Asset purchase versus stock purchase - Which one suits your transaction more?

A company is usually acquired through one of the two routes: acquisition of equity shares of the target business or acquisition of its assets. Various aspects are taken into consideration while making this decision, such as tax exposure, hidden liabilities, existing contracts, and intellectual property rights. The decision also factors in the acquirer’s objectives and reasons for the acquisition.

If you are going to acquire a business, you can take either of the two routes: acquire equity shares of the target business or acquire its assets. Both would vest control in your hands; however, tax consequences for the acquirer and the seller could be materially different under the two routes.

When a business is acquired through stock purchase, the acquirer acquires all the assets of the target, along with liabilities, recorded in the book as well as off the balance sheet. The title of the asset does not get directly transferred to the acquirer, but the latter enjoys ownership by virtue of owning the target.

On the other hand, in asset purchase, the title gets transferred to the acquirer, while no liability is passed on unless any assumed by the acquirer as part of the transaction.

Due to the differential tax treatment, acquirers prefer asset purchase over equity purchase; however, sellers prefer stock sale. Asset acquisition provides higher depreciation benefit to the acquirer, whereas the seller’s realization from the transaction is higher in stock sale.

When assets are acquired, the acquirer’s asset base for tax computation increases. This results in higher depreciation expenses, reducing tax liability for the acquirer. However, in case of asset sale, shareholders of the selling corporation are effectively taxed twice on their gains from the sale. If a corporation sells assets, gain on the sale of assets is taxed first at the corporation level and thereafter again on distribution to shareholders.

Contrary to asset sale, if the transaction is structured as a stock sale, shareholders of the target pay only capital gain tax on sale of their individual holding; this helps in avoiding corporation level taxation of the gain. However, stock purchase transaction deprives the acquirer of the tax benefit arising from higher depreciation expense.

While tax consequences are the prime factor on which the deal preference of transacting parties rests, certain non-tax considerations also play a significant role in the final selection.

Large size of target business may make asset purchase cumbersome
As under asset purchase, the title of each individual acquired asset is transferred to the acquirer, asset sale may not be the right transaction structure for the acquisition of a large business. Transfer of the title of a large number of assets would delay the transaction.

Non-transferability of some assets makes stock purchase inevitable
All assets held by a selling corporation may not be freely transferable. This issue typically arises with companies holding the right to use intellectual property, contracts, leases or permits. Many a times, the transfer of these contracts is contingent upon the consent from other parties to the agreement, which may or may not be granted. Thus, under such circumstances, stock purchase is preferred over asset purchase.

Asset purchase can avoid exposure to contingent or hidden liabilities
Under stock purchase, the acquirer assumes all liabilities along with the assets of the target business. As part of the package, the acquirer absorbs contingent or hidden liabilities as well.

Therefore, the buyer needs to be very careful in getting representations, warranties and indemnifications from the seller to avoid negative surprises in future. On the other hand, an asset purchase can safeguard the acquirer from any such exposures.

Business acquisitions are a way to expand and diversify. The process of acquisition selected must ensure maximum benefits for the company. While structuring the deal, the acquiring company must look at various aspects, such as tax exposure, hidden liabilities, existing contracts, and intellectual property rights, and thereafter make the correct choice. The route to be adopted for acquisition should be based on the company’s vision and objective for the acquisition.