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Asset or Stock Purchase, in Buying a Business?
The first thing that needs to be disclosed with this post is that we are not Attorneys and we do not provide legal advice; we are not CPA’s and we do not provide accounting advice. Our intent here is to provide the reader with enough information to let him/her know some very basic information about the difference between an Asset versus a Stock purchase. The goal is to provide sufficient incentive for the prospective Buyer to understand that he/she should engage the services of both an Attorney and a CPA, when making such a purchase.
When buying a small Business, the vast majority are executed to the purchase of the Business’ Assets. This means that you, the Buyer establishes your own Company, and through the purchase, you transfer those Assets to your own Corporate or Company entity. (We are talking about Corporations or Companies, but you could very easily establish your own partnership, proprietorship or whatever Business classification you feel is best for you and your Business interests, again hopefully in cooperation with and guidance of both your Attorney and CPA.)
The key to why this is such a popular method of acquiring the Business, is that the Buyer is then purchasing only the positive elements of the Business. These may include the Company goodwill, equipment, Company files, inventory, etc. It very purposefully does not include any liability. Liabilities might include past bills that the Seller has yet to pay, any legal issues that may be hanging over the Company’s head, and so forth. This allows the new owner to obtain the Business on a “free and clear” basis. The Contract of sale will normally include clauses that state that any income and bills generated prior to the time and day of settlement belong to the Seller. Any income generated or bills originating after the time and day of settlement are the responsibility of the Buyer.
An important aspect of this is the fact that there may be unknown liabilities hanging around out there – things of which even the Seller is not aware. You do not want this to come back to haunt you, particularly if you are in a Business where these kinds of liabilities may crop up, from time to time.
By comparison, a Stock purchase means that you are purchasing the entire corporate umbrella, owned by the Seller. In this scenario, you do not establish a separate Corporate entity, because you are taking his Company over, completely and wholly. You purchase all of the Assets, which now include any cash in the Sellers checking account, any petty cash, any invoices that are due from customers, and any bills that the Seller owes, at the time of settlement.
In some cases, there are real advantages to purchasing the Company’s Stock. For example, the Company may be doing most or all of its Business through signed Contracts or Purchase Orders. If you were to buy the Assets of the Company, you are now doing Business under a different Corporate umbrella, which may invalidate the very Contracts you need in order for it to make sense to buy that Business. Stated another way, in buying the Assets of the Company, if the Company’s Contracts are written in the name of the ABC Corporation, and you have formed a new Company called XYZ Corporation, the Business’s service Contracts may not cover you in any way they are written in the name of the old Corporation. The Clients are contracted with ABC, not your XYZ Corporation.
Even if you are purchasing the Stock of the Company, there is no guarantee that the Compan’s Contracts can be transferred to you. Many Contracts of this sort stipulate that any change in majority Stockholders can give the Client a reason to cancel any remaining Contract, or at least review the new ownership and make a decision as to whether to continue as a Client. This is important to the Client for a number of reasons. Suppose the Client is purchasing computer software development services from the original Company, and the new Buyer happens that have a background that consists of nothing more than perhaps being… maybe a Business Broker. A Business Broker may have been a software engineer, prior to becoming a Broker; on the other hand, the Broker may have worked only at cutting lawns for a living. He may be a GREAT grass cutter! But what does he know about writing software?!? The Client needs to understand that the new ownership has the education and experience to fully execute his software development needs. He needs to reserve the right to cancel that Contract, if he has a realistic concern that the new ownership will be unable to meet his professional need.
Keep in mind that a huge number of variables are negotiable, in any purchase. Accounts Receivable, (abbreviated as either AR or A/R,) represents invoices for work done in the past, that have not yet been paid to the Company you are buying. Accounts Payable (AP or A/P,) are those bills that same Company owes, theoretically to pay the expenses for all that same work that was done in the past. In an Asset sale, the Seller will normally retain both AP and AR. That is not a guaranteed thing! Again, everything is negotiable. But you cannot assume that you, the Buyer will retain AR and AP, particularly since in the vast majority of small Business transactions, they do not convey with the sale. Each of these things needs to be very carefully delineated in the Contract of sale, and this is why you need to very carefully work with an experienced Contracts Attorney.
Some of these issues are very routinely conducted, and there is very little in the way of decisions to make about these terms. Others, depending upon the Business, are critical to both the short term and long term health of the Business. These are the kinds of things that you need to know, before you go looking for a Business to purchase.
(Receive in-depth, personal consulting online, with The BAF Group’s principal at https://clarity.fm/donaldbarrick .
The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Thank you for your interest.)