Idaho attorney Louis V. Spiker explains how to structure the purchase and sale of a business. He explains the differences between purchasing the equity in a business and purchasing the stock in a corporation.
Hello, I am Louis Spiker. I am a partner with Johnson May in Boise, Idaho, and this is the first video in our "So You Want to Buy a Business in Idaho?" series. We are going to take a dive into what buyers are looking for, the different ways in which businesses can be purchased, and some of the considerations we think it's important for you to think about when you want to enter into a transaction.
It doesn't matter if you want to buy something as small as a two-man lawn care business or if you want to step into something that has annual sales of 10 million dollars a year. There are common characteristics in these sales and the concerns that buyers have. What we are going to talk about today are some pretty broad topics, and that's with regard to how you structure one of these sales.
Generally, you are looking at either purchasing the equity in the business. So that is the membership interest in a limited liability company or the stock in a corporation. As always, this video is general information and is not individual legal advice. We're happy to meet with you to discuss your concerns.
Liability Considerations
The primary difference or the primary focus of when you're making the decision as to whether you want to buy that membership interest or that stock, or if you just want to buy the assets, really comes down to liability. And what I mean by that is when you buy someone's equity in the business, all the existing liability remains with that business; it is an ongoing concern. The entity still exists, and claims that could be made before you were involved can still be made against the business. The only difference is now you are the owner and you have to deal with those claims. Maybe you've negotiated such a purchase price that those concerns are worth it to you, and those are things that you have to think about. It's an individualized decision and it really is part of the negotiating process.
Tax Treatment
The other consideration, in addition to the liability that you are assuming when you purchase the business, would be the tax treatment. Buyers generally prefer an asset purchase. Sellers generally prefer to sell the equity, and this really has to do with how the gain is associated with these assets. A seller is generally going to have depreciated those assets down, so they are going to have more gain based on the price that's in there and a greater tax liability, where they may not have the same amount of gain if they are selling the equity interest.
Buyers really want to step up the basic assets they purchase so they have the ability to depreciate that down in the future.
Example and Considerations
Going back to the liabilities and why that matters, let me give you an example. Let's say you purchased a small manufacturing facility, single line, decent amount of revenue, but you've got 20 employees, and one of those is a shift manager that's been sexually harassing their subordinates. It doesn't matter that this occurred three months before you purchased the business or that you fired this person immediately upon hiring. You didn't know about these claims; you just didn't like the person or they weren't performing. What matters is that they were an employee of the same business that you purchased the equity in.
So the claims of those subordinates can be brought against the company, the one that you just bought. If you would've purchased the assets instead, which comes with the technicality that all of the employees are fired and then generally they are rehired by the new entity or an existing entity that you control that steps in and buys these assets, and that can be vehicles, equipment, the customer list, the existing contracts that that business has. All of those things can be purchased.
The other side of that is that you get to pick the liabilities that you are choosing to assume. There may be contracts that have the return on investment that you want to maintain, but you have the liabilities associated with that; you actually have to perform under those contracts. But the potential liabilities that existed at the time you bought that equity interest, those remain with that entity. There are some exceptions, and those are primarily environmental liabilities, which is why it's important to have an appropriate due diligence investigation. It's not just important, but it's essential. We intend to cover that in a later video in the series on the questions that buyers should be asking.
Asset Purchase vs. Equity Purchase
When we look at the choice between an asset purchase or buying the equity in a business, like we've talked about, buyers generally prefer an asset purchase, but there are situations where purchasing equity may be desired.
Primarily, those are situations where the business has existing contracts or licenses or permits or some other reasons that that entity needs to continue to exist. The price that you negotiate to purchase that business or the equity in that business may be different and, frankly, probably should be different than if you were purchasing the assets of the business. There is not a one-size-fits-all choice with regard to the type of transaction.
What we like to do for our clients is help them evaluate the risks and the potential opportunities that are associated with either an equity purchase or, again, just purchasing those assets.
Importance of Having a Team
As we talked about earlier, you may have some stiff resistance from the seller who really just wants to be done with it and sell the equity, where you don't have to worry about rewriting contracts or the seller's concern that there is a whole backend performance that is associated with these contracts going forward. When you purchase the assets, the new entity either has to assume contracts, which requires the consent of that business's customers, or it has to rewrite those contracts, and those are additional considerations that you have to address.
It's important to have a team, and when we think of a team, we think of a tax advisor, we think potentially of a business consultant if that's something you feel that you need, and then someone that can help on the legal side, which is where we come in. If you need assistance with the purchase or the sale of a business in Idaho, please reach out to us to help navigate that transaction.
