Disadvantages of an Asset Sale
The structure of any deal is often a hotly debated deal point between buyer and seller. No two transactions are alike. While some deals present an obvious structure, benefiting both buyer and seller, most instances buyer and seller may be at odds with one another over which deal structure would appease both parties without blowing things up. Asset sales, which are often used by unlicensed brokers and by buyers looking to mitigate potential liability issues, have their own shortfalls in some instances. Since no single size fits all, it’s helpful to understand how some asset sales present large disadvantages when attempting to push a deal across the finish line.
First, asset acquisitions are notorious for double taxation to the seller. There is a corporate-level tax for the selling company as well as a tax at the shareholder level at the time the proceeds are distributed. Secondly, asset sales are typically more time-consuming than stock sales. There is greater accounting, legal and regulatory complication to the sale process. Because the sale of assets requires legal transfer of each, individual asset, it can make for a longer, more drawn-out process, particularly if a great deal of assets are involved. In some cases, a large asset count makes an asset sale nearly impossible. Here are a few immediate examples that come to mind where this could be the case.
- In the case of hundreds of distribution agreements in a wholesale distribution business, the cost of preparing a large number of new contracts with suppliers and/or manufacturers could be altogether cost-prohibitive and cause the deal to be dragged-on much too long for the patience of both buyers and sellers.
- In the case of an oil & gas deal, each pipeline could require land rights and/or numerous permits with complex surface and sub-surface rights. Such a structure creates an increase in complexity when doing an “asset only” deal.
- The state and local transfer taxes that occur when real estate is involved can be onerous, but particularly when real estate is transferred outside of the entity as an asset. Worse still are the local tax assessment groups that may work to increase the assessment of the property at the time of sale, thereby creating an increase in the tax burden on the company. If the property are spread across different jurisdictions, the complexity of an asset sale is further complicated.
Thirdly, in the case of intangible assets such as leases or contracts, the leases may not be assignable except that a third party (perhaps with no real interest in the transaction) provides consent. Even in the event that the third party provides consent, it is likely not to come without a price. An example of this could include a real estate lease where the company’s current lease is below prevailing real estate comparable rates for similar properties in the area. Consent for transfer of the lease may not come without a renegotiation of the lease contract, which has the potential of increasing the rent for the acquirer. In fact, any other lease or contract where the seller has currently favorable terms has the potential of renegotiation to terms that may prove detrimental to the overall deal. Buyers should also be careful to provide due diligence on all loan agreements to ensure an asset deal does not trigger any sort of default provision if the seller attempts to reassign to a new buyer.
A fourth potential issue could involve local licenses. In some jurisdictions, the company may hold a local license that is required to operate a particular craft within the guise of the law. In the case that a transfer of ownership is imminent, the transfer of such a license may involve administrative delays, lengthy hearings and other requisite hoops to jump through. Worst of all might be the risk of losing the license all together. It could get worse, particularly in the case for companies that are grandfathered into a license and may be exempt from current or new requirements–requirements that could require costly improvements mandating fixes, improvements, training or upgrades. Conforming to such rules could require a great deal of out-of-pocket expenses for a potential buyer. Other issues could result from things like bulk sales laws wherein buyers must conform to local state laws in the selling of seller inventory.
Buyers who go in eyes wide open through due diligence may discover an asset transaction may require biting off more than they anticipated. In the event that complexities and nuances create a more expensive asset sale than previously anticipated, there will obviously be negotiations which will discuss how the burden of the increased cost is to be shouldered.
While often touted as a great boon for buyers and sellers (particularly on mitigating liability issues for the buyer), asset sales do pose their own risks. Navigating the hurdles of the type of deal structure can be brutal. Having a knowledgeable professional in your corner is paramount to success for both buyers and sellers. Remember, this is not legal, accounting or investment advice. You should consult knowledgeable professional assistance when making business and investment decisions.
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