Asset Sale or Stock Sale: What the Structure Changes

In an asset sale, the buyer purchases specific assets of the business and assumes only the liabilities it agrees to. In a stock sale, the buyer purchases the owner's shares or membership interest, and the entity continues with all of its assets, contracts, and liabilities. The structure affects the seller's taxes, what the buyer is responsible for after closing, and which contracts, licenses, and permits carry over. Most smaller business sales are structured as asset sales.

How an asset sale works

The buyer selects the assets it is acquiring, typically equipment, inventory, customer lists, intellectual property, goodwill, and the business name, and identifies which liabilities, if any, it will take on. The seller keeps the legal entity along with any excluded assets and liabilities, and usually pays off its own debts at or before closing.

Why buyers generally prefer asset sales:

• They can leave unknown or unwanted liabilities with the seller's entity.
• They can typically record the acquired assets at the purchase price, which can create new depreciation and amortization deductions.
• They choose exactly what they are buying.

How a stock sale works

The buyer acquires ownership of the entity itself. Nothing is transferred asset by asset. Contracts, licenses, bank accounts, and employees stay with the company, and so do its liabilities, including ones that are not yet known.

Why sellers often prefer stock sales:

• The tax treatment can be more favorable, particularly for owners of C corporations, who may face two layers of tax in an asset sale.
• The seller walks away from the entity rather than winding it down.
• Contracts and permits that are difficult to assign may remain in place.

Buyers who agree to a stock sale usually ask for broader representations, warranties, and indemnification from the seller to protect against liabilities they cannot see.

Where buyer and seller interests collide

Tax treatment

The same price can produce very different after-tax results depending on structure, entity type, and how the price is allocated. The effect differs for C corporations, S corporations, LLCs, partnerships, and sole proprietorships.

Purchase price allocation

In an asset sale, the price is allocated among categories of assets such as equipment, inventory, non-compete agreements, and goodwill. Each category can be taxed differently for the seller and deducted differently by the buyer, so the allocation is negotiated rather than assumed. Both parties generally report the allocation to the IRS, and it should be consistent on both sides.

Contracts, leases, and licenses

In an asset sale, leases and key contracts must usually be assigned to the buyer, which often requires consent from the landlord or the other party. Some licenses and permits cannot be assigned at all and must be obtained by the buyer. A stock sale can avoid some of those consents, though many contracts include change-of-control provisions that still require approval.

Liabilities

An asset sale limits the liabilities a buyer inherits but does not always eliminate them. In California, buyers commonly take steps during escrow to avoid becoming responsible for a seller's unpaid state taxes, such as requesting tax clearance from the CDTFA and EDD and holding funds in escrow until clearance is issued. Your attorney and escrow officer will guide the specific steps.

Deciding on structure

Structure should be discussed with a CPA and an attorney before negotiations begin, because it affects the price that makes sense for both sides. A seller who understands the after-tax result of each option can negotiate price and structure together rather than giving ground on one without seeing the effect on the other. Related: Structuring and Financing the Sale of a Business.

Nothing in this article is tax or legal advice. To discuss how structure fits into the sale of your Southern California business, contact BusinessQuest Brokers.

Frequently asked questions

Which is more common for small businesses, an asset sale or a stock sale?

Asset sales are more common for smaller businesses, largely because buyers prefer to limit the liabilities they take on.

Why would a seller prefer a stock sale?

A stock sale can offer better tax treatment, particularly for C corporation owners, and it can keep hard-to-assign contracts and permits in place.

What is purchase price allocation?

It is the division of the purchase price among asset categories such as equipment, inventory, and goodwill. The allocation affects taxes for both parties, so it is negotiated as part of the deal.