When business owners are looking to sell or buy a new business the most common question we get is whether the transaction should be structured as an asset sale or a stock sale. The below is a brief summary of the differences between the two transaction types.
An asset sale is when a company sells substantially all of their assets in the business to a third party. Assets will include customer list, all intellectual property, and relationships with vendors, etc. It is usually negotiated whether the company or buyer will receive certain assets such as the cash, accounts receivable and accounts payable related to the business. Once the asset sale is completed the company will most often dissolve and then distribute the consideration received in the asset sale to its shareholders. Buyers most often prefer an asset sale because the company remains liable for all business activities prior to closing and except for a few items (such as sales taxes or other liabilities the buyer agrees to assume) that liability cannot be transferred to buyer. Buyers also prefer the tax treatment they receive from an asset sale because they can depreciate or amortize the purchase price they paid for the assets based on how the purchase price is allocated to the assets. An asset sale could cause higher taxes to seller because the allocation of the purchase price to certain assets, such as equipment, real estate and accounts receivable could be taxed at higher ordinary income rates or depreciation recapture rates (compared to capital gain rates). These tax possibilities should be analyzed before seller agrees to structure the transaction as an asset sale. One big consideration on whether or not an asset sale structure will work is the assignability of the company’s major contracts. If those contracts cannot be assigned without undue hardship then an asset sale should not be the choice for the transaction structure.
A stock sale is where the shareholders of a company sell all of their stock in the company to a third party. A seller most often prefers a stock sale because the company the shareholders are selling remains liable for all pre-closing business activities but since they are no longer shareholders that ultimate liability falls on the new owners. Buyers will often mitigate this risk in the stock purchase agreement by requiring indemnification by the selling shareholders for certain pre-closing liabilities. This is often times a major negotiating point between buyer and the selling shareholders. Sellers also prefer the simpler capital gain tax treatment they will receive in the stock sale. The company’s major contracts still have to be reviewed to make sure there is no change of control provision that could trigger a default but in general there are less issues with contracts to deal with when the transaction is structured as a stock sale.
Stay tuned for a future blog on a tax election that can be made that can combine the liability benefits of the stock sale for the seller with the tax benefits of an asset sale to the buyer.
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