Asset Sale vs Stock Sale

Hey gang! It’s Walker Deibel, author of Buy Then Build and creator of the Acquisition Lab. During my many years of buying companies and now I spend the majority of my time advising buyers and sellers. Sometimes, it'll come up on the buy-side in regards to how I think about these certain liabilities that the seller has on their on their balance sheet? And then I come to figure out that it's really sort of a question around asset sale versus stock sale. Once you understand the structure, I think a lot of it starts to make sense. So, let's understand what the difference is between an asset sale and a stock sale. Why you would want to do certain things in them? Or make certain decisions around them. So the selling entity… The selling business is a legal entity. This legal entity is liable for any sort of legal things and it's the legal entity that pays taxes and reflects ownership of the companies’ stock in this legal entity, is owned. But this legal entity owns a bunch of assets inside of it. Now these assets can be tangible or they can be intangible. What I mean by that is a tangible asset might be a printing press or a powder coat oven, or some big physical industrial piece of equipment. Intangible is going to be the brand, the logo. Frankly, the culture of the people, the sort of standard operating procedures the intellectual property, the website, all of these kinds of things. And the truth is that the legal entity in and of itself, doesn't actually generate any cash, does it? It's the assets. It's the assets that generate the cash, right? So, it's ultimately the cash flow and the assets that you're after whether or not you want this blue legal entity is usually dependent on just a couple of things. But let me say it like this… Almost all lower middle market and main street transactions are going to be an asset sale and not a stock sale. An asset sale is where you form your own legal entity. And then we're going to move all of these assets and all of this cash over into your legal entity, leaving this one hollow. In other words, we would have this cash flow that of course is coming from these assets. Don't make fun of my drawings, I know you're thinking about it. What we did was we moved them from here to there, so this of course is now a hollow legal entity and that's it. Sometimes it could be this legal entity over here, maybe there was a building or something like that… It is owned and that was an asset that this company didn't want. Something like that in which case this building should be black. Maybe this legal entity still owns a building or a separate online business it had or something like that. More common or not, it's actually left empty, and then this is a shell of an entity that this the seller. They might accept a seller's note or something like that. They might leave it open to start a new business. Often times they'll kind of shut it down. And then that legal entity is gone. You've moved all of the assets and all of the cash flow things that generate cash flow over here, that includes employees and all the rest of it. Usually, you have to terminate them from this legal entity and hire them on that legal entity. Usually done in the days following the transaction. Listen, the reason this is beneficial, it's a cash-free debt-free transaction. Let's write that down, cash-free. What does that mean Walker? It means that any cash that was in that original entity is not is retained by the owner. So, any cash that was in here and any cash balance is retained by the owner. That would be… I had a million dollars in cash, I'm going to take that cash and then I'm going to sell you these assets, so cash does not move over. The other thing would be liabilities. It’s debt-free, okay? Debt-free, if you made fun of my drawings, you'll also be making fun of my handwriting. I had a million dollars in cash and I had 250 000 in debt. I keep my debt, if I'm the seller and you, as the buyer, don't accept any of the cash or any of the debt. Why does this happen? Well, it really is to the benefit of the buyer, because it limits the sort of historical risk of the original legal asset. Let's say, you buy this… You buy the stock of this company and you as the owner, are liable for the entire history of this entity. You buy Whiteboard Manufacturing Corporation, you buy the stock, okay? And then four years after you buy it, a bunch of toxic waste, barrels show up in the Pacific Ocean, with Whiteboard Corporations printed on them or there was a bunch of bad products that failed. You're now liable because you are the owner of this legal entity. When you buy the assets and not the legal entity, you are not liable for anything that did not happen on your watch. A huge benefit to a buyer and the core reason why most of them happen that way. It is the default setting. The other reason… I'm sorry, let me see it differently. The reason why you would do a stock sale typically, because of there's some kind of contract. A supplier contract or a customer contract, or some kind of license that is non-transferable. That is essential to the business, okay? That's probably number one. Number two would be… Obviously, if you are investing in a minority role, like say a startup or something like that, you're buying Equity. And the third would be… Once you get into a sort of larger deals, it becomes easier and calmer, slightly more common in a stock sale. But it might be like if the seller is going to stay on and continue to retain. Let's make it up 20% of the business and you're gonna buy 80% of the company in sort of a private equity situation there might be a reason in this structure to do a stock sale. If you, as the buyer decide to buy it as a stock sale it has tremendous tax benefits to the seller and so as a result, what almost always happens is that the purchase price… If I'm going to buy a purchase price on assets, it's usually higher than if you buy it with stock. The reason why is that the cost of the purchase price tends to be worth more to the seller. So a bad example but just to make an example. Let's say, I'm going to buy a company for a hundred dollars and after taxes, this person is going to get sixty-five dollars. If I buy his company for a hundred dollars as a stock sale then this person might get seventy-five dollars. By the way, if you buy a Canadian company or an Australian company or anything like that. These have drastically different impacts, to the point that a lot of them say at first that…It’s gotta be a stock sale, right? And so in essence, this gap between the 75 and the 65 is not lost on the buyer, ever. They know that this is worth more to a seller. And so they will very often say well look… If I spend a hundred dollars here or if I spend I came to that mouth in my head but let's just say ninety dollars, if I spent a hundred dollars as an asset sale or ninety dollars as a stock sale, it ends up being worth the same to you. So that doesn't exactly transfer. The only other thing that I want to add is that when you do an asset sale, you might say… Well, I bought Whiteboard Corporation but LLC is called Walker Deibel Corporation. How on Earth does that, I can't name it the same thing, right? Legally. And so all that happens is that this new asset that you buy, has a doing business as you file a DVA with your state government and it's just that simple. You file it online, it's like ten dollars then you have to re-up it. I think every three years something like that. Listen, thank you so much. When I first went out and tried to buy a business in 2004 I failed. There was no good information, there was no good instruction, it was an opaque private marketplace that I had to navigate, very fragmented. And along the way, I ended up acquiring seven companies. I've acquired 16.5 million dollars in revenue over a 10 year period. I ultimately wrote Buy Then Build as sort of like what I learned walking that path and it was always sort of my dream to ultimately create some kind of world-class instruction around this, and it wasn't until readers started asking me to help them find and buy a business. I was like… That's crazy! I can't do that. I can't charge you enough, it's way too hard and I can't guarantee results. And so, what we did was I recognized that there was… You could sort of do it yourself, like buy a copy of Buy Then Build, go out, and buy a copy of the Harvard Business review guide to buying a small business and sort of go out there. Do it yourself or you can hire a buy-side advisor for five thousand dollars a month, plus a double Lehman success formula, which would be about on average of 150 000 extra expenses to a buyer. Well, if you're an acquisition entrepreneur, why would you increase the cost of your transaction like 15% to bring on someone that's not doing anything that you can't do? A lot of us search is full-time or heavy part-time, right? So ultimately, I created the Acquisition Lab. The point here was to build world-class instruction, a suite of tools, and ongoing coaching, so that we could provide assistance on the subject you needed when you needed it. Rather than just having a pre-recorded online course. They had to go back and dive into it. I wanted to do all this. Just a vetted community, that we made sure that everyone was accepted would actually be able to acquire a business. They've got this sort of like business sophistication or they kind of drive to do so and also just has access to at least a little bit of capital in order to get that done. We did that, it's called the Acquisition Lab and what I didn't expect was that the vetted community would take off in the way that it has. It's such an impressive group of people, it's such a thriving community. And if you are looking to buy a business in the next 6 to 18 months, we created the acquisition lab as a do it with you, buy-side advisory service and it's offered all at the cost of less than one month of a buy-side advisor, with lifetime access to you. If you have an interest in joining us, we run cohorts every so often. Please go to acquisitionlab.com and apply. I look forward to working with you soon. Thanks!