Corporate Finance
Feb 21, 2023
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This guide is designed to quickly walk you through the decision to make an asset purchase vs a stock purchase. When a business is bought or sold (Learn more about the M&A process here) the buyers and sellers have a choice to make. Should they structure the deal as a purchase and sale of assets, or a purchase and sale of common stock.
When you’re thinking about buying or selling a business, this is an important decision to make. To put it simply, we’re trying to decide, legally, what the buyer literally gets in exchange for their money. The purpose of this guide is to examine the decision-making criteria.
With an asset purchase deal, the buyer is effectively acquiring all of the target company’s assets. Asset purchases are basically the sum of a massive number of individual asset sales from the seller to the buyer. Through this process, they acquire the company by buying everything that made the target business valuable.
While there are key distinctions between asset purchase transactions and stock purchase transactions, remember that they lead us to the same end result (a business is sold).
In the lower-middle market, the vast majority of M&A transactions occur as asset purchases. Typically, buyers prefer to structure deals as asset purchases, all things remaining equal. The major reasons why buyers prefer to do deals this way are concerning the legal, tax, and operational implications of the transaction.
First, there are legal concerns that buyers need to give consideration to when structuring deals as stock purchases. This is because through a stock purchase, where the buyer acquires a legal entity, they are adopting any legal risk associated with the business’ past. Through an asset purchase agreement, the acquiring business forms a new legal entity that will acquire the target business’ assets. We will go into more detail about this inherent risk when we explain stock purchases, but asset purchases typically offer the buyer better legal protection.
Second, typically in an asset purchase, the buyer doesn’t acquire any of the liabilities that the target business has. They are in effect purchasing the assets of the business. These liabilities will stay with the seller. This is important because most buyers use leverage to finance the purchase price. By avoiding any existing liabilities (ie. debt) the target business may have; the buyer can afford to add their own debt to the business to help finance the purchase price.
Third, buyers tend to prefer asset purchase agreements for tax reasons. Once the buyer and seller both agree to structure the deal as an asset sale, the purchase price needs to be allocated to the assets the acquirer is buying. From the seller’s perspective, purchase price allocation has mostly to do with the tax implications that the arrangement has on the purchase price. From the buyer’s perspective, they are more concerned with the ability to depreciate assets and with goodwill. In some instances, buyers won’t be able to amortize goodwill if the deal is structured as a stock purchase. We will discuss goodwill in more detail below.
Now that we’ve seen some reasons why buyers typically prefer to structure deals as asset purchases, we’ll quickly highlight a notable exception. If the target business is insolvent (or close), then the acquiring company may be incentivized to structure the deal as a stock purchase. In this circumstance, if they take ownership of the legal entity, then they may have significantly more control over the process. These restructuring deals can create turnaround opportunities for qualified buyers.
Now that we understand asset purchase deals in more detail, it’s much easier to explain stock purchase deals.
In a stock purchase deal, the buyer is effectively acquiring the business by taking ownership of the legal entity the business currently operates under.
Often, sellers prefer to structure deals as stock purchases. This preference has mostly to do with the tax savings that the seller will normally have on the purchase price.
Additionally, it can make sense to structure the deal as a stock purchase instead of an asset purchase if the target business has any licenses or contracts that are with the actual legal entity itself and can not be transferred. Under these circumstances, it is in everyone’s best interest to structure the deal as a stock purchase.
Above, we talked about how buyers typically prefer to structure deals as asset purchases as opposed to stock purchases. We discussed how a big reason for this was the legal implications of structuring the deal as a stock purchase.
In stock purchase deals, as the buyer assumes ownership of the legal entity the business operates under, they also assume legal liability for the business’ past. A major drawback to structuring a deal to buy a lower-middle market business through a stock sale would be the added legal fees associated with structuring a deal this way. Basically, the final contract (definitive purchase agreement) that closes the deal will have to include an indemnification clause that will be a big topic in negotiations. There will be a lot of back and forth between the seller’s legal team and the buyer’s legal team trying to hammer out an agreement that protects both parties. In practice, these indemnification clauses add a lot of fees to these deals and they increase the time it takes to close on them.
