Buying or Selling a Business: Stock vs Asset deals explained.

Businesses are bought and sold all the time.  Transactions range in size from under $100,000 to billions of dollars.  For most sales of small to medium-size companies, the transaction is usually structured in one of two ways:  asset or stock purchase. In this post I will describe each type of purchase, in general terms.  The way the deal is structured can have a more or less favorable impact on each side, and in a later post I will describe which structure each party prefers and why.

Asset purchases

When a buyer purchases the assets of a company, he or she is buying just that: assets.  The buyer can pick and choose which assets to purchase: equipment, inventory, contracts, real estate, intellectual property, etc.   In an asset deal the buyer will want to exclude liabilities such as retirement plans, mortgages, any ongoing litigation or government proceedings, etc. The buyer does inherit any obligations in contracts that are purchased (or “assumed”).  If the buyer wants to retain some or all of the employees of the business, the seller must terminate their employment as of the closing, and the buyer will re-hire those employees that he or she wants to keep. The parties must decide how to address such issues as accrued vacation and sick leave, and any employee benefit plans will normally be terminated with the sale.

After the closing, the seller is left with the liabilities of the business, as well as any cash and accounts receivable in the business as of the closing.  The seller will usually wind up the business and pay out the sale proceeds in some form of distribution to shareholders or members (if the selling company is an LLC), and the legal entity remains in place unless the seller dissolves it.

Stock purchases

In a stock purchase, the buyer purchases the stock of the selling company.  In most cases, the buyer wants to purchase all of the stock, so that he or she does not have a minority shareholder in the picture.   Assuming the buyer acquires 100% of the company’s shares, he or she is now owner of the entire company: both assets and liabilities. If the acquired company had some claims against it, such as a tax claim, or a lawsuit, the buyer now has responsibility for that.  If there was a mortgage or deed of trust on real estate, or a security interest in some piece of equipment, the buyer is responsible for that as well.

Because the buyer is inheriting all of the target company’s liabilities, the due diligence process is particularly important: the buyer and his or her advisors need to dig into everything going on at the target company, and require that the seller disclose all known liabilities, whether actual or potential.

Which side prefers which type of sale?  Buyers generally prefer asset sales, while sellers prefer stock deals.  In my next post, I’ll explain why.