One method of acquiring a business is through buying the ownership (equity) of the owners. If a business is managed by governing people who are not owners, then a buyer can obtain control of as business through buying the equity directly from the shareholders, even if management is against the sale. Usually, this will not be the case when purchasing a privately held entity, where the principals typically negotiate the deal.
Typically the purchase price is paid at closing, subject to indemnity escrows, working capital calculations, and earnout payments. In these situations, buyers negotiate to hold part of the purchase price in escrow as a partial security for seller's obligations, payment indemnity claims, or to calculate working capital requirements. The simplest is cash at closing. Another option is a deferred payout. In this structure, post-closing payments are usually tied to the seller's profits and are often called an “earnout.”
Liabilities of Selling Entity.
In an equity purchase, the target entity remains subject to its existing debts, liabilities, and all unknown, contingent, or undisclosed liabilities, all of which reduce the value of the target and, correspondingly, the value of the equity acquired. To protect against this concern, the buyer may require an asset purchase. If that is not feasible, generally because of the double taxation potential if the target is a c-corporation, then the buyer may protect against these eventualities by obtaining personal guaranties, indemnification provisions, holding part of the purchase price in escrow, or deferring and paying a part of the purchase at a later date, with a right of offset for any pre-closing liabilities that surface after the closing.
Equity Sale Compared to Asset Sale.
Tax considerations usually affect the choice between buying the equity and buying an entity's assets. In taxable acquisitions, the target entity must pay taxes on its gain if the purchase price is greater than the entity's basis in its assets. When the net amount is distributed to shareholders, if the seller is a c-corporation, they will also be taxed on the gain.
Other considerations often cause one party or the other to favor an asset sale. It may be easier to accomplish an asset purchase than an equity purchase if there are many owners often requiring individual negotiation. Sometimes, the parties will prefer an equity sale because of their flexibility in dealing with unwanted assets, with the transaction remaining nontaxable. A larger number of tracts of real property or many items of titled personal property may make an equity sale preferable.
THIS INFORMATIONAL MEMORANDUM is provided as a courtesy to provide items of interest in the business acquisition area. It is not intended to be an exhaustive treatment of its subject matter but an overview of some elements of such subject. It is not legal advice or a legal opinion and should not be relied on in making legal or business decisions. If you have questions, please call.