Are you considering an asset or stock sale but are bombarded by the complexity and potential tax implications of each deal?
If you’re in this situation, you’re not alone! Several small businesses want to pursue a stock or asset sale but need help understanding how to pursue it.
Hi! My name is AJ, and I recently sold my business for multiple seven figures. Now, I help growing companies find success through Small Business Bonfire!
One thing I discovered during the process of selling my business was the ins and outs of an asset sale vs stock sale.
If you are ready to learn how to navigate these deals, keep reading! I uncover everything you need to know and more!
What is an Asset Sale?
During an asset sale, whoever sells the products retains possession of the legal entity.
Also, the buyer, during asset sales, purchases company assets.
Some examples of assets involved during this type of sale include the following:
- Telephone numbers
- Intellectual Property Rights
Usually, an asset sale does not include cash, which is a common misconception.
Further, the seller of an asset sale maintains the long-term debt obligations associated with the sale.
Therefore, asset sales are sometimes called cash-free, debt-free transactions.
In addition to individual assets, these types of sales usually include net working capital.
Net working capital is the difference between a company’s short-term assets and debts and liabilities.
Ideally, a business wants a positive net working capital because it signifies it is meeting its financial obligations.
Some examples of net working capital include the following things:
- Accounts receivable
- Accounts payable
- Prepaid expenses
- Accrued expenses
Asset sales come with several advantages (which I’ll get into later).
However, one of the primary reasons an asset sale occurs is to mitigate asset-related risks and obtain free cash flows.
How Does an Asset Sale Work?
Typically, asset sales take place in one of two ways.
The first example occurs in the following way.
An individual or group purchases a troubled business from its creditors.
Asset sales generally occur through an organized bankruptcy process or foreclosure sale in these cases.
Another way an asset sale can take place is in the following manner.
The owner of a healthy company sells individual (tangible or intangible) assets to another party.
Usually, this happens to raise cash within the company’s balance sheet.
In order to facilitate the sale of certain assets, the seller must obtain consent from any entity that possesses liens on the company’s assets.
This entity is informally known as a “secured party.”
The secured party has the first right to be repaid for their claim when selling off a business’ individual assets.
As such, they significantly influence which specific assets the business can sell and the method of sale.
If a secured party approves an asset sale, moving forward is more manageable.
However, if the secured party does not consent to the sale, they may have legal options to protect their interests and capital gains.
Also, an asset sale requires extensive paperwork and documentation to ensure that all parties are protected and their rights are respected during the transaction.
These rights and forms of protection include the following things:
- Sales agreements
- Transfer of ownership documents
- Any necessary legal contracts
- Intellectual property rights and paperwork
Asset Sale Pros and Cons
When it comes to an asset purchase, you must be aware of the advantages and disadvantages associated with such a purchase.
Let’s take a closer look!
Buyer Pros and Cons
Some buyers prefer asset sales because there are fewer tax consequences.
However, like everything, there are pros and cons to know about!
From a buyer’s perspective, some benefits of an asset sale include the following things:
- There are beneficial tax implications because buyers can allocate a higher value for quickly depreciating assets.
- Taxes are reduced sooner compared to ordinary income tax rates.
- The company’s cash flow improves during the first few years of business.
- Buyers can easily avoid inheriting potential liabilities because sellers maintain legal ownership of several asset details.
- Buyers can more easily avoid contingent liabilities like product liability, contract disputes, product warranty issues, and employee lawsuits.
Still, there are disadvantages when a buyer purchases individual assets in this type of sale.
These cons include the following things:
- Certain assets are more challenging to transfer because of assignability, legal ownership, and third-party consents.
- Things like intellectual property, contracts, leases, and permits are hard to transfer.
- Getting a purchase agreement and consent can be time-consuming.
- Refiling permit applications can slow down the transaction process.
Seller Pros and Cons
An asset deal impacts sellers differently than buyers.
For example, some pros sellers enjoy regarding an asset sale include the following things:
- These sales generate higher taxes because they are subject to ordinary income tax rates.
- The seller has no liability for the company’s employees (they don’t have to pay back wages, payroll taxes, or vacation pay).
- The costs paid for the assets are depreciable.
- The seller can clean their credit, reputation, and worker’s compensation rating.
On the other hand, some of the cons to know about with asset sales include the following things:
- Negotiating the transfer of leases and contracts can be time-consuming and tricky.
- They must pay sales tax on furniture, fixtures, and equipment.
- Intangible assets are taxed at capital gains rates.
How is an Asset Sale Taxed?
The way the government taxes asset sales depends on the type of corporation.
For instance, if the sold entity is a C-corporation, the seller faces double taxation.
That said, the first taxation comes at the corporate rate when the buyer receives the sale proceeds.
The second taxation comes at the individual rate on the distribution to shareholders.
