Asset Sale or Equity Sale? | Gross & Romanick, P.C.
There are two primary methods for buying or selling an existing business:
(1) The asset purchase and,
(2) The equity purchase. The advantages and disadvantages of each method should be assessed in every business sale. The purpose of this article is to explain in very general terms how these two transactions differ.
In the equity purchase, the buyer acquires an ownership interest in the business that is sufficient to control the company. If the business is a corporation, the buyer purchases stock in the corporation from the existing shareholders. If the business is a limited liability company (LLC), the buyer purchases a membership interest in the company from the existing members. The equity purchase is typically used when the existing business has valuable contracts or licenses that cannot be transferred or assigned due to legal or business reasons. The debts and liabilities of the business are not affected, and the buyer inherits responsibility for the satisfaction of these obligations, including potential legal claims that have not yet been asserted. Equity sales can be attractive to the buyer in that they generally allow for an easier transition with employees, vendors, and customers of the business, as the business operations do not cease and certain contracts may not have to be assigned. However, it can be highly risky for a buyer to agree to inherit the existing and unknown liabilities of the business.
In the asset purchase, the buyer purchases the existing assets of the business, but does not purchase any ownership interest in the seller’s business entity. Oftentimes, the selling entity will be terminated after the asset purchase. The asset purchase allows the buyer to acquire the business without assuming the debts and obligations of the seller. In some cases, the trade name of the seller is one of the assets purchased by the buyer, and after the sale the buyer will operate under the same name the seller used before the sale. This process allows the buyer to purchase the brand and existing goodwill of the seller, without assuming the selling entity’s liabilities. Asset sales are attractive for this reason, but can also require significant legwork on the part of the buyer to allow for a smooth transition at closing (e.g. setting up a new payroll system, entering into new agreements with employees, vendors, and customers, securing assignments of business contracts, obtaining required licenses, etc.).
In every sale, the parties should consider the advantages and disadvantages of both methods. Typically, the buyer will choose the method of purchase after completing a due diligence investigation of the business and discussing the tax implications of each method with a CPA. A proper due diligence investigation will reveal the legal structure and business registrations of the seller, the specific assets owned by the seller, the existing contracts and obligations of the seller, and the history of seller’s taxes, liens and legal disputes. This information will assist the buyer in determining how best to proceed. A more detailed explanation of the issues a buyer should investigate before choosing the preferred structure of the sale can be found below and here.
Most buyers prefer asset sales for both tax reasons and liability reasons, and most sellers prefer equity sales for tax reasons and liability transfer reasons. However, every business sale is unique, and the two sides will need to align on the structure and economic/tax consequences of the transaction in order for the deal to consummate.
For more information about buying and selling a business, check out our videos at: http://gross.com/need-lawyer-buying-selling-business-fairfax-virginia and http://gross.com/buying-selling-restaurant-fairfax-virginia