What is An Equity Sale?

Ever wondered what is an equity sale, and how does it fit into event-driven investing strategies? When companies sell ownership stakes, what risks and rewards arise for investors? Is acquiring equity a pathway to control, or does it expose you to unknown liabilities? Uncover the intricacies of equity sales in corporate deals.

An equity sale is the transfer of ownership interest in a company, usually in the form of shares of stock. The buyer acquires a percentage of the company's equity, and with it, the associated rights, such as voting power and claims to future profits or dividends. Equity sales can occur in stock markets or privately in negotiated deals. In an equity sale, the buyer essentially becomes part-owner of the business, inheriting both its assets and liabilities. To better understand what is an equity sale, let’s review a few key features:

Transfer of Ownership - The buyer gains a stake in the company, which may include control or influence over decisions depending on the size of the purchase.

Assets and Liabilities – Equity ownership precipitates the buyer assuming a proportionate share of the firm’s assets and liabilities.

Tax Treatment – Depending on the jurisdiction, equity sales may provide a more favorable tax treatment for sellers compared to asset sales.

Equity sales are common in mergers and acquisitions (M&A), venture capital investments, and private equity deals.

How Does an Equity Sale Work?

An equity sale transfers the ownership of company shares to a buyer in exchange for capital or other considerations. Let’s review the process:

Valuation and Negotiation – Valuation is the first step in determining the value of the company or the portion of equity being sold. Revenue, earnings, margins, interest-bearing debt, and additional financial metrics are evaluated within the context of existing market conditions. The seller and buyer negotiate the terms and conditions of the sale which include, but are not limited to, price, the ownership percentage to be transferred, governance rights, and future profit-sharing.

Due Diligence – The buyer performs the due diligence of examining the firm’s financial records, legal standing, and other important factors to verify the company’s value and assess potential risks. This step ensures the buyer understands the company’s operating assets and liabilities and any future obligations they may inherit upon purchasing the equity.

Drafting an Agreement – Upon completion of the due diligence process, the parties draft a Purchase and Sale Agreement (PSA) outlining the agreed-upon terms of the equity sale. The agreement is the tangible representation of the buyer and seller’s previous negotiations and will include added terms, such as any precedent regulatory determinations or third-party consents, all warranties and representations made by both parties, and an effective transaction closing date.

Regulatory Approval – The sale may be jurisdiction-dependent and require regulatory approval. This mandate is more prevalent when a significant stake of a company is transferred or if the buyer is a foreign entity.

Transaction Consummation – On the closing date, the agreed-upon equity is transferred to the buyer, and the buyer provides the seller with payment or other consideration, which can be an exchange of shares in another company. The ownership changes hands, and the buyer assumes the associated rights and claims to assets, liabilities, and dividends.

Post-Sale Transition – The post-sale is followed by a transition period, especially in private company transactions, where the seller may stay involved temporarily to ensure smooth operations.

Let’s recap what is an equity sale and how it works. An equity sale is a process of transferring equity ownership from the seller to the buyer in an orderly valuation, negotiation, and sale consummated manner.

What is the Difference Between Asset Sale and Equity Sale?

The difference between an asset sale and an equity sale lies in what is being transferred, the assumption of liabilities, tax implications, and the structure of the transaction.

In an asset sale, the buyer acquires specific assets and possibly some liabilities of the company, such as equipment, inventory, and intellectual property. The legal entity remains with the seller, and the buyer can pick which assets to purchase and which liabilities to assume. This type of sale is typically more complex as contracts, licenses, and agreements need to be renegotiated.

An equity sale involves the transfer of ownership in the company itself. The buyer purchases shares of stock, effectively acquiring the entire company, including its assets and liabilities. The transaction is simpler in structure because the company’s legal entity remains intact, but it comes with higher risks since the buyer assumes all existing liabilities. Tax implications also differ, with sellers in an equity sale often benefiting from capital gains treatment, while asset sales can offer tax benefits to buyers through the depreciation of the acquired assets.

In review of what is an equity sale and why is it preferred by sellers? An equity sale is the sale of common shares of a company, rather than just its assets. In an equity sale, the ownership of the firm changes hands, but the company itself remains the same, including its assets and liabilities. Sellers prefer equity sales because it results in less disruption to company operations, its customers, and employees. However, this type of transaction is not riskless, and buyers must conduct thorough due diligence to uncover any potential liabilities, as they will inherit all disclosed and undisclosed liabilities of the firm.