Now that you have completed some preparations, valued your business and considered proper due diligence, you must determine which type of sale is more advantageous – a stock sale (the ownership interest of your business), or an asset sale, (selling the assets of your business while ownership of the company does not change). Let’s review the advantages and disadvantages of both options.
In general, an asset sale is preferred by the purchaser because favorable assets can be bought while excluding unfavorable liabilities. Assets can encompass items such as real estate, equipment, inventory, accounts receivable and client lists. Depending upon the allocation of the purchase price, the purchaser may also receive a stepped-up tax basis on the assets, which can result in depreciation and amortization tax deductions in the future. On the other side of the deal, a seller planning to sell one division of the company while retaining another may prefer an asset sale.
Basis is the value that tax law assigns to an investment property to determine the gain or loss on a transfer of that property. Often, the basis equals what the property cost the buyer. If the buyer acquires the property without paying for it, the buyer will have a carryover basis in the property that is equal to what the seller paid for it. So, in a stock sale, the buyer gets a basis in the stock and a carryover basis. This allows the buyer some control to determine his or her basis in assets and, therefore, the tax liability.
Asset sales can take longer to close than stock sales. Each asset or class of assets generally must be transferred individually, which can be especially burdensome if an asset is a “shared asset” within a subsidiary or division. In addition, asset sales often require consents and assignments from third parties. The seller should assign much of the sale price to capital assets because such assets are taxed at a lower tax rate than ordinary assets, which includes inventory, receivables, and covenants not to compete.
A buyer should work to assign much of the sale price to depreciable assets, which generate deductions for future tax years. Depreciable assets include equipment and buildings, but not land. An asset sale can also result in double taxation for a C corporation seller; for other entities, only the shareholders, and not the entity itself, are taxed on gains from the sale of assets.
In a stock sale, the purchaser acquires some or all of the ownership interest of the company directly from individual shareholders and becomes the new owner. The legal status of the company remains the same after the close of the stock sale, but the selling stockholders generally “cash out” and are no longer associated with the company. Following the closing, the selling shareholders are free and clear from any obligations and liabilities, subject to any indemnification or other obligations contained within the stock sale agreement.
From a tax perspective, a selling shareholder may receive more favorable treatment as a result of a stock sale because when a shareholder sells the stock for a higher price than he or she bought it for, the IRS recognizes that income as capital gain and taxes it at a lower rate than the ordinary income, which would result from the sale of assets. Capital assets, the sale of which results in capital gain or loss, are items used in a business over a long period of time and includes items such as real estate, equipment, and community goodwill.
When a purchaser buys the ownership interest of a company, all of the obligations and liabilities of the company remain with the company. Purchasers must be mindful to perform adequate due diligence and thoughtfully structure the transaction documents so that (i) the seller is obligated to fully disclose and remedy the company’s liabilities; (ii) the seller warrants that the entity’s present and foreseeable future liabilities do not exceed a certain amount; (iii) an indemnification agreement is included to obligate the seller to reimburse the buyer’s extra costs if the business fails to meet the seller’s warranties; and (iv) an escrow account is opened to help ensure fulfillment of obligations. Both the seller and purchaser must be mindful of state and federal securities laws.
To fully understand how to structure a sale transaction and the related documents to your best advantage, consult with legal counsel, who can also assist you in developing a post-sale financial plan that may include post-deal participation in the business if you so choose.
Selling your business can be an intimidating undertaking, but preparation and awareness can bring you peace of mind during the transition. Taking the reins by readying your business, educating yourself regarding your best options, and having a strong team in place can steer you clear of potential headaches in order to effectuate the sale in the most lucrative way possible to propel you into your next life chapter.
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Business and Commercial / Real Estate