The Asset Purchase
An acquirer may only want to purchase the assets of a seller. Doing so has the following ramifications:
- Contracts. If the acquirer only buys the assets of the seller, it is not acquiring any contracts with the business partners of the seller. This can cause havoc if the acquirer intends to continue doing business with the customers and suppliers of the seller, since all contracts will have to be renegotiated.
- Liabilities. An asset acquisition actually means that the acquirer buys only those assets and liabilities specifically stated in the purchase agreement. Thus, there may be a transfer of liabilities. However, it will not include undocumented or contingent liabilities; this is the main reason for an asset acquisition.
- Asset step-up. The acquirer records any assets acquired at their fair market values, and depreciates these (presumably) stepped-up values for tax purposes. If the fair market value of the assets acquired is less than their net book values, then there is no tax benefit. In addition, the acquirer can amortize any goodwill associated with the acquisition for tax purposes.
- Net operating loss carry forwards. Since the acquirer is not purchasing the seller’s business entity, it does not obtain the NOLs associated with that entity.
- Title to assets. The acquirer must obtain the title to each individual asset that it purchases – which can involve a substantial amount of legal work if there are many fixed assets.
It may not be possible to disassociate the liability for environmental cleanup from an asset purchase. In some situations, environmental regulations state that the cost of future hazardous waste remediation can attach to assets, as well as legal entities. Consequently, if the acquirer is planning to buy real estate as part of an asset purchase, it should engage in considerable due diligence for environmental problems.
In summary, an acquirer may insist on an asset acquisition if it believes that the risk of acquiring additional liabilities is too great. It may also be a useful method if the acquirer only wants to pluck a specific “crown jewel” asset out of the seller, such as a key patent.
The shareholders of the seller are usually opposed to asset acquisitions, for the following reasons:
- Remainders. They end up owning any residual parts of the seller (usually its liabilities).
- Double taxation. The seller must pay income taxes on any gains realized from the sale of its assets. Then, if the entity chooses to pass through these gains to its shareholders, it does so with a dividend, which is taxed again. To make matters worse, if the seller had previously claimed an investment tax credit on the assets it is now selling, it may have to give back some of the credit, which increases its tax liability. Double taxation does not occur if the selling entity is organized as a subchapter “S” or similar organization.
The asset acquisition can be useful when the acquirer only wants to buy a small piece of the selling entity, such as a specific product line. If so, the only way to complete the transaction will probably be an asset sale, because there is no entity that owns just the desired assets and no others.