Stock vs. asset deal: true long-term liabilities in stock?

May 03, 2021

by a searcher from Stanford University - Graduate School of Business in Sausalito, CA 94965, USA

Working on an acquisition of online accounting business (S Corp, acquiring entity = LLC###-###-#### e) election feasible here, so negligible tax differences to me as buyer (as I understand it). Contracts/ACH agreements with all customers silent on assignability, so at minimum need to provide notice to customers of change in bank accounts/entities to do asset deal. This introduces some churn risk at close (customers don't approve or ask for price reduction in services). SO, considering stock deal (w/ 336 election) to minimize this churn risk.

For an asset light business like this (fully remote, so no RE/enviro risk, no vehicles, no tax work so limited IRS risk), what are the true long-term liability risks that can't be covered by appropriate###-###-#### %) reps & warranties bucket / 15% seller note that will be in place 5+ years?

Are people doing a lot of stock deals these days for asset-light businesses with contract assignability issues? Are you getting cash escrows or mainly just ability to claim against seller note?

Thanks all!

Reply by a professional
from University of Minnesota in Minneapolis, MN, USA

As you've noted, there is risk of liability for the acquirer in a stock sale, and as you're clearly aware, most lawyers will encourage an asset deal where possible. However, you've addressed some legitimate financial concerns that come along with the reduced risk in an asset deal, in addition to the administrative costs and headaches that are often reduced where a stock sale is used. So I don't find that a stock sale is always a bad idea, and oftentimes the risks involved are more than adequately compensated by the benefits....especially when the risks don't come to fruition!

As mentioned above, the legal risks of a stock deal can be mitigated via due diligence, insurance, PA language, etc. My limited and anecdotal experience is that escrow tends to be utilized for known, more significant risk, and indemnification provisions for more abstract risk. Also consider a right of offset for any Seller Note (although I find Sellers HATE this). A thorough public records search can help dig up complaints and other actions that might give you a window into your risk exposure on a stock deal.

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

1) I have known Bill Wiersema for a long time and have learned something new all the time I will suggest f/u on S Inversion. Excluding this, my thoughts.
2) Tax impact to seller between Asset/Stock is low (seller is a pass-through entity and is asset-light) which seller seems to have confirmed.
3) If the business has been in existence for a long time, and a) if customer turnover is low, b) if insurance claims have been low, c) if current insurance company will provide a tail coverage, d) if customer contracts do not have change of control clause (which I doubt exists in such business), e) if the cost to customer to switch provider is high, f) if the cost help the customer leave is low, g) if the cost to acquire new customer is low, h) if customer concentration is low or have access to key customers before closing, i) you have a viable growth strategy, then I think attrition risk of an Asset purchase should be low. relative to risk of stock purchase.
Keep in mind, no seller guarantees customer retention or sales continuity.

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