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Asset Sale vs Stock Sale: What Entrepreneurs Need to Know When Acquiring a Business

Asset Sale vs Stock Sale

When buying a business, one of the key decisions you’ll face is whether to structure the deal as an asset sale vs stock sale. This choice can significantly impact both the buyer and the seller, particularly in terms of taxes and liabilities. 

 

Understanding the nuances of each option will help you make an informed decision. In this guide we’ll look at an asset sale vs stock sale, the benefits to the buyer and the seller, key considerations, and the tax implications.

What Businesses Qualify?

Firstly, it’s important to note that the sale of stock only applies in acquisitions related to C-Corps and Sub S-Corps. Partnerships, LLCs and sole proprietor business structures don’t own stock and therefore can’t use a stock sale deal.

What Is An Asset Sale?

An asset sale involves buying the company’s individual assets and liabilities, while the seller retains the original legal entity. This means the buyer gets assets like equipment, inventory, trademarks, and customer lists, but typically not the company’s cash and long-term debt obligations.

Asset Sale Tax Implications For Sellers

When a seller agrees to an asset sale over a stock sale, they often encounter a complex tax scenario. The nature of the assets being sold dictates the kind of tax rates applied. For intangible assets like goodwill, the tax rate is often the capital gains rate, which currently stands at 20% federally, plus local state tax rates, which differ.

On the other hand, tangible or “hard” assets like machinery and buildings are typically subject to ordinary income tax rates. These rates vary based on the seller’s tax bracket, which can be significantly higher than capital gains rates.

An added layer of complexity arises for C corporations. In such cases, the sellers face what is known as double taxation. Here’s how it works: Initially, the corporation pays taxes on the profit from selling its assets. Subsequently, when these proceeds are distributed to the shareholders, they are taxed again, this time as personal income.

If the business is an S corporation that was previously a C corporation, and the asset sale occurs within a ten-year window known as the Built-In Gains (BIG) recognition period, there’s an additional tax implication. The S corporation might be subject to corporate-level taxes under Internal Revenue Service (IRS) Section 1374. This tax is imposed on the built-in gains that were present at the time the corporation converted from a C to an S corporation.

If you’re weighing up an asset sale vs stock sale and this is starting to sound complicated, speak to a CPA that specializes in ETA services.

Asset Sale Benefits For Buyers

Buyers on the other hand, prefer asset sales because they can ‘step up’ the asset’s basis, leading to tax benefits. The buyer is able to allocate depreciation to assets that depreciate quicker, incurring a higher depreciation cost early on, which helps alleviate cash flow during the vulnerable early years following the acquisition.

Another benefit of an asset sale for a buyer is less exposure to risk and liabilities. Because the buyer isn’t purchasing the legal entity, they usually don’t inherit the company’s past liabilities, claims or potential lawsuits.

Asset Sale Considerations For Buyers

Something to take into account when acquiring a business under an asset sale instead of a stock sale, is that it can be more difficult to transfer less tangible assets, such as patents, leases and intellectual property.

What Is A Stock Sale?

Now let’s look at the flip side of asset sale vs stock sale. In a stock sale, the buyer acquires the company’s stock, essentially taking over ownership of the business entity, including its assets and liabilities. This option is primarily available for corporations with transferable shares, like C and S corporations.

Stock Sale Tax Implications For Sellers

Sellers generally lean towards stock sales for a couple of significant reasons. Firstly, the financial benefit: in a stock sale, the money earned from selling the company’s shares is taxed at the capital gains rate. This rate is typically lower than the ordinary income tax rate, leading to potential tax savings. 

For C corporations, a key advantage of a stock sale is avoiding corporate-level taxes. This means the proceeds from the sale bypass the initial layer of corporate taxation and are only taxed once as personal income to the shareholders.

Another crucial aspect of stock sales that appeals to sellers is the reduced responsibility for future liabilities. Liabilities like product liability claims, contract disputes, employee-related lawsuits, pensions, and employee benefit plans often remain with the company and become the buyer’s responsibility. This transfer of liability can significantly reduce potential future risks for the seller. 

As a buyer, you can structure the terms of the purchase agreement to alter this scenario by assigning liability back to the seller in some cases.

Stock Sale Benefits For Buyers

For buyers, a stock sale can be beneficial when acquiring a business that holds significant intellectual property or has crucial contracts in place. 

When a business possesses a substantial number of copyrights, patents, or other intellectual property rights, a stock sale can be a better strategic choice. This is because, in a stock sale, the ownership of these intellectual properties remains with the corporation itself, not the individual owner. This continuity is crucial as intellectual property rights can be complex to transfer and may involve extensive legal processes if done outside the framework of a stock sale.

If the target company has significant government or corporate contracts, particularly those that are difficult to transfer or reassign, a stock sale simplifies matters. It minimizes the risk of disruptions in these relationships, which might occur if contracts need to be renegotiated or reassigned in the case of an asset sale.

Stock Sale Considerations For Buyers

For buyers contemplating a stock sale over an asset sale, it’s essential to understand certain financial and risk-related implications. One of the primary financial considerations is the loss of the ‘step-up’ in basis for the assets acquired. 

Unlike in an asset sale, where buyers can revalue the assets (thereby gaining tax advantages through higher depreciation deductions), a stock sale doesn’t offer this benefit. The basis for depreciation in a stock sale is the same as the asset’s basis at the time of the sale, often resulting in less favorable tax treatment.

From a risk perspective, stock sales generally involve assuming a broader range of potential risks. In such sales, buyers inherit all the contingent liabilities of the business, which might include unknown or undisclosed risks. 

These could encompass various issues such as potential future legal disputes, regulatory compliance violations (like OSHA issues), or challenges related to employee management. Essentially, these risks, known and unknown, transfer to the buyer as the new owner of the business.

There are strategies within the stock purchase agreement that a buyer can use to mitigate these risks, such as clauses on representations, warranties, and indemnifications.

Comparing Asset Sale vs Stock Sale

In summary, there are pros and cons to both an asset sale and stock sale to consider.

Business Liabilities

In asset sales, buyers avoid inheriting liabilities, which isn’t the case with stock sales.

Tax Rates

Sellers generally prefer the tax treatment of stock sales, while buyers may benefit more from the tax implications of asset sales.

Complexity & Cost

Asset sales are more complex and often costlier due to the need to appraise individual assets.

Asset Sale vs Stock Sale: Key Considerations For Entrepreneurs

If you’re an entrepreneur looking to acquire a business, consider:

  • Your business structure: Does it align better with an asset sale or stock sale?
  • Tax implications: How will each option affect your tax situation?
  • Potential liabilities: Are you prepared to take on the company’s existing liabilities?

Understanding the differences and implications of each option is key to making a choice that aligns with your business goals and financial situation.

The information provided above is meant as a guide and doesn’t serve as actual financial advice. We highly recommend that you consult with a professional tax accountant who specializes in entrepreneurship through acquisition.

Reach out to Midwest CPA for personalized advice and support tailored to your acquisition strategy.

Disclaimer

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting, or investment advice. You should consult a qualified legal or tax professional regarding your specific situation.

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