MBA Mondays are back after a week hiatus. We are several posts into a series on Merger and Acquisitions. In our last post, we talked about the key characteristics of mergers and acquisitions. And we touched on the two kinds of purchases, the asset purchase and the company purchase. Today I’d like to talk about the asset purchase.
As I said in the prior post, a buyer can either purchase the entire company or the buyer can purchase select assets and assume select liabilities. This kind of transaction is known as an asset sale.
Asset sales can happen as a partial exit or a complete exit. In the partial exit, a company transfers certain assets and certain liabilities to another company in exchange for some consideration, and then continues operating as a going concern. In the complete exit, the company transfers all of the assets and liabilities that the acquirer is interested in and then winds down the company and settles all remaining liabilities and then liquidates.
In the partial exit, the asset sale is a desirable transaction. It is the way that many spinoffs are done. Many companies will build or buy themselves into a diverse set of operating businesses and they ultimately realize that the business has gotten too complex to operate or too complicated to explain to investors. They can simplify their business by spinning off, selling, and otherwise exiting some, but not all, of their businesses.
In the complete exit, the asset sale is often an undesirable transaction. If there is not going to be an ongoing business left after the sale transaction, it is most often best to get the purchaser to take all the assets and all the liabilities via a company purchase.
The asset sale allows the purchaser to “cherry pick” the desirable assets and take on the liabilities they are comfortable with and leave the seller with undesirable assets and remaining liabilities. The seller then has to unwind what is left and liquidate the company. The seller may have to use some or all of the consideration that was given (cash or stock) for the desirable assets to settle the remaining liabilities. The seller cannot liquidate the business and take out the consideration before settling with the creditors. If the liabilities are larger than the consideration obtained, a bankruptcy or some other settlement procedure with creditors may be necessary.
The asset sale may also be undesirable for tax reasons. In a company purchase, the acquirer purchases the stock from each of the stockholders and takes control of the entire business. The stockholders get a capital gain, either short term or long term depending on the length of time they held the stock. In an asset sale, the consideration goes into the seller’s company and is used to settle liabilities and wind down and liquidate. Any remaining cash after all that will be distributed out in a liquidating distribution. There may be taxes to be paid at the company level on the sale transaction which will further eat into the proceeds which can be paid out. And there is the possibility of taxation of the liquidating distribution depending on what kind of business entity the seller was operating. That is called “double taxation” and you want to avoid that in an acquisition transaction.
There may be times when an exit is best done via an asset sale. I can imagine a set of circumstances where it might actually be desirable for a seller to do that. But those circumstances are not very common and it is generally true that if you are looking to exit a business, you want to do it via a company purchase transaction, not an asset sale transaction.
If you are the acquirer however, asset purchases can be very desirable. They allow you to avoid liabilities you don’t want to take on and cherry pick the assets you want.
In my experience, asset sale transactions are generally done in “fire sale” situations and company sale transactions are generally done in all other M&A transactions. At least that is how I’ve seen it done in venture backed technology companies.
Next week we will talk more about the company sale transaction.
Having bought more than a few companies, I can only recommend the asset purchase for an acquirer.
I am totally unsympathetic to the seller’s implications and any such implications are fully represented and compensated for in the purchase price.
Acquirers need to be careful about what they ARE and what they ARE NOT acquiring. You want to acquire all the assets which are creating the cash flow or are core to the business and NONE of the liabilities.
You would be surprised as to the number of assets which are not obvious on the first blush — trade names, logoes, customer lists, files, opportunities currently presented to the company, etc. etc. etc.
These assets should be listed by name on an Exhibit to the maximum extent possible and then a global description should be written which comprehensively describes the class of assets.
When dealing with intellectual property, confidential information, proprietary information it is also important to ensure that the seller owns it and that current and former employees are not able to walk out of the building with these same assets.
It is also important to take physical possession of the assets and to ensure there are not copies lying around for the rest of the world to misappropriate.
Last and perhaps most important consideration — always have a 12 month holdback of some considerable amount of money or recite a right of “set off” if you are acquiring the assets in part with a promissory note.
Having a bit of the other guys money is fundamental discipline. I suggest 15% of the total purchase price.
Remember, you only get what you negotiate, not what you deserve or thought you were getting. It is not because folks are bad but after a sale, you cannot find the seller. Believe me on this issue.
Just one additional detail, make sure that the seller indemnifies you and holds you harmless in any and all attempts by liability holders to collect from you. Remember anybody with $25 for the filing fee can sue you to collect.
If the seller is going to liquidate thereafter, make damn sure that you have an indemnification that represents reality. An indemnification from an entity which is gone is not going to provide any assurance.
Every liability in the world will plead that the conveyance of the assets to you was “fraudulent” made in order to remove some element of common law collateral from their grasp.
This article was originally written by Fred Wilson on December 20, 2010 here.