Buying a Business: Why Asset Purchases Are the Key to Success

When buying a business, whether it’s to start a new endeavor or to acquire a competitor, it’s best to start on the right foot. The structure of the purchase can end up being the difference between long-term success and a “crash and burn.” This article will discuss the difference between an Asset Purchase and a Stock Purchase when buying a business.

What’s the Difference?

Generally speaking, an asset purchase is when an individual, either with an existing entity or by  forming a new entity (LLC or Corporation), buys the assets of a business without buying the business itself. Asset Purchases entail buying everything that the business owns (the Assets). Stock Purchases entail buying the ownership of the business itself (and thereby owning all of the business’ assets) (the Stock). So, the difference is in the details.

Pros and Cons of an Asset Purchase

Pros:

1. The buyer can acquire everything that makes up a business without assuming any of the downside associated with the business;
2. The buyer can pick and choose what assets he or she wants to buy and exclude all or most of the associated liability of the business, including taxes, creditor claims, and potential legal liability for employment claims;
3. The buyer can avoid any unknown or unknown liabilities which the seller may not even know about;
4. The buyer can start fresh with the formalities of the entity – i.e., annual reports, taxes, meeting minutes, bylaws, etc.
5. The buyer can also receive a stepped up cost basis in the assets to the extent the purchase price exceeds the seller’s cost basis;
6. The buyer also avoids any issues with remaining the remaining shareholders of the seller;
7. The buyer does not have to make any sort of securities filings because they are not acquire securities (unlike a stock purchase); and
8. The goodwill being acquired by the buyer can be depreciated over time.

Cons:

1. The assets being acquired will need to be re-titled to the buying entity’s name;
2. The buyer may need extra consent or approval to take over contracts, permits, or licenses that are not assignable.
3. Asset purchases do not qualify for tax treatment as a tax-free reorganization;
4. A stock transfer may be less complicated if there are few shareholders of the seller company; and
5. There may be sales or transfer taxes associated with the purchase of assets.

Pros and Cons of a Stock Purchase

Pros:

1. Purchasing the stock allows you to take everything that comes with the company – no re-titling of assets, creation of new bank accounts, assigning of contracts, etc.;
2. The buyer would be able to benefit from the existing contract, licenses, and permits of the seller without worrying about having to assign them or get third-party consent;
3. The stock purchase may qualify for a tax-free reorganization of the company;
4. Buying stock is a lot less complicated in terms of the logistics of the transaction;
5. A stock transaction can avoid sales and transfer taxes.

Cons:

1. You take everything with the company – including existing debts and liabilities;
2. You may not know of all of the liabilities at the time of the transaction, and more could arise for several years after the transaction has closed;
3. The buyer would not receive a stepped up basis in the assets of the company, because they’re not buying the assets;
4. There may be minority shareholders who refuse to sell their stock and create a problem with the business moving forward; and
5. There may be securities filings at the state and federal level related to the purchase of stock (securities).

Conclusion: Which is Better?

The Asset Purchase allows the buyer to have as much certainty about the deal as possible. The stock purchase leaves too much to uncertainty. Unless the seller is solvent and willing to sign a pretty robust indemnification agreement protecting the buyer should anything come up in the future, the Asset Purchase is going to best protect the investment of the buyer and make sure that unexpected liabilities don’t knock the train off the rails.