The Biz Blog
February 26, 2019 by Alex Estrin
There are three principal ways to acquire a business: a purchase of the target's assets or stock, or a merger. Alex Estrin business broker with BizEx, and Alex Prasad, business attorney with AEGIS Law, present a high-level summary of stock purchases.
Stock Purchase
In a stock purchase, an acquiror buys the target company directly from its shareholders; the result, if the Buyer is an existing business entity, is that the target becomes a wholly-owned subsidiary of the acquiror. Since the acquiror in a stock purchase takes complete control of the legal entity of the target, it takes on all of the assets – and all of the liabilities – of the target as of the closing date. If the deal is structured as a "cash-free, debt-free" deal, as most US domestic deals are, the Buyer will often require the Seller satisfy certain liabilities with the closing proceeds simultaneous with the closing.
Depending on the organizing documents of the target (specifically, whether it has a drag-along provision), it may be difficult to buy 100% of the stock of a target. “If that is the case, a Buyer may be forced into a relationship with minority shareholders that may not see eye-to-eye with the Buyer,” says Alex Prasad. If this is the case, the parties may instead elect to conduct a short-form merger.
Sellers generally favor a stock sale over an asset sale since there likely will be only one level of taxation – at the shareholder level – rather than the potential for two (at both the corporate and shareholder levels) in an asset sale. Also, such a sale likely will be taxed at lower capital gains rates. When a Buyer and the Seller are C-corporations or S-corporations, certain tax elections can be made to make a stock sale tax efficient for both the Buyer and Seller. For example, if the proper conditions are satisfied, and the Buyer and Seller agree to coordinate their tax filings, IRS Code Section 338(h)(10) may allow a transaction to be treated as an asset sale (beneficial to the Buyer) but avoid two levels of taxation as the selling entity is deemed dissolved in conjunction with the sale (beneficial to the Seller).
A stock purchase can be simpler than an asset purchase and may be the preferred choice when the acquiror is purchasing a going concern – many third party contracts will remain in place and unaltered since the legal form of the target will remain static. This is because while many contracts have anti-assignment provisions (which would be triggered in an asset purchase), fewer have change in control provisions (which are triggered in a stock purchase). “However, since the Buyer will be assuming all of the liabilities of the going concern, a stock purchase agreement may be more complicated than an asset purchase agreement, requiring more negotiation,” says Alex Estrin.
Since a Buyer is taking on all of the assets and liabilities of the target, much of the diligence focus will be on liabilities of the target – both known and unknown. Other factors being equal, indemnification limits are usually higher and holdback or escrow periods longer in a stock purchase as compared to an asset purchase.
This information is intended for high-level informational purposes only. Prior to making any decisions regarding the acquisition of a business, readers should seek the advice of an attorney and tax professional. The publishing of this article does not constitute endorsement, recommendation, or favoring by BizEx.
Alex Prasad, AEGIS Law business attorney, is a contributing author to the BizEx blog. Alex specializes in middle market M&A, as well as working with early-stage and startup companies.
How to Buy, How to Sell, Business Sales Process
