If you’re thinking about purchasing an existing company, you need to understand the difference between the different types of acquisitions. In general, most buyers prefer asset sales and most sellers prefer stock sales. Tax implications vary between the two structures, but all parties must reach an agreement.
You can purchase some or all of a company’s assets. In this case, you are not purchasing stock. Asset sales are common on companies that are experiencing financial distress or have gone completely bankrupt. It can be a great opportunity to snag a deal on equipment, inventory or property. All acquisitions and dispositions must be reported to the SEC within four days.
- Pros: As the purchaser, you record the new asset on your books at fair market value, not the seller’s carrying value. This means a higher value for short-lived assets like equipment and a lower value on assets that amortize over a long period of time. This can really improve your cash flow. Because you assume a higher basis, your tax liability will be lower if you choose to sell off an asset for a gain in the future. While goodwill does not amortize for financial accounting, it does for tax purposes.
- Pros: Another key advantage is the ability to handpick which assets you want and which ones to leave behind. You easily avoid contingent liabilities like contract disputes and warranty cases. Furthermore, you don’t have to bother with stubborn shareholders who refuse to sell.
- Cons: All assets must be retitled, and they’re still subject to tax. Additionally, the purchase price is usually higher than it would be for a stock purchase. This is generally to compensate your seller for having to pay a high tax on any gains while you enjoy top-rate tax breaks.
- Cons: For more complicated assets, determining fair market value can be a costly and complex process. Furthermore, government-regulated assets and contracts may require further consent, which can put a major stall on the transaction. Contracts, permits, leases and intellectual property are a few assets that are difficult to transfer.
In a stock sale, you are purchasing a company’s stock directly from the shareholders, at which point the assets and liabilities are sold. You assume the seller’s tax basis for all assets. This is generally the preferred option when purchasing a company with a large number of copyrights, patents or government contracts.
- Pros: It’s fairly simple and inexpensive. You don’t have to bother with costly valuations and retitles. In most cases, buyers can assume non-assignable licenses and permits without consent. You may also be able to avoid paying state and transfer taxes.
- Cons: Securities laws can complicate situations involving a large number of shareholders. Also, it may be difficult to convince some stockholders to sell their shares. The main disadvantage, however, is that you receive neither the step-up tax benefit nor the advantage of handpicking liabilities. All asset and liabilities transfer at carrying value, and goodwill is not tax deductible. The only way to eliminate unwanted liabilities is to contractually sell them back to the seller.
Also, there’s typically more risk involved with a stock sale as compared to an asset sale. You are assuming all unknown or potential liabilities, such as regulatory violations and employee disputes. However, you may be able to mitigate some risk through indemnification.
Which Structure Should You Choose?
Obviously, the decision to structure a deal as a stock or asset sale only arises when the seller is a corporation. Proprietorships, LLCs and partnerships do not issue stock. The owners of these entities can simply sell their ownership interests as the alternative to an asset sale. In any case, you should always seek legal counsel before planning a buyout. You and the seller must come to an agreement before any transaction takes place.
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