Want to Buy Just Part of a Business? Consider Using an Asset Purchase

Asset purchase agreements can be a useful way to create a new business or enhance an existing one. The buyer benefits from adding desired resources to generate revenue while leaving unwanted resources and potential issues with the seller and the existing entity.

There can also tax benefits if structured properly — the buyer depreciate certain assets even if the same assets were already fully depreciated by the seller.

Why use asset purchase agreements?

Asset purchase agreements are a useful way to:

• Carve out certain assets of a business without taking on liabilities or debt obligations.
• Start a new business using assets from an existing business.
• Obtain tax benefits related to depreciation or applicable credits and incentives that vary by state.
• Gain access to client lists, contracts, or relationships with customers and suppliers.

Typical inclusions in asset purchase agreements

In an asset purchase, it’s all about the intent. Buyers carve out targeted items like certain staff, contracts, accounts receivable, inventory, supplier relationships, customer lists, and more. Assets can also include intangibles like tradenames, trademarks, patents, rent deposits, etc.

Assets are often bundled together, e.g., certain engineers plus specialty production equipment plus specific customer contracts. If a company wants to sell off equipment only, these deals are transacted as equipment sales versus an asset purchase agreement.

How does an asset purchase agreement compare to a stock agreement?

An asset purchase agreement is a legally binding contract between a buyer and a seller outlining the terms of transferring assets. Asset purchases are often compared to stock purchases where an entire company is acquired. In an asset purchase agreement, the seller's cash, liabilities, and equity/stock usually remain with the seller. In a stock or membership purchase agreement, the buyer acquires the business’s stock/equity so the entire business survives the transaction.

Asset purchase agreements step by step

From the buyer’s perspective, here are a few steps to consider:

1. Legal counsel — Yes, you’ll need to lawyer up. Seek legal counsel early to help explain the steps and navigate complexities.
2. Due diligence — Review the assets to be purchased, including ownership, condition, and any legal or financial issues that may affect the purchase. Lean on your management team and legal advisors to identify risks and liabilities associated with each deal asset.
3. Valuation — Determine fair market value of the items using market comparisons or discounted cash flow analysis. Third parties are needed to value both intangible and tangible assets. If real estate is involved, a commercial real estate agent can assist with valuation.
4. Negotiate the purchase agreement — Work with the seller to negotiate the terms of the purchase agreement, including the purchase price, payment terms, and any warranties or representations.
5. Letter of intent — Lean on your legal team to help with a letter of intent outlining the inclusions (and exclusions), proposed terms, timeline, and other key details. 
6. Agreement draft — Again, lean on your legal team to craft an asset purchase agreement including agreed upon terms, conditions, contingencies, and warranties. This will include an opening section, schedules, disclosures, exhibits, indemnification, liability protection, termination provisions, etc.
7. Financing — Determine how you will finance the deal and secure funding. The top three typical vehicles are cash, debt, or equity, with debt being the most prevalent. Lower value deals are often paid in cash.
8. Regulatory compliance — Check if regulatory issues or other approvals need to be considered before closing. Many of these are industry-specific and may involve the Environmental Protection Agency, Food and Drug Administration, etc. Also consider if bank accounts need to be closed or transferred.
9. Closing — Coordinate the logistics of preparing to close, including signing the purchase agreement, transferring ownership, and paying the agreed-upon purchase price.
10. Stakeholder notifications — Consider who needs to be notified of the ownership change, including customers, vendors, and employees. Prepare and provide information about how the sale will impact them.
11. Integration — Now the real work begins. Begin the process of integrating the newly acquired assets into your existing operations, which may include hiring employees, implementing new processes, drafting new leases, updating technology systems, and more. If employees are part of the acquisition, plan for a smooth transition with frequent communication regarding integration strategies.
12. Post closing obligations — Finalize accounting adjustments, transfer licenses, and update ownership records. If you’re creating a new company, you’ll need to:
    1. Register with the Secretary of State
    2. Register with the Department of Revenue for all necessary taxes
    3. Establish any treasury needs including new bank accounts and credit cards
13. Track success — Monitor the performance of the newly acquired assets and evaluate their impact.

Accounting for an asset purchase

The legal form of the acquisition being an asset purchase can have its benefits. Whether the deal is an asset or a stock (equity) purchase, the transaction needs to be assessed for a business combination or asset purchase accounting. In other words, the legal form of an asset deal doesn’t drive how the transaction is accounted for. Instead, the transaction needs to be assessed whether as defined by ASC 805 Business Combinations.

This is a complicated process and requires specific experience. Here is a high-level step-by-step approach to determine which accounting guidance should be followed:

1. Definition of a business — An integrated set of activities and assets capable of being conducted and managed for the purpose of providing a return.
2. Apply the screen test — Determine if it’s a single or group of assets.
3. Evaluating the business components — Does the business have inputs, processes, and outputs?
4. Assess the presence of substantive process — Determine if the set includes — at a minimum — an input and a substantive process that significantly contribute to create outputs.
5. Conclude — Whether it’s a business or an asset acquisition for accounting.

Day one differences in asset or stock (equity) purchases

In many instances, the operational impacts of executing an asset acquisition versus a stock acquisition is overlooked. Fundamentally, for an asset acquisition, you’re not “acquiring” any legal entity. Therefore, all people, processes, and systems need to be “attached” to another entity, which can be newly created or existing. Either way, you will need to assess and determine how to accomplish that. Some key items to assess are:

1. Business registrations — Is the acquiring entity registered in the states it needs to do business?
2. Employment — If employees are a part of the transaction, do you need new I-9s, offer letters, benefit enrollments, etc.?
3. Contracts — Can they be assigned? Do you need to re-execute?
4. Banking — Legally banking cannot be reassigned, so new accounts may need created. This requires set up, as well notifying any payors or any direct debit.

How CLA can help with asset purchases

Asset purchases are a common and useful way to build a business. Considering an opportunity for your business? CLA can help with many activities including strategy, project management, tax diligence, integration, state and local tax registrations, purchase price allocations, and more.