When buying or selling a business, there are generally two ways the transfer can occur, a transfer of the all (or substantially all) of the assets or a transfer of the equity in the entity that is operating the business.  For convenience purposes, we’ll refer to the latter as stock transfer, which may include transfer of shares of stock in a corporation, membership interests in an LLC, or partnership interests in partnerships.
In this article, we’ll explore some of the basic concepts and pros/cons of each method.

1.     Asset Purchase: An asset purchase involves the buyer of the business purchasing all, or substantially all, of the existing business’s assets from the seller, which is typically an entity that owns and operates the business.  The term “substantially all” is used because some of the business’s assets may not be needed or desired by the buyer.  Certain tangible assets, such as equipment or inventory, may not be needed by the new owner of the business.  Certain intangible assets, such as a trade name, intellectual property, may not be desired as well.  In general, the buyer and seller agree on which assets will convey to the buyer.

This leads to one of the greatest advantages of buying assets as opposed to stocks.  The buyer is buying only the assets that the parties agree to, and nothing more.  In addition, generally existing liabilities, known or unknown, of the seller do not necessarily transfer over to the buyer.  Of course the parties can agree that the buyer will assume certain known liabilities, such as an equipment lease, but the important factor is that, subject to certain exceptions,  no unknown or unagreed liabilities will transfer over to and become the obligation of the buyer.
2.     Stock Purchase: A stock purchase involves the buyer purchasing the equity interests of an entity that owns and operates a business. In contrast with an asset purchase, the stock purchase agreement is between the buyer and the owners of the stock of the entity, not the entity that owns the assets.  By virtue of acquiring the entity that owns and operates the business, the buyer acquires all of the assets of the entity.

The buyer will also acquire all of the existing contracts of the entity.  Contracts are double sided, you get something but you have to give something as well.  Think of leases, service contracts, or employment agreements.  For instance, in a financing contract for the installment purchase of equipment, a buyer will essentially step into the former owners’ place and assume making payments on the contract, as well as assuming other obligations.  However, a large number of contracts include provisions that a “change in control” of an entity would be considered an assignment of that contract.  And if an assignment is prohibited under the contract, then the parties must make arrangements so that such equipment subject to the contract will be free and clear of encumbrances (i.e. this usually means fully paid off) prior to the stock transfer.  In other cases, you may have to obtain consent from the other party to the contract in order for it to assign with a change in control.

In addition to the known and disclosed liabilities, the buyer will inherit unknown or undisclosed liabilities of the entity.  For example, if the entity wrongfully terminated an employee prior to the stock purchase, the wrongfully terminated employee can bring an action against the entity, even if the ownership of the entity has changed.  These unknown or undisclosed liabilities may be a great deterrent to a buyer in a stock purchase.

PRACTICAL COUNSEL: We’ve looked at the very basics of asset and stock purchases.  Typically, a stock purchase will involve much deeper due diligence than an asset purchase, while providing continuity in business operations.  Asset purchases are safer for buyers, but may cause disruptions in business operations due to contracts that cannot be assigned to the buyer.  Each method has advantages and disadvantages that should be considered on a case-by-case basis with the assistance of counsel.

The differing tax consequences of these two methods of transferring a business will be discussed in a future issue of this Corporate/Tax Counselor.