Selling Your Business - Asset Sale Vs Stock Sale
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When selling an incorporated company, one of the most complex issues is deciding whether to structure a transaction as an asset or a stock sale. To complicate the matter even further, sellers and buyers will typically favor opposing structures because of the legal and financial implications. Due to the legal nature of this issue, we strongly suggest both parties consult with their professional advisers to explore all possible options.
Asset Sale:
Unlike S-corporations or C-corporations, partnerships, sole proprietorships and limited liability companies (LLC) can only be sold through an asset sale. In this deal structure, sellers retain ownership of the original legal entity and sell individual assets, such as equipment, fixtures, company names, telephone numbers, inventory, licenses, contracts, etc, to the buyer. This reduces the future liabilities for the buyer but create significant tax consequences for the seller.
Seller’s Viewpoint:
Asset sales can present a distinct disadvantage for business owners of S-corporations and C-corporations because proceeds from the transaction are usually double taxed. In most cases, the corporation is taxed first upon selling the assets to the buyer, and the owner is taxed again when the proceeds are transferred from the corporate account to the personal account.
In addition, while intangible assets sold through an asset sale are taxed at the capital gains rate, tangible assets are taxed as income tax. In most cases, the state and federal income tax rate is significantly higher than the capital gains rate.
Buyer’s Viewpoint:
While asset sales appear to be harmful to sellers, buyers will generally favor this structure. According to IRS guidelines, buyers are allowed to “step-up” the assets’ depreciation basis, which can help them reduce corporate taxes during the vital first years, and asset sales limit the amount of hidden liability the buyer would be responsible for because he or she did not purchase the legal entity.
However, asset sales also present a few disadvantages for buyers. First, non-transferable assets, like copyrights and patents, remain with the seller, and the new owner would have to lease the rights. In addition, establishing a new legal entity and transferring each asset to a new owner require a lot of paperwork. If the company sold is heavily contract or equipment based, the transaction could be delayed.
Stock Sales
Available only to S-corporations or C-corporations, stock sale is the purchase of the owner’s shares in the company. Depending on the terms of the contract, the buyer typically assumes responsibility of all accounts and may be responsible for all future liabilities. However, because the buyer purchases the legal entity, he or she is also buying all the assets without additional paperwork.
Seller’s Viewpoint:
Advisers will usually encourage owners with S-corporations or C-corporations to sell the company as a stock sale. In this structure, proceeds are taxed as capital gains without facing double taxation. In addition, by selling the entire legal entity, sellers are less liable during future claims or lawsuits. However, depending on the contract terms, the buyer may ask the seller to retain some responsibility.
Buyer’s Viewpoint:
Stock sales are generally less beneficial for buyers because unlike asset sales, the depreciation basis of the assets is based on the book value. This means that buyers lose the ability to gain new depreciation on the assets, which could mean higher taxes. In addition, by purchasing the legal entity, buyers inherit all future claims and lawsuits filed against the corporation, including all hidden liabilities. As a buyer in a stock sale, it is especially important to have a team of professional advisers representing you during due diligence.
Conclusions:
According to Pratt Stats database, about 30 percent of all transactions are stock sales. However, the majority of stock sales are generally found in larger deals (companies with annual revenues $3 million and more).
In any transaction, the deal structure can affect the outcome for both the buyer and seller, but many other factors must also be considered during negotiation. The best advice is to consult with professional advisers carefully to review the options for both parties and arrive at a mutually agreeable decision.
Tim Skarda is the President of Allied Business Group, Inc., a business valuation and mergers and acquisitions firm in Leawood, Kansas. To learn more about Allied’s services, visit http://www.AlliedBizGroup.com or call us at 913-897-3599.
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