When buying a business, deciding on how to structure the transaction plays a very important factor for both buyer and seller. Typically, buyers prefer to buy assets and sellers prefer to sell stock. However, since often each party benefits from the opposite structure, it is important to understand the dynamics of each structure as they relate to both buyer and seller.
An asset sale is the purchase of individual assets and liabilities whereas the stock sale is the purchase of the owner’s shares of the corporation. There are many factors to consider when structuring a transaction, however, tax and potential liabilities can be primary concerns. In an asset sale, the seller retains the legal entity and the buyer purchases individual assets of the company such as accounts receivable, inventory, equipment, trade names, licenses and goodwill. Asset sales generally do not include cash and the seller is responsible for the long term liabilities.
Buyer View in an Asset Deal
Buyer’s prefer to buy assets because of the “step-up” in the depreciable assets of the company. As a result of allocating higher valves to assets that depreciate quicker (ex. Equipment, which has a 3-7 year life) and lower values on assets that amortize more slowly (ex. Goodwill, which has a 15 year life), the buyer can reduce their tax burden and improve the company’s cash flow. Also, buyers prefer assets sales because they can avoid potential liabilities such as product and warranty and disputes and lawsuits.
However, assets sales can problematic to buyers. Certain assets are more difficult to transfer such as permits, intellectual property and contracts. Often the transfer of these assets many require third-party consents and re-filings, all things that can slow down the transaction process.
Seller View in an Asset Deal
For sellers, asset sales generate higher taxes because hard assets are often taxed at the ordinary income level while intangible assets such as goodwill at taxed at the capital gains level. In addition, if the company sold is a C-corporation, the seller will face double taxation on the proceeds. The corporation is first taxed upon selling the assets to the buyer and then the owners are taxed again when the proceeds transfer outside the corporation.
In a stock sale, the buyer purchases the selling shareholders’ stock directly and gains ownership in the seller’s legal entity. In a stock sale the assets and liabilities acquired can be similar to an asset sale. Similarly, assets and liabilities not desired by the buyer can be distributed or paid off prior to the sale. Also, unlike asset sales which require the detailed conveyances of every asset, stock sales do not require many conveyances since the title of the assets is with the corporation.
Buyer’s View in a Stock Deal
Buyer’s lose the ability gain a stepped up basis in the newly acquired assets. This will result in lower depreciation and higher taxes for the new owners. In addition, the buyer runs the risk of exposing themselves to additional risk through future liabilities which they may be unaware of. These could include potential product and environmental liabilities. The buyer can mitigate their liability exposure through the purchase agreement through representations and warranties and indemnification.
On the other hand, if the business is very contract dependent, a stock sale may be the only way to move forward especially if the contacts are non-transferable. There is also a special tax election under Section 338(h)(10), which permits taxpayers to achieve the tax benefits of an asset sale while structuring the transaction as a stock sale. We will discuss the 338(h)(10) election in a separate follow-on post, however, the election can provide the best of both worlds to all parties involved.
Seller’s View in a Stock Deal
Sellers prefer a stock sale because the proceeds are taxed at a lower capital gains rate and in C-corporations, the corporate level taxes are bypassed. In addition, sellers can have reduced exposure for future liabilities, although the buyer will try to push those back onto the seller through the purchase agreement. Sellers are also indifferent to the 338(h)(10) election as long as their additional tax burden associated with the election is covered by the buyer. Again something we will cover in a later post.
Deal structures play a fundamental role in the future for both buyer and seller. There are many other factors in addition to what was mentioned above and it is very important for parties to consult the appropriate professionals early in the sales process. This brief article is to outline some general concepts behind acquiring assets vs. stock and Third Coast is not intending to provide any legal or tax advice. Every transaction is unique and buyer and sellers should always consult with appropriate tax professionals (attorneys and accountants) when considering a transaction.