By Dr. Jim Dahle, WCI FounderWhile contemplating a potential sale of WCI—as we have occasionally done over the years (no, we didn't sell, but we also don't expect to own WCI 20 years from now)—I spent some time learning about stock sales vs. asset sales. I think this knowledge could be helpful to a lot of white coat investors who own businesses, whether from a side gig or from their main practice. There are advantages and disadvantages to both a stock sale and an asset sale. We'll go over both today.
What Is a Stock Sale?
When you do a “stock sale,” the purchaser owns the company that you have built. You're selling them the stock in the company. You then pay capital gains taxes on the difference between the sale price and the basis. Nothing else in the company changes except the person or entity that owns it. The contracts with vendors, employees, and clients all stay in place. The company still owns everything that it owned before. Same bank accounts. Same warehouses. Same intellectual property. You get the picture.
What Is an Asset Sale?
With an asset sale, the seller still owns the business entity that was the company. However, that business entity has been hollowed out because everything (or at least some things) inside it has now been sold. The seller pays the business for those assets and liabilities. The business no longer holds the assets or liabilities, but it does hold cash or at least some kind of note instead. An asset sale generally does not include cash (other than working capital) and often does not include any long-term debt—the classic “cash-free, debt-free transaction.” The asset sale can be more complicated as each asset is conveyed separately.
More information here:
Selling Your Medical Practice for an Early Retirement
Medical Practice Valuation: 5 Most Important Elements
Can You Do a Stock Sale If You Are Not a Corporation?
Technically, a sole proprietorship, partnership, or Limited Liability Company (LLC) cannot do a stock sale, because they don't have any stock. However, they can do something very similar with a “partnership or membership interest sale.”
Stock Sale vs. Asset Sale: Which to Choose?
As a general rule, sellers prefer stock sales and buyers prefer asset sales. With an asset sale, the buyer can get a step up in basis on the company's depreciable assets. Equipment (3-7 years) can be depreciated faster than goodwill (15 years) and provide some tax advantages and cash flow improvements in the next few years. Perhaps more importantly, an asset sale allows the buyer to avoid some potential liabilities—such as employee lawsuits, product liability or warranty issues, or contract disputes. All of those stay with the original company that continues to exist.
Sellers don't like asset sales so much because they can potentially generate higher taxes. While intangible assets (goodwill, a brand, securities, trademarks, patents, and copyrights) qualify for long term capital gains rates, the sale of “hard” assets can be subject to ordinary income tax rates. Hard assets are machinery, inventory, a fleet of trucks, office furniture, and buildings. In addition, if the original business was a C Corporation, those proceeds can be subject to double taxation. First, you pay taxes on the sale at corporate ordinary income tax rates (21%) and then you turn around and pay dividend taxes (up to 20%) and potentially Obamacare (NIIT) taxes (3.8%) for a total of 44.8% instead of just 23.8%. This is not an issue with an asset sale from a sole proprietorship, partnership, S Corporation, or an LLC filing as any of those entities.
A seller likes a stock sale, because everything gets taxed at capital gains rates, and all of the liabilities go with the company when sold rather than being retained by the owner (although they can be shifted back by agreement). With a C Corporation, the double taxation issue is also avoided. It's also just a really clean transaction.
A buyer generally does not like a stock sale due to getting less of a depreciation expense and due to the additional liabilities. However, there are some advantages, even for a buyer. There is less risk of losing contracts, and it is much less hassle to reassign intellectual property to the new owner.
One additional advantage of an asset sale for a seller is that the entity lives on, along with its employee contracts, 401(k), and other benefits. This could allow the seller to pay employees (including the owner or owners) part of the sale price (or even salaries or bonuses) and take a deduction for those payments as well as make additional retirement account contributions from them. This might be an easier way to pay out employees instead of trying to get the acquiring business to write it into the sales contract.
Don't get too hung up on whether the sale of your business is going to be an asset sale or a stock sale. If a particular type of sale leaves one member of the transaction at a significant disadvantage, the sale price or terms can always be adjusted to account for that. However, recognize there is an advantage to your buyer to offer you an asset sale instead of a stock sale, so make sure you are compensated appropriately for that.
In need of help on your financial journey? Over the years, The White Coat Investor has carefully curated a recommended list of professionals who have been thoroughly vetted and trusted by thousands of readers. Explore our handpicked selections today, and get the exceptional support you deserve.
What do you think? Have you sold or bought a business? Was it a stock sale or an asset sale and why? Were you glad you did it that way?
Physician practices, especially those in primary and urgent care, have unique attributes that can make an asset sale appealing to both buyers and sellers. These include a low physical asset-to-goodwill ratio and a high liability risk.
