When acquiring a business, one of the first decisions a buyer will have to make is whether to purchase the target business’s stock or purchase its assets. Both approaches carry with them their own set of unique legal, financial and business implications, so understanding the key differences is critical when structuring the terms of the acquisition. This article explores the key differences between stock and asset purchases, highlighting the important legal considerations a buyer must keep in mind for each.
Stock Purchase vs. Asset Purchase: Understanding the Difference in Structure
In a stock purchase, the Buyer acquires the target company by purchasing the equity in the entity, i.e., the shares of stock in a corporation or the membership interest in a limited liability company. This means that the buyer takes control of the company as a whole, stepping into the shoes of the existing shareholder(s) or member(s) and assuming all of the company’s assets, liabilities, contracts and obligations. Essentially, the legal entity remains unchanged and continues operations with new ownership in place, making the transaction itself simpler to document.
On the other hand, an asset purchase occurs when the buyer is purchasing substantially all of the assets of the target company, while any excluded assets or liabilities remain with the seller. The buyer can selectively choose which assets to purchase, such as inventory, equipment, real estate, and intellectual property. Liabilities can also be assumed, but the buyer typically negotiates which ones to take on.
Key Considerations
There are several key differences between asset and stock purchases that we consider when advising our clients, including the liabilities they want to assume, the form of business operations, the material contracts or licenses in place, and the potential tax implications.
Liabilities
In a stock purchase, all of the target company’s existing liabilities, both known and unknown, are assumed by the buyer along with the equity in the company, including contractual obligations, employment issues, pending litigation risks, and other potential exposures. Unless otherwise negotiated in the transaction documents, the buyer is acquiring the target company “as-is”, which makes thorough due diligence even more critical so that the buyer understands the extent of the liabilities prior to closing.
In an asset purchase, the buyer has the ability to pick and choose which assets it wishes to acquire in the transaction, which includes any liabilities, debts or contractual obligations of the target company. As a result, any liabilities not otherwise assumed by the buyer will remain the obligations of the seller after closing.
Business Operations and Contract Approvals
One of the benefits of a stock purchase is that, while the ownership of the target company changes, the legal entity itself remains intact. As a result, most existing contracts, such as leases or third-party vendor agreements, remain in effect without needing third-party consent, approvals, or assignments. A buyer may also find this beneficial with respect to certain business or professional licenses held by the target company. Please note, however, that some contracts and licenses include change-of-control clauses that may be triggered by a stock purchase and require the consent from the other party.
In an asset purchase, any material contract related to target company’s business operations must typically be assigned or novated in the name of the buyer, which often requires cooperation from a third-party. This process can prove to be a time-consuming and have the potential to hinder the efficiency of a deal if material contract or licenses cannot be easily transferred to the buyer.
Tax Implications
From a tax perspective, stock purchases generally are not considered a “taxable event” at the company level. Instead, the seller is taxed on any gain from the sale of the stock and the buyer is able to circumnavigate any sale and transfer taxes imposed at the state level. However, a buyer may see reduced future tax benefits as a result of depreciating acquired assets since the tax basis in the company’s assets remains unchanged following the sale.
On the other hand, asset purchases have the ability to provide significant tax advantages to a buyer. In most cases, the buyer can allocate the purchase price to specific assets and “step up” the tax basis, allowing for future amortization or depreciation of certain assets. However, asset purchases do not qualify for tax treatment as a tax-free reorganization, and many states, including Maryland, impose sale and transfer taxes on the sale of assets. In either case, the interests of the buyer and seller are often adverse when it comes to tax considerations, so it is important to seek the advice of a tax attorney or accountant in structuring an acquisition.
Do Your Due Diligence
Ultimately, the decision whether to structure a business acquisition as a stock purchase or an asset purchase will depend on the unique circumstances of a particular transaction and the parties involved. In either case, upfront planning and awareness of these issues is vital, which is why having experienced legal counsel to guide you through each step of the acquisition process – from drafting the agreement to completing the due diligence – is the key to protecting your interests and ensuring a successful transaction.
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Kathleen Millrood is an Associate Attorney at Liff, Walsh & Simmons and a member of the firm’s Real Estate, Business Law, and Commercial Finance practice groups.
If you have questions on this article or another business law matter, our attorneys are here to help. Please contact Liff, Walsh & Simmons for assistance.
