Every day, businesses are bought and sold. For most sellers, and even buyers, the purchase and sale of a business is a monumental event. Think of when you bought your first home, or when you sold your first home (hopefully with substantial equity), and you realize the similar moments for a business owner.
Whether you are a buyer or a seller, and whether the business has been around less than a year or been around more than a few generations of your family, the structuring of the transaction is a big deal. The structuring of the deal sets the framework for closing the deal and apportions the risks, liabilities, and administrative tasks. And, above all, it materially influences the net cost of acquiring the business for you, as the buyer, or the net proceeds from selling the business for you, as the seller.
The issues to consider extend beyond just tax planning. The tax consequences are always very important and typically will dictate the structure of the deal. But other non-tax factors can be critically important and may dictate the deal structure. Even if such non-tax factors do not dictate the deal structure, they still warrant consideration and should be evaluated by each party to ensure the best possible deal for each party.
This blog identifies non-tax considerations that both buyers and sellers need to consider and think about in structuring a deal. These considerations are relevant when assessing whether to structure a deal as an asset sale or a sale of the entity itself. In case the distinction is new to you, an asset sale is where a business sells its assets to the purchaser but not the entire business, i.e. its liabilities and other obligations. As you may expect, the sale of the entity itself sells the entire entity, including all of its assets and all liabilities. This is accomplished most often as a sale of the outstanding shares (typically common stock in a corporation), the outstanding membership interest (in a limited liability company), or the sale of the partnership interests (in a partnership). A third potential structure is the merger between two business entities, which I only mentioned in passing to be complete as another option. A merger can be considered a variation of a transfer of ownership interests but with a few more moving parts. More discussion is beyond the scope of this post. For now, we will think generally in terms of the sale of assets or the sale of the entity. Let’s get to the list.
- Undisclosed Liability Exposure – Buyers should understand that the acquisition of the business entity comes with all the skeletons within the business. The skeletons may come in the form of liabilities. Liabilities come in many forms. Some of the more significant include unpaid taxes, product liability exposure, employee claims, environmental liabilities, contract disputes, potential other litigation exposure, and regulatory violations. The purchase agreement should contain important language to address these. The provisions include seller’s representations and warranties and provides indemnification provisions and possible escrow hold back provisions. The indemnification provision works to shift responsibility for future liabilities back to the Seller. The escrow hold back provision escrows a portion of the purchase price to protect the buyer against the cost of unforeseen liabilities. Each of these provisions is designed to shift undisclosed liability risk back to sellers and manage buyer risk. These provisions act to better protect the buyer against material undisclosed liabilities. In circumstance where the potential for liability is high, a Buyer may opt for the asset purchase agreement, as a preferred structure by simply buying the valuable assets.
- Non-Party Stakeholder Disruption – The purchase and sale of a business can have a substantial impact on non-party shareholders, such as employees, customers, vendors, and others. If the deal is structured as a business sale, the change in ownership may have less of an impact on these stakeholders. There may be little or no material difference with a change in ownership, though that is subject to the strategy of the new ownership. With the sale of the assets, the assets are transferred to a new entity and the stakeholders soon realize they may or may not also be transferred. The uncertainty raises insecurities and may require attention and a proactive approach. If the stakeholders are not transferred, they may be left out and steps should be taken to ease this burden.
- Non-party consents. The choice to sell assets will likely lead to the need to acquire more non-party consents from third parties than with an ownership transfer. Non-party consents are the necessary and required consents from parties to other operational agreements with the business. This involves reviewing leases and contracts to check the assignment provisions and ensuring compliance with the assignment provisions, which may include other party consent, which, depending on the language, may or may not be reasonably withheld. Negotiation with these parties may be critical to closing and should be considered early in the deal process and secured as early as possible. With the sale of the entity, these concerns are diminished but leases and contracts must still be reviewed for change of control provisions, which may also require some review and consent but often the burden is less.
- Unwanted Assets. After due diligence, the Buyer may determine that some of the Seller’s assets will benefit the Buyer’s business operations where other assets of the Seller will not be beneficial and may even be undesirable. In such cases, an asset purchase would allow for the selective acquisition of valuable assets based on the Buyer’s analysis. This may at times even be more beneficial for the Seller, as well. The Seller may then be able to sell some assets to the Buyer, which then leaves assets of value for a different Buyer. This type of structure may also allow for unwanted assets to remain with the Seller and the Seller can maintain some flexibility in dealing with the future transfer of the remaining less desirable assets, particularly considering the tax impact of those assets transfers.
- Insurance Ratings. This can come into play when a business has been operating for a number of years without claims and has favorable insurance rates due to the long standing relationship. In this instance, the sale of assets may terminate the long term customer status and benefits. In contrast, the sale of the entity with a change of ownership may preserve the long standing status and save insurance costs for the new owners going forward.
- Securities Law Exposure. The sale of an entity includes the transfer of an equity interest in the entity to be acquired. In this type of deal structure, securities laws may be triggered and, with that, come anti-fraud provisions. This creates a greater legal obligation for the Seller to eliminate all misleading material facts related to the sale. Great care is required. In a complex business operation, where the Buyer may only see just below the surface, such latent material omissions lead to additional liabilities for the Seller. To ease the Seller’s potential unease with this deal structure, the Seller may represent to the Buyer that the Seller has not “knowingly misrepresented any material facts” and take care in drafting other reps and warranties, as well. An asset sale structure typically would not trigger the securities law exposure, as the sale does not involve the transfer of securities.
- Ease of Closing. Closing an entity deal is typically an easier transaction to close and document. The sale of an entity typically is accomplished with the transfer of stock or transfer of a membership or partnership interest (with an LLC or partnership). In an asset sale, each asset may have its own transfer document, such as an assignment, bill of sale, or deed. This may be required for each tangible and intangible asset, along with each license, lease, and contract. The same may be necessary for any liabilities that may be transferred, such as a mortgage or promissory note on an asset to be transferred. While the ease of closing and documenting the closing is typically the less important consideration in a deal structure choice, it is worth noting the additional time, effort, paperwork, and attention to detail necessary in an asset sale relative to an sale of the entity. This will also impact closing costs, so plan ahead.
There you have it. Just a few important non-tax considerations when you explore buying or selling a business and how such considerations may influence how to structure a deal.
To all the entrepreneurs and emerging small businesses, and all of you aiming to be better today than you were yesterday: Keep striving, keep pushing, and always remember the best is yet to come.Dislaimer: A Deeper Dive with DLT and each blog post is not intended as legal advice, nor should you consider any part of this blog or website as such. Nothing herein acts to create any attorney client relationship with the lawyers at DLT Law Group. The blog is designed to provide general information and thoughts from the lawyers at DLT Law Group. You should not act upon any information contained in this website without first seeking professional advice from a lawyer licensed in your state or country.