However, if the business is an S-corporation that was formerly a C-corporation, the sale can trigger significant taxes at a corporate level.
Further, S-corporations, limited liability companies, and partnerships are only taxed once, when the proceeds pass through to the owners.
This taxation is at the individual rate, which is higher than the capital gains rate.
Still, it is better than being taxed twice!
What is a Stock Sale?
During a stock sale, the buyer purchases a shareholder’s stock directly.
As a result, the buyer gets ownership in the seller’s legal entity.
Typically, the actual assets and liabilities a buyer receives in a stock sale are similar to asset sales.
Also, if a buyer doesn’t want certain assets or liabilities that are part of the stock sale, the seller will distribute or pay them off before the sale.
Although stock sales have similarities with asset sales, there are a few essential distinguishing differences (which I’ll get into later).
How Does a Stock Sale Work?
Generally, the stock sale process is more straightforward than an asset sale.
Typically, a buyer must obtain a purchase agreement and credit financing (from their bank) to buy the stock.
After that, the buyer can take over the existing entity as its new owner.
In some cases, buyers may ask for a seller’s indemnity in case of legal disputes.
A seller’s indemnity means the seller will reimburse the buyer for a loss or liability resulting from the purchase.
Additionally, buyers may purchase an insurance policy to cover liabilities.
Stock sales are subject to certain taxes, depending on the type of stock and other factors.
For instance, a buyer can forgo taxes on gains in their stocks by paying them back into the business.
I’ll explain the tax situations of stock sales in a later section!
Stock Sale Pros and Cons
Stock sales have certain advantages and disadvantages both buyers and sellers must know before entering the process.
Let’s look at some of these pros and cons from each perspective.
Buyer Pros and Cons
Some of the pros buyers can take advantage of during a stock sale include the following things:
- There are lower depreciation expenses.
- There is a higher likelihood of better future taxes.
- Potential liabilities can be mitigated (future lawsuits, environmental concerns, OSHA violations, employee issues, and other liabilities).
- They can reduce the risk of losing contracts with prominent vendors or customers.
Regarding the cons associated with stock sales, buyers must consider the following things:
- As a buyer, it is possible to be at risk for all liabilities, depending on the stock purchase agreement.
- Buyers can inherit the seller’s depreciable base.
- Stock sales take a lot of work to sell to professional accountants and lawyers.
Seller Pros and Cons
Stock sales have pros and cons for sellers, just like buyers.
From a seller’s perspective, stock sales come with the following advantages:
- All the proceeds from the sale are taxed at a lower capital gains rate.
- Sometimes, sellers are less responsible for future liabilities (product liability claims, contract claims, employee lawsuits, pensions, benefit plans, etc.).
Although a stock sale includes numerous benefits for sellers, there are some disadvantages to remember.
For example, these types of sales come with the following cons:
- The seller must give up some type of ownership.
- Sellers must relinquish control over the stock involved in the sale.
- The liabilities can be placed on the seller depending on the stock purchase agreement.
How is a Stock Sale Taxed?
Stock sales are taxed differently depending on the type of corporation.
For example, with a C-corporation, the corporate-level taxes are bypassed.
Bypassing corporate taxes is an extreme advantage for sellers.
In other types of corporations, the proceeds are taxed at a much lower level because the government taxes them at a capital gains rate.
The tax advantages are the central aspect that makes these types of sales so appealing.
What is Better, an Asset Sale or a Stock Sale?
Whether you structure a sale as an asset sale vs. a stock sale depends on taxes.
Typically, a stock sale is more beneficial for sellers.
However, an asset sale is more beneficial for buyers.
When comparing an asset sale vs. a stock sale, it is critical to remember that there are endless variations of how both parties can create a contract.
Therefore, it’s best to receive professional advice from tax and legal professionals before proceeding with any sale.
When selling assets, the seller transfers a collection of their business’s assets to a prospective buyer.
Sometimes, these assets are tangible, such as furniture, inventory, etc.
In other cases, the acquired assets are intangible, such as the value of a brand, customer lists, etc.
Tax consequences of these types of sales vary depending on the type of corporation.
During stock sales, the buyer purchases shareholder stock directly from the seller.
Again, there are various tax implications each party must be aware of.
Therefore, it is always best to have a professional help you negotiate these deals.
So, what’s better, an asset sale vs stock sale? The answer depends on whether you are a buyer or seller.
Additionally, the type of contract and tax benefits strongly impact which type of sale is best in your situation.
Asset Vs. Stock Sale Final Thoughts
The difference between a stock and an asset purchase is critical to understand.
Asset purchases involve buying tangible or intangible aspects of a business entity, such as customer lists and inventory.
In comparison, a stock deal involves buying and selling shareholder stock directly at the source.
Regardless of the deal you wish to pursue, consult a tax and legal professional.
Are you more interested in a stock or an asset deal? Let us know in the comments section below!