When considering buying a business, whether it is large or small it is important to plan and structure the purchase correctly, otherwise there may be financial consequences. Using a business broker will help you find the business you want to purchase. However, many times the business broker does not understand how to structure the purchase. Worse case scenario, you may end up buying a business that may have a lot of liabilities. A common method of acquiring a business is called a “stock purchase” which is typically used for larger businesses that have a lot of assets and ongoing liabilities.
1. Benefits of a Stock Purchase
Most of us understand stock purchases in the sense of investments. You buy and sell stock for profit. However, stock in a company represents ownership in a company, and if you buy enough of the company’s stock, you become the owner of the company just based on the number of votes each stock receives. The concept is fairly simple. To do a stock purchase, you go to all the shareholders of a company and offer to buy their shares for a certain amount. Once you have bought at least 51% of the outstanding shares, you become the majority shareholder and can then control who sits on the board of directors of that company.
In a stock purchase, the outstanding stock of the company is transferred to the buyer and the company continues to operate as it existed prior to the transaction, but it is owned by the buyer. Unlike an asset sale, the buyer in a stock purchase effectively purchases all of the assets and the liabilities of the company. As a result, a stock purchase tends to be simpler than an asset acquisition from a structuring and documentation standpoint because the parties generally do not need to identify the specific assets and liabilities being purchased. In addition, because the company’s contracts, licenses and assets are not being transferred to a new entity, fewer third-party consents and other transfer approvals, if any, will be required. Also, because the business is being conducted by the same entity, all insurance policies in place prior to closing would continue after the sale of the stock is complete.
2. Disadvantages of a Stock Purchase
For the buyer, a stock purchase can be less desirable than an asset acquisition because (i) the buyer cannot exclude assets it does not wish to purchase and (ii) the buyer must assume all of the company’s liabilities.
Although stock sales often require fewer consents and approvals in order to complete the transaction, the company’s contracts will still need to be reviewed for change-of-control provisions that may require third-party consent because they are triggered by a stock sale or other substantial change in ownership of the company. In addition, licenses and permits should be reviewed for similar restrictions triggered by a stock sale.
Another significant drawback of a stock purchase is that a buyer may end up owning less than 100 percent of the outstanding stock of the target if one or more stockholders refuse to sell their shares. Each stockholder of the buyer has the ability to decide whether to sell their shares. Therefore, if the company has a large number of stockholders, a stock purchase can be virtually unworkable.
The stock purchase method of buying a business is simpler and can avoid a lot of the hassles involved in the previously mentioned asset purchase method in part one. However, stock purchase method basically means you are buying all the assets and liabilities of a company. Additionally, in a stock purchase, the buyer is directly engaging in the current shareholders of the company and the price is determined by the shareholder. Ultimately, this may result in owning less than 100% of the company and therefore less control in a company. It is important to have an attorney review over stock purchase agreements and conduct a thorough review of the company’s current assets and liabilities.
Eric W. Ching is a real estate & business attorney with Ching & Seto, APC.