Asset Versus Stock Deals – The Lurking Business Risk

October 23, 2021

Private equity will often prefer to buy all of the assets of the business (and assume its operating liabilities) rather than buy its capital stock.  Often the buyer will agree to cover any incremental taxes being borne by the seller (since the buyer is taking all of the acquired company’s assets, income tax may be incurred at the target company, and that tax will usually exceed the tax that would have been incurred by the seller in an equity transaction).  Asset deals generally improve the depreciable asset values received by the buyer (saving cash taxes in the future) and work to the seller’s advantage because the seller can liquidate the remaining company post-closing and limit or eliminate his or her exposure to unknown creditors.

There is, of course, some “grayness” to the approach because few buyers focus on product warranties from parts/products made several years prior to the sale, particularly those accruing to existing customers.  Were those liabilities assumed by the buyer or is the seller left to determine whether it might have some exposure?  You’ll take care of your key customers post-closing (though the seller may have to indemnify the buyer) but what about those customers that you aren’t currently doing business with? It’s unlikely anyone can review whatever terms govern the sale that took place years ago (likely pursuant to a PO that might incorporate terms on a website that have long since been updated) because no one is going to confront the customer with the transaction (and seek out its consent).

But there’s another issue, one that hasn’t yet reared itself to our knowledge.  Both private equity and strategic acquirors often acquire businesses because of the customers that the acquired business services.  OEMs in all industries continue to work on consolidating their supply chains to create more control and leverage over their contract manufacturing partners – and getting and staying on their “approved supplier” or “approved vendor” lists is difficult and has real value.  But what most parties don’t think about in the context of an asset deal is the customer risk that has inadvertently been created.  The asset deal shelters both buyer and seller because the operating company post-closing is a different legal entity.  The name, people and location might be the same, but the legal entity is not.  And here’s the problem – quality requirements at most (if not all) OEMs should result in the new entity forfeiting the “approved supplier” status of the former operating company.  Some quality requirements are so strict they won’t even allow a supplier to file for a DBA (doing business under a fictitious name) without going through a lengthy re-approval process from the OEM.  As a result, the acquired company’s competitors could create disruption by raising the issue with mutual customers.  And the target company (in addition to upsetting its customer) might be on the sidelines until it can be requalified.

Want to some advice on how to manage this risk?  We can help identify the customers and industries at risk and know senior sourcing professionals at several OEMs who may be able to help.