As discussed in Part I of this series on buying a business, regardless of the scope of the operations and purchase price, there are a number important legal issues you need to consider before signing the purchase agreement. The first installment discussed the role of the Exclusivity Agreement when considering the potential transaction and the terms that should be included if the parties agree to exclusivity while the due diligence is conducted and the purchase agreement is being negotiated. In this Part II, the structure of the transaction is discussed, contrasting the stock purchase transaction from the purchase of assets of the business. The take away is that it is usually preferable for the acquiror to purchase the assets of the business rather than the stock of the company because of the (a) tax advantages and (b) potential risks and liabilities in connection with purchasing shares of a business.
1. Tax Advantage of Purchasing Assets of a Business.
The acquiror will obtain a tax benefit from purchasing the assets of the seller rather than the equity of the business entity. When the acquiror purchases the assets, it gets the right to step-up the tax basis in the acquired assets. This means the basis is not what the seller paid to acquire the assets (often many years prior to the transaction) but what the buyer pays for the assets. Also, note, that it is very important to work with your accountant when allocating the purchase price to the purchased assets -- for example, assets depreciate at different rates (and some cannot be depreciated at all), which will affect your profits and losses.
2. Purchasing Assets Reduces the Chance that Buyer has Assumed the Seller's Liabilities.
When the purchaser acquires the stock of the business entity by way of a stock purchase transaction or merger, the buyer is deemed to have assumed the liabilities of the seller. In contrast, the parties to an asset purchase transaction can assign liabilities in such a manner as expressly stated in the asset purchase agreement. In most circumstances, the purchaser will expressly deny the assumption of any of the liabilities of the selling entity. There may be liabilities the buyer elects to assume (for example, a promissory note or perhaps the risks from a pending litigation), and because the liabilities can be assigned as the parties agree in the purchase agreement, the asset purchase transaction gives the parties greater flexibility to negotiate existing or potential liabilities.
3. There are Some Liabilities the Purchaser Cannot Avoid.
Even if the parties adopt the structure of the asset purchase transaction, some liabilities will by operation of law become the obligation of the purchaser -- this is referred to as the doctrine of successor-liability. The doctrine of successor liability precludes a buyer from avoiding certain types of liabilities Among the liabilities which the buyer will be deemed to assume regardless of the structure of the purchase transaction, include (a) environmental liability, (b) certain taxes, such as sales taxes, employment related taxes, and other taxes as provided under state law, (c) certain employee benefits and labor matters, and (d) liability under “bulk sales” law, which can arise, depending on applicable state law, in connection with unpaid sales taxes or an attempt to avoid creditor obligations -- as a word of warning, do not overlook the bulk sales law of your state as this often missed and can result otherwise avoidable liability for the purchaser.
4. Indemnification Basket for Liabilities.
As a purchaser, you can address the risk of unforeseen liabilities by creating a basket (or escrow) for the indemnification of the buyer with respect to such liabilities. The buyer and seller should agree to escrow a portion of the purchase price to address post-closing liabilities that the purchaser did not agree to assume. Whether the escrow is the sole recourse for a buyer to be indemnified is often a sticking point the parties will need to negotiate -- obviously the buyer would prefer not to be limited to the recourse of the escrowed funds. Whatever the parties negotiate as to amount of the escrow (or alternatively a hold back) and if it is the sole avenue for indemnification, the escrow (or hold-back) rights need to be properly drafted, detailing the terms and procedures for asserting a claim for indemnification.
Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters