Types of Business Acquisitions Explained

Asset purchase: buy the pieces you want

In an asset purchase the buyer picks specific assets, such as equipment, inventory, customer lists and brand, and generally leaves unwanted liabilities with the seller.

This is the most common structure for small businesses. The buyer and seller agree on which assets and which obligations transfer. Because the buyer is not taking over the seller's entity, most past debts and legal claims stay behind, unless the buyer agrees to assume them.

Advantages for the buyer: cleaner risk, a chance to step up the tax basis of the assets, and flexibility to leave out what is not needed. Disadvantages: contracts, permits and leases may need each counterparty's consent to transfer, and the paperwork is heavier.

Sellers often prefer a stock sale for tax reasons, so price and structure are negotiated together. Both sides should talk to a CPA and attorney before agreeing.

Stock or equity purchase: buy the whole entity

In a stock or equity purchase the buyer acquires the owners' shares or membership interests, taking the company with all its assets and liabilities, known and unknown.

The business keeps operating as the same legal entity, with the same contracts, licenses and employees, which can make the handover smoother. For the seller, the sale is often simpler and may have tax advantages.

The buyer, however, inherits history, including debts, tax issues, lawsuits and anything the seller failed to disclose. That raises the importance of due diligence: reviewing financial statements, tax returns, contracts, leases, employee records and any pending claims. Buyers often ask for representations and warranties, an escrow or holdback, and an indemnity in the purchase agreement.

Read more about what to check in a guide for your first merger and acquisition.

Mergers and consolidations

A merger combines two companies into one surviving entity. It is often used when two businesses of similar size want to join, often by exchanging ownership interests.

In a statutory merger, one company absorbs the other, and the target ceases to exist as a separate entity. In a consolidation, both combine to create a new company. State corporate law governs the process, and it generally requires approval by owners and filings with the state.

Merging suits owners who want to pool strengths, such as two regional service companies, a manufacturer and a supplier, or two firms that share customers. Because the result takes on all liabilities, due diligence matters as much as in a stock purchase.

Expect hard conversations about governance, titles, culture and who runs what. Many mergers struggle on these human issues even when the numbers work.

Other common structures

Management buyouts, employee ownership, seller-financed deals and franchise or business purchases each change who buys and how the price is paid.

• Management buyout. The existing managers buy the company from the owner, which can preserve continuity and relationships.
• Employee ownership. Employees acquire the company over time through a plan or cooperative. See why America needs employee-owned companies.
• Seller financing. The seller accepts part of the price in installments, which reduces the cash the buyer must raise and keeps the seller invested in the transition.
• Turnkey or franchise purchase. A buyer acquires an operating business or system with established processes. Read what a turnkey business is.
• Earn-outs. Part of the price depends on future performance, which bridges disagreement over value.

Valuation, taxes and due diligence

Price is usually based on earnings and risk, then adjusted for assets, debts and terms. Taxes and liabilities can change the real value of a deal.

Small business valuations commonly use a multiple of seller's discretionary earnings or adjusted earnings. The multiple varies by industry, size, growth and risk, so be careful about rules of thumb. A business that depends entirely on its owner is worth less than one that runs without them.

Before signing, work through a checklist:

1. Verify revenue against bank statements and tax returns.
2. Review customer concentration. Does one client account for much of sales?
3. Check leases, licenses and contracts for transfer limits.
4. Find out about liens through a UCC search. Learn how in UCC filings and business loans.
5. Have your CPA model the tax effect of asset vs. stock structures.

How acquisitions are financed

Buyers combine their own cash, seller financing, bank or SBA loans and sometimes outside investors. The structure should leave enough working capital after closing.

Most small acquisitions mix several sources. A typical stack might include a down payment from the buyer, a portion financed by the seller and a lender-funded balance. SBA loans can be used for business purchases and often offer the lowest cost, though they are slower and require documentation. See how to buy a business with an SBA loan.

ROI Funder does not place acquisition loans, so use a specialized lender for the purchase itself. We can help afterward. Many new owners need working capital in the first months to cover payroll, inventory and upgrades. In this illustrative example, a buyer who spends everything on the purchase price may need $50,000 of working capital within 90 days. ROI Funder considers businesses with 6+ months in operation, $20,000+ in monthly revenue and 500+ FICO, so the acquired company's own history can support an application. See working capital.