Buying a Business in Arizona: Asset vs. Entity Purchase

The Two Structures in Plain English

Entity purchase: You buy the company. Title to the assets never moves. The corporation, LLC or partnership continues to own the equipment, hold the leases, employ the workers, owe the debts and be the defendant in any lawsuit. The only thing that changes is who owns the company. The public may never know the business was sold.

Asset purchase: You buy the things. The selling company keeps its existence, its owners and everything you did not buy, and it walks away with the sale proceeds. You take title to the purchased assets, normally in the name of a new Arizona LLC you formed for the purchase, and you assume only the liabilities listed in the purchase agreement.

That single structural decision drives price, taxes, employees, leases, licenses, financing and risk. It should be the first thing you decide, not the last.

Side-by-Side Comparison

Issue	Asset Purchase	Entity Purchase
Unknown liabilities	Buyer assumes only what the agreement lists. Big advantage to buyer.	Buyer inherits everything, including liabilities nobody has discovered yet.
Buyer's tax basis	Stepped up to the price paid. Larger depreciation and amortization deductions.	Unchanged. Buyer inherits assets that may be fully depreciated.
Seller's tax result	Depreciation recapture produces ordinary income. A C corporation seller may be taxed twice.	Usually all capital gain, taxed at lower rates.
Contracts and leases	Must be assigned. Consent usually required.	Stay in place, but change-of-control clauses may still require consent.
Licenses and permits	Generally do not transfer. Buyer applies for its own.	Frequently stay with the entity, though many agencies require notice or re-approval.
Employees	Seller terminates. Buyer hires whom it wants as new employees.	Nothing changes. Buyer inherits every accrued employment obligation.
Closing complexity	Higher. Bills of sale, assignments, consents, new accounts, new licenses.	Lower. Transfer the ownership interests and update the records.
Typical price	Higher, because the buyer is getting a cleaner deal and a better tax result.	Lower, or should be, because the buyer is absorbing far more risk.

Asset Purchase: The Pros

1. You choose which liabilities you accept.

This is the reason prudent buyers insist on an asset purchase. The general rule is that an asset buyer is liable only for the liabilities it expressly assumes in the purchase agreement. A properly drafted agreement lists the assumed liabilities and states in plain language that the buyer is not liable for any other obligation of the seller, whether known or unknown, disclosed or undisclosed, accrued or contingent. The seller's disputed vendor invoice, the customer who slipped in the parking lot last year, the wrongful termination claim nobody mentioned, and the guaranty the owner signed on a piece of equipment stay with the seller.

2. You get a stepped-up tax basis.

The buyer's tax basis in the purchased assets is generally what the buyer paid for them, allocated among the assets. That basis produces depreciation and amortization deductions going forward. Equipment is written off over a few years. Goodwill and covenants not to compete are amortized over fifteen years. In an entity purchase, none of that happens. You inherit whatever basis the entity had, which on a business with old, fully depreciated equipment can be close to nothing. On a seven-figure deal, the difference is real money every year for many years.

3. You can leave the junk behind.

You are not required to buy everything. You can decline the aging delivery van, the obsolete inventory, the receivables the seller has been unable to collect and the equipment lease the seller signed at a terrible rate. In an entity purchase, everything the entity owns and owes comes with the entity.

4. You start with clean records and a clean entity.

A new Arizona LLC formed to acquire the assets has no history: no prior tax filings, no old minute book, no defective prior transfers, no ambiguous membership records, no ex-partner who claims he was never bought out. In an entity purchase, you are buying somebody else's corporate housekeeping, and it is often worse than they said it was.

5. Financing is usually easier.

Lenders, including SBA lenders, generally prefer asset purchases. The collateral is identifiable, the borrower is a clean entity, and the lender is not underwriting a company's undisclosed history.

Asset Purchase: The Cons

1. It is not a complete shield.

Arizona and federal law impose successor liability on asset buyers in several situations, including unpaid Arizona transaction privilege taxes under A.R.S. § 42-1110, unpaid unemployment contributions under A.R.S. § 23-733, certain environmental obligations, bulk transfers of inventory in some circumstances, and de facto merger or "mere continuation" claims where the buyer is really the old business under a new name. Buying assets reduces risk. It does not eliminate it.

