Growth through acquisition of another company is a legitimate strategy that has been with us for a long time. When a privately held acquisition target is found, one of the primary decisions is whether to buy the stock in the company or buy its assets. Outlined below are some of the things that should be considered in making that decision. In either case, it is important to weigh the pros and cons with respect to price, risk, deal complexities, tax implications, licensing, legal consequences, and other considerations.
Asset Purchase
From the purchaser’s perspective, an asset acquisition is generally preferrable. There are often tax benefits to the purchaser resulting from receiving a step up in basis for acquired tangible assets, and the ability to depreciate those assets as well as potentially good will. One of the key advantages of an asset purchase is that the purchaser can specify which assets it will acquire and which liabilities it will assume. That can reduce the risk of being straddled with unforeseen liabilities and expenses. In other words, the purchaser will control the risk that will be taken in the deal.
Stock Purchase
Stock purchases, on the other hand, are generally less complicated to document. In such a transaction, the purchaser simply steps into the shoes of the selling shareholder. A stock purchase may be preferred when the target company holds licenses or permits that may be hard or take a long time to obtain. Key contracts will also go along with the sale, and customer, landlord, and other consents may not be required. From the seller’s perspective, the tax treatment is often more favorable. The downside of a stock deal is that the purchaser acquires the entire company, warts and all, including any unknown, unforeseen, or other surprise liabilities. One example of an unforeseen risk is a potential employee FLSA claim. While those risks can be addressed through indemnity agreements and monetary holdbacks, they are real risks that should be considered carefully.
What to do
The decision on which path to take will depend on whether you are the buyer or seller. That path should be negotiated before a letter of intent is signed as it will determine the nature of the deal documentation, the due diligence that must be conducted, the tax consequences that should be considered, the risk that will be taken, and the nature and scope of indemnitees that each party will desire or demand. In other words, the form of the transaction will dictate the action each party will take until the deal is closed. As always, it is best to consult your tax and legal consultants early in the deal so that you can make the right decision for your circumstances.