Buying Assets versus Buying Stock
So, What’s the Difference?
In an asset purchase, a buyer is buying “stuff” – assets. But an important point here is that the buyer need not buy all the stuff. For example, if the company has outdated inventory or raw materials; if one or more pieces of equipment are obsolete; if the company owns the real estate that the business occupies but the buyer plans to move the business, the buyer can, during negotiations try to determine what “stuff” is included in the sale and what stuff is not.
For instance, the buyer might want the client and vendor lists, the intellectual property, the receivables, the two newest trucks and the 70% of the inventory that is not outdated; but not the outdated inventory, the payables or the four beat-up trucks that date from the Clinton administration.
On the other hand, in a stock purchase, the buyer is buying the company itself — the entity. This includes everything that that the company owns – all the assets, but also all it’s liabilities. More on THAT in a moment.
Buying all the assets includes all the outdated inventory, broken-down fork lifts, all the old unusable office furniture that has been gathering dust in the storage building, the 27 IBM computers running DOS and the riding lawn mower that was last started when IBM was still making computers. The transaction includes everything the company owns – and the buyer will have to figure our what to do to get rid of the useless stuff.
But as challenging as ridding oneself of all the useless assets after the acquisition close, liabilities are another story altogether.
Liabilities include contractual obligations, payables, financing instruments, various taxes, pending law suits and a host of other sink holes that can come back to haunt the buyer.
In an asset sale, the buyer should try to specify the liabilities they are willing to assume while having the seller retain certain other liabilities. We have been involved in many deals where the parties negotiated this issue successfully. In a stock purchase, by comparison, the buyer is purchasing the business in its entirety. There may be some pieces the buyer doesn’t want or even certain liabilities that are unknown or uncertain – and that issue, itself, is a major downside and one that causes us, when we are advising buyers, to caution against a stock acquisition.
The Real Potential Danger
What’s so bad about that, you ask? Can’t the buyer confirm during the due diligence period what the company owes? Well, yes and no.
Going through the bank records and comparing them to invoices will help. This will also go a long way toward enabling a buyer to confirm the list of vendors provided by the seller – which, in turn, enables the buyer to contact the vendors and confirm whatever amounts are owing.
But the biggest concern that we see is the possibility that the seller has not paid to the tax authorities the money that has been withheld from the employees’ paychecks. And, depending on how many employees the company has and how long the withheld funds have not been sent to the authorities, this could be a BIG number.
Small business owners are often required to remit all such withholding taxes every 30 days – and generally no less often than quarterly. However, many times, if a company hits a cash crunch, the owners may not send that money in. But the company – not the company’s owner – still owes it. And that debt stays with the company when the company changes owners.
If the company employs 20 workers at an annual average wage of $50,000 and doesn’t remit that necessary withholding taxes for a year, the unsuspecting buyer could be faced with a several hundred thousand dollar greeting card when the feds eventually get around to discovering that the company had been withholding the withholding (as it were).
There are all sorts of stories of buyers discovering tens and even hundreds of thousands of dollars in withholding taxes owed by the company a year or more after the purchase transaction closed. Buyers think they can argue that the previous owner was/is responsible for these taxes. He’s not. The company is responsible and the feds will be looking for the current owner, not the previous one.
There are other tax issues that must also be considered when determining whether to structure the deal as an asset or stock purchase. Goodwill can be amortized by the buyer over 15 years in an asset purchase but such a purchase may not qualify as a tax-free reorganization.
Another concern in an asset sale is that all the assets that are part of the sale will have to be re-titled in the buyer’s name. In a stock sale, there is no need to do this as the buyer is buying the entity – the company – and the company already owns all the assets.
Similarly, in a stock sale the company’s contracts, permits, licenses and other multi-party obligations and permissions are acquired by the buyer without the need to worry about whether the other parties would agree to assign such obligations and permissions. This lessens “the hassle factor” considerably.
The Business Broker
A business broker or adviser knowledgeable about the pluses and minuses of both asset and stock purchases is, along with the seller’s other advisors, of enormous value when preparing for a sale. Likewise, an experienced business broker’s advice to a buyer could save that client untold headaches and money in both the short and long term. Professional brokers create a “book” or “Offering Memorandum” for the market that describes the company that’s for sale and allows potential buyers confidential access to additional information.
Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
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The Bottom Line
When we are representing the seller – which is usually, but not always the case – we advise them that a savvy buyer, or one with knowledgeable representation, will probably understand these two methods of acquiring the business. We try to get our client to recognize that certain assets are really not assets at all and the business’ value must reflect this reality.
When we are representing the buyer, we advise our client of the pros and cons of both that asset and stock sale methods of acquisition. It has been our experience that most buyers ultimately feel that the additional hassles involved in an asset sale are far outweighed by the potential liability of a stock sale and we structure the transaction accordingly.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
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