By Philip N. Kabler, Esq.
Bogin, Munns & Munns, P.A.
In a prior article the steps to start a Florida company from scratch were addressed. In this piece the topic of buying a business will be considered.
There are two basic ways to buy a business – purchasing the ownership interests, the equity, such as corporate stock or limited liability company membership interests, of an existing company and purchasing the assets of a company, such as real estate, equipment, inventory, and supplies. For the purposes of this article the discussion will be limited to private firms as opposed to publicly held companies. There are similarities for both categories of transactions, and there are important differences, as well.
Some of the similarities between equity purchases and asset purchases are:
- Due diligence: A buyer of an existing company’s stock or assets must know what they are buying. For example, are the assets or the equity subject to restrictions on sale, such as owner agreement of other contractual rights of first refusal or collateralization by existing loans? What is the quality of the items to be purchased, such as the class of stock or the physical capacity and maintenance status of the assets? These types of matters can be addressed by inspections and investigations, and are customarily resolved before a buyer’s final decision to close the deal is definitively made.
- Financing: A buyer of equity or assets can pay cash for the deal or they can finance it with debt from a third-party lender or even from the seller. Typically the repayment of debt is secured by collateralizing the equity or debt, so the lender can take the equity or assets as a substitute for repayment if the buyer does not pay the loan.
- Documentation: Both equity and asset purchases are described in a series of carefully negotiated documents starting with a purchase and sale agreement and ending in such closing documents as bills of sale, deeds, equity transfers, settlement statements, mortgages, security agreements, and financing statements.
The differences, and consequences to buyers, between equity purchases and asset purchases can be quite stark. Some of those differences are:
- Structure: Asset purchases are fairly simple – before the transaction closes the seller owns, has the right to use, maintains and repairs, and is otherwise responsible for the assets, and after the closing those rights and responsibilities pass to the buyer. Equity purchases can take a wide and highly creative variety of shapes – a buyer can purchase 100 percent, or at least a majority, of a company’s equity from a seller, the two companies can merge causing the target to disappear into the acquirer, or those companies can consolidate causing both the target and the acquirer to disappear into a newly created business entity. And, to make things even more interesting, there can be hybrid debt/equity transactions.
- Liability: When a buyer purchases assets it gets the assets purchased and the present and future maintenance, repair, and tax responsibilities that pertain to those assets. When a buyer buys at least the majority of a firm’s equity it assumes the existing, present, and future responsibilities and liabilities related to the company. Examples include ongoing lawsuits, debt obligations, warranty obligations, and claims against the company for past errors or omissions, even if not presented to the seller before closing. This is another reason for the due diligence activities described above. There are methods to limit or mitigate a buyer’s liabilities related to equity purchases, such as contractual risk-shifting mechanisms. Examples include indemnification, hold-harmless, and defense arrangements, which are complicated, technical, and typically heavily negotiated between a buyer and a seller and insurance.
- Tax treatment: The tax consequences to both a seller and a buyer in either an equity or an asset sale are complex, and must be reviewed by both parties’ tax attorneys and accountants at the beginning of the negotiations because the desired outcomes to both sides can affect the ultimate deal structure.
All of the similarities and differences described above should be reflected in the initial purchase and sale agreement, which can be amended if the parties’ needs or underlying business or financing conditions change, and the other documents used to carry the equity or asset purchase to consummation by closing.
The next time, we will write about buying a franchise.
For more information, call Philip N. Kabler, Esq. of the Gainesville, FL office of Bogin, Munns & Munns, and P.A. at (352) 332-7688, www.boginmunns.com/gainesvillelawoffice, where he practices in the areas of business, real estate, banking, and equine law.
NOTICE: The article above is not intended to serve as legal advice, and readers should not rely on it as such. It is offered only as general information. Readers should consult with an attorney regarding their legal matters, as every situation is unique.