Equity acquisition is generally simpler than asset acquisition. However, there are pros and cons to each deal type that both buyer and seller should explore with the help of a professional legal advisor.
When an Equity Purchase Agreement Is Used
There are two main situations in which a business might be interested in selling shares of the company. The first is to raise money. Selling stock to investors can provide capital to pay down debt, make investments, or expand the business.
When a company sells stock to raise money, new shareholders are brought onboard, but the transaction does not result in a transfer of the ownership of the business entity. This is true even if a new shareholder is the majority shareholder.
Ownership of the business changes hands when the shareholders sell all of the company’s stock to a buyer. The buyer who purchases the stock (i.e., the equity) becomes the new company owner. Other than the ownership transfer, the business remains unchanged. It has the same assets and liabilities as before the equity purchase.
Another way to become the de facto owner of a company is by purchasing its assets, rather than its stock. In this scenario, even though the assets of the company change hands, the ownership does not. On paper, the company ownership remains unchanged. Like selling company shares, selling assets can be a targeted way to raise money. It does not necessarily entail a radical change in the direction of the company.
Using an Equity Purchase Agreement in the Sale of a Business: Pros and Cons
According to Corporate Finance Institute (CFI), stock purchases are simpler and more commonplace than asset acquisitions. Hedge funds often conduct mergers and acquisitions in the form of stock purchases. Kruze Consulting notes that big companies almost always buy the assets of small companies, while deals between equal companies are typically equity purchases.
A business sale structured as a stock sale is usually preferred by sellers, while buyers tend to prefer asset sales. The reasons for this are related to structural differences between the deals and their implications.
As noted, an asset purchase transaction does not result in transfer of the ownership of the business. The buyer purchases individual company assets, such as equipment, licenses, inventory, and customer lists. They can also exclude specific liabilities from the deal. Contrast this with an equity purchase, in which the buyer acquires the stock of the target company—along with all of its assets and liabilities—and assumes company ownership.
Buying a company lock, stock, and barrel, as opposed to negotiating specific assets and liabilities to purchase and exclude, is simpler but also risker. It is simpler because assets do not need to be retitled and revaluated, and employment agreements and contracts with suppliers and customers do not need to be renegotiated. It is riskier because the buyer could be taking on unintended liabilities, such as an undisclosed lease or lawsuit.
Tax-wise, there are advantages and disadvantages to business acquisition equity purchases. The buyer may be able to avoid paying transfer taxes, but they lose the step-up tax benefit that can affect capital gains taxes down the road.
From the buyer’s side, current shareholders can complicate a stock sale if they cannot agree to sell. In addition, applicable securities laws can prolong the equity purchase process, especially when the target company has numerous shareholders.
From the seller’s side, buyers may offer a high price on asset purchases. In addition, a stock sale offers tax benefits to the seller and can free them from liabilities and contracts.
Elements of an Equity Purchase Agreement
A real-world example of an equity purchase agreement is available here on the Securities and Exchange Commission website. As you can see, the agreement lists numerous provisions that are typically found in an equity purchase agreement. These include the following provisions:
- Definitions/defined terms
- Names of the parties
- Terms of the deal (i.e., how many shares are being sold and at what price)
- Representations and warranties of the buyer, seller, and company
- The laws that cover the agreement
- Indemnification
- Pre- and postclosing covenants
- Payment details, including when payment is due and the closing date of the deal
- Confidentiality and nondisclosure agreements
- Conditions, indemnification, fees and expenses, and other miscellaneous provisions, such as how employee issues will be handled after the transaction and any ongoing consulting or transition services
- Dated signatures
Whether you are selling stock in your company or buying equity in a company, the transaction should be conducted with an equity purchase agreement that reflects the specific parameters of the parties’ contractual relationship.
Not sure if an equity purchase or an asset purchase is the best way to proceed? Need help performing due diligence? Have questions about tax implications? Contact our legal team to set up an appointment.
