It’s an exciting time when your business has reached the point where you are thinking of acquiring another company. Before you begin the process, you will need to decide which avenue is right for you and your intended purchase. Generally, there are three avenues through which a company can purchase an existing business. The purchasing company may either purchase the target company’s assets, purchase the company’s stock, or merge with the target company.
There are many factors that a party must consider when determining which transaction structure to use, some of these factors include: commercial considerations, legal considerations, third party and corporate consents, and deal process and timing.
This blog post will help to explain the difference between an Asset Purchase and a Stock Purchase, the advantages of each, and the basic steps that lead to a successful transaction.
The Difference Between an Asset Purchase and a Stock Purchase
Let’s start with the basics by explaining the difference between an Asset Purchase and a Stock Purchase:
In an asset purchase, the purchaser only acquires the assets and liabilities it identifies and agrees to acquire and assume from the seller.
In a stock purchase, the purchaser acquires the target company’s outstanding stock (typically, all of the target company’s outstanding stock), and as a matter of law, acquires all of the target company’s assets, rights, and liabilities (including undisclosed or unknown liabilities).
The Advantages of an Asset Purchase
Purchasers may prefer asset purchases over stock purchases because it provides the purchaser with flexibility.
In an asset purchase, the purchaser retains the ability to cherry-pick specific assets and liabilities it wishes to acquire and assume.
With an asset purchase, there is a lower risk of the purchaser assuming undisclosed or unknown liabilities.
A significant tax implication that factors into a purchaser’s inclination toward an asset purchase is that the purchaser receives a cost basis in the acquired assets. This means the purchaser’s basis in the acquired assets equals the purchase price paid plus assumed liabilities and certain other items.
The Advantages of a Stock Purchase
Generally, stock purchases are more straightforward than asset purchases.
The parties sign the Stock Purchase Agreement and related documents that outline the terms of the deal, and the seller(s) transfer the target company’s stock to the purchaser. With this the purchaser assumes all of the target company’s liabilities.
A stock purchase is ideal for a purchaser desiring to purchase a business that is functioning without the threat of liquidation for the foreseeable future. Yet, there is also a risk that the purchaser will be assuming the target company’s unknown or disclosed liabilities (if any).
In the instance of an economic downturn, a purchaser might prefer a stock purchase over an asset purchase because the purchaser’s basis in the purchased assets cannot exceed the fair market value of the purchased assets. Meaning, if a purchaser is purchasing assets from a seller whose asset values have diminished (e.g., the seller’s basis in its assets exceeds their fair market value), the asset purchase would result in a “step-down” basis of the purchased assets.
A stock purchase’s tax treatment is also more favorable for sellers because the transaction usually results in a single, stockholder level of taxation. This is opposed to potential double taxation, at both the entity and shareholder levels, in an asset purchase.
Doing Your Due Diligence
For both asset purchases and stock purchases, once the parties agree to the initial documents, the purchaser should conduct its due diligence. This means the purchaser should gather all information about the seller to determine the issues that are relevant to and may impact the transaction.
Both transaction structures contain similar due diligence issues such as transfer and procedural issues.
Common due diligence issues unique to asset purchases include: the nature and condition of the specific assets and title to those assets.
Common due diligence issues unique to stock purchases include: the seller’s title to the target company’s stock, terms of key contracts, identifying the target company’s liabilities, and the nature and condition of the target company’s assets.
The purchaser’s necessary level of due diligence is typically greater in a stock purchase as opposed to an asset purchase because the purchaser usually assumes greater risk.
Process, Consents, and Approvals Needed for Purchase Agreements
Asset purchases usually require more formalities and documents than a stock purchase since asset purchases require transfers for each of the seller’s separate assets and liabilities.
Although stock purchases may require certain consents such as corporate approvals, statutory or regulatory approvals, or contractual consents, more such consents or approvals are generally required for asset purchases. For example, an asset purchase typically requires more third-party consents since most contracts contain anti-assignment clauses. Conversely, stock purchases usually do not require the assignment of contracts, so third-party consents are not required unless the contracts contain change of control provisions.
Further, stock purchases are often not subject to as many filing requirements that need to be satisfied by the parties (if any). Yet, if the target company has many stockholders, a stock purchase may become cumbersome since there is an increased potential for lengthy negotiations, hold-outs, or other complications. Also, in situations where the purchaser is unable to purchase all of the target company’s stock, the purchaser may end up owning the target company with other stockholders who may be difficult to work with.
Once you have worked through the consents and approvals, you will be on your way to finalizing the transaction through either an Asset Purchase Agreement or a Stock Purchase Agreement.
Finalizing Your Asset Purchase Agreement
The Asset Purchase Agreement is typically drafted by the purchaser and outlines the transaction’s key terms.
The Asset Purchase Agreement provisions generally include: the parties; the specific assets and liabilities that will be transferred and assumed; the agreement to sell; consideration; the procedure for how the assets are to be transferred and the obligations of the parties with respect to those transfers; representations, warranties, and indemnities; pre-closing covenants; conditions precedent to closing; and restrictive covenants. Additionally, disclosure schedules will accompany the Asset Purchase Agreement.
Disclosure schedules contain information required by the Asset Purchase Agreement that qualifies the representations and warranties made in the Asset Purchase Agreement, and they often explicitly identify the purchased assets and assumed liabilities.
Further, other ancillary documents are often required to perfect the transfer of assets from the seller to the purchaser (e.g., deeds, bills of sale, lease assignments, assignments of intellectual property, assignment and assumption agreements, etc.).
Stock Purchase Agreement
As with the Asset Purchase Agreement, the Stock Purchase Agreement is typically drafted by the purchaser, and it outlines the key terms of the deal.
The Stock Purchase Agreement generally includes the following key provisions: the parties; the agreement to sell; consideration; representations, warranties, and indemnities, pre-closing covenants; conditions precedent to closing; and restrictive covenants. Additionally, disclosure schedules will accompany the Stock Purchase Agreement.
Disclosure schedules contain information required by the Stock Purchase Agreement that qualifies the representations and warranties made in the Stock Purchase Agreement. Such disclosures may include a listing of the target company’s intellectual property or important contracts, employee information, or qualifications or exceptions to the representations and warranties made by the seller in the Stock Purchase Agreement. Disclosure schedules are considerably important because if a party fails to raise an objection to the information included in the disclosure schedules, that party may lose its ability to terminate the transaction for issues relating to those disclosures.
When the time is right for your business to acquire another company, contact our trusted Green Bay business attorneys at 920-499-5700.
Attorney Terry Gerbers and his team have assisted clients in mergers and acquisitions ranging from $1 million to $50 million. Our team assists in negotiating sales, acquisitions, financing, mergers, shareholder redemption, and providing insight as to tax consequences and structuring the transaction. Contact us today to help with your upcoming merger or acquisition.