As mentioned in the article, sellers of many businesses prefer a stock sale as it is advantageous to them from a tax perspective. However, most physician practices have limited physical assets. Unless the medical practice owns the building in which it operates, most are asset-light.
Even if the operator owns the building, it is usually held in a separate legal entity for liability purposes and can be sold separately. A practice will have furniture, fixtures, and equipment (FF&E), or all the business’s non-fixed items. For non-specialty clinics, the most expensive equipment may be an X-ray machine; otherwise, it’s just furniture and maybe some lab equipment. Any immovable building components or TI (tenant improvements) are considered part of the building and are the landlord’s property. A practice may also have inventory, but this will be minimal if the business runs efficiently.
So, what is a buyer of a medical practice actually buying? Goodwill, including patient lists, reputation, and patient habits. Since goodwill is still tax-efficient for the seller, this low physical asset-to-goodwill ratio makes asset sales more palatable. The buyer prefers less goodwill since its depreciation schedule is extended, but it is hard to argue for physical assets that just don’t exist.
Next, medical practices carry non-negligible medicolegal risk. If you purchase the entity associated with a practice in a stock sale, you buy all the risk related to that practice’s history. Many malpractice cases take time to reach the defendant, often years. This makes an asset sale even more appealing to the buyer, and the nature of medicolegal risk leaves the seller unable to argue against it.
I can recommend two books on business transactions. Buy, then Build by Walker Diebel, and Strategic Acquisition by David Annis and Gary Schine.
Thanks for weighing in with that additional info.
@WCI
When did this blog really start to take off? When did you hire your first employee? How much money does it make? When did you hire your children as child models? When did you hire your wife? How much do you pay Rikki? Do you worry about Rikki?
I’m trying to start my own venture and it would be helpful to learn from your story!
I’m not sure how seriously to take you with that name but you can search on the blog for “state of the blog” posts and follow along since 2011. Everything I’m willing to reveal about this business can be found there.
Hello Dr. Dahle,
Forgive me if this was the wrong locations to ask this question, but I believe you’re the only person who can help me since I do not have a CPA
In 2020, I invested in a equity fund at 50,000. I exited my position in october 2023. When doing my taxes it asks for the Sale price, selling expense, partnership basis, ordinary gain and 1250 gain if applicable on applicable.
My ITD was 20,628 from the 2Q2023 report before I sold, which included a return of capital of 9543 after a sale of a property in 2022. After the 2Q2023 quarterly report, I never received any additional distributions and in october my position was closed and my equity balance of 40,456 was returned to me (sale price)
My 2023 K1 says my net long term capital gain is 25,628. I emailed the sponsor to ask why my net long term capital gains is not 20,628, and he said this is because Distributions and income/gain are not the same thing and “When calculating an exit from an investment you have to get your capital account to $0 (see box L on the K-1). If you look at the starting balance in box L on your K-1 you’ll see $15,135. This corresponds to your $15,135 ending balance on your 2022 K-1 Box L. Your buyout amount was $40,456. Take $40,456 minus $15,135 and you get $25,321. You received two distributions in 2023, one for $112.09 on Feb 15, and one for $194.94 on May 5. That totals $307. Add $307 to $25,321 and you get $25,628, which equals your net long-term capital gain as shown on your K-1.”
Does this make sense?
More importantly, I do not know how to fill out the questions in turbotax. I know my selling price as above. The sponsor said the 1250 gain is 0.
Is the Ordinary gain I have to report 25,321?
For partnership basis he said It’s either the beginning capital account shown in box L of the K-1, or it’s your cash basis in the investment which would be my sale price. Which is it?
For selling expense he said it would be any costs I had to incur like wiring fees but they did not charge me anything for the sale.
I am sorry for the long email, I just figured more information would help. Thank you so much!
The likelihood of me being THE ONLY person that can help you seems low, but I might be one of the few doing this sort of thing for free. I can tell you for sure that I’m not a Turbotax expert nor the Turbotax help line, which might be who you should call. Or perhaps hire a CPA. I had to when the Turbotax approach no longer worked for me. I’m also nowhere near an expert on how to CREATE a K-1 in a situation like this, but the explanation seems reasonable to me so I don’t think I’d push it much further.
Cost basis isn’t your sale price. It’s what you paid for your share of the business. I don’t know the questions in Turbotax but if the K-1 is reporting a gain of $25K, that’s what I’d put down if I was asked for my gain.
I did my own taxes until about 3 years ago. With 20+ K-1s, multiple corporate returns, and now a trust return, I really need an expert to answer questions like the ones you have, especially when filing in a dozen or more states. I know a lot more about taxes than most docs, but still a lot less than a really expert tax preparer. Maybe you’re getting to the point where it would be worth a few thousand a year to get professional help.
You pay at capital gains rates. The buyer gets new basis equal to their purchase price.