If you are entertaining the idea of selling your business, you may have two options to structure the sale: an asset sale and an equity sale. However, both have different business, legal, accounting, and tax implications. Additionally, they both come with distinctive advantages and disadvantages which you must carefully evaluate before proposing or accepting one or the other.
Business buyers often prefer an asset sale whereas sellers would like to opt for an equity sale. There are several reasons for this, but the primary one is that there is typically beneficial tax treatment for sellers when selling equity, while most institutional buyers such as private equity groups will only agree to do asset purchases due to the increased contingent liabilities they would be inheriting if they were to purchase equity of companies.
For several accounting, legal, tax, or business reasons, it makes more sense to structure some deals as asset sales and others as equity sales. For instance, equity deals are more straightforward for legal and tax purposes, however buyers might shy away from them.
What is an Asset Sale?
An asset sale is a sale transaction in which the seller retains ownership of a business as a legal entity while selling individual tangible and intangible assets like equipment, inventory, patents, customer lists, real estate, trademarks, contracts, and intellectual property.
Based on your industry and the specifics of your business, the buyer might spell out specific items like contracts, customer lists, and patents on the purchase agreement. Once the buyer holds the assets, it controls the business by virtue of owning everything that makes the seller’s equity worth something.
Typically, asset sales do not include cash and the seller pays off all long-term liabilities on the company’s balance sheet at the time of close. This is called selling on a “cash-free and debt-free” basis.
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If you are interested in selling only a part of your business, our “How to Sell a Portion of a Business” guide can help you.
What are the Advantages of an Asset Sale for a Business Owner?
Here are the key advantages for a seller in an asset sales transaction:
- Selling selective assets: Asset sale allows sellers to choose which assets to sell, allowing them to retain ownership of assets they consider essential or more valuable in the future.
- Focusing on the core business: Selling non-core or underperforming assets helps you concentrate your resources on your primary business activities.
- Tax advantages: Depending on the jurisdiction, what their basis is in various assets, and a handful of other considerations, the seller might benefit from favorable tax treatment on the sale of specific assets.
- Valuation Control: In certain cases, spinning off or selling individual assets or lines of business can sometimes fetch a higher price than selling the entire business, particularly if the assets have a distinct, high value.
Drawbacks of Asset Sales for a Seller
Here are the key disadvantages of an asset sale for the seller:
- Tax implications: In an asset sale transaction, the proceeds from an asset sale may be treated as ordinary income facing higher tax rates than capital gain tax. Moreover, if the assets being sold have been depreciated, the seller may be required to pay taxes on the recaptured depreciation at higher ordinary income tax rates.
- Liability retention: While selling an entire business, liabilities too are transferred to the buyer, or they have to be paid off before the close as a condition of getting the deal done. However, in an asset sale, liabilities such as long-term debts are paid off by the seller before closing.
- Complexity: In an asset sale transaction, buyers may be interested in certain assets (for instance specialized machinery or only a specific business division) with a particular purpose. Therefore, asset sale transactions can be more time-consuming and require more paperwork as individual assets, rather than the entire business, need to be transferred.
- Consents and assignments: Third-party consents or approvals may be required to transfer certain assets.
Definition of Equity Sale
In an equity sale, the buyer purchases all outstanding equity interest (either stock or membership interest units) of the company to become its legal owner.
An equity sale enables the buyer to acquire ownership of the entire business including all its tangible and intangible assets, liabilities, contracts, and obligations.
After the conclusion of an equity sale, the existing business continues under a new management. Equity deals are more common when larger corporations acquire smaller competitors or entities to expand their business. Also, the buyers in equity deals are more commonly financial buyers, rather than strategic buyers.
An equity sale is often preferred by sellers because they may benefit from preferential capital gain treatment on any resulting proceeds. However, buyers typically prefer not to buy stock, which prevents them from receiving a step-up in the tax basis of the corporation’s assets.
In some cases, buyers would be inheriting unknown or contingent liabilities with an equity purchase as well. Many investment groups such as private equity firms are averse to this and therefore will not execute equity deals.
To deal with this situation, an “F” reorganization, under the IRS Code Section 368(a)(1)(F), allows for a stock sale to be treated as an asset purchase by the buyer while enabling the seller to receive preferential capital gain treatment.
This may help a transition go more smoothly as the customer contracts do not need to be reassigned as they will still technically be working with the same company post-close.
On the other hand, Section 338(h)(10) allows treating a stock acquisition as an asset acquisition for federal income tax purposes.
Selling a business, irrespective of the mode of sale, is an exhausting process. So, it’s crucial for you to work with a professional M&A advisor who can help you achieve the most favorable terms for exit.
Asset Sale Vs. Equity sale – Key Differences?
Asset and equity sales are different in that asset sales can be a complex and time-consuming process. It has unfavorable tax implications for the sellers. In addition, the seller retains the business’ long-term liabilities.
A stock sale is a more straightforward way of selling your business – it allows you to sell your entire business including all its assets and liabilities while lowering your tax liabilities. However, stock sales may face certain legal and regulatory hurdles that can prevent certain deals from going through.
Moreover, stock sales may fetch a lower sale price if buyers want to negotiate a lower price to compensate for its higher tax liabilities.
Both asset and equity sales offer unique advantages and advantages. As a business owner, selling your business is a significant decision – therefore, choosing the right transaction structure (asset sale vs. stock sale) is crucial to protect your interest.
While selling a business through asset or equity sales, along with the use of Section 338(h)(10) election and F reorganization, you need to consider factors like the assets and liabilities of the business tax implications, business circumstances, and the objectives of both parties.
Every business has unique business circumstances – therefore, consulting with business brokers or M&A advisors with experience in selling businesses through both asset and stock sales can help you achieve the ideal outcome.
At Raincatcher, We implement a bespoke process for each unique transaction that is proven to drive the best value and terms for our clients. Get in touch with us today and explore how we can help you unlock the full potential of your business.
