure” for all transactions. Each deal must be evaluated based on the facts, the specific position of parties involved, and their end goals and preferences. For buyers, the priority is often risk-mitigation and tax efficiency. For sellers, it’s usually tax minimization and simplicity. At the end of the day, it’s important to use a structure that aligns the interests of the buyer and seller, to ensure a smooth and collaborative transaction, while minimizing the chances of a fallout after the deal is closed. The right advisors, legal, tax and financial, are indispensable in helping you navigate these decisions with clarity and confidence.

If you have any questions about an M&A transaction, whether as a potential buyer or seller, whether in the advance planning stages or in the middle of negotiations, contact Kohler Legal today for a consultation with an M&A attorney.