Private Transaction Structures: Asset vs Stock Sales

Navigating the complexities of structuring a business sale is a critical and often challenging task for both buyers and sellers. One of the fundamental decisions in this process is choosing between an asset or stock sale – each of which has their own respective advantages and disadvantages – which can oftentimes be a complicated process given that buyers and sellers have competing interests. In this article, we delve into the nuances of asset and stock sales, highlighting key distinctions to help you make an informed decision in structuring your next business transaction.

 

Asset Sales

In an asset sale, the selling business entity transfers specific tangible and intangible assets to the buyer rather than transferring equity ownership of the selling entity. After the transaction is closed, the buyer and seller each maintain their respective corporate structure, and the seller retains those assets and liabilities not acquired by the buyer. 

Advantages

  • Flexibility: Asset sales offer both buyers and sellers the flexibility to determine which assets and liabilities will be included (or excluded) as part of the proposed transaction. A simple analogy would be to compare asset sales to shopping at a grocery store, where a shopper (the buyer) selects only the items they wish to purchase, leaving the rest behind. This is in direct contrast to a stock sale, where the buyer would acquire all the assets and liabilities of the seller that are outstanding as of the closing date.


  • Liability Protection: Asset sales allow buyers to avoid assuming the liabilities of the seller unless otherwise explicitly agreed upon by both parties. As such, buyers can start the business fresh and without fear of any serious or unknown liabilities that the seller may not have disclosed. From a seller’s point of view, retaining liabilities may also be advantageous as they can then direct and control the payment and satisfaction of those liabilities post-closing. 

 

  • Tax Implications: By purchasing the assets, buyers can take advantage of a step-up in basis to the fair market value of the purchased assets as of the date of the transaction, which then allows each asset to be depreciated or amortized over its useful life regardless of whether the seller has already depreciated such asset, thereby providing a bigger tax break to the buyer than would otherwise be available in a stock sale. 

 

Disadvantages

  • Time and Cost: For businesses that have many assets, negotiations are often complex and time consuming. The process of identifying which assets will be sold, the price of those assets, or whether any liabilities will be assumed by the buyer can create delays in the process. Additionally, because buyers are often purchasing the assets through a new entity, there are many formation, operation, and credit costs that must be paid by the buyer. 

 

  • Transfer Process/Third Party Consents: In an asset sale, any assets or liabilities to be acquired by the buyer must be specifically assigned at closing. As part of this process, numerous third party consents are oftentimes required since most contracts contain anti-assignment clauses which prohibit transfer absent the advance consent of the third-party. 

 

  • Bulk Sales Tax:  Depending on the state in which the asset sale occurs, there may be an additional bulk sales tax to be paid on the transfer of specific assets which would not otherwise be incurred if the transaction were instead structured as a stock sale. For example, the State of Maryland imposes a 6% bulk sales tax to be paid on the purchase price of certain tangible personal property.

 

Stock Sales

In a stock sale, ownership of a company is transferred through the sale of its shares. This means that the buyer purchases the ownership interest in the entire company, including all its assets and liabilities. Essentially, the buyer steps into the shoes of the seller, assuming control of the company and inheriting all its historical obligations and commitments. This type of transaction is often simpler in terms of transferring ownership but may involve greater risk for the buyer due to the potential unknown liabilities inherited from the seller.

Advantages

  • Simplicity: The negotiations of a stock sale are often much simpler than those of an asset sale. Rather than working through identifying individual assets and liabilities, the overall value of the business is the critical factor. In this way, the buyer can get a more complete picture of the health of the business which can create a guiding path for the buyer going forward.

 

  • Tax and Liability for Sellers: In a stock sale, the proceeds received by the seller are taxed at a lower capital gains rate. Sellers can take advantage of the lower tax rate and take substantially more proceeds than they would in an asset sale. Additionally, while the purchase agreement can shift some responsibilities between parties, a stock sale can allow a seller to be less responsible for future liabilities and claims against the business. 

 

  • Continuity: Many buyers are concerned that a change in ownership could prevent some customers from utilizing the business going forward, resulting in substantial losses in profitability and operations. A stock sale allows the buyer to inherit the seller’s name recognition, goodwill, customer following, relationships, and contracts with current vendors, employees, etc., which can be invaluable in the buyer’s future success. 

 

Disadvantages

  • Tax Implications for Buyers: As explained throughout this article, the tax implication for both types of deals is a serious consideration when determining which structure is most beneficial. While the tax implication for a seller in a stock sale is an advantage, the opposite is true for the buyer. The buyer cannot step up the value of the assets purchased, and any asset that was previously depreciated cannot be depreciated again. Further, the assets transfer at the same value they held at the time of transaction, meaning any tax deduction would likely be lower. 

 

  • Lack of Choice: A buyer in a stock sale has very little choice as to what assets and liabilities they can exclude. A buyer may end up with an above market lease payment, inventory or equipment with little to no value, or a significant tax bill for incorrect tax filings from previous years. The buyer assumes all risk of unknown or undisclosed liabilities and may have to resort to filing suit against the seller – which could be a long and expensive process in which the buyer may not even recoup their losses.  

 

Conclusion

Understanding the difference between stock sales and asset sales is essential for participants in business transactions. Stock sales involve transferring ownership of the entire business, including its assets and liabilities, while asset sales selectively transfer specific assets, leaving others and their associated liabilities behind. 

Each method presents distinct advantages and considerations related to taxes, liability protection, and asset control. Therefore, parties should carefully assess their objectives, financial situation, and legal implications to determine the most suitable approach. The members of Chesapeake Growth Network are experts in the intricacies of business transactions and can help guide clients through this process to achieve their business goals. Call us today

Share this article: [addtoany]