I once received an executed letter of intent (LOI) from a new client who asked me to prepare the underlying purchase agreement. The business broker-prepared LOI simply referred to “the sale of the business” — without specifying the proposed structure of the transaction, which is (almost always) either an asset sale or a stock sale. This is a critical point that absolutely needs to be set out in an LOI… but what’s the difference?
In an asset sale, the buyer purchases specific assets of the business (equipment, inventory, intellectual property, customer lists, contracts, goodwill, and so on) and typically assumes only specifically identified liabilities. The selling entity itself (typically a corporation or LLC) is not transferred; it remains with the seller, who retains ownership of it along with any liabilities not expressly assumed by the buyer. In an asset sale, the actual “seller” is the business entity, not the individual owner(s).
In a stock sale (or, in the case of an LLC, a membership interest sale), the buyer purchases the ownership interests in the entity itself and then becomes the owner of the entity operating the business. The sold entity continues to own all its assets, remain a party to all contracts, and is still liable for all liabilities, whether known or unknown at the time. The entity continues on unchanged; only its ownership changes hands. In a stock sale, the owner(s) (often individuals) is/are the “seller(s)”.
A simplified analogy is a warehouse from which a small microbrewery is operated; the owner of the brewery also owns the warehouse. In this scenario, the warehouse can be viewed as the business entity (corporation, LLC, etc.), and the brewery equipment constitutes the business assets. An interested buyer can offer to purchase just the brewery equipment, then have it moved to a new location — this is analogous to an asset sale. Alternatively, the buyer may offer to purchase the entire warehouse, including all its contents, which would include not only the brewing equipment, but also all mechanical systems, alarm systems, and the warehouse structure itself — this is analogous to a stock sale. If it’s subsequently discovered that the warehouse needs a new roof, that’s not an issue for the buyer if only the equipment is purchased (asset sale), but if the entire warehouse is purchased (stock sale), then all issues involving not only the equipment but also the warehouse are also assumed by the buyer. The leaking roof could represent a potential liability which ordinarily would remain with the business entity — in an asset sale, it’s unlikely liability for the claim would follow to the buyer, but in a stock sale, the claim absolutely remains with the sold entity and now the buyer needs to deal with it.
Buyers Generally Prefer Asset Sales. From a buyer’s perspective, asset sales tend to be preferred for two primary reasons: liability and taxes. As illustrated above, when a buyer purchases assets rather than stock, as a general rule, they do not inherit the seller’s pre-existing liabilities, which may include pending litigation, tax obligations, employment claims, and the like. The buyer gets a relatively clean slate, unlike in a stock deal when liabilities of the sold entity remain in place (with the sold entity), and now the buyer “owns” those liabilities as well. Additionally, an asset purchase often provides the buyer with favorable tax treatment, as the purchase price can be allocated among the acquired assets and depreciated or amortized going forward.
Sellers, on the other hand, frequently prefer a stock sale, primarily for tax reasons. In a stock sale, the seller’s gain is generally taxed at capital gains rates, which tend to be lower than ordinary income rates. In an asset sale, depending on how the purchase price is allocated among the various asset classes, portions of the gain may be taxed as ordinary income. Depending on the facts of a given deal, the difference between these two tax treatments can be substantial — but each deal is unique.
Beyond taxes, a stock sale can also be simpler to execute from the seller’s perspective. In an asset sale, contracts, licenses, and permits often need to be individually assigned or re-issued in the buyer’s name, which can be time-consuming and often require third-party consents. In a stock sale, since the entity itself doesn’t change, these agreements typically remain in place without the need for assignment (though a “change of control” trigger in an assignment clause can still require the consent of a contracting party).
It’s Usually an Asset Sale. In practice, for small to mid-sized privately held businesses, the large majority of transactions are structured as asset sales. Buyers tend to have the stronger negotiating position on this point, and most sellers acquiesce. An exception to this presumption is if a major asset of the selling business is one or more key contracts — if these contracts do not permit an outright assignment, nor contain a “change of control” clause, then in that unique situation, a stock sale may be preferred by both parties.
Final note: if you own a business structured as a C-corporation, speak with your tax advisor before you start exploring a potential sale. Tax consequences involving a business sale of a C-corporation can be even more dramatic than with tax pass-through entities (S-corporations and LLCs), so it’s advisable to have a solid understanding of the situation before you involve a third party in the conversation.
Ander Smith is an accomplished attorney with a practice dedicated to assisting clients on a wide range of business transactions. Prior to his current solo practice, Ander worked both in-house and at national law firms. You can contact him at [email protected].
Information contained in this article is not intended to and does not constitute legal advice, recommendation, or counseling under any circumstance. This article does not create an attorney-client relationship. Pursuant to applicable rules of professional conduct, portions of this publication may constitute Attorney Advertising.