Although deal lawyers generally describe their practice as involving “mergers and acquisitions,” the sale of a small or medium-sized business is usually structured as either an equity sale or an asset sale. Which structure is right for you depends on your circumstances. Below is a cursory overview of some of the differences between Asset and Stock Sales. That said, no two deal are the same so its best to look at sales on a case by case basis. For more information on a Seattle Business Sale, consider check our a Seattle Business Sale Broker, or call me (Scott) at 206.306.4034
Two ways of structuring a business acquisition:
Equity sale (Stock Sale): buyer purchases the equity from the owner or owners of the target company — stock in the case of a corporation and membership interests in the case of a limited liability company. The business is transferred to the new owners, corporate (or limited liability company) entity and all, and the target (i.e., the business being purchased) becomes a wholly-owned subsidiary of the purchaser. There is no change in the status of the target entity itself, and its contracts, assets, and liabilities remain with the entity.
Asset sale: specified assets are transferred from the target company to the purchaser, while the corporate or limited liability company entity remains in place and continues to be owned by its owners. The assets transferred might be all of the target company’s assets, or they might be more limited in scope. Similarly, some or all of the target’s liabilities might be transferred to the purchaser or retained by the target company, although most of the liabilities often stay with the target.
Pros and Cons
Now let’s take a look at some issues that buyers and sellers need to consider when structuring a business acquisition. In general, buyers prefer asset sales and sellers prefer equity sales.
Which one do I use?
Do the parties want all of the target’s assets and liabilities to be transferred to the business buyer?
In an equity sale all of the assets and liabilities remain with the target company, so if the parties want only some of the target’s assets be transferred to the buyer, then an asset sale will be preferable. In addition, if the buyer wants to leave some or all of the target’s liabilities with the seller, then an asset sale will be preferable, because the buyer indirectly assumes responsibility for all of the known and unknown liabilities of the target when a transaction is structured as an equity sale.
As a practical matter, I always prefer Asset Sales for small business buyers to protect from the unknown liabilities (State & Local Taxes, IRS, etc)
An advantage to the buyer of an asset sale is that the buyer can allocate the purchase price for tax purposes among the various purchased assets to reflect their fair market value. In addition, the buyer’s tax basis in the assets is equal to the purchase price of the assets. In the case of assets that have been depreciated by the target company, the buyer’s basis in the assets is higher than it would be on the books of the target company.
A disadvantage to the seller of an asset sale is the double taxation that can result if the target is a C corporation. The sale of assets is generally a taxable event that results in the assessment of tax at the corporation level. The sale proceeds are taxed again when they are distributed to the shareholders in the form of a dividend. In contrast, in an equity sale, the seller generally pays the applicable short-term or long-term capital gains rate on the sale of his or her stock, and there is only one level of taxation.
Governmental authorizations, permits, and licenses
Some governmental authorizations, permits, and licenses are not transferable. If the target company holds such permits and licenses, an equity sale might be preferable to avoid the necessity of transferring them to the purchasing company. Structuring a transaction as an equity sale won’t solve the problem in all cases, but it often does.
Contracts requiring consent for assignment
If the target company has important contracts that aren’t assignable without the consent of the target’s counter-party due to anti-assignment clauses contained in the contracts, an equity sale might be preferable. Because the target’s contracts remain intact in an equity sale, they generally are not assigned and thus consent isn’t required. The parties should use caution, however, because some contracts define “assignment” to include a change of control, which would be triggered in the event of an equity sale.
State corporation laws
State corporation laws need to be considered when a business is sold via an asset sale. The sale of all or substantially all of a corporation’s assets generally requires the approval of the corporation’s board of directors and shareholders. In contrast, a stock sale does not require the approval of the target company’s board of directors, although in most cases it requires the consent of all the shareholders.