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30,000 Foot View: Asset Sale vs. Stock Sale

By David Jeans

You have been running your business for years, perhaps even decades, and the time has come for you to transition the business to someone else.  The buyer of your business could take a variety of forms, such as a key employee, family member, a competitor in your particular industry or a private equity group.  Regardless of the potential buyer, you and the buyer will have to determine how to structure the transition of your business.

Buyers and sellers in any transaction should carefully consider how to structure the transaction.  There is not a “one size fits all” transaction structure for every business.  Buyers and sellers should carefully consider their goals and objectives when structuring a transaction.

Two of the most important factors to consider when deciding on how to structure a transaction are taxes and liabilities.  Additionally, it is rare that each transaction structure will be beneficial to a buyer and a seller to the same degree.  Thus, buyers and sellers should determine the most important aspect of the transaction for them (such as minimizing tax liability or limiting liability) and try to structure the transaction to meet those main objectives.

The following factors should be considered by buyers and sellers when determining whether an asset sale or stock sale is the right structure for their particular transaction. Please note this article is only intended to provide a “high-level” analysis of several key factors.  Numerous other factors such as entity structure, tax basis and other matters could dictate which structure is more appropriate, and these matters are beyond the scope of this article.

Tax Considerations

Generally, a seller desires to structure a transaction as a stock sale rather than an asset sale for tax reasons. In a stock sale, a seller should recognize capital gain or loss on the sale of the stock, provided that the stock is held for more than twelve (12) months.  In an asset sale, much of the gain may be taxed at ordinary income rates (there are a few exceptions to this rule, such as goodwill and certain intellectual property assets).

On the other hand, a buyer usually wants to treat the transaction as an asset sale for tax reasons (as well as liability reasons, as discussed below). In an asset sale, a buyer gets a stepped-up tax basis in the purchased assets equal to the fair market value of the purchased assets.  The stepped-up basis can allow the buyer greater amortization and depreciation on the purchased assets and can also help decrease the buyer’s tax consequences on the purchased assets when the buyer eventually sells the purchased assets.

Acquired Assets

Under a stock sale, a buyer is acquiring all of the ownership interests (whether stock or membership interests) of the individual owners of the selling entity. In essence, a buyer is stepping into a seller’s shoes in a stock sale.   Accordingly, a buyer inherits all of the assets owned by the selling entity and also all liabilities associated with the selling entity.

In an asset sale, a buyer can pick and choose certain assets to purchase, while excluding other assets from the transaction. Thus, if the entire business is not being sold, a buyer and seller will often agree to transition only a portion of the seller’s assets to the buyer under an asset transaction.

Liabilities

In a stock sale, a buyer generally assumes all liabilities of the selling entity, along with the assets. Thus, sellers usually prefer a stock sale over an asset sale for liability purposes.  Please note, however, representations and warranties that survive the closing of the transaction, as well as indemnification obligations, may require the seller to satisfy certain liabilities or claims that come to light after closing.

In an asset sale, however, the buyer typically only assumes certain negotiated liabilities. The liabilities, which are not assumed by the buyer in an asset sale (commonly called excluded liabilities), stay with the seller and/or must be satisfied by the seller at closing.  Thus, buyers typically prefer purchasing a seller’s assets as opposed to purchasing stock for liability purposes.

Key Contracts

Since a buyer is stepping into a seller’s shoes in a stock sale, the buyer will typically assume all of the seller’s outstanding contractual obligations and rights without obtaining the consent of the third parties to the contracts. Please note, however, that some contracts may require a third party’s consent even in the event of a stock sale, and it is important in due diligence to review all third party contracts for such language.  Thus, if a seller has a lot of outstanding contracts that require a third party’s consent if the seller transfers its assets, the parties may desire to structure the transaction as a stock sale.

In an asset sale, the buyer and seller will usually have to obtain the consent of the third parties to the seller’s contracts. This is usually true for two reasons:  (i) the buyer is not stepping into the seller’s shoes in an asset sale and assuming all the liabilities of the seller; and (ii) most contracts require consent in the event of a sale of all or substantially all of a party’s assets.

As noted above, there are many variables that factor into the decision of how to structure a business sale.  The factors in this article are only intended to highlight a few of these variables.  Please consult an attorney with experience in representing buyers and sellers of businesses prior to entering into any transaction for your business.

 

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