- Posted by cratest2-ca
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One of the most frequent questions we get when it comes to structuring a sale is “Asset Sale or Stock Sale?” With few exceptions, if you are the seller the answer is simple: Stock Sale. Of course, were life only that simple….
First, let’s discuss the basic differences. In a stock sale you are selling the entire corporate. That includes the entire balance sheet – cash, AR, IP, debt, etc etc. Contrast this with an asset sale: when you complete and asset sale, the seller actually retains the corporation. You are literally selling certain assets (and perhaps liabilities) off of your balance sheet.
So What’s the Big Deal?
In a stock sale, the seller is taxed predominately at the more favorable long term capital gains rate. In pass through entities, the tax effect can vary greatly. There are different tax treatments for different asset classes, so work with your tax professional on this. But the REAL issue is trying to do an asset sale as a C-corp. For all intents the tax consequences make the sale unpalletable. Most owner’s are familiar with the double taxation issues of C-Corps. When a C-corp completes an asset sale, they are essentially liquiditating all assets of the company. This is profit that is taxed at the corporate income tax rate. The company then makes a distribution to shareholders who are then taxed as ordinary income.
That’s tough to swallow.
When executing an asset sale, the deal can be structured “ala carte.” That is, the buyer and seller can pick and choose what assets (or liabilities) to transfer in a sale. Assets that are not transferred can then be liquidated by the seller. Perhaps the biggest issue, though, is that in a stock sale the buyer inherits ALL liabilities – known or uknown. While purchase agreements typically require reps / warranties / indemnifications, those provisions will often eventually sunset and leave the buyer with continued exposure. This is probably the number one reason that buyers are adverse to stock purchases.
One of the more attractive reasons for doing a stock sale is the ease in acquiring contracts. Since the buyer is purchasing the corporation, there is no need to novate a contract from one entity to another. Caveat: change of control provisions in contracts.
When executing an asset sale, on potentially attractive element for purchasers is the ability to “step up” assets to fair market value. In doing so, the buyer can essentially “re-depreciate” the equipment and gain the tax bump from doing so. (Buyers can also use the so called 338-H(10) election to treat a stock sale as an asset sale – we’ll save this for a later day).
Of course, stepping up assets has little meaning in a non-asset intensive business. For this reason the impact of stepping up assets is more relavent in asset-heavy deals – think machine shop or trucking company – as compared to professional services firms.
So What is Most Common?
Great question. In smaller deals buyers almost always push for an asset sale. In most main street and lower middle market deals this is the norm. This also makes is very difficult to sell a c-corp without pushing hard for a stock sale. (Note: if you are a c-corp, consider converting now. There is a 5 year holding period to avoid built in gains tax.) As deals get larger stock sales become more prevalent. Also, deals that are heavily reliant on acquiring contracts tend towards stock sales as well. For this reason we almost always see GovCon’s transact as stock sales.