By Dr. Jim Dahle, WCI Founder

While 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:

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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.

asset sale vs stock sale

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.

 

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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? Comment below!