The Benefits and Implication of Stock Sale vs Asset Sale in the US

Stock Sale is defined as the purchase of the owner’s shares of a corporation, while the purchase of individual liabilities and assets can be defined as an asset sale. Depicting a business sale as a stock sale or as an asset sale can be tricky, considering the benefits received by the Seller & Buyer from different systems.

For a business that is an LLC (limited liability company), a sole proprietorship, or a partnership, none of these organizations has stocks. Hence, a transaction cannot be depicted as a stock sale. Incorporating the business as a regular S-Crop or a C-Crop would make the buyer and seller decide if the deal should be structured as a stock sale or an asset sale. The negotiation for such type of transaction is made keeping in mind the potential liabilities and tax implications.

About Stock Sale and its Implication for the Buyer and Seller:

The buyer purchases shareholders’ stock sold directly by the seller. Consequently, acquiring ownership as a part of the Seller’s legal entity. Asset sale and stock sale acquired actual assets and liabilities tend to be similar. The assets and liabilities that a buyer does not desire are either distributed or paid off before the sale commences. A stock sale does not demand separate conveyances of individual assets, as each asset’s title is mentioned within the corporation. This is not the case for asset sales.

Buyer’s Viewpoint:

This loss of the buyer’s ability to gain the upper hand in the assets can result in them not getting to re-depreciate particular assets. A lower depreciation expense translates into higher future taxes for the buyer, in comparison to an asset sale. Furthermore, buyers may purchase a company’s stock, including  unknown contingent risk/liabilities, leading to the acceptance of more risk. Potential liabilities can be mitigated in the stock purchase agreement. This can be achieved through warranties, representations & indemnifications.

A stock sale might be a preferable choice for businesses. It has a lot of patents, contracts with the government or corporations, or copyrights that are challenging to transfer because the corporation, not the individual, retains ownership.

Seller’s Viewpoint:

Sellers often prefer stock sales as all the revenue. Which is taxed in C-Corp at a lower capital gains rate and bypassing the corporate level taxes. Similarly, sellers are sometimes less responsible for future liabilities, such as employee lawsuits, contract claims, product liability claims, and benefit plans. However, responsibilities can be shifted back to a seller via the purchase agreement of a transaction.

About Asset Sale and its Implication for the Buyer and Seller:

Buyers purchase individual assets of the company, while sellers retain ownership of the legal body. The seller usually retains long-term debt obligations. Asset sales commonly do not include cash. A debt-free, cash-free transaction is what is being described here. An asset sale also includes normalised net working capital. Net working capital frequently includes prepaid expenses, accounts receivable, inventory, accrued expenses, and accounts payable.

Buyer’s Viewpoint:

Asset sales allow the buyer to “step-up” the company’s depreciable basis in its assets. By assigning a higher value for assets that depreciate quickly (such as – equipment that generally has a 3 to 7-year life) and lower values on assets that liquidate slowly (such as goodwill with a 15-year life), the buyer can gain additional tax benefits. During the vital first years, this reduces taxes sooner and improves the company’s cash flow.

Buyers prefer asset sales because they can more easily avoid inheriting potential liabilities, especially contingent liabilities in the form of product liability, contract disputes, product warranty issues, or employee lawsuits. Certain assets (like – intellectual property, contracts, leases, and permits) are difficult to transfer due to issues of assignability, legal ownership, and third-party consents.

Seller’s Viewpoint:

Asset sales generate higher taxes for the seller. This is due to the fact that whereas other “hard” assets may be subject to higher ordinary income tax rates, intangible assets (such as goodwill) are taxed at the capital gains rates. Federal capital gains rates are currently 20% and state rates vary. Ordinary income tax rates depend on the seller’s tax bracket.

In addition, the Seller faces double taxation, if the entity sold is a C-Corp. The first tax levied on the corporation is upon selling assets to the buyer. Another tax is applied to the owners of the corporation when the proceeds are transferred outside the corporation.

4i Advisory is a leading financial services firm that provides services related to Direct TaxPrivate EquityAccountingAssuranceUS-India Tax and Payroll services. You can contact us at urvesh.patel@4iadvisory.com, and we would be happy to assist you.

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