Anyone who has decided to act on their passion for wine and get into the wine industry initially needs to decide what type of business they want to run – a vineyard, a winery, or an estate winery. A vineyard is essentially a farm that grows grapes and sells its product to wineries, which produce the actual wine. An estate vineyard or winery, on the other hand, both grows grapes and produces wine. While it takes, on average, three to five years for a start-up vineyard to produce viable grapes, wineries are very capital and labor-intensive businesses. Both ventures therefore require a significant amount of commitment and financial wherewithal.
Once the type of business has been chosen and a suitable property located, the first basic decision that needs to be made in purchasing a vineyard or winery is whether the deal will be structured as an asset purchase or a stock purchase. This decision can be difficult, since what is good for one party is generally bad for the other.
In an asset transaction, only explicitly-assumed liabilities and those assets of the vineyard/winery that are specifically identified in the purchase agreement, such as equipment, inventory, trademarks, and goodwill, are purchased by and transferred to the buyer. The seller retains all other assets and liabilities as well as ownership of its business entity. The buyer must therefore either use an existing entity or create a new entity for use in the transaction.
One contentious issue in almost every asset transaction is how to allocate the purchase price. The buyer will want to allocate as little as possible to capital assets, such as real property, since those assets are non-depreciable. The buyer would rather allocate as much of the purchase price as possible to depreciable assets, especially those that can be written off quickly, such as receivables and inventory, rather than those that must be depreciated over a longer period, such as intangibles like goodwill. The seller, on the other hand, will want to assign as much of the sales price as possible to capital assets since any gain on the sale of those assets will likely be subject to a relatively low capital gains tax rate. It should attempt to avoid assigning much value to assets that result in ordinary income, such as inventory, receivables, and covenants not to compete.
An asset transaction generally favors the buyer for several reasons. First of all, the buyer acquires a new, “stepped-up” cost basis in the assets purchased, equal to the price paid for the assets. That higher basis then enables the buyer to recognize less gain when it eventually sells an asset that goes up in value, and also allows the buyer to take larger deductions on depreciable assets in future tax years. In addition, buyers typically prefer asset transactions for liability reasons. By purchasing only selected assets and liabilities of the seller, the buyer can avoid exposure for most of the seller’s liabilities, including income taxes, payroll withholding taxes, and legal claims.
In spite of the general tendency of a buyer to prefer an asset purchase, there are some circumstances in which an asset acquisition will not be appropriate, even from the buyer’s perspective. For example, if there are licenses, trademarks, leases, or other contracts that are either not assignable or very difficult to assign, it may be advisable to do a stock sale rather than an asset sale since a stock sale does not technically involve an assignment of those items. Even in this situation, however, caution is advised because many sophisticated contracts treat a change in entity control as a prohibited assignment, and approval may be required notwithstanding that the sale is structured as a stock sale.
Stock transactions, on the other hand, involve a sale of the seller’s business entity to the buyer, including all of its assets and liabilities. In effect, the buyer steps into the shoes of the seller and the operation of the vineyard/winery continues in an uninterrupted manner. Unless specifically agreed otherwise, the seller has no continuing interest in or obligation with respect to the assets, liabilities or operations of the business. Stock transactions are generally simpler than asset transactions since nothing other than the ownership of the seller’s entity is transferred.
A stock transaction generally favors the seller because it enables the seller to simply “walk away” from the business. In addition, if a seller sells the stock of its entity for a higher price than that for which it was purchased, the resulting income to the seller is taxed at a lower capital gains rate than the ordinary income that would result from the sale of assets. On the other side of the coin, a stock purchase will not enable the buyer to take a write-off until it sells the stock of the entity that it acquires. Additionally, if the stock is subsequently sold at a loss, the loss is generally only deductible to the extent the buyer has capital gains from other sources.
However, in some instances stock deals may favor both parties. For example, stock transactions can provide for continuity in relationships with suppliers and other vendors when those relationships are critical to the success of the business, such as grape supply contracts and wine distribution agreements. In addition, a stock transaction usually makes it unnecessary to obtain consents to contract assignments, which is important when the seller’s contracts prohibit assignments to third parties without such consent and it is anticipated that it will be difficult or impossible to obtain those consents.
In any case, in order to protect itself against liability for unknown seller liabilities, any buyer who acquires a vineyard/winery by means of a stock sale should, at a minimum, seek to obtain explicit written representations and warranties regarding the liabilities of the business, such as a representation that there are no undisclosed tax, employee, environmental, contract, or litigation liabilities, as well as an indemnification agreement obligating the seller to reimburse the buyer for any costs or liabilities incurred by the buyer as a result of a failure of any of the seller’s representations.
Once the parties have agreed as to how the transaction is to be structured, a purchase agreement will need to be negotiated. A carefully crafted asset or stock purchase agreement should allow a prospective buyer a reasonable period of time to determine the suitability of the property for the buyer’s intended purposes. Part 2 of this article will examine some of the basic investigations and reviews that should be performed by the buyer before deciding whether or not to sign on the dotted line.