M&A (Mergers and Acquisitions) involves consolidating companies or business assets. The consolidation is done through financial transactions between the companies participating in the deal. One company may absorb the other by purchasing it outright, merging with it to create a new entity, or it can acquire some or all of its significant assets.
Alternatively, the acquiring company can make a tender offer for the seller’s stock. Hostile takeovers, another option, are also a form of M&A.
In any M&A transaction, one of the key things to decide on is the deal structure. Should the buyer acquire the assets or the stock of the target company? The decision will impact every detail of the entire deal.
There are times when the optimal deal structure is evident. Sometimes, it can take a long time to work out the best possible decision. Buyers and sellers can spend a lot of time and resources towards the determination. The definitive purchase agreement for each deal is unique and depends on the transaction structure agreed upon by the parties.
Is an asset sale better than a stock sale? It depends on numerous factors, including tax considerations and other items that are highly deal-specific. Here, we examine the advantages and disadvantages of an asset sale. Ideally, those walking into an M&A process should be familiar with asset sales and discuss their decision with accounting advisors and tax counsel to make the best possible decision.
What is an asset sale?
An asset sale is a transaction that involves the sale of assets used in a business. A selling company or seller sells these assets to a buyer. The assets involved in the purchase usually represent substantially or encompass all the assets of the selling company. At times, however, the assets in question involve those from a select aspect of operations or division.
In asset deals, the buyer typically assumes only specified business liabilities, and the seller retains most of the liabilities.
Asset sales allow significant flexibility among the transacting parties. They enable parties to negotiate the specific assets and liabilities in the deal. For a buyer, this means potentially reduced risk of assuming unknown liabilities on the part of the business being acquired. Asset sales also prevent buyers from spending money on undesirable or unwanted assets.
Sellers are usually less inclined to choose asset sales over stock sales. However, in some cases, sellers decide to dispose of only a portion of their business holdings. Asset sales are usually made with the purchase of distressed businesses, in transactions with significant concerns regarding unknown business liabilities, or in the sale of a particular business division.
Thus, in an asset sale, tangible and intangible assets are acquired by the buyer as a means to take over a target business. The liabilities are selective or optional—the buyer can “cherry-pick” the liabilities included in the deal, reflecting the risk they are prepared to absorb.
In the final purchase agreement, you would segregate the assets of the seller’s company into several buckets, which reflect tangible and intangible assets, including equipment, inventory, training, goodwill, and real estate.
How To Accomplish an Asset Sale
There are crucial processes involved when you execute an asset sale. Each step requires considerable review and negotiation.
Due diligence
The first thing to do is to conduct thorough due diligence. The buyer does this to identify the specific assets and liabilities to be acquired. The due diligence process encompasses operational, financial, legal, and environmental aspects.
Valuation of assets
The next step is computing the fair market value of all assets to be acquired. This stage involves assessments, appraisals, and negotiations, all aimed at reaching a mutually agreeable price.
Purchase agreement negotiation
After all assets are valued, the parties enter into a negotiation. During the negotiation, the terms of the purchase agreement are outlined. In these terms, you’ll have the specific purchase price, assets, liabilities, and conditions of the transaction.
Asset transfer
When the purchase agreement is finalized and mutually signed, the process of transferring assets begins. The buyer takes possession of the assets, with their ownership transferred accordingly. This step involves financial, legal, and operational aspects.
Assumption of liabilities
In an asset sale, the buyer entity assumes only the agreed liabilities. Such liabilities may include contracts, debt, and other obligations. At this stage, it is crucial to document all transactions and follow legal procedures diligently.
Regulatory approvals
The transfer of a company’s assets may require approvals, licenses, and filings, depending on the industry. Such authorizations may be necessary for the future company to operate.
Integration
After the purchase, the buyer company must integrate the purchased assets into its current operations. The process may involve process alignment, system integration, and workforce transfers.
Companies using MDM solutions for remotely working staff might be more relaxed about integration due to the flexibility of their technology setup. Nonetheless, properly aligning technology systems must facilitate a seamless transition during mergers and acquisitions.
How are asset sales different from share sales?
Asset sales are sometimes characterized as debt-free and cash-free deals. However, they involve different degrees of assumption of liabilities and are not strictly debt-free or cash-free. In an asset sale, the buyer selectively purchases specific assets of the target business.
These assets may include inventory, equipment, and contracts—both tangible and intangible assets. It is sometimes characterized as “cash-free” because there may be no cash involved outside of working capital. In some cases, the seller typically pays off debt obligations at closing. Buyers reap legal and tax advantages in an asset sale.
A stock sale, on the other hand, is more straightforward in terms of integration. The buyer purchases ownership of the target company. This purchase can be in the form of membership interest or shares. In the case of an LLC, the buyer buys the legal entity that owns the target business. There are legal challenges that come with this type of deal. The buyer will become responsible for trailing liabilities. Therefore, it’s crucial to run careful due diligence before moving forward.
The eventual agreement in a stock sale is called a Stock Purchase Agreement or SPA. It is synonymous with a “Definitive Purchase Agreement”.
You would rarely find small business transactions structured as a stock sale. Buyers prefer a stock sale when they want to transfer something that the seller’s company or entity owns that cannot be independently transferred or isolated from the rest of the company. Examples of such items are contracts, which require the explicit permission of the counterparty.
