Introduction

The article will first give you the must-know about an asset sale and a share purchase - including understanding what sets them appart from each other. It will also provide you with an understanding of the rationale for choosing each alternative, what the major benefits and major challenges are with each transaction type.

What is an Asset Sale?

Definition

An asset sale involves the buyer purchasing specific assets (and sometimes taking over liabilities) of the target company - not buying the company itself. The legal entity (that is the company) will remain under the control of the shareholder(s) of that company.

Advantages of an Asset Sale

For Buyers:

1. Asset Selection: Given that it is not the entire entity that is bought, the buyer can cherry-pick desired assets and avoid unwanted liabilities or debts.

2. Tax Benefits: Could potentially be beneficial as it could allow buyers to "step up" the tax basis of assets, potentially enabling future depreciation or amortization.

3. Reduced Risk: Given that the entity is not transferred, the buyer will not automatically assume the responsibilites it has. This means that they will avoid inheriting hidden liabilities that are tied to the company’s prior operations, including for example disputes, tax issues, employment issues and/or ongoing litigation.

   
   

For Sellers:

• Better Price: Many small to medium sized businesses are tightly connected to the business owners. This can mean that the business as a whole can prove challenging to sell. There could be few buyers attracted to the totality of the business, and they might be hesitant to take over known or unknown liabilities. In such a case, being able to offer a cherry picking of what assets the particular buyer finds attractive could give room for a better deal as there may be more interested buyers, and therefore result in a better price and a better deal overall.
  

• Strategic Retention: If you don't sell the company as a whole you, as the shareholder, can retain the corporate entity while selling selected assets strategically and keep running other business areas and or retain assets within the corporate entity.

  
  

• Less Seller Liability: In an asset sale, the selling entity will be the company - not its shareholders/owners, as the case would be with a share purchase. This means that the company is party to the purchase agreement, and accordingly the party that is subject to the obligations and liabilities under it. Hence, the shareholder is not a direct party to the agreement and is therefore one step removed - and thereby more protected against personal liability. However a savvy buyer will most likely require that the shareholder also assumes joint liability, at least in relation to the bigger issues including any warranties and post-closing conditions.

  
  

Disadvantages of an Asset Sale

For Buyers:

1. Complexity: In an asset sale, the fact that you have to identify and transfer each individual asset can be time-consuming and legally challenging. The attractive contracts that drive value - customers, suppliers, licensing arrangements, office space etc - will be signed by the seller, i.e. a legal entity that is not transferred. Therefore the parties to the asset sale typically cannot simply agree that the contracts will be assigned willy-nilly to the buyer. Instead, they will typically need to seek consent from - or even renegotiate with - the counter-party to each relevant agreement. The buyer also needs to consider the scenario where warranties are breached - if the seller's assets have been distributed to the seller's shareholders, the buyer will only have recourse against a virtually empty company.

   
   

2. Employee Issues: While employees in many (especially European) jurisdictions have a right to transfer with a business unit being sold through an asset sale, the employees can opt out from transferring with the business. As such, the buyer may need to negotiate new contracts, with a risk of losing key competence.

   
   

3. Risk of value loss: Due to the fact that value that is based on contracts (customers etc according to above) there is a great risk of loss of value if such contracts (i) can not be transferred, (ii) need to be renegotiated and only signed on less favourable terms, (iii) some key contracts are not identified and therefore not included in the asset transfer as would have been optimal. Value loss can also be due to the loss of key employees.

   
   

4. Tax Implications: Some jurisdictions impose double taxation - corporate taxes on profits from the sale, and withholding taxes on distributed proceeds. A transfer can also be subject to VAT, especially if the assets that are transferred are not seen as a "business unit".

   
   

For Sellers:

1. Retained Liabilities: Seller still controls and owns the entity that is selling the assets and such entity will retain many of its liabilities, including debts, lawsuits, or tax obligations.

   
   

2. Tax Burden: Asset sales can trigger significant tax liabilities, particularly if gains are taxed as ordinary income and the transaction turns out to be subject to VAT.

   
   

3. Fewer Assets Sold: A cherry-picking buyer might result in the seller getting a lower price in total compared to if the company and its assets are transfered as a package. In such a case, it can also prove harder for the seller to find a buyer for the remaining assets. This can in particular be troublesome if the seller at the same time wants to liquidate the company in order to distribute the sales proceeds as well as reduce the risk of future liabilities and disputes being raised.

   
   

What Is a Share Purchase?

