Structuring a Business Sale: Asset Sale Versus Stock Purchase Agreement

 Posted on December 00, 0000 in Corporate Law

When selling or buying a business, a number of factors must be considered, namely how the transaction will be structured. Essentially, there are two primary options: asset value and stock purchase agreement. Understanding the benefits and potential shortcomings of each can help to ensure the best outcome for both buyers and sellers.

Asset Sales

Commonly referred to as cash-free, debt-free transactions, asset business sales do not typically involve the transfer of cash or long-term debts. Instead, company assets and liabilities are sold. Examples include equipment, leaseholds, trade names, licenses. Networking capital, such as inventory, accounts receivable, and accrued expenses are also often included in asset sales.

Buyers may experience some tax benefits, including the ability to “step-up” the company's depreciable basis in its assets. This can reduce their tax responsibility and improve cash flow during the vital first years. It can also provide buyers with some protection from potential liabilities, like contract disputes, product warranty issues, employee lawsuits, or product liabilities. However, certain assets, such as intellectual property, permits, leases, and contracts, may be more difficult to transfer.

Asset sales may generate higher taxes for sellers because, although intangible assets like goodwill are taxed at capital gain rates, “hard” assets are subjected to higher, ordinary tax rates determined by the seller's tax bracket. In addition, sellers may be subjected to double taxation if the entity sold is a C-corporation. S-corporations are also at risk for built-in gains (BIG) taxes under the IRS Section 1374 if the sale is within the 10-year BIG recognition period.

Stock Purchases

With stock purchases, the buyer obtains the seller's legal entity by purchasing the shareholders’ stocks. The same assets and liabilities procured through asset sales are typically transferred in stock purchases, but those that the buyer does not wish to purchase can be distributed or paid off prior to the sale. Another key difference is that, unlike in asset sales, stock purchases do not require the separate distribution of each asset because the title rests with the corporation itself.

Buyers lose the ability to use the “step-up” in assets in stock purchases. This can result in lower depreciation expenses and higher future taxes when compared to asset sales, and it can lead to increased risks, including contingent risks. However, buyers may be able to mitigate potential liabilities through representations, warranties, and indemnifications. This makes stock purchases most beneficial for buyers when there are a number of copyrights, patents, or difficult to assign assets.

Sellers, on the other hand, typically favor stock purchases because the proceeds are taxed at lower gains rates. They also typically hold fewer responsibilities when it comes to future liabilities, such as product liability claims, employee lawsuits, benefit plans, pensions, and contract claims. However, this purchase agreement can also shift responsibilities back to the seller.

Buying or Selling a Company? Seek Professional Legal Counsel

Source:

http://www.alliedbizgroup.com/resources/publications/asset-sale-vs-stock-sale.html