Village Wellth

If you’re interested in the world of acquisition and want to move forward with the steps required to purchase a business, it’s certainly in your interest to research the transaction process.

Get curious.

Learn about the ways that people actually go about financing acquisition transactions (you can read our article that details the 3 most common ways to finance a business here). Figure out how small to medium business transactions are typically structured—how do buyers financially and legally assume ownership from previous owners? Conversely, how do buyers purchase business assets and shares from shareholders? What are the benefits and the negatives to particular transaction methods?

Being knowledgeable about the general principles of deal transactions will help you understand the kind of business you want to purchase and how to actually acquire the sorts of materials and resources you’re looking for. It will also help you understand potential sellers’ intentions and allow you to easily align with their selling intentions, hopefully making the process of negotiation and purchase agreement drafting easier.

When it comes to small-to-mid-sized enterprise (SME) acquisitions, there are two principal methods for deal structuring transactions. The first is called a stock purchase, and the second is called an asset purchase.

What is a Stock Purchase?

A stock purchase occurs when a buyer purchases all or most of a company’s shares. Through a stock purchase, the target company remains intact under its new ownership. In other words, “the acquirer buys the stock of the target and takes the target as it finds it…”

Typically, this method of transaction is the preferred approach for sellers because the new owner assumes all risks associated with the business. For example, the buyer takes on the seller’s debts, obligations and liabilities. Additionally, in the case of a stock acquisition, sellers commonly obtain the tax advantage of capital gain exemptions.

Pros of a Stock Purchase for Buyers:

Through a stock purchase a buyer doesn’t typically have to re-value or retitle acquired assets.
Through a stock purchase a buyer usually takes on non-assignable licenses and permits without having to gather consent.

Cons of a Stock Purchase for Buyers:

Through a stock purchase the buyer doesn’t get the advantage of choosing which assets and liabilities they want to acquire.
Through a stock purchase the assets and liabilities transfer at their book value.
Through a stock purchase, a buyer cannot forgo acquiring unwanted liabilities unless separate agreements are drafted that determine the seller’s responsibility for them.
With a stock purchase, buyers typically have to conduct heavy due diligence to ensure that there aren’t liabilities hidden throughout the structure of the business—to avoid skeletons in the closet.
Factors can complicate the process of a stock purchase. For example, if a company has multiple shareholders some may not want to sell their stocks. In this case it’s important to certify, through due diligence, the party who assumes the major shares and has the right to sell the business.
Through a stock purchase, assets like goodwill are not tax-deductible.

What is an Asset Purchase?

The asset purchase method allows a buyer to pick and choose which specific assets of a business (i.e building, vehicles, equipment, inventory, customer lists and so on) to purchase as opposed to purchasing the business, its shares and corporation as a whole. In a common asset purchase, the buyer is not required to take on a seller’s total debts or liabilities. Instead, an asset purchase allows a buyer to decipher and negotiate which liabilities and debts they wish to acquire.

“An asset purchase minimizes the chances of a nasty surprise from finding undisclosed liabilities after your purchase.” - Richard S. Ruback and Royce Yudkoff

Generally speaking, asset purchase is the preferred transaction method for buyers. The buyer can decipher their risk, and give the seller, if they are willing, the responsibility “to liquidate any assets not purchased, pay any liabilities that have not been assumed, and take care of any leases that need to be terminated.”

Pros of an Asset Purchase for a Buyer:

Through an asset purchase, a buyer gains flexibility. With careful research of the target, the buyer deciphers what portions of the business they want to assume and can determine their comfortable risk level.
With an asset purchase a buyer can dictate the specific liabilities they are comfortable assuming post-transaction. “This limits the buyer’s exposure to liabilities that are large, unknown, or not stated by the seller.”
As hidden liabilities are less likely with asset purchases, a buyer may need to spend less money and time conducting due diligence on the company as a whole. Instead, the buyer would focus their research on the specific assets in their interest.
With an asset purchase, a buyer can amortize goodwill assets.
With an asset purchase, a buyer can re-value depreciated assets to their fair market value and depreciate assets overtime.
With an asset purchase, the buyer can still purchase assets even if minority shareholders are not in agreement with the sale terms.
Because a buyer can assume which portions of the company they want to acquire over which they do not, the buyer can choose which employees “they want to retain... without impacting their unemployment rates.”

Cons of an Asset Purchase for a Buyer:

With an asset purchase, a buyer may need to revisit or reinvent relationships with the target’s customers and suppliers. Specifically, a buyer may need to renegotiate or rewrite particular business-to-business and business-to-consumer contracts.
With an asset purchase, the seller can choose to disagree with buyer initiated terms. The seller may also expect a higher purchase price as the tax cost associated with a purchase asset is typically higher for the seller.
An asset purchase may require a buyer to retitle their assets.
With an asset purchase, a buyer may have to update or renegotiate employment agreements.

Stock Purchase or Asset Purchase?

As a buyer, you may be wondering which transaction method is preferable for you. The answer will always be conditional. The specifics of the acquisition—size, scope, purpose, financing available and so on—will determine the conducive transaction structure.

If your main interest is to acquire the skeleton of a business (i.e its assets, customer basis, branding and so on) over the stocks and shares of a company, an asset purchase would be favorable. Likewise, if the size of the target company is relatively small, then an asset purchase may be the only possible transaction method.

All in all, when creating a deal structure, it's crucial to understand that your purchase interests need to align with the target seller’s interests in order to make the transaction favourable for both parties.

Your purpose and plan for the transaction, or acquisition as a whole, needs to be in sync with the seller. If communication between the buyer and seller is either non-existent or out of touch, the transaction is likely never going to come to fruition.

Therefore, it’s beneficial, as a buyer, to understand your position and interests. Village Wellth helps you decipher those critical factors—the reasons for why you’re purchasing a business, what kind of business you want to buy, the financing options that are available to you—by providing you with personalized guidance as well as connecting you with advisors fitted to you.

In understanding your intentions as a buyer, you’ll be able to better grasp the process of acquisition and which deal structure will be instrumental for you and your professional objectives.

Creating a Deal Structure for an SME Acquisition