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Should you consider an asset sale or stock sale?

By / February 22, 2018

One common question that comes up as a deal moves toward a closing is whether the sale should be an asset sale or a stock sale.

A couple quick points before we get into specifics: First, this column contains around 1/100th of the information required to adequately cover this topic. So, any decision you make—asset vs. stock—must be made in consultation with your accountant and tax attorney. Secondly, in the “lower middle market” (up to $100 million in sales), 70%-plus of sales are asset sales, because, to put it bluntly, that’s what buyers demand.

That said, of the five different company types, (sole proprietorships, LLCs, partnerships, C-corporations and sub-S corporations), each has idiosyncrasies that will affect your election. However, “non-corporate entities” (sole proprietorships, LLCs, and partnerships) can present special tax peril for the sellers, and no one-size-fits-all rule applies. Accordingly, in the most general terms, the election to go with an asset sale or a stock sale largely depends on the legal liability assumed by the acquirer, and by the tax implications to the seller and acquirer.

Liabilities: In an asset sale, the acquirer gets to rule in and rule out what assets it wants to purchase, whereas in a stock sale the liabilities are not just the encumbrances of the assets, but also any liability that may arise for wrongdoing of the entity under its prior ownership…unless the seller rules out certain liabilities in the “representations and warranties” within the purchase agreement. See why most acquirers want an asset sale?

Depreciation: In an asset sale, the acquirer’s basis for depreciation is the fair value paid for each asset, or class of assets, regardless of the tax basis of each asset or all assets taken aggregately. To the extent that the fair value of the company is greater than the fair value of its assets, this “excess” is allocated to “goodwill,” which is depreciated for tax purposes as a separate asset over 15 years. So, the acquirer has an incentive to allocate as much of the purchase price as possible to assets with the shortest recovery periods, determined with reference to the allocable purchase price. The seller’s gain is determined with reference to the basis in each asset sold rather than the aggregate basis of all assets. Again, you see why acquirers want an asset sale.

Rights: In a stock sale, you may risk that minority stock holders can block a sale. Many corporations protect minority shareholder rights by agreement, but such agreements can also compel minority shareholders to sell their interests, even when they don’t agree with the majority. This a frequent occurrence. (Minority shareholders may also assert their rights by filing a lawsuit claiming that majority shareholders are betraying fiduciary duties.)

Assets: Note that in an asset sale, there are some assets that are difficult for a seller to assign to an acquirer, such as a rail siding agreement, or a land-use covenant assigned to the seller’s family; licenses, permits…the list goes on. A stock sale entitles the acquirer to these assets without a reassignment, driving down legal costs…and the time it takes to close a deal.

Taxes: Generally, the taxes are higher for the seller in an asset sale because of the differential tax rates that may apply to certain types of assets. The seller may end up paying capital gains rate on some aspects of the sale, and the seller’s marginal rate on others. But note that the seller’s tax treatment is due to tax rates on certain types of assets, but also due to exposure to ordinary income treatment for the portion of gain attributable to recapture of prior depreciation.

What’s right for you?

Confused? I don’t blame you. When I’m asked if a stock sale or an asset sale is preferred, I have to answer: “Well, it depends, but the best advice I can give is to speak with your tax accountant and a solid tax attorney.”

Every business is idiosyncratic. When determining what’s best, we look at tax implications, the number of share-holders, and how willing they all are to sell their shares. We also look at the company’s locations, as well as the nature of the assets themselves (e.g. are there an abundance of licenses, permits, leases, etc.), and all potential liabilities—the known knowns and unknown unknowns. Only then do we make a recommendation that’s right for our client.

John D. Wagner

John Wagner is a managing director at 1st West Mergers and Acquisitions, which offers a specialty practice in the LBM sector. To learn more, contact John at: [email protected], or visit www.1stwestma.com.