If you are considering buying or selling a business, your primary focus is likely the purchase price, and rightfully so. However, a factor that is just as important is the method of acquiring the business. Two primary means of buying a business are to either acquire the assets, or the equity, of the business. There are meaningful tax, liability and practical implications for both structures. Deal structure is a decision that varies from business to business and depends on many situation-specific factors. These factors will usually cut in opposite directions for buyers and sellers, meaning that negotiating the deal structure will be one of the first hurdles to clear, and that the outcome will probably have a direct impact on the purchase price.
In an equity deal, the buyer acquires the ownership interests of the legal entity itself (e.g. the stock of a corporation, the membership interests or units of an LLC, or the partnership interests of a partnership). The buyer steps into the shoes of the seller and inherits everything associated with the business. Conversely, in an asset deal, the buyer purchases the assets and sometimes the liabilities of a business and leaves the legal entity behind, allowing flexibility to leave certain assets and liabilities with the seller.
Buyer’s Perspective on Asset Deals
From the buyer’s perspective, asset deals are usually the preferred structure for several reasons. First, buyers can choose which assets and liabilities they acquire subject to negotiations with the seller. Don’t want that old building in a poor location? Don’t buy it. Don’t want that contract requiring below-market pricing? Don’t assume it. Just remember that if you don’t want an asset, the seller might not want it either, so plan to negotiate these items and be prepared for purchase price adjustments as a result.
Relatedly, buyers in an asset deal have a materially lower risk of inadvertently inheriting unknown or undisclosed liabilities. These might include future litigation for pre-closing events; fines or penalties for violations of environmental or data privacy laws; and other land mines that don’t reveal themselves until after closing. Because the buyer is able to intentionally exclude unknown liabilities from the transaction, the pre-closing diligence burden is also lower.
Additionally, a buyer in an asset deal can assume a new tax basis and start a new depreciation schedule for the assets they acquire. This is in stark contrast to an equity deal where the buyer inherits the seller’s basis and depreciation schedule. This distinction can result in substantial tax benefits to a buyer but, unfortunately for sellers, doesn’t often yield a commensurate increase in purchase price.
Buyer’s Perspective on Equity Deals
The benefits of an equity deal to a buyer are mostly practical and usually don’t outweigh the benefits of an asset deal. Because the buyer steps into the shoes of the seller, the buyer can often avoid obtaining new licenses and permits as they travel with the business entity. Note, however, that some regulations require certain steps upon a change of ownership to maintain licenses or permits. Contracts also transfer more easily in an equity deal because there is no need to expressly assign the contracts, and the counterparties will still deal with the same entity, bank account, mailing address, etc. The primary hurdle will be restrictive covenants in some contracts that require notice or consent from a counterparty or prohibit transfer entirely. Legal diligence is critical in equity deals to ensure the buyer can identify and address those provisions before closing if necessary. Titled and deeded assets, like vehicles and real property, also transfer more easily because they remain in the name of the purchased entity.
Seller’s Perspective
For sellers, an equity deal will typically yield the best result. Where asset deals are tax favorable to buyers, the opposite is true for sellers. In an equity deal, sellers recognize the entire sale at the lower capital gains tax rate. In an asset deal, tax treatment is determined on an asset-by-asset basis, meaning certain items like inventory, accounts receivable and depreciation recapture will be taxed at the higher ordinary income rate.
An equity sale also offers a cleaner exit for sellers. There are no leftover assets or liabilities for the seller to deal with post-closing, no need to find a buyer for unwanted property, no dissolving a shell entity and no need to assist with retitling assets or transferring licenses and permits.
Other Considerations
Understanding these considerations is important, but leverage will have a significant impact on deal structure in practice. In a competitive bid process, for example, a seller may prefer an equity sale but receive offers for asset deals and face a real choice about whether the price justifies accepting it. For both buyers and sellers, recognizing that deal structure is a negotiating lever and understanding how it interacts with purchase price, indemnification and post-closing obligations can be just as valuable as getting your preferred structure.
Landon P. Tracy is a member of Parsons Behle & Latimer’s corporate practice, focusing on complex transactions and corporate governance. Drawing on experience advising private equity sponsors and their portfolio companies, he brings a deal-focused perspective to clients navigating acquisitions and sales, ownership transitions and the day-to-day legal needs of running a business. To discuss this or related matters, contact Landon at ltracy@parsonsbehle.com or by calling 801.532.1234.
Adam D. Ott is a Parsons Behle & Latimer director, vice president and secretary and a shareholder in its corporate practice. He is an experienced and trusted advisor to a broad spectrum of clients, including large multinational corporations, closely-held private businesses, financial sponsors, family offices, boards, executives and individual investors, on matters ranging from general outside counsel needs to complex, high-stakes transactions and dealmaking efforts. Adam can be reached at aott@parsonsbehle.com or by calling 801.532.1234.