| February 23, 2018
By: Evan Sauer
Buying and selling an Amazon, other e-commerce business, or any business for that matter, comes with many issues and considerations. Although this post will focus on the legal issues involved, I will briefly touch on other considerations as well. Purposes of the Parties
In order to advise my clients on the structure of a purchase and sale, I need to understand the purposes for the buyer buying a business and the seller selling the business.
As for the buyer of an e-commerce business, a few of the most common motivations, include diversification into new product lines; obtaining needed working capital; obtaining additional or new sources of supply or channels of distribution; obtaining the tax benefits of the selling entity such as loss or investment tax credit carryforwards; or obtaining particular assets of the selling entity, such as patents or trademarks.
As for the seller, the most common motivations for selling, include the opportunity to enjoy a substantial profit; or business adversities or considerations such as capital shortage, loss of a source of supply, lack or aging of management, strategically exiting a market or disposing of a business unit, or a declining market. Investigation of Seller’s Business
Before making an offer, buyers should investigate the marketability of the seller’s current and future products, the stability and strength of the seller’s customer base, the quality and depth of management, sources of supplies and channels of distribution, the seller’s position within its product category, seller’s material contracts with suppliers, vendors, employees, and independent contractors, intellectual property ownership and licenses, and the overall future of that industry.
Buyers should also review the seller’s financial statements and tax returns for the previous 3-5 years in order to obtain an accurate appraisal of the business’ performance over time. A complete discussion of techniques for analyzing corporate financial statements is beyond the scope of this post. Forms of Acquisitions
There are various structures for the acquisition and sale of a business that the parties can explore, such as: 1. Mergers
Merger means the combination of two or more entities, where one entity absorbs one or more other entities, takes over all property and rights of the other entities, and
becomes liable for all of their liabilities and obligations. The entities being acquired terminate their legal existence, and their shareholders or members exchange their stock or interests for cash and/or shares, securities, or obligations of the surviving entity. 2. Consolidations
Consolidation occurs when two or more entities combine and form a new entity. The procedure for consolidation normally is similar to that required to effect a merger, and the results produced by the two methods are almost identical. In effect, the consolidating companies merge into the new entity. 3. Sale of Assets
An entity may, under many state statutes, sell all or substantially all of its properties and business to another. The sale may be made for cash or other property, including, in many states, shares or interests. After the sale, the selling company may dissolve, but it need not do so. If shares or other securities of the buying entity are received as consideration and then are distributed to shareholders or interests of the selling company upon its dissolution, the end result is similar to that of a merger or consolidation. 4. Sale of Shares or Interests
The sale of shares of a corporation by its shareholders or interests of a limited liability company by its members does not require specific statutory authority or formal action by the corporation or limited liability company. The parties may agree on cash, shares, or securities of the buyer or other property as consideration. In further contrast to the preceding methods of corporate acquisition, the buyer of shares or interests does not become the immediate owner of the entity properties and business, but the business and financial effect on the selling entity’s owners is practically the same. Choosing the Right Structure – Non-Tax Considerations
. 1. Liability Assumption
If you are a buyer, you need to consider whether you are okay with taking on all of the liabilities (known and unknown) of the seller. Below is a brief explanation of what structures would require and not require assumption of the seller’s liabilities.
A surviving entity in a merger
inherits all of the obligations and the liabilities of the constituent entities.
A buyer purchasing the assets
of another company often expressly assumes all of the
debts and liabilities of the seller. In such cases, the buyer becomes directly liable. However, the parties can agree to limit the buyer’s liabilities. The buyer is not liable for debts and obligations of the seller other than those it has assumed expressly in the purchase contract.
There are exceptions. The buyer could be liable for debts of the seller if the buyer pays the consideration for the acquired assets directly to the shareholders or members of the seller instead of to the selling corporation or limited liability company itself. By this process, the selling entity is stripped of all assets that previously were available to pay creditors, and creditors have successfully asserted liability against the transferee entity under those circumstances.
In addition, a buyer could be liable for the obligations and liabilities of the seller when the buyer entity is merely a continuation of the seller entity (i.e. common officers, directors, and shareholders); or when the transaction is entered into fraudulently to escape liability for such obligations.
