What Liabilities Could a Business Buyer Inherit In an Asset Sale Versus a Stock Sale?
When buying a business, a buyer should fully understand what liabilities may be inherited from the seller as a result of the transaction. This is important in order to effectively structure the business purchase agreement and conduct appropriate due diligence.
Asset Sale Versus Stock Sale
An asset sale is when the buyer purchases only the assets of the target business. A stock sale is when a buyer purchases the actual shares (if a corporation) or interest (if a LLC). When a buyer purchases the assets, the buyer typically creates its own entity and uses that entity to purchase the target’s assets. In this case, the buyer must clearly document the transfer of assets and employees to the new buyer’s entity. In a stock sale, the buyer can individually purchase the stock or interest of the target business or use an entity to purchase the stock and purchase as a “parent” company. In this case, all of the assets do not transfer.
Liabilities Inherited In An Asset Sale
Asset sales are popular, especially for smaller deals, because by definition, the buyer does not automatically inherit the target business’s liabilities. This is due to the fact that the buyer is creating a separate entity to buy the assets of the target company. Many people unfortunately believe that because a buyer is not buying the entity, then the liabilities of the target business do not automatically transfer, and the buyer purchases the assets free and clear.
However, the buyer in an asset sale should be mindful of two main things:
- Inquiring about the target’s business’s debts and reviewing any associated loan agreements, and lien searches. Typically business debt uses the assets of a business to secure the loan, and transferring those assets can trigger a default clause in the loan agreement. The buyer may lose the assets or inventory it received from the seller associated with the loan.
- The buyer should review the local bulk sales laws. Payroll and retail taxes are often tied to a business’s assets by statute. By submitting a bulk sales notice to a department of revenue and obtaining tax clearances, the buyer can confirm that seller does not owe any taxes, which otherwise attach to the assets that the buyer is paying for.
Liabilities Inherited In a Stock Sale
Due to a buyer buying the stocks or interest of the target business, technically the buyer assumes all of the liabilities. Unlike in an asset sale, the buyer inherits the legal liabilities related to licensing, potential lawsuits, and regulatory compliance matters. This is in addition any financial liabilities. This is why it is very important for a buyer to conduct thorough due diligence and negotiate the purchase agreement to include various warranties and indemnitees from the seller. If the seller indemnifies a buyer for certain post-closing legal liabilities that result from pre-closing issues, then the seller maintains those liabilities. The parties can also negotiate holdback amounts to cover any potential liabilities that appear in the first year or so post-closing.
Motiva Business Law provides business acquisitions services to entrepreneurs, startups, professionals, and companies throughout Florida. We assist clients in Tampa, St. Petersburg, Clearwater, Sarasota, Bradenton, Orlando, Lakeland, Brandon, Wesley Chapel, Zephyrhills, Lutz, Land O’ Lakes, Fort Myers, Naples, Miami, Fort Lauderdale, West Palm Beach, Jacksonville, Tallahassee, Gainesville, and communities throughout Hillsborough County, Pinellas County, Pasco County, Polk County, Manatee County, Sarasota County, Orange County, and beyond.
Motiva Business Law also serves clients throughout Illinois including Oak Brook, Burr Ridge, Naperville, Hinsdale, Lombard, Addison, Downers Grove, Oak Park, Darien, Chicago, Lisle, Westmont, Willowbrook, Clarendon Hills, and the Chicagoland Area.