Mergers & Acquisitions

Purchase and Sale of a Business: Structuring the Transaction

We continue our series on the purchase and sale of a business by exploring the structure of the transaction. These transactions generally fall under one of two categories, an asset sale or a stock sale. Today’s post highlights some of the key features and differences between the two structures.

The Asset Sale
An asset sale is the purchase of the individual assets and liabilities of the business. In an asset sale, the seller will retain possession of the legal entity, e.g. ABC Corporation, and the buyer purchases the individual assets of the company, including equipment, inventory, fixtures, licenses, goodwill, trade names, etc. Typically the seller will retain the company cash, and the seller often remains responsible for any long-term debt obligations.

Buyers tend to prefer asset sales for a few reasons. First, the buyer receives a “step-up” basis in the company’s depreciable assets. By allocating a higher value for assets that depreciate quickly (e.g. equipment) and allocating lower values on assets that depreciate slowly (e.g. goodwill), the buyer will gain additional tax benefits. Typically, this will reduce the corporate taxes in the future and improve the company’s cash flow. Second, buyers avoid inheriting potential or undisclosed liabilities in an asset sale. The buyer only assumes the liabilities expressly contracted for in the asset purchase agreement.

There are some drawbacks of an asset sale for buyers. The buyer is required to file paperwork to form a new entity, and the new company must re-assign all contracts, leases, and permits to the new entity. This can significantly slow down the transaction depending on the number of contracts and the other parties’ willingness to allow the transfer of the contract.

The Stock Sale
A stock sale is the purchase of the seller’s shares of a corporation. The buyer will buy the seller’s legal entity itself and assume ownership of the corporate stock. Generally all of the company’s accounts are transferred to the new owner. Stock sales are typically a “cleaner” transaction since they do not require numerous transfers of individual assets because the title remains in the name of the corporation. In a stock sale, the buyer essentially steps into the shoes of the seller and takes over the existing corporation. Unless specifically agreed to, the seller has no continuing interest in, or obligation to, the assets, liabilities or operations of the business.

Sellers tend to favor stock sales because the proceeds are taxed at capital gains rates, which are typically significantly lower than tax rates for ordinary income. Sellers also reduce their amount of future liability because the liabilities of the corporation will remain with the corporation, and the seller will (generally) not be responsible for the corporation’s liabilities after the sale.

Buyers lose the ability to gain new depreciation on assets in a stock sale. The basis of the assets is carried over and remains at the book value at the time of the sale. This often results in higher taxes for the buyer as compared to an asset sale. Further, buyers assume additional risk and liabilities in a stock sale, since all liabilities will generally travel with the corporation to the new owner. For this reason, it is especially important in a stock sale to perform extensive due diligence. As we’ve discussed in previous posts, you want to be aware of the various liabilities you may face when you take over ownership of the company.

In the end, each transaction is unique and will require an analysis by a business attorney and CPA to determine the “right” structure for you. If you’d like to learn more about structuring your purchase or sale of a business, please contact us today for your free initial consultation.

          


Gavin Johnson

Gavin enjoys craft beer and is learning the art of brewing.


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