2. Everything has to be transferred, and every transfer needs consent.

The lease has to be assigned and the landlord has to consent. Vendor contracts, equipment leases, franchise agreements, software licenses, maintenance contracts and customer agreements have to be assigned, and many of them require the other side's approval. Each consent is a place the deal can stall or the counterparty can extract a concession. Titled assets need title transfers. Intellectual property needs written assignments. Domain names need registrar transfers.

3. Licenses and permits usually do not come along.

An Arizona transaction privilege tax license does not transfer. A Registrar of Contractors license belongs to the licensee, and a buyer generally must qualify for its own, which may require a qualifying party with the necessary experience, a bond and an examination. A liquor license transfer requires approval from the Arizona Department of Liquor Licenses and Control and usually the local governing body. Professional licenses do not transfer at all. Health, fire, sign and occupancy permits may have to be reissued, and reissuance sometimes triggers an inspection that reveals code violations you now have to cure.

4. The employment relationships restart.

The seller terminates its employees and you hire the ones you want as new employees of your entity. New Form I-9 for everyone, new payroll, new withholding accounts, new workers' compensation coverage. Key employees can decline to come. Any accrued vacation or paid time off you agree to honor should be paid for with a purchase price credit from the seller.

5. The seller will want more money, or will refuse.

An asset sale costs the seller real tax dollars through depreciation recapture and, for a C corporation seller, potentially double taxation. Sellers know this. Expect the seller to demand a higher price for an asset structure, and expect some sellers to refuse outright.

6. It takes longer and costs more to close.

More documents, more consents, more applications, more moving parts. A straightforward asset purchase typically takes 45 to 90 days. Landlord consent, liquor and contractor licensing, SBA underwriting and the Department of Revenue tax clearance letter are the four items that most often delay closing.

Entity Purchase: The Pros

1. Continuity. The business does not skip a beat.

Contracts, leases, permits, vendor accounts, customer accounts, bank accounts, insurance policies, phone numbers, merchant processing and payroll all stay exactly where they are because the legal owner never changed. For a business built on long-term contracts, hard-to-replace permits, a below-market lease, or a government or institutional customer base with a lengthy vendor approval process, continuity can be worth more than the liability protection you give up.

2. Fewer consents to chase.

Because nothing is being assigned, many consent requirements are never triggered. Read the documents carefully, though. See the caution below.

3. Simpler, faster and cheaper closing.

A stock or membership interest purchase agreement, an assignment of the interests, updated entity records and a resolution can close a deal that would otherwise take a stack of bills of sale, assignments and consents.

4. It is what the seller wants, which is leverage.

Sellers prefer entity sales because the gain is generally capital gain. Offering the structure the seller wants is a legitimate negotiating chip. Use it to buy something valuable in return: a lower price, a bigger escrow holdback, longer survival of the representations, or personal indemnity from the owners.

5. The seller's favorable tax attributes may come along.

In some transactions the entity holds attributes worth keeping, such as an established unemployment experience rating with a low tax rate, an operating history that supports financing, licenses that took years to obtain, or a name and brand with real equity. Have your CPA quantify this before you decide.

Entity Purchase: The Cons

1. You inherit every liability, including the ones nobody knows about.

This is the whole risk in one sentence. The entity remains liable for its contracts, leases, debts, guaranties, employee claims, tax obligations, product liability, negligence claims and every other obligation it has ever incurred. The sale of the owners' interests does not affect the entity's liabilities at all. The lawsuit filed eighteen months after closing over something the seller did three years before closing is now your lawsuit, and your money.

2. Due diligence must be far deeper, and it still will not find everything.

In an asset purchase, diligence is largely about confirming the assets exist, work and are unencumbered. In an entity purchase, diligence has to reach the entity's entire history: tax filings and audits, payroll compliance, litigation and claims history, insurance loss runs, environmental history, employment practices, licensing compliance, ownership records, prior transfers of interests, guaranties, undisclosed side agreements and every contract ever signed. You will spend more on diligence and still be exposed to what nobody documented.

3. No basis step-up.

You paid current market value and you get the entity's old, often heavily depreciated basis. Fewer deductions every year you own the business.

4. Change-of-control clauses can wipe out the continuity advantage.

Many commercial leases, franchise agreements, bank loans, license agreements and key vendor contracts define a change in ownership of the entity as a transfer requiring consent. If they do, you get all of the consent work anyway, plus all of the liability. Read every material agreement before you conclude that the entity structure avoids consents.

