One of the biggest conflicts that exist within transactions is the type of deal you’re doing – asset sale or stock sale. Buyers typically prefer assets and sellers prefer stock sales. The key for any acquisition entrepreneur is understanding the big differences between both these types of sales.
In this piece, I’ll help you navigate through those differences and elaborate on the benefits associated with both so that you can make the best decision.
Understanding the Differences
The seller is not actually an individual rather a legal entity that is liable for taxes and reflects the legal ownership of the company. This selling company has several assets inside it – both tangible assets (heavy equipment, land, buildings, inventory, and so on) and intangible assets (intellectual property, culture of the people, employees). In an asset sale, the seller transfers these assets, which generate cash flow to the buyer. And then, the buyers can form their own legal entities with the help of those assets.
It usually depends on the seller whether they transfer all their assets or just a part of it. Sellers and buyers often negotiate upon what assets they are interested in buying and selling.
Assets can include something as simple as the business name or website domain which can carry significant value. Typically resulting in continuing the existing brand through a dba with the newly acquired entity. For instance, there is this one service line that the seller does not want to include because they want to focus solely on that aspect of the business moving forward.
Assets can include everything from employees, software, hardware, equipment, buildings, contracts, automobiles, etc. These are the aspects of the business that are required to carry out day-to-day operations.
In an uncomplicated transaction, they will sell their assets, shut down the legal entity, and terminate it. In the days following the transaction between the buyer and seller, the assets, including the employees, are transferred to the buyer’s legal entity.
Stock sales are completely different from asset sales. In this kind of sale, the buyer purchases stocks of the selling company. This makes the buyer the legal owner of the original business entity. Now the buyer is responsible for all the assets and liabilities of that business entity. This kind of purchase usually happens when there is some kind of contract, supplier contract or customer contract, or some type of license that is not transferable to a different legal entity. This can be seen commonly in industries that rely on government contracts, business-to-business service companies, etc.
Stock sales also occur when the seller wants to stay involved in the business entity and retain its ownership. For instance, if the seller wants to retain 20% of the business and sell the remaining 80%.
Asset Sale vs. Stock Sale: The Advantages
An asset sale is considered more advantageous to buyers, and a stock sale is usually better for the seller. However, it’s not just that simple. Both have intricate nuances and require further elaboration.
Advantages of Asset Sales
An asset sale is a cash-free, debt-free transaction. This means that, unlike tangible and intangible assets, any cash balance and debt of the selling business will not be transferred to the buyer. This means if there was any cash in the original business entity, it would be retained by the seller.
Let me explain this with an example. If the selling business has $1,000,000 in cash and, say $250,000 in debt, this cash and debt will not be transferred to the buyer. The owner of that entity will retain any cash or debt. This makes it beneficial for the buyer because they can start afresh without being worried about the old liabilities. And as such, an asset sale limits the historical risk of the original legal asset.
Unlike asset sales, if you purchase a business in stock, you will be responsible for the entire history of that legal entity, including its assets and liabilities before you bought the company. Make sure to assess the history and risks of a company before buying it.
For instance, you bought a detergent company, and then years later, you are in the news because your company’s toxic waste was found in the Pacific ocean. This might not have happened under your watch, but you are now liable for it because you are the legal owner of that business. This is not the case when you are buying as asset sales, and you are not liable for anything that didn’t happen under your legal ownership. This is a huge benefit to the buyer and the reason why most of them prefer asset sales.
Advantages of Stock Sales
Stock sales offer tremendous tax benefits to the seller. The purchase price when buying in assets is usually higher than buying in stocks. This is because the cost of the purchase price is always worth more to the seller.
For instance, if you are buying a company for $100 as an asset sale, the seller gets only $65 after taxes. On the other hand, if you buy the company for $100 as a stock sale, the seller gets $75 after deduction of taxes. This does not make any difference to the buyer, but the seller saves taxes.
Stock sales also give buyers an opportunity to negotiate with the seller. Following the same example as above, the buyer can ask the seller to make a stock sale for $90 instead of an asset sale for $100 since the seller will be getting the same price after the deduction of taxes. This way, buyers can save some money by negotiating the asset and stock sale price.
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