Most Main Street transactions are structured as asset sales, because buyers prefer them and lenders are comfortable with them. The structure is still negotiable, and it affects what the seller keeps after tax, which liabilities move to the buyer, and how complicated the closing will be. Sellers should understand the difference before price is discussed, since a price agreed under one structure may be worth materially less under the other.
The two structures
In an asset sale, the buyer forms or uses its own entity and purchases specified assets from the seller's company: equipment, inventory, customer relationships, the trade name, contracts and goodwill. The seller's entity continues to exist, holds whatever was not sold, pays its remaining liabilities and distributes the proceeds to its owners.
In a stock sale, the buyer purchases the ownership interests in the entity itself. For an LLC, these are membership interests. The company continues unchanged, with all of its assets, contracts, history and liabilities. Only the owner is different.
Why buyers prefer asset sales
Two reasons dominate.
Liability. An asset buyer takes only the liabilities it agrees to assume. Obligations arising from the seller's period of ownership, including unknown ones, generally stay with the seller's entity. There are exceptions under state law for certain taxes, employment matters and environmental claims, but the protection is substantial.
Tax basis. The buyer records the acquired assets at the purchase price and depreciates or amortizes that amount. Equipment can often be written off quickly, and goodwill is amortized over fifteen years. These deductions reduce the buyer's taxes for years after closing. In a stock sale, the buyer generally inherits the company's existing, lower basis and loses that benefit.
Why sellers often prefer stock sales
Speak with an advisor
Whether you are buying or selling, an initial conversation is confidential and carries no obligation.
The seller's reasons mirror the buyer's.
A cleaner exit. All liabilities transfer with the company, subject to whatever the seller agrees to cover through representations and indemnification.
Tax treatment. A sale of stock held more than a year is generally taxed as long-term capital gain. In an asset sale, part of the gain may be taxed as ordinary income, particularly amounts allocated to equipment that has been depreciated, to inventory and to certain other items.
Simplicity with contracts. Because the entity does not change, many contracts, licenses and permits stay in place without assignment.
Entity type changes the analysis
The tax difference between the two structures depends heavily on how the selling company is taxed.
S corporations, partnerships and most LLCs are pass-through entities. An asset sale produces a single level of tax at the owner level. The seller may pay somewhat more than in a stock sale because of ordinary income on certain assets, but the gap is often manageable.
C corporations face a harder problem. An asset sale is taxed once at the corporate level and again when proceeds are distributed to shareholders. For a C corporation with significant gain, the difference between an asset and a stock sale can be large, and it is frequently the central issue in the negotiation.
Owners of C corporations should raise this with a tax advisor well before a sale. Some planning steps require years to take effect.
Purchase price allocation
In an asset sale, buyer and seller must agree on how the price is divided among asset classes, and both report the same allocation to the IRS. Their interests diverge.
Buyers favor allocating more to equipment and other assets that can be deducted quickly. Sellers favor allocating more to goodwill, which is generally taxed at capital gain rates. Amounts allocated to a non-compete or a consulting agreement are ordinary income to the seller.
The allocation is a negotiated term with real after-tax value on both sides. It should be addressed in the letter of intent or shortly after. Leaving it to the week of closing is a mistake.
When a stock sale is the better answer
Certain circumstances favor a stock sale even when the buyer would otherwise resist.
- Contracts or licenses that cannot be assigned. Government contracts, certain payer agreements in healthcare, and some permits may be lost or delayed in an asset transfer.
- A large number of contracts or titled assets, where reassignment would be costly.
- A C corporation seller, where double taxation would consume too much of the price.
- Partial sales. When the seller is retaining an ownership interest, the transaction is ordinarily a purchase of equity.
Middle paths
Tax law offers elections that allow a transaction to be a stock sale legally while being treated as an asset sale for tax purposes. These are available mainly when the target is an S corporation or is restructured before the sale. They give the buyer a stepped-up basis while preserving contracts and licenses. They add cost and complexity, and they require qualified tax counsel.
Bridging the gap with price
When structure benefits one party at the other's expense, the usual solution is an adjustment to price. A buyer who gains valuable deductions from an asset purchase can afford to pay more. A seller asked to accept that structure can calculate the additional tax and request an increase to offset it. The discussion is productive when both sides have run the numbers and unproductive when either is guessing.
What to do first
Three steps prepare an owner for this conversation.
- Confirm how the entity is taxed and how long that status has been in place.
- Ask a tax advisor to model after-tax proceeds under both structures at a realistic price.
- Identify contracts, leases, licenses and permits that require consent to assign or that contain change-of-control provisions.
With that information, the owner can evaluate offers on what matters: the amount retained after tax and the obligations that remain.
This article is general information and is not tax or legal advice. Twelve31 Advisors works with each owner's tax and legal counsel to evaluate structure before a business goes to market.