5. Ownership defects become your problem.

If a former member was never properly bought out, if an operating agreement restricts transfers, if a spouse has a community property interest that was never addressed, if shares were issued without proper authorization, or if a member is in bankruptcy or divorce, those problems now attach to what you bought. In an asset purchase, most of them stay with the seller.

6. Your remedy is a lawsuit against people who already have your money.

In an entity purchase, your protection is contractual: representations, warranties and indemnities. That protection is worth exactly what the indemnitor is worth when the claim arises. An indemnity from an LLC that will distribute the sale proceeds and dissolve thirty days after closing is a sentence in a document, not a remedy.

The Tax Difference, Stated Simply

The buyer and the seller want opposite things because the same dollar is taxed differently depending on the structure.

Buyer's view: An asset purchase gives a stepped-up basis and future deductions. The buyer wants more of the price allocated to assets that are written off quickly, such as equipment and consulting agreements, and less to goodwill, which is amortized over fifteen years.

Seller's view: An entity sale generally produces capital gain across the board. An asset sale triggers depreciation recapture taxed as ordinary income on depreciated equipment, and if the seller is a C corporation, the corporation pays tax on the gain and the shareholders pay a second tax when the after-tax proceeds are distributed.

The allocation fight: In an asset sale, the buyer and seller must each file IRS Form 8594, Asset Acquisition Statement, reporting how the purchase price was allocated among seven asset classes. If the two forms do not match, both parties have invited scrutiny. Negotiate the allocation in the purchase agreement, attach it as an exhibit, and require both parties to report consistently with it. This one provision prevents an expensive argument nine months after closing.

Ask your CPA to run both structures on your actual numbers before you negotiate. The tax difference is frequently large enough to fund the price concession that gets you the structure you want.

When an Entity Purchase Actually Makes Sense

The asset purchase is the default for good reason, but it is not automatic. An entity purchase deserves serious consideration when:

• The business holds a license, permit, certification or government contract that is difficult, slow or impossible to obtain in a new entity.
• The value is concentrated in long-term contracts that cannot be assigned, or that can be assigned only with a counterparty's consent you are unlikely to get.
• A below-market lease with substantial remaining term is central to the value and the landlord will not consent to an assignment on acceptable terms.
• The entity is young, has a short and fully documented history, and diligence can realistically cover all of it.
• The seller's owners are financially substantial, will still be around, and will personally indemnify you with real assets standing behind the promise.
• The seller will not sell any other way and the business is worth the risk at a price that reflects it.

How to Protect Yourself If You Buy the Entity

If you accept an entity structure, the purchase agreement has to do the work the structure will not do for you.

• Price the risk. The entity structure saves the seller taxes and hands you risk. You should be paid for that in the purchase price.
• Get personal guaranties and indemnities from the individual owners. An indemnity from the selling entity alone is usually worthless after the proceeds are distributed. If the owner is married, get both spouses' signatures, because under Arizona law a judgment on a guaranty signed by only one spouse generally cannot be collected from community property.
• Hold back a meaningful part of the price in escrow. A holdback is the only remedy that does not require a lawsuit. Twelve to twenty-four months is common. Money you already control beats a claim against someone who has moved to another state.
• Negotiate survival periods that mean something. Representations that expire ninety days after closing protect nobody. Tax, title, ownership and environmental representations should survive far longer than operational ones.
• List every liability you will let the company keep. The agreement should identify each obligation the company may pay after closing, and obligate the sellers to indemnify you for every other obligation the company pays or incurs after closing.
• Run the searches. Judgment searches in every county where the entity does business, recorded lien searches with the County Recorder, UCC searches with the Arizona Secretary of State, and bankruptcy searches through PACER. These cost almost nothing compared to what they find.
• Get a tax clearance letter and a DES statement. See the section below. Both are free and both cap exposure.
• Get a covenant not to compete from the individual owners, not just the entity. The person who built the customer relationships is the person who can take them away. Arizona courts will not enforce an unreasonably broad covenant and generally will not rewrite one, so have it drafted by an Arizona attorney.
• Buy the seller's time. Condition closing on a consulting or employment agreement that keeps the owner available through a transition period.

Two Arizona Traps That Follow the Buyer in Either Structure

Unpaid transaction privilege taxes

Under A.R.S. § 42-1110, a purchaser of a business or stock of goods must withhold from the purchase money enough to cover the transaction privilege taxes, interest and penalties the seller owes, until the seller produces a receipt from the Arizona Department of Revenue showing the taxes are paid or a certificate showing nothing is due. A buyer who fails to withhold is personally liable for the former owner's unpaid taxes, interest and penalties. Make delivery of a Letter of Good Standing an express condition to closing and hold back part of the price until it arrives. The Department must respond to the seller's Tax Clearance Application within fifteen days. This protection is free, and buyers still skip it.

