When considering the sale of a business, the legal structure of the sale is an important initial consideration. Two of the most common ways of structuring the sale of a privately owned company are: asset sales and equity sales. Determining the structure may be challenging because buyers and sellers have competing interests and different perspectives. As a general rule, buyers prefer asset sales, and sellers prefer equity sales. Consider the following…
In an asset sale, the buyer purchases only those assets it wishes. Buyers often favor this structure for its flexibility. They can pick and choose the assets they wish to acquire and, as a general rule, the buyer does not assume the liabilities of the seller. As with any rule, there are exceptions. Under certain laws (e.g., environmental laws) and common law principles (e.g., successor liability), a buyer may nonetheless “inherit” the seller’s liabilities. In many cases, the risk of inheriting the seller’s liabilities can be mitigated through contractual protections and business practices. At times, there may be a business reason for assuming a liability of the seller, and, of course, the buyer may do so if the buyer wishes.
An asset sale can be more complex and time-consuming than an equity sale because of the need to identify and transfer each important asset. Most tangible assets, such as equipment, may easily be transferred by a bill of sale or other instrument of title. Intangible assets, such as intellectual property require a separate assignment. A deed will be required to transfer real property (e.g., land and buildings). If the key assets include the seller’s customer agreements, the consent of the other party to the contract may be required for a transfer. And, at times, key assets (e.g., business permits and licenses) are not transferable at all.
In an equity sale, the buyer most typically acquires all of the equity in the company from the equity holders. In an equity sale, the company stays exactly the same—its assets and liabilities unchanged. The only thing that changes is the owners of the entity. If the entity in question is a corporation, the buyer will purchase the stock of the company from its stockholders. If the entity in question is a limited liability company (“LLC”), the buyer will purchase the LLC interests of the company from its members. Thus, an equity sale may be very attractive where the key assets of the company cannot be easily transferred. At the same time, the company’s major contracts (e.g., loan agreements and commercial leases) may require the consent of the other party in the event of a “change of control,” such as the sale of a controlling share of the company’s equity. Also, insofar as the company’s liabilities—both known and unknown—remain with the company, due diligence becomes even more important. Also, the buyer will want to negotiate representations and warranties concerning the company’s assets and liabilities, and will also want to establish an escrow, obtain a guarantee, or establish other such mechanisms so that there is a reasonable ability to recover losses in the event the seller’s representations and warranties prove to be false.
There are numerous ways to structure a sale of a privately owned business. Asset sales and equity sales are the most common. Each structure presents unique challenges and raises important legal and tax consequences. Thus, whether you are the buyer or seller, competent professional advice is key to designing a mutually advantageous sale structure.