Time is the biggest killer of M&A deals and every week that passes where a final agreement can’t be reached not only racks up legal fees, but threatens to break the deal.
Conversely, stock purchase agreements can be much simpler transactions for larger companies or for businesses that are publicly traded. If the business is very large, the legal structure of the company is complex, and there are an unusually large number of assets, then it may make more sense to structure the deal as a stock purchase.
A major implication behind the decision to structure a deal as an asset purchase or a stock purchase is surrounding goodwill. Goodwill is the difference between the net assets acquired (fair market value of assets acquired minus any assumed liabilities) and the amount spent by the buyer to acquire the target business. Goodwill may reference value in things such as brand name, reputation, etc.
Basically, when a company buys another company for more than its fair market value, the difference goes on the acquirer’s balance sheet as an intangible asset. So, if a company spent $30 million to buy a company with net assets of $25 million, that extra $5 million goes onto their balance sheet as an intangible asset.
In the majority of cases where a healthy business is sold there will be competition for the deal. This competition drives the sale price up as the seller now has multiple buyers bidding for the same business. So, in the vast majority of cases, buyers will pay more than fair market value in order to acquire a strong business. The amount that they pay above that fair market value can be amortized in many cases.
This amortization gives the acquiring business a non-cash expense. This means that the amount of the purchase price spent to acquire the business that’s over the fair market value can be recouped over the amortization period in the form of tax savings.
There are distinctions between publicly traded companies and private companies when it comes to goodwill. You can learn more about that distinction in our article on goodwill. Whether or not an acquiring business can amortize goodwill will influence the structure of a deal.
For public companies, with an asset purchase, that goodwill is amortized over 15 years (straight-line method) for tax purposes. This tax advantage is not realized in a stock purchase. As of this writing, under both US GAAP and IFRS accounting standards, goodwill is an intangible asset with indefinite life and therefore doesn’t need to be amortized.
Under a stock purchase the buyer cannot deduct goodwill until it sells the shares it’s buying, later on. For publicly traded companies, goodwill is not tax-deductible when it is in the form of share price premium.
This distinction is for publicly traded acquiring companies. Privately held businesses can amortize goodwill in either instance (asset or stock) over a 10-year period.
For an understanding of the timeline for the sale of a company, whether the deal is structured as an asset purchase or stock purchase, please refer to this guide: The M&A Process Explained. Although the buyer will normally propose a specific deal structure (asset purchase or stock purchase) in their initial outreach to the seller, this will be an ongoing point of consideration. The final decision to structure a deal as an asset purchase or a stock purchase will likely be made during the negotiation phase in the M&A process—after the acquiring business has performed its full valuation and assessment of the target business. Why?
We’ve mentioned before that most times, the buyer prefers to structure the deal as an asset purchase, and the seller often prefers to structure the deal as a stock purchase.
It’s also established that for a deal to happen, both parties must agree to it.
Generally speaking, it’s a good negotiating practice to try and determine what’s more important to the other side earlier on in the negotiation process. To make it simple, consider: price vs terms. If both companies are firm that they need to have the best price possible, it’s unlikely a deal will get done. Why?
Because the buyer wants more for their business and the seller wants to pay less for it. That’s how they each “win” on price. So, they’re at odds in this case.
Say that the seller wanted a good price, and the buyer was OK paying that price, but wanted better terms for them in return for paying that higher price. In this example, say the seller got their price, and the buyer got their terms—the deal structured as an asset purchase vs stock purchase. During the normal process of negotiations, one side will most likely get more favorable terms such as deal structure in concession for something else.
Furthermore, in the vast majority of M&A transactions, there is competition. Meaning more than one buyer for each business trying to get sold. So, terms like how to structure the deal allow buyers a way to potentially offer sellers more money and still get a good deal. Terms like these also allow for ways to get creative with offers so better deals can be made.
As always, good negotiations are a give and take process.
