Banking and Business Monthly – November 2022

Our transactional team is in the middle of another busy Q4 push to get M&A deals done by year-end. A question we are often asked is how to structure the sale of the business – whether it should be an asset purchase or an equity purchase. Like any good attorney response, the answer is that it depends on the facts. Each type of transaction differs in terms of what is being acquired and its tax consequences. Below is a quick overview.

ASSET PURCHASE

In an asset purchase, the buyer agrees to purchase specific assets and liabilities, such as working capital (accounts receivable and payable), inventory, furniture, fixtures, equipment, contracts, licenses, and intellectual property such as trade names, trade secrets, and customer lists. The buyer takes on the risks only associated with those assets and liabilities purchased, with the seller retaining ownership of the remaining assets (typically cash, bank accounts, tax assets, organizational documents, and personnel records, among others) and liabilities.

Advantages

Most buyers prefer asset purchases so that they can pick and choose which assets and liabilities they want to acquire. Buyers can thus exclude unwanted assets, such as old inventory and equipment, and can exclude many liabilities. In addition, buyers prefer asset purchases due to the tax advantages of acquiring a stepped-up basis in the purchased assets, so that they can depreciate or amortize them.

Disadvantages

Sellers often have to pay higher taxes in an asset sale, as more of the gain may be considered ordinary income versus capital gain. Asset purchases also carry additional complexity because specific assets must be assigned to the buyer. There may be assignment provisions in the underlying contractual relationships that require obtaining consent from third parties, such as customers, lenders, and landlords. Often, these relationships may need to be renegotiated, adding complexity and time to the deal. For example, a customer may be resistant to signing a new contract with the buyer, or a landlord may insist on onerous new terms. Employment agreements with key employees may need to be negotiated as well. Finally, certain businesses are easier to sell by way of an equity purchase instead of an asset purchase, such as a trucking company with a large fleet of vehicles (and all of the underlying certificates of title which would otherwise need to be assigned), or a company with an important license or permit that is not assignable by its terms.

EQUITY PURCHASE

In an equity purchase, the buyer purchases the stock, membership interests, or other equity of the company, which represents a sale of the entire company rather than specific assets and liabilities.

Advantages

As mentioned above, buyers may prefer an equity purchase due to its simplicity, since buyers would be purchasing the entire company without needing to ensure specific assets and liabilities are assigned correctly. No retitling of assets or obtaining third-party consents to contract assignments generally would be necessary since the underlying company continues operations under its existing contracts (absent any change-in-control provisions). Sellers often prefer equity purchases as well for tax purposes because more of the gain on the sale would be taxed at lower capital gains rates.

Disadvantages

That simplicity for buyers, however, comes with the cost of losing the tax benefits of a stepped-up basis in the company’s underlying assets. Also, the buyer could be inheriting undesirable business assets and liabilities, in addition to those business assets and liabilities they do want. Finally, there may be issues with minority equityholders who are not required to sell to the buyer.

The facts and circumstances of the seller, buyer, and underlying business all come into play and require careful planning to minimize risks and maximize sales proceeds. Sellers and buyers are encouraged to assemble a team of tax advisors and attorneys to assist with the transaction before any letter of intent is signed.

For further inquiries or questions about asset and equity purchases or other banking or business matters, please contact me at smigala@lavellelaw.com or at (847) 705-7555.