Overview of Deal Structures When Selling a Business – PART II(Liabilities) | BizTaxBuzz by Trevor Crow

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8thSeptemberOverview of Deal Structures When Selling aBusiness – PART II (Liabilit ies)

Posted by Trevor Crow

This is Part II of a two-part series of posts about deal structures that business owners use when selling a business. Thispost focuses on another big factor to consider when deciding between an asset sale and a stock sale: the transfer ofliabilities.

NOTE: Throughout this post I refer to stock generically as the representation of ownership interests in the business, butthe same concepts apply if you’re dealing with membership interests in a LLC.

Asset Sales

Liability Factors. Similar to the tax factors, an asset sale is generally a better structure for the buyer to minimize potentialliabilities. With an asset sale the buyer can pick and choose the assets to buy and what, if any, liabilities to assumefrom the seller. With an asset sale the buyer does not become responsible for liabilities and debts that the buyer doesnot specifically assume. This structure avoids the potential for purchasing unknown or contingent liabilities, which cancome in the form of tax liabilities, environmental liabilities, and many others.

It’s important to note that there is a doctrine of successor liability, which I will discuss in a separate post, that provides anarrow exception to the rule that the buyer only becomes responsible for the liabilities it specifically assumes in an assetsale. However, this is a narrow exception that typically will not apply.

Stock Sales

Liability Factors. From the seller’s point of view, the best way to reduce risk is to provide complete and accuratedisclosure to the buyer and to carefully review all representations and warranties in conjunction with the disclosureschedules to make sure they are accurate. In other words, structuring the deal as an asset sale or a stock sale doesnot provide much benefit to the seller either way from a liability standpoint. The standards of liability between the two willbe slightly different because there are statutory securities fraud implications in stock sales, which you can read abouthere, but the seller’s best way to avoid liability is still to provide complete disclosure and review the reps and warrantiesin the purchase agreement for accuracy.

With a stock sale, the target entity (now owned by the buyer) will remain liable for all liabilities including any unknownand contingent liabilities. Thus, a stock sale is usually less attractive to a buyer from a liability perspective. A buyermay reduce the risk of unknown liabilities through indemnification provisions in the stock purchase agreement. However,unless the stock purchase agreement provides for a certain amount of the purchase price to be held in escrow for aperiod of time to pay for any unknown (or undisclosed) liabilities, collecting from the seller may be difficult after the sale.

Bottom Line: Make it a point to discuss the deal structure early in the sale process as this decision can have seriousimplications on liabilities and taxes to the parties.