The majority of businesses in the United States are family owned and/or do not have a public market within which ownership interests can be bought and sold. Buy-sell agreements can provide certainty, providing business owners with a framework for the purchase and sale of their interests, including disposition on death, retirement, disability, or bankruptcy. When buying or selling a business, generally the first, and perhaps most far-reaching, decision that willing parties (i.e. a buyer and a seller) to the transaction must agree upon is whether to structure the transaction as a Stock Purchase Agreement or as an Asset Purchase Agreement. In a Stock Purchase Agreement, a shareholder sells his/her/its stock in a corporation to a buyer, who takes the corporation as he/she finds (with all assets and liabilities, known and unknown, existing as of the time of the sale). In an Asset Purchase Agreement, on the other hand, the corporation sells some or all of its assets (as negotiated between the corporation and the buyer) to a buyer, who then becomes the owner of the assets. Provided below is a summary of the many issues to consider when considering the purchase / sale of a business. Not surprisingly (if you have read entity formation), many of the issues largely revolve around “tax” and “liability”.
Note, the following summary assumes the business is a corporation, as opposed to a sole proprietorship, general partnership, limited partnership, limited liability company, or limited liability partnership; the reason being, that only corporations have “stock”, and thus one can’t enter into a “stock purchase agreement” without there being a corporation at hand. Many of the issues below also apply to these other entity types, but for more specific information please contact Rassman Law today.
Tax Issues
Stock Purchase Agreement:
- From the selling shareholder’s perspective, there is only one (1) level of tax, namely a capital gains tax that the selling shareholder will pay on the difference between the sales price and the selling shareholder’s basis in his/her stock. If the corporation is a c-corporation, a stock purchase agreement generally results in less tax to the selling shareholder than results from the two (2) levels of tax incurred in an asset purchase agreement (see below).
- From the buyer’s perspective, the corporation has a “carry-over basis” in its assets; as a result, the corporation continues to depreciate its assets on the same schedule as existed prior to the transaction. Generally, a “carry-over basis” is less favorable to a buyer than a “step-up basis” that results from an asset purchase agreement (see below).
Asset Purchase Agreement:
- From the selling shareholders’ perspective, if the corporation is a c-corporation, there would be two (2) levels of tax to the selling shareholder: 1) first, the corporation would pay a tax on the “gain” resulting from sale of its assets; and 2) second, the selling shareholder would pay a tax on the dividend he/she receives from the corporation after the sale.
- From the buyer’s perspective, he/she will receive a “step-up basis” in the assets he/she acquires, allowing greater depreciation deductions for the acquired assets. The buyer may also be able to amortize the “goodwill” purchased in the transaction, again allowing greater depreciation.
Asset and Liability Issues
Stock Purchase Agreement:
- From the buyer’s perspective, because he/she takes the corporation as he/she finds it, the corporation continues to own all assets, and carry all liabilities (known and unknown), that existed prior to the transaction. The risk of assuming all liabilities (known and unknown) of the corporation often requires additional due diligence from the buyer and results in greater legal fees for the buyer.
Asset Purchase Agreement:
- From the buyer’s perspective, he/she can choose which assets to acquire from the corporation, and which liabilities to exclude; as compared to a stock purchase agreement wherein all assets and liabilities remain in the acquired corporation.
- From the selling shareholder’s perspective, he/she may have to wind down the corporation after its assets are purchased, which includes paying any liabilities not assumed by the buyer and dissolving the corporation.
Titling Issues
Stock Purchase Agreement:
- From the buyer’s perspective, because he/she takes the corporation as he/she finds it, he/she may not have the “titling” issues that may exist after an asset purchase agreement (see below).
Asset Purchase Agreement:
- From the buyer’s perspective, he/she may have to re-title the assets purchased, assign contracts entered into by the corporation (e.g. leases, employment agreements, etc.) that the buyer assumes, assign permits / licenses bought from the corporation, etc. – all of which may result in greater legal fees for the buyer.
Securities and Bulk Sales Laws
Stock Purchase Agreement:
- Stock purchase agreements may involve Federal and California securities issues, resulting in greater legal fees and administrative requirements.
Asset Purchase Agreement:
- Asset purchase agreements may involve bulk sales laws, resulting in greater legal fees and administrative requirements.
Minority Shareholder Issues
Stock Purchase Agreement:
- If the corporation has more than one (1) shareholder, complications may arise obtaining the consents of minority shareholders, resulting in greater legal fees and administrative requirements.
Asset Purchase Agreement:
- Even if the corporation has more than one (1) shareholder, less complications arise with respect to minority shareholders under an asset purchase agreement than under a stock purchase agreement.
Summary: For both tax and liability reasons, you can see that sellers generally prefer Stock Purchase Agreements while buyers generally prefer Asset Purchase Agreements, though of course every transaction is different and this is not a bright-line rule.