acquisition agreement

acquisition agreementHow to Structure a Business Acquisition

I talked in a previous post about buying and selling a business.  That post’s main focus was on the valuation of the business.  I think it is important for business owners to understand a bit about the acquisition agreement and what some of the various provisions are meant to accomplish.  In this post, I will explain some of the things to consider in deciding how to structure the business acquisition agreement.  I will discuss other provisions of acquisition agreements in future posts.

Structure of Acquisition Agreement

 There are several ways you can structure an acquisition agreement.  For purposes of this post, I am going to talk about two of the most common structures.  I will give you some of the pros and cons of each type of acquisition agreement, but keep in mind, that much of what I will discuss in this post depends on your particular situation and what you are trying to accomplish.  The structure that you prefer will also depend on whether you are the buyer or the seller.

Stock Purchase Acquisition Agreement

 A stock purchase agreement is generally favored by the seller of a business.  One of the primary reasons a seller favors a stock deal is that the gain from the sale of stock is taxed at the more favorable long-term (if the stock was owned for over 12 months) capital gains tax rate instead of being taxed at the ordinary income tax rate.  If the seller is a C corporation, it can also avoid double taxation by structuring the acquisition agreement as a stock sale.  However, any value assigned to a non-compete will be taxed as ordinary income.

In addition, a stock purchase business acquisition agreement may be helpful for the transfer of any contracts the seller has.  Many contracts have a provision that prohibits the transfer of a contract, without the other party’s consent.  However, if the acquisition is done by the sale of stock, the contract is not being transferred, because the party to the agreement has not changed.  The Seller, whether a corporation, limited liability company or other entity, has not changed.  The buyer and the seller need to conduct proper due diligence on the contracts of the seller’s business to evaluate any clauses prohibiting transfer  Some of the contracts may explicitly say that a transfer includes a transfer by sale of stock or a merger, or otherwise if the ownership of the seller changes.

A buyer generally would prefer not to structure the business acquisition agreement as a stock sale.  The buyer will be subject to all the seller’s liabilities with a stock purchase agreement and will be purchasing all the assets.  However, the buyer can get some protection from this potential liability through other provisions of the agreement.  Furthermore, with a stock purchase agreement, the buyer’s basis (the value of the asset on the company’s books) will equal the carryover basis, which is the seller’s tax basis in the net assets.  The buyer’s basis in the stock is “stepped-up” to the purchase price. This basis cannot be recovered until the stock is sold or liquidated.  This means that in the event the buyer later sells the business, his or her gain will be calculated on the difference between the sale price they get and their basis.

Another consideration for the buyer using the stock purchase acquisition agreement, is that since there is no step-up in basis of the assets, the amount of depreciation and amortization expense that can offset income will be lower, which influences cash flow.

Asset Purchase Acquisition Agreement

 An asset purchase agreement is generally the preferred structure by the buyer of the business.  The asset purchase agreement can be more complicated, because you will often need to obtain consent to transfer most contracts, and other documents will be required to transfer the assets and any assumed liabilities.  For example, a bill of sale, assignment and assumption agreement and deeds are some of the documents that may be required.

Generally speaking, a buyer can expressly limit what liabilities she is assuming.  However, there are certain liabilities where the buyer cannot limit her exposure.  A couple of examples of this are product liability and environmental liability.

With an asset acquisition agreement, the buyer can usually obtain a step-up in tax basis of the assets.  This means that the buyer’s basis in the assets will equal the purchase price paid.  The buyer can then allocate a good portion of the purchase price to assets that depreciate quickly.  This results in a depreciation expense that offsets any income and results in better cash flow.  The higher basis puts the buyer in a better position on taxable gain if the business is later sold. Another consideration in how to structure the acquisition agreement is the treatment of net operating losses (NOL).  In an asset acquisition agreement, the buyer is not entitled to the NOLs of the acquired entity.  In a stock purchase acquisition, the buyer is entitled to the NOLs.

When contemplating the sale or purchase of a business, it is very important to consult with an attorney experienced in the sale and purchase of businesses, as well as an account or tax lawyer.

Client Portal