By Elizabeth Shauger, CPA, Mauldin & Jenkins
Are you acquiring or selling a business? Buying or selling a business has a lot of moving parts. Although there are many complex types of mergers and acquisitions, the stock or asset sale are among the most straightforward. There are advantages and disadvantages to both an asset sale and a stock sale of a business. It is important to know the difference between each type, before negotiations begin, so that you can properly assess the next steps in the purchase or sale of your business.
Stock Sale
A stock sale involves selling the corporate shares of the business to the buyer, with the buyer obtaining ownership in the seller’s legal entity. Note that a stock sale is only possible for C-corporations and S-corporations. A transaction involving a sole proprietorship, partnership, or LLC is structured as a sale of its partnership or membership interests.
If there are contracts, copyrights or patents that are difficult to assign, a stock sale may be the better option because the corporation, not the owner, retains ownership of these assets.
The buyer accepts unknown or undisclosed risk by purchasing the company’s stock. These risks include the potential for future lawsuits, employee issues and other liabilities that become the responsibility of the new owner. The buyer can often mitigate this type of risk by having the seller provide comprehensive warranties and indemnities (an indemnification clause in the sales agreement) to cover specified events, should they come to pass.
Generally speaking, sellers prefer stock sales as any liabilities automatically transfer to the buyer. Sellers bear little or no responsibility for future liabilities such as contract claims, employee lawsuits and product liability claims unless the purchase agreement shifts the responsibilities back to the seller. Sellers also typically receive more tax benefits through a stock sale, because all the proceeds are taxed at the lower capital gains rate and avoid the double taxation that accompanies asset sales in a C-corporation. However, the company’s purchase price may be lower since the buyer would be assuming the liabilities.
Asset Sale
An asset sale involves selling the individual assets and liabilities of the company. The buyer and seller can choose which assets to transfer; this could include real property, fixtures, equipment, inventory, intellectual property, trade names, goodwill, contracts, permits, leases and more.
For tax purposes, an asset sale is generally more beneficial for buyers because they get a step-up in basis of the transferred assets and can claim a tax deduction for depreciation. The result is lower taxable income, which boosts cash flow in the vital first year, following a transfer in ownership. Buyers are not required to keep all employees, although the seller may require a buyer to retain existing employees, or sign new contracts with employees, to avoid wrongful dismissal claims.
The purchase price may be higher in an asset sale since the buyer may be choosing which assets to transfer and avoids assuming additional liabilities. Transferring individual assets is also more complex because it involves more paperwork to ensure they are transferred properly. In addition, it may be necessary to obtain authorization from third parties to transfer an asset in some cases, which can be a costly and time-consuming process.
The optimal path
Determining how to structure a business transaction is a significant decision, which involves many different considerations, as the structure, as well as the language used in the agreement, have a major impact on the financial future of the buyer and seller.
Each approach carries advantages and disadvantages, with consequences that vary in significance depending on the specific goals and circumstances of the parties. Other factors such as the company’s structure, sector or industry, relative attractiveness of the selling price, complexity of the transaction and additional tax implications will also influence the ultimate decision.
It is vitally important for buyers and sellers to consult with their business intermediaries, legal counsel and qualified accounting professionals, early in the process. Careful analysis by experienced advisors can facilitate a full understanding of the issues, allowing you to find an approach that meets all parties’ needs and offers maximum benefit to both the buyer and the seller.
Elizabeth Shauger, CPA is a Director with Mauldin & Jenkins in the Bradenton, Florida office. Elizabeth has over 15 years of tax experience in public accounting servicing a wide range of industries. She specializes in corporate, partnership and high net worth individuals, as well as tax planning. Elizabeth received her Bachelor of Business Administration in Accountancy, from Florida International University, in 2005, and Master in Taxation, from Nova Southeastern University, in 2007. She is a member of the American Institute of Certified Public Accountants (AICPA) and Florida Institute of Certified Public Accountants (FICPA). Elizabeth and her husband reside in Tampa, Florida with their two sons, William and Matthew.