Asset Sale vs. Stock Sale
Deciding whether to structure a business sale as an asset sale or a stock sale is complicated because the parties involved benefit from opposing structures. An asset sale is the purchase of individual assets and liabilities, whereas a stock sale is the purchase of the owner’s shares of a corporation. . Generally, buyers prefer asset sales, whereas sellers prefer stock sales.
In an asset sale, the seller retains possession of the legal entity and the buyer purchases individual assets of the company, such as equipment, fixtures, leaseholds, licenses, goodwill, trade secrets, trade names, telephone numbers, and inventory. These types of sales typically do not include cash and the seller retains the long-term debt obligations. capital is also typically included in a sale. Accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses are also normally included in the sale.
Within IRS guidelines, asset sales allow buyers to “step-up” the company’s depreciable basis in its assets. By allocating a higher value for assets that depreciate quickly (like equipment, which typically has a 3-7 year life) and by allocating lower values on assets that amortize slowly (like goodwill, which has a 15 year life), the buyer can gain additional tax benefits. This reduces taxes sooner and improves the company’s cash flow during the vital first years. In addition, buyers prefer asset sales because they more easily avoid inheriting potential liabilities, especially contingent liabilities in the form of product liability, contract disputes, product warranty issues, or employee lawsuits.
For sellers, asset sales generate higher taxes because while intangible assets, such as goodwill, are taxed at capital gains rates, other “hard” assets can be subject to higher ordinary income tax rates. If the entity sold is a C-corporation, the seller faces double taxation. The corporation is first taxed upon selling the assets to the buyer. The corporation’s owners are then taxed again when the proceeds transfer outside the corporation. This type of sale also has the potential to generate additional tax to the seller attributed to built in gains if the company is an S-corporation that was formerly a C-corporation.
Through a stock sale, the buyer purchases the selling shareholders’ stock directly thereby obtaining ownership in the seller’s legal entity. The actual assets and liabilities acquired in a stock sale tend to be similar to that of an assets sale. Assets and liabilities not desired by the buyer will be distributed or paid off prior to the sale. Unlike an asset sale, stock sales do not require numerous separate conveyances of each individual asset because the title of each asset lies within the corporation.
With stock sales, buyers lose the ability to gain a stepped up basis in the assets and thus do not get to re-depreciate certain assets. The basis of the assets at the time of sale, or book value, sets the depreciation basis for the new owner. As a result, the lower depreciation expense can result in higher future taxes for the buyer, as compared to an asset sale. Additionally, buyers may accept more risk by purchasing the company’s stock, including all contingent risk that may be unknown or undisclosed. Future lawsuits, environmental concerns, OSHA violations, employee issues, and other liabilities become the responsibility of the new owner. These potential liabilities can be mitigated in the stock purchase agreement through representations and warranties and indemnifications.
If the business in question has a large number of copyrights or patents or if it has significant government or corporate contracts that are difficult to assign, a stock sale may be the better option because the corporation, not the owner, retains ownership. Also, if a company is dependent on a few large vendors or customers, a stock sale may reduce the risk of losing these contracts.
Sellers often favor stock sales because all the proceeds are taxed at a lower capital gains rate, and in C-corporations the corporate level taxes are bypassed. Likewise, sellers are sometimes less responsible for future liabilities, such as product liability claims, contract claims, employee lawsuits, pensions, and benefit plans. However, the purchase agreement in a transaction can shift responsibilities back to a seller.
There are a variety of factors that need to be considered when structuring the sale/purchase of a business, such as the company’s business entity structure, industry, and types of asset held to name a few. It is critical for both parties to consult with their legal and accounting professionals early in the process. When negotiating a transaction it is important for clients to have a team that understands both the legal and tax implications, and both can have a significant impact in the price paid or accepted.
By Chris Williams, Partner at Williams, Crow, Mask