Definition

In a share purchase sale, the buyer acquires ownership of the company by purchasing its shares from the party or parties that are holding the shares at that point in time. When buying the shares and the entire entity, this will include all assets, liabilities, and operational control. You hence inherit also historical liabilities but also the company's value, current set-up and relationships, and its "attractiveness" in totality.

Advantages of a Share Purchase Sale

For Buyers:

1. Continuity: Given that the entity will continue operating without being directly impacted (the ownership shift happens one level up), all contracts, employees, and customer relationships typically transfer seamlessly. This will be attractive for many buyers, in particular when the business being bought is medium to large size and the work with identifying, carving out and transfering contract through an asset sale can be highly complex.
   

2. Simplicity: The buyer acquires the business as a whole, avoiding the need to identify and transfer individual assets.

For Sellers:

1. Clean Exit: Sellers exit the business entirely, often transferring liabilities along with the company (however see as regards reps and warranties that the seller must give below).

   
   

2. Simplicity: There will be no need to manage the remaining entity (liquidating it or keeping it alive and including having to respond to upcoming liabilites, potential claims and the need to re-direct third parties to the buying entity).
   

3. Tax Efficiency: Gains are often taxed as capital gains, which generally have lower tax rates than ordinary income.

   
   

4. Better price: Selling the company as a package could render a higher price compared to if a buyer gets to only cherry pick the top assets, in particular if the remaining assets are tangled with liabilites and prove hard to sell.

Disadvantages of a Share Purchase Sale

For Buyers:

1. Hidden Liabilities: Buyers inherit all liabilities, including matters such as lawsuits, tax issues, and environmental risks. This hence includes matters occuring before the buyer takes control over the company and regardless of if the buyer knew about them or not when buying (and pricing) the company.

   
   

2. Due Diligence Complexity: Extensive due diligence is required to uncover hidden risks.

   
   

3. Tax Inefficiency: Buyers cannot typically "step up" the tax basis of assets, which may result in higher future taxes.

For Sellers:

1. Needs to assume liability: Buyers will practically always require representations, warranties, and indemnities in relation to the state of the company and to protect them against the hidden risks mentioned above. This will increasing the seller’s risk.

   
   

2. Lower Valuation: Buyers may discount the company’s value due to perceived risks.

   
   

Choosing Between an Asset Sale and a Share Purchase

When to Choose an Asset Sale

• The buyer wants to avoid liabilities - the company is particularly "messy", or it has other business units that the buyer does not want to aquire/the seller does not want to sell.

• The business has legacy issues, such as lawsuits or tax disputes.

• The buyer is interested in specific assets rather than the entire company.

  
  

When to Choose a Share Purchase Sale

• The seller desires a complete exit.

• The value is to a significant extent connected to the continuity of contracts, employees, and relationships.

• The buyer is comfortable assuming liabilities after thorough due diligence.

• The business is comprehensive and doing an asset sale with all the needed specific transfers of contracts etc would prove too time consuming.

  
  

Major Risks and How to Mitigate Them

1. Hidden Liabilities (Share Sale) - main mitigation: Conduct detailed due diligence; include indemnities and warranties in the agreement.

   
   

2. Tax Implications - main mitigation: Engage tax professionals to structure the deal in a tax-efficient manner.

   
   

3. Contractual Issues (Asset Sale) - main mitigation: Identify critical contracts early and obtain consents or renegotiate terms as needed. (Remember that also in a share purchase you must identify any change of control clauses and renegotiate in relation to such agreements.)

   
   

4. Employee Concerns - main mitigation: Understand local labor laws and communicate transparently with employees. In relation to an asset sale, if you are concern with retaining the competence, ensure to offer the employees competitive terms, and provide comfort that in relation to job safty early on in the process (as early as possible with respect to confidentiality and other stakeholders).

   
   

5. Regulatory Compliance - man mitigation: Ensure compliance with all relevant laws and secure necessary approvals to prevent delays.

Conclusion

Both asset sales and share purchase sales have unique advantages, risks, and complexities. The right choice depends on your goals as a buyer or as a seller, the nature of the business, and the legal or tax implications. A thorough understanding of these factors, paired with professional legal and tax advice, ensures a smooth transaction and protects your interests.

Need Help Navigating a Business Sale?

STG Corporate and Commercial Law specializes in business transactions, including asset sales and share purchases. Contact us today for expert advice tailored to your needs at katarina.strandberg@stgcommerciallaw.com Stockholm, 2024-12-09 Author: Katarina Strandberg