By Brian P. McMahon

RISKS INVOLVED IN ACQUIRING BUSINESS ASSETS
Know the risks

by

Brian P. McMahon, Esq.

The two most common ways of acquiring business assets (fn 1) are to purchase the shares of stock of the corporation that owns the business assets ("stock purchase agreement"), and to purchase the business assets, only, from the corporation that owns them ("asset purchase agreement").

1.)        Stock Purchase Agreement.  In a stock purchase agreement, the buyer purchases all of the shares of stock of the corporation from its current shareholders.  In effect, "stepping into the shoes" of the current shareholders.  This method of acquiring business assets is significantly less common than an asset purchase agreement method.  The reason it is less common is because there is a high risk of acquiring unknown liabilities of the corporation. 

For example:

A.        Prior to the acquisition of the business, the corporation’s president signs a binding contract to purchase a product exclusively from a third party for three years.  During negotiations for the sale of shares of stock there is no mention of the contract because the selling shareholder(s) don’t think to mention it or simply forgot there was a contract signed.  After the sale is completed and before the three year contract has expired, the new shareholder(s) finds the same product available from a different supplier for 50% less than they have been paying this third party.  In this circumstance, the third party will have the right to enforce its contract directly against the corporation even though the contract was signed before the acquisition and/or the contract was unknown to the new shareholder(s).

B.         Prior to the acquisition of the business, the corporation manufactures and sells a product to a third party.  Some time after the sale of the shares of stock to the new shareholders, the third party is injured by the product because of a defect attributable to the way it was manufactured.  In this circumstance, the third party will have the right to sue the acquired corporation even though the product was not manufactured while owned by the new shareholders.

That is not to say stock purchase agreements are always bad.  Sometimes there is a tax advantage to using a stock purchase agreement.  For example, the new buyer may be able to “carry forward” the “net operating losses” of the corporation to offset income from the corporation after it is acquired or other income of the new shareholder(s).  Also, many of the risks associated with acquiring “the history” of the corporation can be avoided by drafting purchase agreements that contain indemnification provisions and by performing detailed “due diligence” before the acquisition in an attempt to discover all risks.  However, the tax advantage seldom outweighs the cost of performing the level of due diligence necessary and/or the risk of not being able to discover all the liabilities.

2.)        Asset Purchase Agreement.  In an asset purchase agreement, the buyer (usually a newly created corporation) acquires only the assets of the corporation not the shares of stock of the corporation that owns the business assets.  However, acquiring business assets using an asset purchase agreement is not without risk even if the agreement specifically says “buyer assumes no liabilities.”  For example, if the buyer of the business assets is determined to be a “successor” of the corporation that sold its assets to the buyer, the buyer will be liable for certain taxes the corporation selling the business assets failed to pay including sales tax, use tax, withholding tax and unemployment taxes. 

The exposure to liability for taxes can be easily avoided by including a requirement in the asset purchase agreement that the seller obtain a “Conditional Tax Clearance” (which can only be obtained after the actual sale); and by requiring a portion of the purchase price be escrowed until the Certificate is delivered to secure payment for any taxes that may be due.  It is also important to make sure there are no liens against the assets. 

Unfortunately this simple solution is often overlooked or unknown.  One scenario in which it is commonly overlooked is when the acquisition of the business assets includes the acquisition of the real estate on which the business is operated.  All too often the seller and buyer treat the transaction more as a real estate transaction that just happens to include a business as well.  This is especially true if the real estate is significantly more valuable than the business itself.  For this reason it is important to make sure the purchase agreement for any transaction, including a transaction that involves the sale of real estate as well as a business, addresses the risks mentioned above.

Although it is likely a buyer will have legal recourse against the seller, lawsuits cost money and sellers may be hard to find and/or not have money to pay the damages by the time a judgment is obtained.

This article mentions only a few of the many issues that need to be considered when acquiring the business assets from an ongoing business..

Footnote 1:  The term "business assets" refers to the assets a business needs to operate.  For example, the term business asset includes a truck that a business needs to deliver the widgets to market.  It does not include "inventory."  For example, the term business assets does not include buying a truck from a truck dealer.