When people think about buying a company, they have thought the only option was to purchase the company’s stock. But there’s a better way to go about buying companies that takes away many of the risks that pop up when you purchase a company’s stock. Let me explain.
When I buy the stock of a company, I’m essentially buying everything inside that business-including all of its assets. But I’m also buying its liabilities as well-;some of which might be unknown at the time of the purchase. In some cases, those liabilities could have been created years before. Yet, after you buy the company’s stock, they could suddenly rear their ugly head and force you to deal with the consequences.
There is no doubt that you will do proper due diligence as you consider the purchase of a business, but it’s really impossible to uncover every risk. This is especially true for hidden risks that even the owner doesn’t know about.
For example, let’s say that the business makes a popular lawn-care product. Every spring, homeowners spread the product all over their grass to make it as green as possible. Unfortunately, the product is also toxic to humans. The company didn’t know that it was toxic, so it kept selling its product for years-;up until the day you buy the company’s stock. Then the news breaks about the toxic nature of the product. Guess whose problem that is now? That type of issue sounds very expensive, but it’s easy to think up dozens of such hidden liability time-bombs.
While it is possible to create some protections from these kinds of surprises in your purchase agreement, where you try to assign liabilities to a seller and indemnify yourself, it can tricky to identify all of the unknown risks. Even worse is trying to recover a large settlement from seller well after escrow has cleared.
That’s why the better way to buy a company is to just acquire its assets rather than its stock. This essentially means that you create a new corporate entity-;call it Newco-;which then acquires all of the assets of the company you’re buying. You will hollow out the old business to build the new one. That includes employment contracts, intellectual property, machinery, and long-term leases. Even the name and brand equity would transfer over to the new business. You purchase all of the assets needed to operate the firm on a going forward basis.
If I was buying Coca-Cola, for example, I would want to acquire the incredibly valuable brand otherwise I would just be purchasing fizzy brown water company.
The key known and unknown liabilities, however, stay with the old business. While you might have to assume certain minor liabilities like any accounts payable owed to suppliers, the big risky backward-looking liabilities remain the responsibility of the seller.
Of course, there are always tax implications with any acquisition, so I also highly recommend that you consult an attorney and CPA to get the best advice on structing your deal when you acquire the assets of a business.
While this approach might sound obvious, I saw firsthand how not understanding this approach can be devastating to a business. There was a case where an inexperienced management team acquired the stock of a company before checking in with their board. By the time we heard about it, they were too far down the path to turn back and so the sale was consummated as a stock purchase.
That decision came back to bite us when we learned that there was a problem in how the acquired company had been billing its customers for the past few years. All of a sudden the new owner, Us, needed to fix that problem-;which quickly became incredibly expensive. It wasn’t long before everyone regretted making the deal in the first place.
So remember, when you have the opportunity to buy a company, steer clear of the stock and buy the assets instead. Not only will it make the deal easy to close, it also will allow you to avoid lots of potential risk.