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The Value of Inventory Management
The Value of Inventory Management

When Selling A Business: Asset Sale or Stock Sale

By Edward L. Fixen

One of the many complicated issues that business owners must face when it comes time to sell their business is whether the deal should be structured as a stock sale or as an asset sale.  This decision will be driven by tax-related considerations and factors related to the uncertainty involved in the transfer of liability.  This article discusses some of the issues and considerations related to evaluating whether to structure a business sale or acquisition as an asset sale or a stock sale.

Unfortunately, the goals of the buyer and seller are often at odds with respect to whether the deal is structured as an asset sale or stock sale.  Typically, the seller prefers a stock sale for tax reasons, while the buyer prefers an asset sale for liability reasons.  It is my experience and belief that the vast majority of small and medium sized, privately-held business sales are asset sales.

Stock Sale

In a stock sale, the buyer acquires all shares of the corporation and the company’s balance sheet without adjustment.  This means the buyer acquires all assets at depreciated value and all liabilities including unknown liabilities that do not show up on a balance sheet.  Unknown liabilities are not measurable but can be significant and include product, employee, environmental, legal and other risks.  For example, in a stock sale, the new owner could be liable if a former employee were to successfully sue the company for illegal conduct that occurred under the prior ownership.  Although the acquiring company will typically secure indemnifications from the selling shareholders, the acquiring company is still at risk and must still defend itself.  It is because of these unknown risks and liabilities that most buyers of small and medium sized, privately-held companies will not even consider a stock purchase.

On the other hand, sellers usually benefit from a stock sale because from a tax perspective, the seller is usually able to pay taxes at the lower capital gains rate.  In a stock sale, the seller recognizes a gain or loss based on the difference between the sales price and the current basis in the stock.

In some cases,  licenses, contracts, or other key rights that belong to the corporation and cannot be easily transferred through an asset sale will dictate the use of a stock sale so that key rights remain with the new owner.  For example, a corporation with a hard to obtain FDA license would likely be structured as a stock sale so that the FDA license is maintained by the corporation and transferred to the new owner(s).

Asset Sale 

As the name implies in an asset sale, the buyer only acquires the assets of the business unless specifically negotiated otherwise.  Liabilities both known and unknown are excluded from the purchase of the business.  Although they are assets, cash and accounts receivables are often excluded from the purchase in the sale of small businesses.  In larger, more complicated acquisitions, a net working capital target is usually negotiated and included in the purchase.  From the buyer’s perspective, the lack of liabilities both known and particularly unknown is very attractive.

From the seller’s perspective, gains realized from an asset sale may result in both capital gains and ordinary tax rates applying to portions of the gains and result in a higher tax liability.  Additionally, equipment or other assets that have been depreciated will be subject to depreciation recapture based on the final allocation of purchase price related to equipment.

The best scenario is when both the buyer and seller work together with their respective attorneys and accountants to create a deal structure and terms that is equitable to both parties.  The allocation of the purchase price can have a significant impact on the tax ramifications to both the buyer and seller and can be used as a means to balance the needs of both parties.  Of course, a buyer and seller should consult their attorney and accountant regarding the legal and tax implications of any acquisition, including determining the legal structure of the deal.

Author: Mr. Fixen is the President of BusinessQuest, a business valuation and M&A brokerage firm serving small & mid-size, privately-held businesses throughout Southern California.  Mr. Fixen is a Certified Business Appraiser (CBA) and Certified Business Broker (CBB).  Ed can be reached at ed@businessquestbrokers.com.

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