How to Evaluate Alternative Sale Structures for Your Business
Capital structure analysis is important for determining the right structure for selling your business. Generally, you have two ways to sell a business. First, you can sell company stock known as a “stock sale.” Stock is always owned by shareholders, rather than by the company itself, so in a stock sale, the individual shareholders (such as you, the owner and any partners) sell the stock. Second, you can sell the company’s assets; this is known as an “asset sale.” In an asset sale, the buyer purchases assets from the company itself rather than from individual shareholders.
In general, capital structure analysis involves examining the pros and cons of an asset sale vs stock sale. Each of these sale structures offers different benefits and liabilities for both buyer and seller. If you’re open to both types of sale structures, you may attract more or varied buyers. But before agreeing to a certain type of sale, it’s important to understand the tax and liability consequences of each one.
Typically, for tax and liability reasons, most business buyers want to purchase the assets of the business, rather than undergoing a stock sale. In an asset sale, the buyer can limit his or her liability for business obligations to things that arise after the sale. He or she can make sure that former stockholders would remain responsible for the company’s pre-sale liabilities.
In addition, with an asset sale, a buyer’s tax basis will be the amount he or she chooses to pay for those assets. The buyer has more control over his tax basis with an asset sale, because he agrees to pay a certain amount for the assets. On the other hand, with a stock sale, the buyer isn’t paying directly for the assets, so his cost basis would be based on what the seller previously paid for the assets.
If you decide to sell your business through an asset sale, you and your buyer will have to negotiate prices for various assets including capital assets, depreciable assets, and intangible assets, such as goodwill, licenses, patents, trademarks, supplier loyalties, and business methods.
Typically, sellers prefer a stock sale over an asset sale. Selling stock is usually less complicated than selling assets. Stock sales may be necessary if certain contracts or intellectual property cannot be easily transferred.
For sellers, a stock sale typically means they no longer have sole responsibility for things that happened in the business prior to the sale, such as tax obligations and product warranties. To compensate for the extra liability, however, a buyer may ask the seller to agree to a warranty that the business’s liabilities will not exceed a certain amount, or the seller will reimburse the buyer for expenses over that amount. A stock sale buyer may also request to pay for the business in installments over time or to include a consulting arrangement in the deal, so that the seller must stay on board to provide advice for a certain length of time.
When it comes to taxes, a stock sale offers advantages for the seller. The sale of stock is subject to capital gains taxes, which are lower than the ordinary income tax rate at which the sale of assets would be taxed. Because the stock is sold by the shareholders, the business itself recognizes no gain or loss when its stock is sold. That results in a seller paying tax only once, on the sale of his or her stock. In contrast, an asset sale may create double taxation, once on the corporation and once on the shareholders when they receive dividends.
Because tax and liability implications of both asset sales and stock sales can be highly complex, it’s a good idea to work with a CPA who understands all the options available for the specific sale structure you choose. An advisor who has deep experience in structuring the sale of businesses will be able to help you negotiate and provide options that may satisfy both the buyer and the seller.
For example, if you want to sell your business as a stock sale, but your buyer wants to purchase it as an asset sale, an experienced advisor can help develop a strategy that may work for both of you. A CPA who has experience with structuring business deals can file a 338(h)(10) election, which allows you to sell the Company stock, but allows buyers to treat the acquisition as an asset purchase for tax purposes.
Taking time to understand the ins and outs of various business sale structures can help you be better prepared to negotiate a sale that will meet your needs and goals.