Business Acquisitions: Asset or Stock Sale

Once you have identified a business that has everything you are looking for, you’ll want to structure the deal to your best advantage.

Asset or Stock Sale: What's the Difference?

Business acquisitions are typically structured in one of two ways—as an asset sale or a stock sale (sometimes called an equity sale). In an asset sale, the buyer acquires some or all of the contents of the business such as equipment, inventory, and accounts receivable. In a stock sale, the buyer acquires shares or, put another way, equity in the business.

In an asset sale, buyers can pick and choose the assets they want to buy. They can take all of the business's assets or exclude some, and they don't have to take on any liabilities such as loan debts, provided, of course, that the seller agrees to the terms. Most sellers would prefer to find a buyer willing to take all or most of the assets. If they are unable to reach a deal with one buyer, however, they might seek out several buyers or use another method of disposition like an auction or liquidation.

Buyers who acquire a business through a stock sale buy the business as it exists. If the business has debt, the debt comes along. If lawsuits are pending against the business, the new buyer might be responsible for defending against them.

Tax advantages for buyers and sellers are also different for asset and stock sales.

Sole proprietorships, partnerships, and limited liability companies can be sold only in asset transactions, because their owners are individuals. But buyers of S Corporations and C Corporations can structure the acquisition using either method.

When Would You Choose an Asset or Stock Sale?

Asset sales are generally more favorable to buyers, and stock sales are more advantageous to sellers because of the way each is treated for tax purposes. But buyers and sellers might have reasons besides tax benefits to choose an asset or stock sale.

All things being equal, asset sales can take longer to close, and the business might be priced higher than it would be as a stock transaction. For example, a hair salon owner who wants to expand might want to only acquire additional styling station chairs and other furnishings to use at an existing location. This type of buyer would likely favor an asset sale. But a buyer who wants to start up a hair salon business might find an asset sale to be too time-consuming and costly, and opt for a stock sale.

Asset Sales: Pros and Cons

These are some of the advantages and disadvantages of asset sales:

Pros:

You don't have to purchase assets that are not profitable or that might add costs to your business. Because an asset purchase allows you to buy only the assets that you want, you can avoid buying assets that won't generate much revenue or will cost more than they'll contribute. Let's say, for instance, that you are acquiring a tool manufacturing business that sells mostly to small hardware store accounts. Many of the accounts have gone out of business, and their unpaid invoices remain on the seller's books. In this case, you might choose to exclude the company's accounts receivable assets from the sale because you probably won't be able to collect on those accounts anyway.

You don't have to acquire liabilities that can be costly down the road. Businesses might have present and future liabilities, such as product liability claims, warranty disputes, and employee lawsuits. You can structure an asset sale transaction to exclude these types of claims and disputes. Sometimes, however, states hold the buyer of a business responsible for certain liabilities like sales or employment taxes the former owner failed to pay. Make sure your due diligence reveals these types of potential liabilities.

Your tax basis might be lower. Buyers typically pay more than the value recorded on the seller's books (the carry value) for assets, and the IRS allows buyers to use this higher "step-up" basis when they depreciate the expense on their taxes, providing a bigger tax break.

Let's take the example of the two hair salon entrepreneurs above. The buyer who transacted an asset sale paid $2,000 for the chairs and other furnishings, but the seller's carry value was $1,000. The buyer can depreciate the chairs at a cost that is twice the carry value, probably resulting in a larger tax deduction. It doesn't matter if the seller already depreciated the assets. The IRS allows the new buyer to start over with the new step-up value.

You can select only the employees you want to retain. Buyers in an asset sale start fresh. Suppose the buyer in the tool business example above decides not to keep the sales manager and reps whose territory is local hardware stores because the new strategy focuses on big box stores. The decision won't affect the business's unemployment insurance rate because the sales team was never employed by the new business.

Cons:

You might pay more for the business in an asset purchase. Sellers typically pay higher taxes on asset sales because the proceeds are taxed as income (as opposed to stock sales, where proceeds are taxed at the lower, capital gains rate), and they usually want to pass along that cost to the buyer in the form of a higher sale price.

It might take longer to close an asset sale. When many assets are included in an acquisition, negotiations are more complex and can take longer. Other delays might result when titles must be transferred, or leases must be re-assigned to the new owner (often requiring the consent of the landlord and sometimes the landlord's lender), or when contracts with employees or vendors have to be renegotiated. Some states require sellers to obtain a bulk sales permit and give public notice of the sale, another process that can delay the sale close.

Buyers have to set up their new business. Unless you are buying assets to add to an existing business, you'll have to set up a business for the assets you are acquiring. As the buyer, you'll have to go through the process of registering your business in the states where you plan to operate; and when licenses and permits cannot be re-assigned, you'll need to apply for and receive them before you can begin operations. You'll also need to apply for, and meet requirements for, any credit you need.

Stock Sales: Pros and Cons

The biggest hurdle to completing a stock sale is usually getting all of the shareholders to agree to the transaction. The more shareholders, the harder it might be to get buy-in. Here are some other advantages and disadvantages of a stock sale:

Pros:

You can step into the existing business with fewer interruptions. While a stock sale might not give a buyer a completely turnkey solution, buying all of a going concern, including name recognition, a customer following, relationships and contracts with vendors and employees, operating systems, and equipment, make it easier to get up and running quickly.

You might need less operating capital. A successful business will already have cash flow in place, reducing the need for additional operating capital.

You start out with valuable intellectual property. It makes sense to acquire some businesses in a stock sale –such as technology companies that rely on patents, or well-known brands that rely on copyrights-- when these valuable patents or copyrights are central to the company's offerings and success.

You don't have to apply for new licenses and permits. All of the licenses or permits that are assigned to the business stay with it in a stock sale. Although the buyer won't have to re-assign or re-title assets or renegotiate contracts, these advantages can also have unforeseen consequences as you'll see below.

Cons:

You might not want all of the assets you get in a stock sale. Suppose, in the hair salon example, the business has a contract with a masseuse who rents a back room for $1,000 a month, and the buyer's due diligence shows that other salons charge twice that rent for rooms of the same size in equally strong locations. In a stock sale, the buyer might try to renegotiate the rental contract with the masseuse, but if they can't agree, the buyer will likely be stuck with a below-market agreement until the contract expires.

You get the company's liabilities as well as assets. As already discussed, buyers in a stock sale get the business as is, including any known or unknown liabilities. Liabilities might include debts, accounts payable, unpaid wages, and lawsuits. Adding an indemnification clause (a promise that the seller will reimburse you if you have to pay money to cover specified damages or losses), or a hold harmless agreement (a clause that shifts responsibility for risks associated with a business service provided) to the purchase agreement might offer some protection, but you might still end up in court to recover these types of costs.

You don't get the same tax benefits as an asset purchase. When you acquire a business in a stock purchase, you cannot step-up the value of assets as described above. The assets transfer at the same value they were carried under the former ownership, and the allowable tax deduction will likely be lower as a result. A stock sale also differs from an asset sale in that any assets that the business previously depreciated can't be depreciated again.

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