Businesses can be acquired via an asset sale or a stock sale. Please note that whenever there is a comparison between these two ways of transferring a business, we are not referring to an asset liquidation sale of a business that has, or will, cease operations. Also note that a stock sale can take place with a private or public company. Our discussion relates to private companies in the domain of business brokers and M&A professionals. Transfer of public companies is the domain of investment bankers. And finally, we are providing an introduction that is not to be taken as tax or legal advice. Please seek the advice of both a tax professional and a legal professional on this topic.
What Are the Differences Between an Asset Sale and Stock Sale?
Ongoing businesses can be sold via an asset sale or a stock sale and the key differences lie in the tax implications, the transfer of liabilities, the business entity running the business, and the amount of professional and legal involvement. Each method has pros and cons for the seller and buyer that are typically opposed. In some cases, a hybrid method is utilized. See this comparison table of an asset versus stock sale.
How Does an Asset Sale Work?
Asset sales are the most common method of transferring small business ownership. In an asset sale, the new owner may keep the name of the business or change it. However, the underlying business entity is a completely different entity run by the buyer. Business brokers utilize asset purchase agreements. Business brokers are motivated to close deals so their purchase agreements are generally fair and well balanced between the seller and the buyer.
How Does a Stock Sale Work?
Stock sales are more common in larger business transactions. Occasionally, they make sense in smaller transactions when both buyer and seller agree that the benefits outweigh any disadvantages. In a stock sale, the new owner may keep the name of the business or change it. However, the buyer assumes the business entity already established by the seller. Stock sales require securities licenses which business brokers usually do not have. Nonetheless, a business broker may be involved until the point that both parties determine a stock sale is preferable, and then considerable attorney involvement is required. M&A advisors who are involved in larger transactions are more likely to have the licenses required for stock sales. Nonetheless, M&A attorneys will still be involved on these larger deals.
Who Keeps the Business Name in an Asset Sale Versus a Stock Sale?
In either an asset sale or a stock sale, the new owner can choose to keep the business name or change it. Most new owners will not change the name of the business, at least initially. If the buyer purchases via a stock sale, then some of their reasons for acquiring the business may be the same reasons for them to keep the name of the business. We’ll discuss that later in this article.
What Are the Tax Implications of an Asset Sale Versus a Stock Sale?
From a tax standpoint, a seller would prefer the tax advantage of a stock sale over an asset sale. A buyer would prefer the tax advantage of an asset purchase over a stock purchase. Tax impacts are zero-sum game where there is no win-win. However, tax impacts of the sale are only one consideration in the decision to conduct an asset sale or a stock sale.
How are Liabilities Treated in an Asset Sale Versus a Stock Sale?
In an asset purchase, the buyer operates under a new business entity and therefore avoids any liabilities of the existing entity. In a stock sale, the buyer assumes the existing business entity and therefore assumes its liabilities, known or otherwise. This is why most small businesses are transferred via an asset sale. Small business sellers often default to an asset sale despite the less desirable tax ramifications for several reasons.
- They may be unaware of a choice
- They realize most buyers will not buy their business via a stock sale
- The tax consequences may be minimal given the size and simplicity of their business
- A stock sale typically requires legal negotiations that will offset the tax benefits to the seller
Is an Asset Purchase Always Better for a Buyer than a Stock Purchase?
In certain cases, a buyer may want to do a stock purchase to retain, or not jeopardize, key value components of the business such as key contracts or customer relationships, a zoning usage that is grandfathered for the business, or any other condition that may be disrupted or terminated upon transfer of ownership. A stock sale may help the parties sidestep such triggers since the business entity does not change. However, the parties need to consult their attorneys.
Is a Stock Sale Always Better for a Seller than an Asset Sale?
With most smaller deals, Sellers will have a difficult time convincing buyers to do a stock purchase because of the liability that the Buyer would inherit. Therefore sellers often do not have the ability to demand a stock sale. Sellers need to know that another reality of stock sales is that any tax advantages they may receive will be eroded by substantially higher attorney fees for a stock sale. This is because the buyer will likely engage an attorney to help mitigate the liabilities and risks that accompany a stock purchase. This will require considerable negotiations back and forth on the legal terms of the purchase.
What are Some Examples of Asset Sales?
The examples are plentiful and predominant in small business transfers. Most sellers of small businesses, if they are even aware of their options, accept that they cannot attract the best buyer by demanding a stock sale for their tax benefit. Most business brokers operate with an asset purchase agreement and do not have stock purchase agreements because they are rarely involved in them, and must act in a different capacity in a stock sale due to licensing issues.
In one case where a small profitable business had only one customer, the sellers and the buyers agreed to carefully manage the transfer and communicate with the sole customer in a way that would preserve the customer’s business. The seller and buyers did not utilize a stock sale, but instead moved forward successfully with the common asset sale approach.
What are Some Examples of Stock Sales?
In one case, the owner of an adult fashion and novelty store who had operated in a downtown area for decades was grandfathered by the city when the city changed the zoning. The buyer was open to a stock purchase so as to not trigger a potential sunsetting of the grandfathered zoning.
In another case, an Amazon DSP last-mile delivery business received 100% of their revenue from Amazon. In both cases, both the seller and buyer agreed to a stock purchase so as to not trigger any further involvement by Amazon beyond approving the new owner.
Is There a Way to Get the Best of Both an Asset Sale and Stock Sale?
Creative minds are always seeking the best of both worlds with a hybrid approach. For example, some asset sales are conducted where all of the payments for a corporation’s assets are made directly to the shareholders. And some stock sales attempt to retain some of the corporation’s assets for the seller as if it were an asset transaction. Even the Internal Revenue Code Section 338(h)(10) allows certain transactions to be structured as stock sales, but taxed as asset sales. This is known as a Deemed Asset Sale or Hybrid Asset-Stock Sale. These advanced maneuvers must be carefully executed with the advice of tax and legal professionals. It is highly likely that one party may be in favor of such creativity while the other is not.