Authored by Jim Sowers, Managing Partner, Transact Capital
If you are a business owner that is considering selling your company, one of the questions that you need to understand is – Should I sell the Stock of my company or should I sell the Assets?
The answer is complex but often boils down to two issues:
• What is the tax impact on both the buyer and seller?
• What are the assets being transferred?
If the seller is an S or LLC corporation, the tax benefits to the buyer favor an asset sale, while for C corporations, the tax paid by the seller favor a stock sale. Further, if the assets being sold are difficult to transfer, such as government contracts, the buyer may require a stock sale.
Advantages & Disadvantages
Both a stock sale and an asset sale can accomplish the goal of passing ownership of a company from a seller to a buyer, but a buyer may inherit additional risk with a stock sale. In an asset sale, the legal agreement lists the specific assets and liabilities that are being acquired. The legal entity and any excluded liabilities remain the responsibility of the seller. In a stock sale, all of the assets and liabilities of the company transfer to the buyer (exceptions include customer contracts requiring approval for change of control). Risk for past events such as underreporting taxes or a sexual harassment lawsuit can pass to the buyer in a stock sale that don’t transfer in an asset sale. Consequently, buyers often prefer to buy the assets of a company. Of course, a good lawyer can limit the risks transferred in a stock sale.
Tax Implications
The tax implications can vary widely between an asset or stock sale, so the decision to sell stock or assets is often dictated by taxes. A C corporation pays taxes on income while an S and LLC passes the income through to the owner. The owner of a C corporation also faces taxes on dividends from a company, which can cause a double taxation on the sale of assets – the company paying taxes on the sale of assets, and the owner of the company paying taxes when the proceeds of the sale are transferred to the owner. As a result, owners of C corporations generally prefer a stock sale.
For an LLC or S-corporation, buyers often pay more for an asset sale than a stock sale for tax reasons while a seller is often indifferent. With an asset purchase, the buyer gets to “step up” the tax basis of the acquired assets, which means the buyer gets tax deductions for the entire purchase price (except for land) over a period of time. For a stock sale, the buyer takes over the tax situation of the company (carryover tax basis). Each situation is different, but using a theoretical example, a buyer of a $10 million company will get $10 million in tax deductions over time (less if land is involved) under an asset sale and maybe $1 million in deductions under a stock sale. The $9 million in additional tax deductions for an asset sale saves the buyer approximately $3 million taxes, so you can see why buyers prefer to buy assets.
Regardless of the tax benefits, a buyer may insist on a stock sale if the company has assets that are difficult to transfer. In general, the assets automatically transfer in a stock sale but must be individually transferred in an asset sale (lots of exceptions so understand the transfer clauses in your contracts). If your company has a large number of contracts, vehicles or licenses, the buyer may insist on a stock sale.
Bottom Line
The sale of a business is very complex, and this article only touches on a few of these complications. For example, a stock sale under a section 338 (h)(10) election has the automatic transfer benefits of a stock sale and the tax benefits to the buyer from a stepped up basis of an asset sale. Transact recommends that business owners hire experienced lawyers, tax advisors, and investment bankers prior to undertaking a sale of their business. Any
one of us at Transact Capital Partners would welcome the opportunity to discuss your specific situation as you prepare for a potential sale.