What to Look For When Buying a Business

There are two types of deals when purchasing a business: the purchase of its assets, or the purchase of its stock (assuming it's a corporation). In addition, a merger is a special type of stock acquisition, as discussed below. In general, sellers prefer to sell the stock of a business, while buyers prefer to purchase the assets.

Purchasing the assets of a business rather than its stock offers the buyer some tax advantages and the option to acquire only the desirable assets and skip the liabilities. The buyer of a business's assets does not inherit the liabilities of the business, while the stock purchaser does. This is a critical factor in deciding which type of deal is best for you.

However, there are some instances that can tip the scales in favor of the purchase of stock. Certain contracts are not assignable, so if you wish to benefit from them, you may need to purchase the stock of the company.

Engaging in due diligence should help you determine whether the business's contracts are assignable, and whether the contracts will continue if you purchase the company's stock. (Read Due Diligence When Buying a Business for guidelines on specific documents you should examine.) Many contracts with major companies, businesses, and vendors have specific clauses concerning both the sale of a company's assets, and the sale of its stock.

Most sellers of a business will prefer selling stock, as they'll be able to obtain tax-favored capital gains treatment on the sale. Stock acquisitions can be accomplished through direct stock purchases from all the selling shareholders or through a merger.

A merger is a creature of state law (so you have to follow the legal rules in your state) that results in one entity being combined (or "merged") into another. After the merger, the merged-out entity no longer exists, and the business of the combined entities continues in the form of one company.

Mergers can have certain tax advantages. For example, you may be able to accomplish a tax-free merger, where the selling shareholders receive stock in another company, and don't have to pay immediate tax on the sale of their shares. Mergers also have the advantage of not requiring every shareholder to approve the deal.

But mergers are complicated, and you'll want the guidance of an experienced corporate attorney. Be sure to read I Need to Find a Good Business Lawyer. Where Do I Start?