When it comes time to sell your business, what form should the sale transaction take – asset purchase, stock purchase or merger? Each form has its positives and negatives for the buyer and seller. In this three part series, we look at each form of transaction and walk through the advantages and disadvantages of each.
In a Stock Purchase transaction, a Buyer purchases all of the equity in a company. If the company is a corporation, the Seller or Sellers are the shareholders of the corporation, and the document is typically called a Stock Purchase Agreement. If the company being purchased is a limited liability company, the sellers are the members of the LLC and the agreement is typically called an Equity Purchase Agreement or a Unit Purchase Agreement. Throughout this blog post, I refer to a “Stock” Purchase Agreement and a single “Seller,” but the information applies equally to equity purchases and multiple Sellers.
In a stock purchase transaction, the Seller gets himself or herself completely away from the Company and the Buyer steps directly into the shoes of the Seller and the business continues without interruption. Typically, the Seller will prefer a Stock Purchase over an Asset Purchase transaction because the entire Company (including any liability) goes over to the Buyer and the Seller receives more favorable tax treatment. The Buyer usually will prefer an Asset Purchase because it allows the Buyer to pick only the assets he or she wants to buy (and avoid any liabilities) and receive more favorable tax treatment in the form of stepped up basis.
One of the biggest considerations for a Stock Purchase Agreement is that the Buyer continues the operation of the Company – in the same corporate form – as the previous Seller; there is no new entity operating the business of the Company. The name of the Company stays the same, the principal place of business of the Company stays the same, employees continue to work for the Company; everything stays the same except for the owner’s identity. The continuance of the Company means that third party consent for the transfer of contracts is typically not required. (Note that consent can be required if the subject contract has a “change of control” clause.) It is in this way a Stock Purchase transaction can provide a “seamless” transition for clients and/or employees of the Company.
Unless specifically agreed otherwise in a Stock Purchase Agreement, following the sale of the Company, the Seller will have no continuing interest in the Company, the assets or the ongoing business. However, Stock Purchase Agreements typically require the Seller to provide indemnification to the Buyer for pre-sale liabilities of the Company and representations and warranties regarding the Company made at closing. For example, if the Company is assessed taxes after the closing but which relate back to the time the Seller was operating the Company before closing, the Company is still liable for the taxes, but with typical indemnification language in the Stock Purchase Agreement, the Seller would need to compensate the Buyer for those taxes.
In a Stock Purchase Agreement, as in an Asset Purchase Agreement, both the Seller and the Buyer will be asked to give certain representations and warranties as of the closing date and certain covenants that will bind them before and after closing. The “reps and warranties” sections tend to be the most negotiated parts of the agreement. The Buyer wants the Seller to make representations that that the Seller owns all of the stock of the Company, that no one else would have any claims on equity in the Company and that the stock was issued by the Company properly; the most important issue for the Buyer is to ensure that he is buying all of the stock or equity in the Company. The Buyer may also ask for representations about the Company’s financial statements, any possible litigation, and the lack of a “material adverse effect” on the Company’s business.
The Seller usually wants to limit the scope of the representations and warranties to include only those regarding the power and authority to enter into the transaction and the ownership of the stock. Alternatively, the Seller can limit the reps by using knowledge qualifiers (“to the Seller’s Knowledge, there is no …”) and materiality qualifiers (“the Seller has good and valid title to all the Purchased Assets, in all material respects …”). The Buyer typically provides limited representations and warranties as to its corporate power and authority to enter into the transaction and the sufficiency of its funds to complete the purchase.
As in an Asset Purchase Agreement, the Seller also agrees to pre-closing covenants to continue to operate the business in the ordinary course and to pay debts and liabilities as they become due. Seller and Buyer agree to work together toward closing and to share certain information. The Buyer may ask that the Seller agree to a non-compete provision, prohibiting the Seller from competing with the Buyer, or a non-solicitation provision, prohibiting the Seller from soliciting employees or customers, each following the closing.
A stock purchase has certain advantages:
- A Stock Purchase can be easier and quicker than an Asset Purchase;
- No transfers of title to assets are required;
- No need to transfer contracts to Buyer, so typically no third party consents required and less disruption in the business occurs; and
- Buyer gets the “goodwill” and past performance record of the Seller
- Liabilities of the Seller will automatically carry over to the Buyer;
- Buyer cannot “cherry pick” the assets it wants to acquire and avoid the assets it does not want; and
- Buyer takes the Seller’s tax basis in the purchased assets – not a “stepped-up” basis.