The Pros and Cons of Stock Sales vs. Asset Sales When Selling a Business
What is a stock sale?
Stock sales are simply the selling of shares of stock owned by the existing businesses’ shareholders. The buyer purchases the equity in the company, acquiring all of the company’s assets and liabilities. This includes future liabilities and any warranty claims subjecting the buyer to potential litigation from any outstanding claims and liabilities.
Stock sales are not practical for a sole proprietorship, partnership, or limited liability company as these entities do not issue stock. Consequently, stock sales are limited to C-Corps and S-Corps as these corporate entities issue stock as a form of ownership.
What is an asset sale?
With an asset sale, the buyer purchases a defined set of assets and liabilities of the business. The seller keeps the legal structure and ownership of the business and any remaining assets and liabilities. Net working capital is typically part of an asset sale, which includes asset line items such as accounts receivable, inventory, and prepaid expenses and liabilities like accounts payable, and accrued expenses.
The buyer can take the newly acquired assets and add them to an existing business or form a new corporation with the assets. An asset sale provides buyers with added flexibility since they only get the assets they want and can avoid buying current and future liabilities they are not comfortable assuming.
Stock Sale or Asset Sale, Which is better for the seller?
In a stock sale, the seller gets a nice tax advantage because the increased equity value or value of the stock sold is treated as a capital gain. Federal capital gains tax rates are typically lower than ordinary income tax rates, often 20 percent lower while state rates for capital gains vary by state.
Sometimes a business buyer can reclassify the stock purchase as an asset purchase and receive a stepped-up basis on the newly acquired asset. Using this approach, the seller receives the benefit of future tax deductions due to the ability to depreciate and amortize the stepped-up assets. A stock sale offers an added benefit to the seller as is that it allows for the sale of intangible assets like permits, licenses, and assignable contracts.
What are the tax implications of a stock vs asset sale?
If the purchase price of an asset sale exceeds the tax basis of the assets bought, the buyer will step up the cost basis on those assets to the purchase price. This provides the buyer with added depreciation on the business’s fixed assets and future amortization of intangible assets like goodwill. This additional depreciation on the stepped-up value of the assets will reduce future taxable income The seller may experience a tax disadvantage due to gains on assets that are treated as ordinary income, which are taxed at a higher rate than those that are treated as capital gains.
When a business owner uses their 401K to buy the company’s stock using Rollovers as Business Startups (ROBS) they can delay the capital gains tax on the sale. See our past blog post How to Fund Your Business Purchase with Your 401(K) for details.
What other factors should be considered?
A significant factor in figuring out if you should hold an asset sale or stock sale is whether you will have any debts following the transaction. Buyers are often attracted to asset sales because they do not want to assume any potential liabilities. Potential disputes they may want to avoid are contract claims, product warranty disputes, product liability claims, employment-related lawsuits, and other similar cases.