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Asset Sale vs. Stock Sale: Understanding the Differences 

Business owners have two options when going through a merger and acquisition (M&A) process — an asset sale or stock sale. The one you choose will have a tremendous impact on your deal and serve as the foundation of the deal structure, so it’s critical that you understand the differences between the two. 

In this article, we’ll compare an asset sale vs. stock sale to help you understand how they differ as well as the pros and cons associated with each option. We’ll also cover how they both work and impact the sale of your company so you can confidently move forward with the right M&A transaction

What Is an Asset Sale?

As the name indicates, an asset sale is one that involves the sale of a business‘s assets. The buyer purchases the assets of the business as opposed to the stock. The buyer can pick and choose which assets they want to buy, although they will typically want all tangible and intangible assets required to continue operating the business in the same way as the seller. 

In the lower-middle market (businesses that sell for less than $20M), an asset sale is more common than a stock sale. However, even though they are the most common type of sale, they have some disadvantages that sellers need to understand.

What Is a Stock Sale?

A stock sale is one that involves the sale of a business‘s outstanding shares of stock. A stock purchase allows the buyer to purchase equity in a company and requires that they assume all assets and potential liabilities. As such, sellers tend to prefer a stock sale over an asset sale

What Are the Pros and Cons of Asset Sales?

To determine whether an asset sale is right for you, it’s important to consider both the pros and cons of the potential deal. 

Pros of Asset Sales

An asset sale is advantageous to buyers because it allows them to restart the clock on depreciation under the “step-up” clause. Depreciation has considerable tax implications, as it allows businesses to reduce their taxable income. Doing so, in turn, lowers their total tax burden. The Internal Revenue Service (IRS) provides an in-depth guide for depreciation and tax treatment

Many buyers also prefer asset sales because it allows them to start their own corporate entity. Because they purchased assets only, there are no liabilities assumed and no past legal exposure, unless otherwise stated in the Purchase Agreement

Cons of Asset Sales

One of the biggest downsides of an asset sale for a seller is that this option does not transfer liabilities. New owners are not liable for anything that happened under the previous owner’s watch. This means that sellers are responsible for future liabilities and warranty claims that occurred during their ownership, even though they no longer own the business. 

Another disadvantage of an asset sale is that it’s more likely to create a valuation gap. Calculating the equity value of a company for the purpose of a stock sale is more formula-driven and can be less prone to interpretation, particularly when it comes to valuing intangible assets. 

Sellers would be wise to get an outside business valuation before they sell so they have a reasonable understanding of what they can expect from either type of sale. 

What Are the Pros and Cons of Stock Sales?

Asset Sale vs. Stock Sale: business meeting

There are key advantages and disadvantages that come with stock sales. Sellers can potentially reap significant tax benefits, but only if their business structure allows them to complete a stock deal.

Pros of Stock Sales

Stock sales are attractive to sellers primarily because of the tax benefits. Under a stock sale, the entire purchase price is taxed at the capital gains rate. The rate of the capital gains tax can vary depending on income earned, but the federal capital gains rate is no higher than 20% right now (state capital gains taxes also apply)

This is noticeably different from an asset sale, in which the IRS categorizes each asset that is sold and assigns it one of two tax rates. This will be spelled out in the Definitive Agreement in a schedule called the Purchase Price Allocation. While some assets are taxed at the capital gains rate, like Goodwill, others may be subject to the ordinary income tax rate. For assets that are taxed at the ordinary income rate, sellers could be paying as much as 35% on a sale.

Sellers also prefer stock sales because they can transfer all financial liabilities, legal obligations, and warranties to a new owner. The buyer absorbs all responsibilities – acquiring both the profit and loss statement and the balance sheet – allowing the owners to have a clean break from the business. Stock sales can also make it easier to transfer customer contracts. 

Cons of Stock Sales

A stock sale is not available in all circumstances. If the seller’s business structure is a sole proprietorship or a partnership, then a stock deal is not possible. Businesses structured as a limited liability company (LLC) can also pose challenges. That’s because these entity types do not issue shares at the corporate level. C-corporations (C-corps) and S-corporations (S-corps) must typically decide between an asset deal and a stock deal

Stock sales can put buyers at a disadvantage because they typically absorb the current depreciation status of the seller’s assets. Buyers are not allowed to set up a new depreciable base around the purchase price; they are stuck with the seller’s existing depreciation schedule. This makes it more difficult for the buyer to reduce taxable net income by claiming allowable year-end depreciation expenses. 

How Do Asset Sales Work and Impact the Seller?

Most businesses in the lower-middle market are structured as pass-through entities, which is why an asset sale is typically the only structure available. If this is the case, part of the negotiating process will include determining which assets are being sold and the purchase price of each. This information is then defined in the Letter of Intent. Though it is possible for these terms to change after both parties perform due diligence, doing so runs the risk of derailing the deal. 

If your business happens to be a C corp, you’ll want to avoid an asset sale if possible because of the tax consequences. If your company is structured as a C corp and is sold in an asset sale, you are subject to double taxation. The corporation itself is taxed on the assets sold to the buyer. Then, shareholders are taxed again under the income tax rate when the proceeds are distributed. 

Speaking with a trusted legal team, and including business brokers, M&A advisors, and CPAs in the conversation can ensure you choose the right deal structure when selling your business. 

How Do Stock Sales Work and Impact the Seller?

From a tax basis, stock sales are very favorable to sellers. However, in the lower-middle market, there may not be a lot of entities structured in a way that allows stock sales to be possible. Buyers also want to step up depreciation and don’t want to assume risks associated with previous ownership. Stock sales mean everything is taxed at the capital gains rate, which is lower than the income tax rate. Moreover, owners bypass double taxation

Stock sales can also be a bit quicker to close, as the deals themselves are relatively more simple. Attorneys don’t need to worry about renegotiating equipment leases or contracts with customers, which may be the case under an asset sale. The new buyer assumes all liabilities and existing contracts. These deals are not necessarily as advantageous to buyers, but they could increase the likelihood that a deal gets done. 

Asset Sale vs. Stock Sale: Which Will You Choose?

When you’re looking to sell your business, knowing the difference between an asset sale vs. stock sale is essential as it informs your deal structure and directly impacts your future earnings and tax burden. 

The first place to start is your current business structure. If you are a pass-through entity that does not have shares, you’ll need to complete an asset sale. This tends to be the case for most businesses in the lower-middle market. 

If it’s an option, you’ll want to strongly consider a stock sale. Completing a stock sale reduces your total tax burden, as you’re only subject to the capital gains tax. It also reduces the possibility of future liabilities. Additionally, if you are a C corp, you’ll want to avoid an asset sale, as you will be subject to double taxation

Perhaps the most important thing to note is that choosing the right deal structure can be complicated, and a big part of negotiating a sale. Fortunately, there are experts available to help. Putting a trusted team in place, including expert M&A advisors, can ensure you receive the best deal possible when selling your company.

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