Tis the season for business planning.  Savvy entrepreneurs know that buying all or part of an existing business – a “going concern” – may be easier and less risky that starting up a new business from scratch.  A dilemma arises when entrepreneurs are more interested in, and therefore more focused on, how they are going to improve and expand the business after the purchase is complete, rather than the purchase transaction itself.

Understanding how business purchase and sales are structured can help you evaluate whether it would be more profitable for you to embark on a new start-up, or whether to purchase an existing business.  Understanding the options for structuring the transaction can also help you decide which type of transaction will be most beneficial for your business over the long term.

There are two major ways you can buy a business:

  • Asset Purchase
  • Stock Purchase

Purchasing business assets may sound like the simplest way to structure the purchase of a business.  But asset purchases become complicated when the assets are intangible – branding, goodwill, intellectual property – and when the assets aren’t owned, but leased or licensed.  A threshold question to ask is whether the assets of the business CAN be sold, assigned or transferred.

Purchasing the stock of a business is typically the simplest way to transfer intangible assets, and may avoid some of the complexity involved in an asset purchase.  However, a stock purchase means that to accurately value that stock you must do the same kind of due diligence you need for an asset purchase.  In addition, a stock purchase means the buyer assumes all debts, liabilities and obligations of the purchased business.  Hidden obligations like future legal claims against the business make stock purchases more risky.

Another key consideration in deciding which structure is best for buying any particular business is how the buyer will pay for it.  Options include cash, equity, or debt.  Most business purchases involve a combination of several financing options.  How the buyer plans to pay for the transaction affects the structure of the deal because if the buyer cannot obtain a loan or other financing, then the seller will need to keep a security or ownership interest in some assets, or may retain some of the stock. 

The more leveraged the transaction, the longer and more involved the seller typically remains in the transaction.  But for a buyer, the more leveraged the transaction, the more profitable it typically is over the long run.  This means the buyer faces a tradeoff between a simple, quick transaction and a more complex yet more profitable transaction which often requires a detailed agreement on ongoing obligations between buyer and seller.

If you are considering buying a business and want to know more about the pros and cons of various purchase and sale transaction options, please contact David Closson, attorney and the head of our Business Law Group, at [email protected].

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