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Asset purchases are one option when an individual or entity wants to acquire another company’s tangible or intangible assets. When purchasing or selling a business’s assets, it’s critical to execute the transaction without legal mistakes. The purchase’s structure may ultimately mean the difference between long-term success and an unprofitable transaction.
This article helps buyers and sellers understand what asset purchases are and how they work from legal and tax standpoints.
What is an Asset Purchase?
Asset purchases, also known as asset sales, occur between a seller and buyer of a company’s assets, including facilities, vehicles, equipment, stock, and inventory. Buyers and sellers use an asset purchase agreement to govern the terms of the transfer or sale.
What’s Included in an Asset Purchase?
Asset purchases include acquiring seller assets under the terms and conditions outlined in the asset purchase agreement (APA). There is a negotiation period, followed by terms drafting, and then the final signing like many contracts. Approaching the negotiation table with fundamental knowledge can produce a better result.
Here are ten terms to know about asset purchases before negotiating or signing one:
Term 1. Letter of Intent
A letters of Intent (LOI) is a proposal outlining and justifying a buyer’s objectives in cover letter format. It is a critical step in the project’s development, as it must typically be approved before any transfers can begin. An LOI is also an excellent negotiation tool so that both parties have a starting point.
Term 2. Due Diligence
Experienced buyers conduct extensive due diligence measures on the seller. Timelines should be included in your asset purchase agreements, as should corresponding representations and warranties from both parties.
Term 3. Employees
Parties should determine whether the buyer will hire any of the seller’s employees during negotiations. Otherwise, the seller is liable for paying salaries, benefits, and severance. Additionally, businesses with at least 100 employees must comply with the Worker Adjustment and Retraining Notification (WARN) Act , requiring you to give staff members at least 60 days’ notice of an impending mass layoff.
Term 4. Indemnification
Indemnification protects parties against misrepresentations and other types of breaches. Consider resources imposed on these indemnification provisions to deter issues from arising in the first.
Term 5. Non-Competition Agreement
Buyers may want to consider non-competition agreements and have the seller and key employees sign one. This strategy protects the value of the assets purchased. However, non-competition agreements are not legal in every jurisdiction, so you will want to determine which local rules apply to your situation before drafting an agreement.
Term 6. Price At Closing
At closing, the purchase price may need to be adjusted based on the business’s performance as indicated by financial information and due diligence reporting results. Purchase prices face adjustments for capital, valuation, revenues, and more.
Term 7. Taxation
The purchase price allocation determines how much the seller can treat as capital gains and thus benefit from a lower tax rate. Consider the tax treatment and implications carefully when drafting your agreements.
Term 8. Third-Party Permissions
Selling companies typically have contracts , leases, and other agreements requiring transfer approval. These approvals typically take a long time to obtain and should be addressed early in the transaction’s development.
Term 9. State-Specific Provisions
It is also worth remembering that some states may require specific terminology when engaging in asset purchases and business transfer agreements . An acquisitions lawyer in your state can go over the legal options available for your situation.
Term 10. Bill of Sale
Each asset must have a bill of sale to prove that ownership belongs to you or your company. The seller should provide this document to the buyer, and your APA should address stipulations surrounding its delivery.
Differences Between an Asset Purchase and Share Purchase
The difference between an asset purchase and a share purchase lies within their functionality. Asset purchases involve a specific asset purchase from another company. In contrast, share purchases involve the purchase of an entire company’s equity portfolio and, thereby, effectively purchasing the company itself.
Let’s take a closer look at share purchases below for greater insight into the differences of both structures:
What Is a Share Purchase?
Share purchases, also known as stock purchases, are when one business buys a company’s shares, in their entirety, from its shareholders. When a buyer purchases a company’s shares, they effectively acquire its entire asset base. However, shares are the only assets that change hands.
The primary legal document for selling the shares is a stock purchase agreement , which details the buyer’s acquisition terms. Stock purchase agreements are lengthy, depending on the complexity of the legal situation. The added complexity is due to buyers becoming the acquired company’s new owner and taking responsibility for all past, current, and future liabilities.
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Tax Implications of an Asset Purchase
When someone purchases acquirable assets, they typically assume most liabilities, even ones from the past. Therefore, you should carefully consider the tax implications associated with asset purchases. However, buyers will be relieved to find that several advantages apply to them.
Below, we’ve outlined four tax implications of an asset purchase to consider before offering or signing one:
Implication 1. Depreciation
Capital assets are prone to depreciation over time. The Internal Revenue Service (IRS) recognizes this situation and allows buyers to deduct a portion of equipment over the expected useful life each year. The higher the asset’s cost basis, the larger the allowable depreciation deductions, generating more after-tax cash flow for the acquirer than a stock sale.
Implication 2. Section 338
Section 338 of the IRS Code permits businesses to tax a stock purchase as an asset purchase. However, both parties must agree upon this election. The purchaser is responsible for any taxes incurred due to the step-up in tax basis, which results in an immediate tax liability.
Implication 3. Step-Up Basis
Buyers get a step-up basis when acquiring assets through an asset purchase transaction. The asset’s purchase price becomes the new tax basis, which is advantageous to the seller as it reduces the ultimate tax liability on sales.
Implication 4. Tax-Basis
It’s necessary to understand the tax basis to understand the associated implications fully. The tax basis of an asset is the amount of money invested by a business in that asset. When a business sells an asset for a profit, the IRS assesses capital gains taxes on the difference between the asset’s sale price and tax basis.
What is an Asset Purchase Agreement?
Asset purchase agreements, also known as asset transfer agreements , are legally binding documents governing business asset sales. With the asset purchase agreement, you will need to include exhibits to provide additional details about the transaction. The purpose of this tactic is to ensure that you account for all assets when there are many of them.
Parties can also require the seller to disclose existing contracts, employee names, licenses, permits, and debts. In summary, your APA and exhibits should describe what the asset purchase includes explicitly. You should not leave issues unresolved, as it can result in uncertainty, potential conflict, and unwanted liability.
This web page also discusses asset purchase agreements.
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