Buying or selling a business is a complicated undertaking. Even after two parties agree to a deal, there are a lot of decisions to make. A significant decision is whether the deal will be structured as an asset or stock-based acquisition. Various factors will drive the decision making process between an asset or stock sale. In an asset sale the buyer acquires the assets of the seller’s business (equipment, inventory and goodwill). When acquiring the stock or membership interest of a seller, the buyer is acquiring not just the assets of the seller, but also its liabilities. How a deal is structured can have long-term tax and liability implications for both parties. Talk through the advantages and drawbacks of asset vs. stock sales with your business attorneys before taking next steps.
Asset or Stock Sales: When You’re Buying a Business
Buyers generally prefer asset sales over stock sales. As the buyer, structuring the deal this way allows you to acquire a company’s assets but not its liabilities. You may buy a business’s building, equipment, inventory, customer lists, vehicles, trade secrets and even its goodwill (essentially, the value of the company’s good name and reputation). You can form a new business entity to own those assets, or transfer them to a business you already own. But the seller retains ownership of the seller entity and any company liabilities that the buyer doesn’t purchase.
Asset sales can also be advantageous from a tax perspective. One tax benefit with asset sales is the buyer can depreciate or amortize the acquired assets. This allows the buyer to write off the purchase price in future years against its income. Say you purchase $50,000 of equipment from the seller. As a buyer you can write off the $50,000 over time (generally 5 or 7 years depending on the asset class). In addition, goodwill, which is often a significant portion of the sales price, can be amortized over fifteen years.
With a stock sale, the buyer buys the stock of a corporation or membership interest of an LLC. In some deals, a buyer may be acquiring the assets of the seller because of a significant contract with a third party vendor or provider. Sometimes, those contracts cannot be assigned; meaning that if the buyer acquires only the assets of the company they may not be able to acquire the target contract. In those situations, the buyer may consider a stock acquisition. Because the buyer is acquiring the entity, those contracts will generally stay with the entity and not have to be transferred to a new buyer.
As the buyer, there are some drawbacks to purchasing the stock of an entity. One drawback is that you cannot depreciate the cost of acquiring the stock of the seller. In addition, any liabilities associated with the seller now belong to the buyers. Any bad acts perpetrated by the previous owner could follow you. Let’s say you acquire the stock of a company that committed previously unknown wage and hour violations. Once you become the owner of the company those wage and hour violations belong to you as the new owner. In Massachusetts such claims could be subject to triple damages plus attorneys fees for the damaged employees. Because of this, the buyer’s due diligence and the indemnification clauses in the contract are important to review closely.
Asset or Stock Sales: When You’re Selling a Business
When you’re selling your business, its entity structure will largely affect whether an asset sale or stock sale is preferable. An asset sale can trigger double taxation if your business is a C corporation. When selling assets from a C corporation there is an entity level tax and there is a tax when the shareholders take money out of the company after the sale. There may be certain strategies to minimize the double taxation when selling assets from a C corporation. Talk with your tax attorney if you are selling assets from a C corporation to see if we can help minimize your tax exposure.
From a seller’s perspective, if you own a C corporation it may be preferable to sell the stock of the corporation to avoid double taxation. When C corporation stock is sold, shareholders are selling their stock in the company rather than the Company selling its assets. The shareholder is then subject to capital gains tax on the sale of stock. This allows the selling shareholder to keep more of the profits than they would with an asset sale.
What You Need to Know
If you’ve never bought or sold a business before, it can certainly seem daunting. The stakes are high and you can’t afford to make a miscalculation. As you think about buying or selling a business, these are some of the most important things to keep in mind.
Lean on your advisors. The business decisions you make now can create ripples that touch every part of your financial future, including your retirement plans. Working with a team of financial and legal professionals gives you access to a wealth of specialized knowledge, allowing you to make the choices that best support your business and personal financial goals. Take advantage of that knowledge by surrounding yourself with advisors you trust, and by asking questions at every step of the process.
In addition to your business attorneys, a business broker might be part of the team that helps you structure and negotiate the best possible deal for you. Working with a broker creates value in a number of ways. For one, it might be a big time saver. “With a broker, the seller is actually able to concentrate on their business and not be involved in negotiations,” says Denis Mezheritskiy, a mergers and acquisitions advisor and partner at ROI Corporation. Brokers like him work with clients to buy, sell and value businesses. “A business broker can bring in multiple offers and get higher valuation than an individual typically could. There’s also the ability to force time. Urgency is a number one business tactic in sales, and a broker can create urgency,” he says. “From a valuation standpoint, the right broker can explain exactly what the value of the company is, and give a good understanding of what that company would be sold for.”
CPAs also play an important role in a buyer or seller’s team. “CPAs work together with legal counsel, estate planning attorneys and wealth advisers to understand such things as entity structure, accounting for the sale, preparation of financial statements, understanding the tax consequences of a purchase or sale, and what the pros and cons of each may be,” says Alan Huberman, CPA and tax principal at CLA Newton. Working with a CPA is also critical for planning a smooth transition after the deal is done. “A CPA’s role is to help the client who is selling or passing on their business, or buying one, think through their goals and ensure that they are prepared for their next step, whether it is retirement (after they have sold their business) or running a business (after purchasing one),” Huberman says. “There is no ‘one size fits all’ strategy for this.”
Start as early as possible. Advance planning is key to structuring a deal that meets your long-term business goals and minimizes your tax obligations. Reach out to your business attorneys as soon as you decide you might want to make a move. Sellers in particular tend to suffer from insufficient planning. If a medical or financial crisis arises and the seller just needs to get rid of their business, they may have to settle for whatever deal they can put together quickly. “That’s why it’s very important for a prospective seller who’s thinking about selling to not wait until they need to sell, but to actually plan the sale,” Mezheritskiy says. “There can be a planning process involved to make it a much easier transition for the seller.”
Know that every deal is a little bit different. Even if you’ve bought or sold a business before, the next sale will always be unique. A lot of specific factors can affect how a deal is set up. What kind of assets and liabilities does the business have? What are each buyer’s goals for the sale? Does the business have goodwill that will be part of the purchase? How did the deal originate—did the buyer target a business they really wanted to own and convince the owner to sell, or is the seller desperate to unload their business quickly? What kind of tax strategy is likely to save you the most money? These are just some of the things advisors take into consideration when working with clients to put together advantageous deals.
The business attorneys at Sassoon Cymrot Law, LLC are here to help you weigh all your options around mergers and acquisitions to make the choices that best serve your specific situation. We’re here to help you weigh all your options around mergers and acquisitions and make informed decisions that help you meet your financial goals—no matter how much (or little) experience you have with business sales.
We welcome any questions you may have. Contact us today!