If the buyer insists on an asset purchase, and seller has known or unknown liabilities, the buyer can protect itself by insisting on payment of creditors before the sale, by withholding part of the purchase price temporarily, and/or by placing part of the purchase price in escrow.
From the seller’s viewpoint, when an entity sells all of its assets and the proceeds of the sale are distributed to its shareholders or members, unpaid creditors of the selling entity may pursue the shareholder or member proceeds to satisfy the entity’s debts. To avoid such a circumstance, seller most states have statutes for dissolution and discharging liabilities with notice to creditors that sellers should follow.
When a buyer purchases shares or interests
of the selling entity, the buyer merely becomes an owner of the seller and the selling entity is still liable for its preexisting debts and obligations. However, a buyer that acquires the shares or interests of another entity does not become personally liable; the risk of unknown liabilities is borne by the acquired selling entity only. 2. Transfer of Contracts
Many contracts are not assignable. Restrictions on assignments normally are strictly construed and may be held not to be violated by merger or by the sale of its shares or interests. Some contracts go further and restrict assignment even by operation of law. Intellectual property licenses should be assumed to be non-assignable unless the license specifically allows for assignment. If restricted contracts are important to the transaction and cannot be renegotiated, either a merger or sale of shares will likely be preferable to a sale of assets. 3. Convenience & Timing
A sale of assets involves a large amount of paperwork, including purchase and sale agreements, bills of sale, and assignments for all its assets and contracts. There is also the danger that some assets will be overlooked and not transferred. A merger or sale of shares or interests avoids these problems. Because less paperwork is involved and typically fewer contractual consents
are required, a merger or sale of shares or interests often can be completed more quickly than a sale of assets. Choosing the Right Structure – Tax Considerations
One of the most important considerations in purchasing and selling a business is the tax ramifications of the parties. If you choose the wrong structure, you could end up paying a lot more in taxes than anticipated. Below is a very brief explanation of the tax implications for each structure. This is not accounting advice, I would recommend speaking with your accountant regarding the tax consequences.
In the case of a merger
, the IRS treats this transaction as a reorganization eligible for tax-free treatment. Treas.Reg. §1.368-2(b). The primary advantage of a statutory merger or consolidation, is the flexibility permitted in determining the consideration to be paid for the acquired entity.
The sale of assets
is relatively straightforward for tax purposes. The overall sale for a single purchase price is treated as separate transfers of each asset purchased and liabilities assumed. The purchase price is allocated among the assets in accordance with their respective fair market values at the time. The selling entity recognizes gain equal to the difference between the adjusted basis of the assets transferred and the amount paid by the buyer. Where there is a complete sale of the business, and the asset sale is followed by a liquidation of the entity, there may be two levels of taxation (depending upon the type of entity) – that is, at the corporate and shareholder levels. From the buyer’s perspective, the buyer acquires the various assets with bases equal to their fair market values, a so-called “step up” in basis. The buyer takes the assets with full basis and new holding periods, and where applicable will get the benefit of depreciation deductions, thereby reducing the buyer’s taxes going forward. Thus, from a tax perspective, this structure would generally be preferable to a buyer.
In a sale of shares or interests
structure, the selling shareholders or members will recognize gain equal to the difference between the purchase price received and their bases in the target entity. The buyer acquires the target’s shares or interest with a stepped-up basis equal to the cash paid and liabilities assumed. For tax purposes, the essential difference to the buyer of acquiring a business through a stock or interest purchase, rather than purchasing the assets directly, is that the individual assets retain their character, bases and holding periods. This has advantages and disadvantages, which is beyond the scope of this post. In general, it would appear that a stock or interest sale would have tax benefits for sellers and result in a corresponding tax detriment for buyers. However, this may not always be the case depending upon certain factors influencing a taxpayer’s taxes. Evan Sauer
is a Chicago business and real estate attorney at Reda & Des Jardins, LLC a forward-thinking, technologically savvy law firm providing top-notch legal services to clients ranging from startups to large companies in a variety of industries. R&D's practice includes business, real estate, litigation and estate planning.