Guide to Structuring the Sale of Your Business

Selling your business can be equal parts daunting and exciting. You’ll need to address legal, tax, and practical considerations. One of the most daunting legal complexities is deciding how to structure the sale: as a stock or asset sale? Let’s look at the key features of the two sale varieties.

Asset Sale

Buyers purchase the assets and liabilities of a business in an asset sale. The seller possesses the legal entity, but the buyer purchases everything else. In an asset sale, the seller typically retains the business’s cash, and remains responsible for liabilities not included in the sale. Buyers prefer this type of sale for several reasons:

  • They receive a “step up” basis in the company’s depreciable assets. They assign a higher value to assets that quickly depreciate, and a lower value to slow depreciation assets, offering the buyer important tax benefits. This can also reduce future tax liability, thereby improving cash flow.

  • Buyers can avoid inheriting potential liabilities, including those undisclosed in the sale. A buyer only has to assume liabilities expressly listed in the purchase agreement. This leaves the seller with other liabilities.

Of course, it’s not all favorable to the buyer. There are some important drawbacks. The buyer must form a new entity, and the new entity must assign all contracts, permits, leases, and other documents. Depending on the number of contracts and the willingness of the seller to transfer contracts, the deal can move slowly, and may even fall apart.

Stock Sale

Stock sales involve the buyer purchasing the legal entity and assuming ownership of the corporate stock. In this arrangement, the company’s assets are all transferred. These transactions are cleaner, requiring fewer transfers and evoking less confusion about who owns what. The buyer steps into the seller’s shoes, taking over the existing entity. Unless the parties agree otherwise, the seller has neither a continuing interest in or obligation to the business’s liabilities, assets, or operations.

Sellers often prefer stock sales because:

  • Sales are usually taxed at capital gains rates, which are much lower than income taxes.

  • The seller can reduce their future liability because the company’s liabilities remain with the company.

However, buyers sometimes want to avoid stock sales because such sales remove their ability to gain depreciation assets. The basis of the assets is transferred, remaining at book value when the transfer occurs. This can produce higher taxes for the buyer, particularly as compared to an asset sale.

Buyers also assume more risks and liabilities with a stock sale, since these liabilities travel with the company to the new owner. This is why it’s so important for buyers participating in a stock sale to engage in an extensive due diligence process, often with the assistance of industry experts. Buyers must understand and be aware of the liabilities they undertake when they take ownership of a business.

Every transaction is unique. There’s no perfect transaction. Nor will any one type of transaction be right in all instances. It’s always wise for sellers to partner with a CPA and M&A advisor, as well as a lawyer, to determine the right sale structure for this transaction. Only armed with this expertise will you be able to make the best decision for your finances and your business.