Business owners are often faced with decisions to either sell all or a portion of their business or to buy all or a portion of a new business. There are two main methods of structuring such transactions: a stock sale or the sale of all or a portion of the assets of the company while retaining ownership of the equity. Owners of companies and their advisers need to be aware of the advantages and disadvantages of these transactions because the structure of the sale of each can have significant tax and economic differences.
Sale of stock
A sale of stock transaction is the simplest way to transfer ownership of a company. In this scenario, the owners of the entity agree to transfer all of the stock to a buyer in consideration for the payment. Unless the agreement provides otherwise, all of the assets owned by the company are automatically transferred in the stock transaction. Keep in mind that there may be certain assets which would be excluded and transferred to the current owners prior to or at the time of sale. The sale document could also provide that the prior owners would either assume or be responsible for any existing or potential liabilities.
Sellers of a company usually prefer a sale of stock transaction. The taxation of the proceeds received on the stock are taxed at the capital gains rate. If the transaction is structured as an asset purchase agreement, there can be a portion of the sale treated as ordinary income and may require analysis to determine the additional income tax amount due.
The sale of stock generally requires that 100% of the stockholders agree to this transaction. This may be an issue, but it is avoidable. The corporate documents should have a “drag along provision” requiring that the minority shareholders automatically agree to and are required to accept the sale, even if they disagree with the transaction.
The disadvantage of a stock sale to the buyer is that the goodwill of the business, which is included in the purchase price of the company, is not deductible. If the transaction is structured as an asset purchase agreement, the portion of the purchase price allocated to goodwill can be depreciated over a 15-year period making this transaction a significant tax advantage to the buyer. Also, none of the assets acquired in the stock purchase agreement receive a step-up in basis for depreciation purposes.
Asset purchase sale
Buyers tend to prefer an asset purchase agreement because of the significant income tax advantages. The buyer is allowed to acquire the goodwill of the company that depreciates over 15 years. They also receive a step-up in basis for the inventory, accounts receivable and other property, which will also depreciate over the agreed-to fair market value of the business.
Buyers also prefer the asset purchase agreement since they can choose which assets and liabilities they will assume in the transaction. Therefore, the entity will be responsible for any liabilities not transferred and buyers keep whatever assets, usually cash, which are not generally transferred. This type of purchase agreement is known as a “no cash or debt” transfer to the buyer. If buyers purchase the assets, many of the existing contracts with landlords, employees, suppliers and customers may need to be renegotiated. There is always the risk that contracts may not be extended or renewed, and could even be terminated. Because an asset purchase generally does not require 100% of the selling owners to agree to the sale, an asset purchase transaction may be the only way to complete the transaction.
Remember, this article is a brief summary of the differences between stock sale and asset purchase transactions. There are many corporate and tax planning opportunities to evaluate when structuring transactions that strategically avoid the pitfalls or disadvantages discussed while enhancing the economic advantages to both the buyer and the seller. Contact a Corporate Transaction & Business Law professional for advice.
Client alert authored by: Terrell J. Isselhard (312 855 4624), Principal.
This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.