Asset Sale or Stock Sale: Which Should You Choose?

So, the day has come, congrats! After all your hard work, someone is interested in buying your business. You’ve got a handshake agreement, and it looks like you’re finally going to sell your business for what could be a pretty penny. What comes next?

Well, first you and the interested party have to flesh out the deal some more. It will take some steps to turn those words on that back of a cocktail napkin into the sale of a business. First, you’ll both need to sign a Non-Disclosure Agreement, so you talk more freely and evaluate what is expected.

If that goes well, the Seller (i.e. you, for the purposes of this article) are expected to prepare a Letter of Intent, also called a Memorandum of Understanding, in which you lay out the terms of the deal generally, including: the essential assumptions to the transaction, closing conditions, and the duration of the no-shop periods, or the timeframe where the you cannot offer your business to other potential buyers.

Another consideration is how to structure the actual sale of your business. After all, what is a business? Is it the assets (the cash, securities, accounts receivable, inventory, tangible property, intangibles, and goodwill?) Or is it the business entity registered with the secretary of state? Is it some sort of combination of the two? Is there a structure that would work better for you? Is there a structure that would work better for the Buyer?

Well, from a 10,000-foot perspective, there’s two ways to structure the sale of a business: an asset sale or a stock sale. Each way has its pros and cons, depending on whether you’re the Buyer or Seller.

An Asset Sale

If you ask the question “what is a business?” an asset sale answers, “the things it owns.”

In an Asset Sale, the Buyer is purchasing everything the business owns: its cash, the inventory, the accounts receivable, the contracts, the intellectual property, its real estate; but not necessarily the Seller’s business entity.

This is the Buyer’s preferred business acquisition structure. An asset sale allows the Buyer to avoid potential liabilities and cherry pick the desirable assets.

For example, if you’re buying a group of restaurants and know one of the restaurant’s stores is facing a potential lawsuit, using the asset sale structure would allow you to avoid purchasing that store while still purchasing the other ones.

Another reason Buyer's prefer the asset sale structure is the ability to increase their basis in the company’s assets. This allows them to take advantage of depreciation, which can be used to reduce income taxes.

A Stock Sale

If you asked the question “what is a business?” a stock sale would answer “the business entity recorded with the secretary of state.” In a Stock Sale, the Buyer is purchasing all of a corporation’s issued shares or stock, or all of a limited liability company’s (LLC) units or ownership interests.

This is the Seller’s preferred business acquisition structure. While a stock sale could theoretically allow the Seller to wash their hands of total liability for the business, the reality is most contracts will contain an indemnification period, or some other other post-closing obligation that will prevent a Seller from completely absolving themselves from any wrongdoing during their tenure as owner. The real benefits to Sellers in a stock sale are the speed and taxes.

In a stock sale, you only need to get the approvals needed to sell a company’s shares. And in most cases, the people who own those shares are already on board with selling the business. So, if you’re looking to move quickly, a stock sale is the more realistic option.

By comparison, in an asset sale, you need to get the approvals needed to transfer every asset owned by the company, this can involve extensive review of records & contracts, creating & completing new filings, discussions with vendors, etc. By its inherent nature, it takes much longer to complete.

Sellers also prefer stock sales because they are required to pay capital gains taxes on 100% of the purchase price. In an asset sale, they may be required to pay ordinary income tax rates on some of their gain from the sale. Capital gains is preferrable to ordinary income tax rates because it’s lower, especially at the higher brackets.

Which One Is Right For You?

So, which one is right for you and your sale? Well, as always, the answer is: it depends. Like you, your business is unique, and your situation should be looked at by a professional before determining the best course of action. You’ve worked hard to get to the point where someone is interested in buying you out. Don’t let all your hard work go to waste!

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