Unemployment experience rating and unpaid contributions

Under A.R.S. § 23-733, a buyer who acquires an entire Arizona business, or substantially all of its assets, and continues operating it takes the predecessor's experience rating account, which determines the unemployment tax rate, and becomes liable for the predecessor's unpaid contributions, interest and penalties. That liability becomes a lien against the acquired assets. There is a protection most buyers never use: on written request, the Arizona Department of Economic Security must furnish a written statement of the amounts due and unpaid as of the acquisition date, and the successor's liability cannot exceed the amount disclosed. Send the request and cap your exposure. If the seller's experience rating is poor, the higher rate can cost thousands of dollars a year, so have your accountant quantify it and negotiate compensation in the purchase agreement.

Frequently Asked Questions

Which structure is better for the buyer?

An asset purchase, in the large majority of transactions. It limits the buyer's liability to what the buyer expressly assumes and gives the buyer a stepped-up tax basis in the purchased assets. The exceptions involve businesses whose value depends on licenses, permits or contracts that cannot practically be moved to a new entity.

Which structure is better for the seller?

An entity sale, in most cases, because the gain is generally capital gain and the seller does not face depreciation recapture or, for a C corporation, double taxation. The seller also walks away from liabilities that would otherwise stay behind in an asset sale.

Can a deal be part asset purchase and part entity purchase?

Yes. Hybrid structures are used, particularly where a business operates through several entities and the buyer wants some of them but only the assets of others. Hybrids add complexity and cost and should be structured with your attorney and CPA working together.

If I buy the assets, can the seller's creditors still come after me?

Sometimes. Successor liability can attach for unpaid Arizona transaction privilege taxes, unpaid unemployment contributions, certain environmental obligations, and under de facto merger or mere continuation theories where the buyer keeps the same name, location, employees, management and ownership and is effectively the same business. Diligence, tax clearance, lien searches, escrow holdbacks and personal indemnities are how you manage that residual risk.

Should I buy the business in my own name?

No. Form an Arizona LLC before closing and buy the business or its assets in the name of the LLC so the business's liabilities do not automatically become your personal liabilities. Have the LLC formed, its operating agreement signed and its bank account open before the closing date, not the week after.

Does an entity purchase avoid getting the landlord's consent?

Not necessarily. Many commercial leases provide that a change in ownership of the tenant is deemed a transfer requiring the landlord's consent. Read the lease before you assume the entity structure solves the problem, and get any required consent in writing before closing.

When should the structure be decided?

Before the purchase agreement is drafted, and ideally in the letter of intent. The structure changes nearly every other provision in the deal, so negotiating it after a draft exists means rewriting the draft.

Can a business broker prepare the documents?

A broker may offer to. Ask who the broker represents and how the broker gets paid. The broker's objective is usually to close the deal so the commission is earned, which is not the same as protecting the buyer. Legal fees on a properly papered purchase are almost always trivial next to the purchase price.

Get Help Structuring Your Arizona Business Purchase

This article is general information, not legal advice. Every purchase has its own facts, and the right structure depends on them. We recommend that every buyer and every seller of an Arizona business be represented by an experienced Arizona business attorney before becoming legally obligated to buy or sell.

Arizona business attorneys Richard Keyt, who has practiced business and contract law in Arizona since 1979, and his son, attorney and former CPA Richard C. Keyt, have formed 10,000+ Arizona LLCs and have prepared the documents that protect Arizona business buyers and sellers for decades. Rick and Ricky will answer your questions about buying or selling a business or its assets at no charge.

Call Richard Keyt at 480-664-7478 or Richard C. Keyt at 480-664-7472, or email rk@keytlaw.com. You can also book a free office, phone or Zoom consultation.

To hire KEYTLaw to prepare your purchase or sale documents, complete and submit our online Business Purchase / Sale Questionnaire.

If you need to form an Arizona LLC to acquire the business, see the fees and contents of our 3 LLC Formation Packages.

To hire us to form an LLC submit our online questionnaire at keytlaw.com/llcq, call 480-664-7478 or email rk@keytlaw.com.