Although valuation is obviously the most critical variable in an exit event, the structure of the transaction can also have significant (and often surprising) effects on the consideration ultimately received by the sellers’ shareholders. Moreover, the buyer’s interests will generally be directly adverse to those of the seller with respect to deal structure. This is particularly true in deciding between an asset sale and a stock sale, where parties often adjust other elements of the deal (including valuation) in order to accommodate one side’s preferred structure. Accordingly, understanding the following three basic drivers of the asset versus stock sale question can significantly improve a founder’s negotiating position vis-à-vis potential purchasers.
In addition to the basic asset versus stock question explored below, there are a number of different decision points that can arise in negotiating deal structures (including various tax elections that effectively eliminate the divergent tax treatment described below). Moreover, the below list is not intended to be an exhaustive categorization of the advantages and disadvantages of asset and stock sales. Accordingly, it is generally advisable to consult with your legal and tax advisors as early in the process as possible regarding the tax and other consequences of a particular deal structure in your given circumstances. That said, the following three categories will generally be the most important factors to consider in deciding between an asset and a stock sale.
Accounting and Tax Consequences
From an accounting and tax perspective, buyers generally prefer to purchase a company’s assets (assuming that they have appreciated in value since the company’s formation), as this structure allows the buyer to “step-up” the basis of the purchased assets to the price paid for them in the transaction. This increased basis in turn increases the amount of annual depreciation taken by the buyer on the assets, thus sheltering a greater portion of the buyer’s revenue from taxes. Conversely, in a stock sale, the buyer assumes the seller’s original basis in the assets of the purchased business (which may already be fully depreciated) and continues to depreciate these assets at the same rate as before the transaction (if at all).
Notwithstanding this buyer preference, an asset rather than stock sale will generally result in significantly greater tax liability to the seller and its shareholders (assuming that the seller receives primarily cash consideration for the sale and thus does not qualify for tax-free reorganization treatment). Specifically, in an asset sale, the selling company itself will be taxed on any difference between the sale price and its basis in the assets, generally at corporate capital gain rates equal to high ordinary income rates (which corporate-level taxes, however, may be offset by net operating losses from prior periods if available). In addition, in order to distribute the proceeds from an asset sale to its shareholders, the selling corporation will either need to dissolve or distribute dividends, both of which are taxable transactions to the seller’s shareholders. In a stock sale, however, there is no “double taxation,” as only the seller’s shareholders are taxed on the difference between the purchase price and their basis in the stock, generally at lower individual capital gains rates (assuming that the shareholders have held the stock for over one year).
Exposure to Liabilities
In addition to the accounting and tax benefits described above, buyers often prefer asset to stock purchases because the former allow them to specify exactly which liabilities they are willing to acquire from the seller and thus to exclude contingent liabilities that may be difficult to value. Although certain categories of liabilities (e.g. tort, tax and environmental) may follow the assets even if not expressly assumed, an asset sale thus generally provides the buyer with significantly greater certainty regarding its exposure to liabilities. This increased buyer certainty, however, comes at a cost to the sellers, who are not able to completely step away from the business following an asset sale because they may still be responsible for liabilities associated with the business but excluded from the sale. Where a buyer is insistent on an asset sale, the sellers can significantly mitigate this risk-allocation problem by negotiating a broad definition, or being diligent in identifying the list, of liabilities to be assumed by the buyer.
In addition to the above disadvantages, from a seller’s perspective, of an asset sale relative to a stock sale, asset sales generally involve significantly greater procedural complexity than stock sales and thus often take longer to consummate. Specifically, identification and separation of assumed versus excluded assets and liabilities, together with the additional documentation required to transfer title to certain assets, can increase legal, accounting and tax transaction costs in an asset sale. Moreover, assignment of contracts in an asset sale more frequently triggers third-party, contractual consent rights than in a stock sale, which represents a mere change in control of the selling corporation rather than an assignment of contracts to a new legal entity. While the burden of these additional transactional complexities may fall disproportionately on the seller, an asset rather than stock sale will generally also increase the transaction costs to the buyer and will extend the closing timeline for both parties. Accordingly, unlike the foregoing issues, in which the buyer and seller have directly opposing interests, the transactional complexities inherent in an asset sale represent an important area of alignment that can be leveraged by the seller in negotiating for its desired deal structure.