Buying or selling a business is rarely as simple as agreeing on a price.
One of the most important questions comes earlier: What, exactly, is being bought?
A transaction can be structured in several ways, but two common approaches are an asset purchase and an equity purchase. The distinction can affect which liabilities follow the business, which contracts and permits must be addressed, how employees and operations transition, the tax consequences of the deal, and ultimately how much risk each side is accepting.
For buyers and sellers, transaction structure is therefore not merely a drafting decision for the lawyers to make at the end. It is a business decision that should be considered early—often before the parties commit to the principal terms of the deal.
In an Asset Purchase, the Buyer Selects What It Is Buying
In an asset purchase, the buyer generally purchases specified assets of the operating business rather than purchasing ownership of the entity itself.
Depending on the business, those assets might include:
- equipment and inventory;
- intellectual property;
- customer lists and goodwill;
- domain names and other digital assets;
- certain contracts;
- accounts or other specified rights; and
- real estate or leasehold interests.
The parties also negotiate which liabilities the buyer will assume and which will remain with the seller.
That ability to define the acquired assets and assumed liabilities is one reason buyers often find asset transactions attractive. A buyer may be able to acquire the parts of a business it wants without intentionally assuming every obligation of the selling entity.
But the distinction is not absolute.
Certain liabilities can follow transferred assets or operations under applicable law regardless of what the purchase agreement says. The transaction also may require third-party consents, contract assignments, permit or license transfers, lien releases, and other steps necessary to move the business from one entity to another.
In other words, an asset purchase can provide considerable flexibility—but that flexibility creates its own diligence and closing requirements.
In an Equity Purchase, the Business Entity Usually Remains in Place
In an equity purchase, the buyer acquires the ownership interests in the company itself—for example, shares of a corporation or membership interests in a limited liability company.
The entity ordinarily continues to own its assets and remain party to its contracts. From an operational perspective, that can make an equity transaction appear simpler.
But the continuity cuts both ways.
Because the buyer is acquiring the entity, the entity generally continues to carry its existing obligations and potential liabilities. Those might include contractual obligations, employment matters, tax exposures, pending or threatened disputes, regulatory issues, debt, or other problems that arose before closing.
That makes due diligence particularly important.
A buyer needs to understand not merely what the company owns and earns, but what obligations and risks reside inside the entity being acquired.
The purchase agreement can then allocate identified risks through representations and warranties, indemnification provisions, escrows or holdbacks, closing conditions, and other negotiated protections. Those contractual protections, however, are not substitutes for thorough due diligence and a clear understanding of the business being purchased.
Why Buyers and Sellers May Prefer Different Structures
The parties’ interests do not always align.
A buyer may prefer an asset transaction because it can offer greater control over the assets acquired and liabilities assumed. Depending on the circumstances, an asset transaction can also produce different tax treatment for the buyer.
A seller, meanwhile, may prefer an equity transaction because it can provide a cleaner transfer of the entire business and potentially avoid the need to assign numerous individual assets and contracts. Tax consequences may also differ materially for the seller depending on the entity and transaction structure.
Neither structure is universally better.
The appropriate structure depends on the company, the parties, the assets, the liabilities, the tax consequences, the contracts involved, regulatory requirements, financing, and the commercial objectives of the transaction.
That is precisely why structure should be analyzed rather than assumed.
Contracts Can Become a Major Deal Issue
A company’s important contracts deserve particular attention when evaluating transaction structure.
In an asset purchase, contracts that the buyer needs may have to be assigned. Some contracts prohibit assignment without the other party’s consent.
An equity purchase may avoid certain assignment issues because the contracting entity itself remains the same. But many agreements contain change-of-control provisions that can require consent or create termination rights when ownership changes.
A company may therefore have an attractive customer relationship, lease, license, supplier agreement, or financing arrangement that cannot simply be assumed to transfer with the deal.
Discovering that problem shortly before closing can delay the transaction—or materially affect its value.
Discovering it while the deal is still being structured gives the parties considerably more room to solve it.
The Purchase Price Is Only Part of the Economics
Two offers with the same headline purchase price can produce very different economic results.
Transaction structure can affect:
- taxes;
- debt repayment;
- working capital;
- transaction expenses;
- assumed liabilities;
- purchase-price allocations;
- indemnification exposure; and
- the amount and timing of cash a seller actually receives.
In certain asset acquisitions, federal tax rules require the purchase price to be allocated among the acquired assets, and buyer and seller reporting positions must be coordinated.
For that reason, legal and tax advisers should usually evaluate the proposed structure together. A transaction that appears attractive from one perspective can look quite different once its full economic consequences are considered.
Structure Should Be Considered Before the LOI Locks In the Deal
A common mistake is to negotiate price first and leave transaction structure for later.
By then, the parties may already have spent significant time negotiating, conducted preliminary diligence, disclosed sensitive information, or developed strong expectations about the transaction.
More importantly, the letter of intent may already describe the deal as an asset purchase or equity purchase.
That language can shape the negotiations that follow even if portions of the LOI are expressly nonbinding.
Before signing an LOI, buyers and sellers should therefore understand at least the basic consequences of the structure being proposed.
Changing structure later is possible. It is simply much easier to evaluate alternatives while the parties still have maximum negotiating flexibility.
Good Deal Structure Begins With the Business Objective
The question is not simply:
“Is an asset purchase better than an equity purchase?”
A better set of questions is:
“What is the buyer actually trying to acquire? What risks is it willing to accept? What does the seller need from the transaction? And which structure gets both sides closest to those objectives?”
Those questions affect the transaction long before the definitive purchase agreement is drafted.
For a business owner considering an acquisition or preparing to sell a company, early legal analysis can identify structural issues while there is still time—and leverage—to address them.
Considering Buying or Selling a Business?
If you are evaluating a business acquisition or sale, the time to think about deal structure is before the major terms become fixed.
Lovstad Law advises business owners, buyers, and sellers on acquisitions, transaction structure, letters of intent, due diligence, contract negotiations, and the agreements necessary to move a deal from initial discussions through closing.
If a transaction is on your horizon—even if you have not signed an LOI yet—schedule an introductory call with Lovstad Law. An early conversation can help identify the questions that should be resolved before you commit to the structure, price, and risk allocation of the deal.
Schedule an Introductory Call with Lovstad Law to discuss your business and the legal issues in front of it.
This article provides general information and does not constitute legal or tax advice. The appropriate structure and tax treatment of a transaction depend on the particular facts and circumstances.
