There are four “share purchase” methods including the three merger varieties plus the purchase of the shares of the target company from the target company shareholders. Click here for more detail. In contrast there is only one “asset acquisition” method by which the acquiring company purchases the assets of the target company.
How should a seller approach the question of whether to sell shares or assets?
The following considerations should be analyzed:
In an asset purchase agreement the buyer has the ability to specify and identify specific liabilities it will assume and to exclude those liabilities which the buyer does not want to assume. For example, a buyer might specify in the asset purchase agreement that it will not assume certain bank debt owed by the target company. A buyer might specifically decline in the asset acquisition agreement to assume a contractual obligation of the seller’s company to repair parts shipped to customers. A buyer might in the asset purchase agreement, specifically state that it will not assume certain outside contracts that the seller is obligated to perform.
Most fundamentally, in a properly structured asset purchase agreement, the buyer has the ability to insulate itself from unknown and contingent liabilities not identified in the asset agreement. Examples include: delinquent taxes of the seller, accounts payable owed to trade creditors, claims by former employees, and lawsuits, whether existing or not yet filed.
There are important exceptions to the general rule that a buyer of assets takes title to those assets free and clear of claims of the creditors of the seller. Click here for more information. Also, liens are a different matter entirely. A buyer generally cannot take title to assets free and clear of liens. Therefore, an adequately represented buyer will perform a “lien and judgment” search to determine if the assets your company seeks to sell are encumbered with any sort of lien.
In most cases, regardless of whether the transaction is structured to sell shares or assets, the buyer may, as a matter of negotiation between the parties, be required to assume some of the known liabilities of the seller. However, in a share deal without any specific delineation of liabilities, the buyer will automatically, by operation of law, acquire the seller’s liabilities.
By contrast, when a purchaser buys assets in an asset transaction there is no automatic assumption of liabilities- subject to some very important exceptions. That is, the general rule in an asset sale is that it requires the conscious effort on the part of both parties to pick and choose which liabilities the seller will transfer to the buyer and which liabilities the seller will retain.
Generally speaking, a seller should expect to make fewer representations and warranties in a definitive agreement for the sale/purchase of assets than in the context of a share sale. For example, in an asset transaction there is arguably no need for the seller to make any representations as to its capital structure, identity of shareholders, number of shares issued and outstanding, number of shares authorized, share options or warrants outstanding. On the other hand, it is perfectly reasonable for a purchaser to want to confirm that the sale has been properly authorized by your company’s equity owners.
In an asset sale a buyer does not need a representation and warranty as to unknown.
One of the most compelling factors driving a buyer to select an asset acquisition structure, as opposed to a share acquisition structure, is the ability of the buyer to “step-up” the basis of the acquired assets for tax depreciation purposes when buying assets.
In an asset acquisition the old depreciated basis of assets of the target are stepped-up to the purchase price of the assets, meaning that the buyer will have a higher basis for depreciation. This results in the reduction of the buyer’s income tax, which increases its cash flow as a result of having to pay less in taxes than the seller was required to do.
The purchase price in an asset acquisition can be allocated to the assets which have a shorter (i.e., faster) depreciation life. This includes machinery and equipment, which has a three to five year life. In contrast, goodwill (i.e. the business reputation of the seller) normally has a fifteen year life. While a tax analysis is beyond the scope of this article., it should be noted that there is an option under the tax code for treating a share deal like an asset deal for tax purposes when both parties file a Section 333(h) election under the Internal Revenue Code.
From the standpoint of the seller of the business, if the business is organized as a C Corporation, when the assets of the business are sold in an asset sale the Corporation must pay a tax on the gain it realizes from the sale of those assets. When the proceeds of sale are then distributed by the Corporation to its shareholders, they will pay a second tax. By contrast in the case of a stock sale of a C corporation, if the shareholders of the C Corporation sell their stock to the purchaser thereby transferring ownership of the C Corporation, the sellers will only pay a capital gains tax on the profit they received from the sale of their stock, thus avoiding the consequences of double taxation in an asset sale of a C Corporation.
If, however, the Corporation has been structured as an S Corporation, it generally makes no difference whether the sellers sell their stock in the S Corporation or the S Corporation sells its assets to the buyer. In either case, normally there would be no double taxation and the tax would be levied only on the shareholder level at their personal individual income tax rates, although an asset sale can produce ordinary income and differences in exposure to state tax liabilities. However, even though it is true that in the case of an S Corporation generally it makes no difference tax wise to the selling shareholders whether the assets are sold or the stock is sold, if the S Corporation was formerly a C Corporation or received assets from a C corporation in certain tax deferred transactions then in the case of an asset sale the built-in gains consisting of unrecognized appreciation, would be subject to corporate – level taxation even in the case of an S Corporation.
In an asset purchase agreement one approach is to attempt to specifically itemize and identify all assets of the seller being acquired by the buyer. For example, each machine could be identified (typically by model and serial number), all raw materials identified, specific copyrights, logos, business names, trade secrets itemized and identified and specifically transferred by a bill of sale from the seller to the buyer.
In an asset transaction the buyer may be faced with the problem of getting third parties’ consents to the transaction. For example, if the seller leases its real estate from a third party landlord, the lease will typically contain a non-assignment clause, meaning that the lease cannot be transferred to the new buyer without the consent of the landlord. Generally stated, this would typically not be the case in a share purchase transaction since no assignment of leases is involved, because the company which is the lessee remains the same. However, some leases may deem transfers of ownership of the company (i.e., changes of control) as an attempted assignment of the lease and require prior consent.
If the seller has material contracts, either supply contracts or purchase contracts with third parties, those contracts may contain non-assignment clauses which will also necessitate contacting each one of those third parties to obtain consent to the assignment of those contracts to the new buying corporation. Similarly when the target has intellectual property licenses from third parties, those licenses may also contain non-assignment clauses necessitating the process of contacting the licensors to permit the new buyer to assume the license.
This becomes particularly important when the seller corporation has government contracts. For example, Defense Department contracts or other contracts with government agencies may contain non-assignment clauses that may necessitate the navigation of the federal bureaucracy in order to obtain consent to the assignment of those contracts to the new buyer.
In cases in which the selling company has certain patents or trademarks on file with the U.S. Patent and Trademark Office, not only must the purchase and sale agreement specifically assign those patent and trademarks to the buyer, but as an additional step, a filing with the U.S. Patent and Trademark Office of the assignment must be made in order to completely effectuate the transfer of the patent or trademark by the selling company to the buyer acquiring its assets.
In contrast to an asset sale, it is not necessary to obtain any of the above third party consents in a share sale, thus the process can be much more efficient and take less time and involve less uncertainty. With that said, it should be noted that even in a share transaction it may be necessary in some cases to obtain third party consents where the original documents, (i.e., original leases, IP licenses, material contracts, government contracts and similar contracts) contain what is known as a “change of control” provision.
To learn more about selling a business, check out this webinar from the expert faculty of Financial Poise.
Additional contributing authors: Tom Petrides, Craig M. Carpenter
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Mr. Orlanski helps companies go public. He also represents companies seeking to find underwriters for an IPO or a follow on public offering or a PIPE financing, structures the terms of the public offering, and represents either the issuer or the underwriter in public stock offerings. He was named a Southern California "Super Lawyer" by…
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