Except for when a business is owned as a sole proprietorship, there are generally two alternative ways to structure the sale of a small business: (1) A buyer can purchase the assets of the business, or (2) a buyer can purchase the common stock shares (or limited liability company membership interest) of the entity that owns the business assets.
In an asset sale, the buyer purchases the business assets and, generally, does not assume any of the business’s liabilities. In a stock sale, the buyer purchases the underlying ownership interest in the corporation or LLC that owns the business assets, and the liabilities of the business are, in effect, assumed by the buyer. A risk inherent in the stock purchase is “contingent liabilities” (i.e., liabilities that are unknown to, or undisclosed by, a seller).
A buyer generally prefers an asset sale because: (a) the buyer generally is not exposed to any of the liabilities of the seller, and (b) the purchased assets can then be depreciated over time to gain tax advantages for the buyer.
A seller often prefers a stock sale for tax reasons, and the tax benefits may be so significant that the seller will accept a lower overall price for the business.
While there are risks inherent in a stock purchase, these risks can be managed and there may be other reasons to consider a stock sale. Using an indemnity provision in stock purchase agreement makes the seller contractually obligated to pay contingent liabilities. Representation and Warranty Insurance can also be used to insure seller’s indemnity obligation.
Often, the business has contracts with third parties that the buyer wants to assume. These contracts may require the 3rd party to approve an assignment of a seller’s contract rights, which can unreasonably delay a purchase transaction and may prevent a transaction. Often, using a stock purchase structure avoids the need to get the 3rd party’s consent.
So, buyers should be open to considering a stock purchase structure when the corporation has existing contracts or when the seller will accept a lower overall price for the business.