It’s a rule of the corporate food chain that the bigger companies devour the smaller—for example, Google purchased YouTube, Coca-Cola bought Odwalla, and General Motors acquired Hummer (R.I.P.). All such deals, whether big or small, are made possible by acquisition agreements. These agreements occur in two ways:
- Entity purchase agreements (also known as “stock purchase agreements”). In this arrangement, the buyer purchases the business entity by buying a majority (or more) of its stock. The new owner generally steps into the shoes of the previous owners, assuming all debts and obligations.
- Asset purchase agreements. In this arrangement, the buyer purchases all of the business’s assets, both its tangible property (inventory, real estate, office equipment, etc.) and intangible property (copyrights, patents, trademarks and trade secrets). The company’s shell—its corporate or LLC ownership—remains in place with the same owners, even though there is no business to run anymore, as a practical matter. This is the deal of choice for the purchase of a sole proprietorship or a partnership because the business has no ”shell” to speak of: Once the assets are gone, there’s no structure left to worry about.
Which is better? There are two issues to consider when choosing an acquisition model: taxes and liabilities for debts and obligations. Tax-wise, an asset sale is usually better for the buyer because the buyer can begin depreciating the assets sooner. The seller usually prefers an entity purchase because the seller pays taxes only at the low long-term capital gain rate. Sellers are especially wary about using an asset sale for a C corporation, because that will leave them at risk for double taxation, once for the corporate entity and then again for the shareholders.
As for debts and liabilities, an asset sale is usually preferable for a buyer, because the buyer won’t be responsible for existing debts of the business unless the buyer agrees to take them on. That’s the not the case with an entity sale, in which it’s assumed that all liabilities are included in the sale. (To make the deal happen, however, the selling shareholders or LLC members may have to accept responsibility for some specified liabilities, such as a recent bank loan.) The choice of acquisition arrangement also affects how ownership is transferred and whether a lease for the business can be transferred or assigned to the new owners.