Asset v. Stock Transactions
So – you want to buy a business that you have been looking at for some time – or – you have decided to sell your business – what structure is right for the transaction? Buyers and Sellers often prefer different transaction structures due to many factors based on the target business. As a general rule of thumb, Buyers prefer asset acquisitions so they can depreciate assets and not “acquire” any of the skeletons or liabilities of the target business. While Sellers prefer a stock sale so that they can receive favorable tax treatment. These preferences may not be true for all transactions and a specific analysis should be done by both Seller and Buyer before deciding the best structure for the transaction. The following highlights some of the differences between asset and stock transactions:
In an asset acquisition, the Buyer purchases specific assets (and sometimes certain liabilities) of the target business. After the closing, both Buyer and Seller maintain their own corporate existence and structure, with a shift of the operating assets of the business to the Buyer.
When purchasing a business, Buyers typically prefer asset deals mainly because (i) they can pick and choose which assets they wish to purchase and (ii) the risk of assuming undisclosed/unknown liabilities is lowered. In an asset deal, Buyers can essentially take what they want (operating assets) and leave what they don’t want (liabilities).
Asset acquisitions can be more complicated (vs a stock transaction) if a business has many valuable contracts and licenses, which will require third party consents or registrations to allow for the assignment of the contracts and licenses. Depending upon the amount of such contracts and licenses, this need for consents and registrations can cause considerable additional work, costs and delay.
Often, a predominant driving force in structuring a business acquisition transaction are tax issues. Buyers often prefer asset acquisitions because they will get the cost basis (based on purchase price) for the acquired assets, allowing them the benefit of depreciating the assets at a stepped-up basis. Essentially, the Buyer would have a greater stream of deductions to use over time to off-set the income of the company. In a stock transaction, the original basis is simply inherited, leaving less depreciation deductions for the Buyer over time.
In contrast, Sellers often prefer a stock sale over an asset sale, because in an asset sale, the seller/target company will recognize taxable income/gain on the sale of its assets. If the target company is a C-corporation, the target company’s shareholders will also be taxed when the proceeds are distributed to them. In the sale of an S-corporation, partnership or LLC, the taxable gain or loss flows through to the owners, avoiding the taxation at the company level. In a stock sale, only the shareholders of a C-corporation recognize any gain. There is not taxation at the company level, so there is only one layer of taxation. The tax effect of a stock or asset transaction is unique to each business and the assets which it holds, so tax advice should be sought to analyze the net tax effect before agreeing to the type of transaction.
In a stock acquisition, the Buyer acquires the stock of the target business directly from the owners of the business being sold. The Buyer therefore acquires all of the assets, liabilities and rights of the target business company.
While Buyers cannot pick and choose assets, sometimes purchasing the company’s stock makes for an easier transition if the Buyer desires to continue the business with little disruption. The liability issue typically will drive Buyers to an asset deal; however, additional protections, including indemnity provisions, can be used in stock transactions to ease the concerns of the Buyer. Due Diligence is also much more robust in a stock transaction to compensate for the added risks being assumed.
Typically a stock transaction will involve much less complexity in terms of transitioning the business as you are not having to move the entire business into a new entity. That said, there still will likely be certain required consents to the transaction. Many contracts and licenses that form a significant part of a business will have a consent requirement, or maybe just a notification requirement, upon a change of control or sale of stock. Barring a change of control provision in contracts and licensure issues, third party consents are generally not needed in a stock deal.
As alluded to above, there still remains a number of tax consideration in choosing whether a stock transaction is right for either party. First, the target company’s basis in its assets will be unchanged in a stock transaction, as the basis is “inherited,” i.e. the same in the hands of the Buyer as it was in the hands of the Seller. The Buyer in a stock transaction will receive a stepped-up basis in the stock of the target company equal to the purchase price, but generally, the Buyer would prefer the step up to be in basis of the assets to allow for more depreciation (write-off in future years post-closing). Furthermore, in a stock transaction, the Seller equity holders will recognize gain on the sale of their stock (primarily capital gain) resulting in only one level of tax, sometimes at a lower rate.
Selecting the best structure when selling or buying a business is often critical to the success of the deal itself and it will often have lasting impact on the future of the business. Accordingly, these considerations must be weighed against the desires of the parties, requiring creativity and planning prior to signing any Letter of Intent, so that Buyer and Seller can reach a mutually beneficial result.
If you have any questions about buying or selling a business, please contact Julie I. Kline of Strassburger McKenna Gutnick & Gefsky at (412) 281-5423 or firstname.lastname@example.org.
This document is intended to provide information of general interest and is not intended to offer any legal advice about specific situations or problems. Neither the author nor Strassburger McKenna Gutnick & Gefsky intend to create an attorney-client relationship by offering this information, and anyone’s review of the information shall not be deemed to create such a relationship. You should consult a lawyer if you have a legal matter requiring attention.