In practice, a business valued at less than $50 million will be structured as an asset sale. This practice is because, from the point of view of a buyer, an asset sale is usually more desirable. The avoidance of unknown legal risks is appealing. From the point of view of the seller, asset sales are less desirable. Hard assets may be subject to higher ordinary income tax rates.
Pros And Cons of Choosing an Asset Sale in M&A
Asset sales offer advantages and disadvantages for both buyers and sellers. Before you decide on your course or deal, it’s important to understand the positives and negatives.
Pros for the buyer
Let’s view an asset sale from a buyer’s perspective. The pros for the buyer in an asset sale include:
Reduced exposure to liability
By being allowed to be selective on which liabilities to assume and which to forgo, buyers are freed from potential unknown contingencies and risks from the purchase.
A contingent liability is a liability that is not known to exist in the transaction. Hence, when the liabilities aren’t specified in the deal, you do not know what you are taking on. In a stock sale, unknown liabilities may exist, and buyers end up assuming those issues when they choose a stock purchase as the eventual deal structure.
Brand independence
After an asset sale, the final step usually involves establishing a new brand or integrating the purchased assets into the buyer’s existing brand. This situation avoids issues tied to a seller’s brand and reputation.
Selective acquisition of assets
Buyers have the freedom to pick which assets favor them. They can be selective over which assets and liabilities they acquire. This move provides greater flexibility and control over the transaction.
Tax benefits
Buyers may benefit from better tax treatment. Some acquired assets may be favorable tax-wise due to accelerated depreciation. Asset sales let buyers step up the tax basis in the acquired assets. Buyers can achieve considerable tax breaks by allocating a higher value for quickly depreciating assets like equipment and allowing slowly amortizing assets to be assigned lower values, such as goodwill, which has a 15-year life.
Cons for the buyer
While asset sales are generally viewed as leaning favorably toward the buyer, they have their disadvantages, too, such as:
Workforce issues
Workforce integration may prove to be complicated. In addition, selective retention of employees can lead to knowledge gaps and HR problems.
Loss of collaboration
In some cases, selling assets can lead to the realization of advantages that would have naturally occurred in a share sale. Companies are more than just their equipment or assets, so buying assets alone may not be enough to create a seamless transition.
Issues with asset valuation and identification
The process of identifying company assets and valuing them can be tedious and challenging on the part of the buyer. This process may cause disagreements between parties during the negotiation stage.
Renegotiation of existing contracts
After purchasing assets, the buyer may be left to renegotiate contracts or agreements tied to the assets acquired, which can be a long and daunting legal hurdle.
Pros for the seller in an asset sale
Asset sales, although not usually associated with being advantageous to sellers, can prove to be beneficial to the selling entity depending on the situation, as illustrated in these examples:
Selective disposal of assets
Sellers tend to be companies in distress. In asset sales, they can retain specific assets while selling others. This situation can be to a seller’s advantage, as in the case of strategic asset optimization. Selective sales also allow sellers to maintain their core business functions.
Keeping the seller’s corporate entity
With an asset sale, a seller’s company remains intact. The preserved corporate entity can benefit a seller if they wish to continue doing business or explore other opportunities.
Tax efficiency
Asset sales tend to be tax-efficient for sellers. They may allow sellers to utilize favorable tax treatment for specific assets. This strategy may help them reduce their tax burden.
Control of liabilities
Sellers can decide which liabilities to hold on to and which to transfer. If they successfully transfer undesirable liabilities, they reduce exposure to these obligations and rid themselves of potential contingencies.
Cons for the seller in an asset sale
Asset sales may create potential disadvantages for sellers, including:
High complexity of transactions
Execution and negotiations for asset sales may take much work for a seller. The entire deal involves the identification of specific assets and liabilities of the company, thus becoming more intricate than a share sale.
Capital gains tax issues
Specific sale structures and jurisdictions of asset sales put sellers at a disadvantage. Sellers may be obligated to pay capital gains taxes on selling individual assets. The deal could increase the seller’s overall tax liability.
Workforce disruption
Selective retention of employees can lead to loss of morale and other HR issues. In addition, it may lead to different types of troubles involving knowledge transfer and operations.
Choose the Best Structure for Your M&A Deals
Asset sales are a common way of structuring a corporate acquisition. However, they must be entered into with care and weighed against the other option, a stock sale. Deciding on the type of acquisition strategy depends on the strategic goals of both parties entering into a contract.
Certain situations favor an asset sale as the best deal structure, such as cases where liability control or limiting liability exposure is a priority or tax efficiency, brand independence, and work flexibility are essential to the buyer.
In addition, sellers benefit from asset sales when they want to divest non-core assets and refocus on their core business. Asset sales may also provide advantages in contract renegotiation for buyers.
Asset sales may be affected by the prevailing market conditions and regulatory landscape. Moreover, choosing the structure of a company sale can have significant differences in liability and tax implications.
Buyers and sellers must carefully run through all the pros and cons of each method. It is crucial to consult with a multidisciplinary set of advisors, ideally including business brokers, accountants, and transaction attorneys, to determine the best approach to suit their goals.