The decision to structure the sale of your business as an asset sale or a stock sale has many considerations. It can be complicated because buyers generally prefer asset sales, whereas sellers prefer stock sales. Other factors including the company structure and industry can influence the decision. While the vast majority of business sales under $500,000 are asset sales, we will provide you with preliminary information regarding both types of deal structures. We recommend consulting with legal and accounting professionals to determine what is best for you.
An asset sale is the purchase of individual assets and liabilities of a company, such as equipment, licenses, inventory, etc. In this case, the seller retains possession of the legal entity. Asset sales generally do not include the company’s cash and long-term debt (referred to as a “cash-free, debt-free transaction”). This structure also typically includes net working capital in the sale. Asset sales are often less complicated from a securities law perspective because involved parties are not normally required to comply with state and federal regulations.
Asset sales generally generate higher taxes for sellers because tangible assets can be subject to ordinary tax rates. Additionally, for C-corporations, the seller faces double taxation. The corporation is taxed upon selling the assets to the buyer, which is followed by the sellers being taxed again when the proceeds transfer out of the corporation.
As allowed by the IRS, asset sales allow buyers to “step-up” the company’s depreciable basis in its assets. A buyer can then gain additional tax benefits through allocating a higher value for assets that depreciate quickly (like equipment) and allocating lower values on assets that amortize slowly (like goodwill). This reduction in taxes can provide much needed cash flow early in the new company’s life. Buyers also prefer asset sales because it is easier for them to avoid inheriting potential liabilities, especially contingent liabilities in the form of product liability, contract disputes, or employee lawsuits.
A stock sale on the other hand is a structure whereby the buyer purchases the selling shareholders’ stock, thus obtaining ownership of the legal entity. Keep in mind that sole proprietorships, partnerships, and limited liability companies do not have stock and therefore cannot be sold through a stock sale. This information is relevant for the sale of C-corporations and S-corporations.
The basis of the assets (book value) at the time of sale sets the depreciation basis for the new owner. Because of this, buyers are not able to re-depreciate certain assets through a stepped-up basis. The decreased depreciation may result in higher taxes for the company. Buyers may be accepting more risk through an stock sale because they are vulnerable to forthcoming contingent liabilities, which could take the form of lawsuits, environmental concerns, employee disputes, and so on. These potential liabilities can be mitigated in the stock purchase agreement through representations and warranties and indemnifications.
Stock sales are often advisable for companies that have large numbers of copyrights or patents because the corporation, not the owner, retains ownership. Also, in the case of companies that are dependent on a few large vendors or customers, a stock sale may mitigate the risk of losing their contracts.
Sellers typically prefer stock sales because the proceeds from the sale are taxed at a lower capital gains rate, and in the case of C-corporations, the corporate level taxes are bypassed. Sellers are also better shielded from future liabilities, including product liability claims, contract claims, and so on, depending on how the purchase agreement is structured.
Disclaimer: This is not intended to be legal or tax advice. Every transaction is unique and we recommend consulting professional attorneys and accountants to find the optimal structure.