Imagine this scenario: a successful small business owner in your community who has spent years growing a business is looking for a way to retire. He or she approaches you with an offer to sell his or her business for a reasonable price, knowing you are the perfect person to run it. At first, you hesitate, unsure if you want to take on the responsibility and risk of owning your own business, but eventually, you realize this is the opportunity you have been waiting for. So, what’s next?
There are two primary methods of buying an existing business. The buyer can purchase the business assets—its inventory, equipment, and other property. In the alternative, the buyer can purchase the stock of the existing corporation, stepping into the shoes of the current stockholders. Either way, the buyer reaches his or her goal—a viable business that is ready to operate. But, depending on the perspective, both options are not equal.
ASSET PURCHASE VS STOCK PURCHASE
Which is better, asset purchase or stock purchase?
Buyers prefer business asset purchase transactions for one primary reason: business liabilities incurred under the previous owner are extinguished. If the previous owner of the business assets had any potential lawsuits, workers’ compensation claims, or outstanding delinquent debts, the buyer will not inherit those troubles. The buyer’s new business is a wholly separate entity that begins anew as of the date of the purchase.
Sellers prefer stock purchase transactions for a similar reason. The seller transfers all of the seller’s liability to the buyer. In a stock purchase transaction, the buyer is the new shareholder/owner of the existing corporation. The seller is paid cash for the stock. This relieves the seller of any continuing obligation for the acts of the corporation prior to the sale.
There are other reasons why buyers prefer asset purchases and sellers prefer stock purchases. Stock purchases can provide tax benefits for the seller, but the overall costs of the transaction increase substantially in a stock purchase. Any buyer considering a stock purchase is wise to have attorneys and accountants perform due diligence to identify pitfalls that could arise after the buyer assumes the seller’s liability. This process is time-consuming and costly even in the simplest of transactions. Complex businesses with large numbers of vendor contracts will increase the cost of due diligence exponentially. The asset purchase process is much less cumbersome. The parties value the assets, execute a purchase agreement, and transfer title. The seller retains all liability.
In small business transactions, avoiding the risks and costs of a stock purchase is usually wise. Buyers should be proactive in presenting a purchase agreement to the seller. Being first to present an offer in writing sets the tone for the rest of the deal, giving the buyer a distinct advantage.