M&A Deal Structure | Asset v Stock Sale | OH IN KY

M&A Deal Structure – Asset Sale vs. Stock Sale

Published on by Harold Kremer in Consulting, Transaction Advisory

M&A Deal Structure – Asset Sale vs. Stock Sale

2021 was a historic year for mergers and acquisitions, with deal volume exceeding $5 trillion – and the trend shows no signs of slowing down, despite increasing economic pressure from inflation and rising interest rates. As dealmakers on both the buying side and selling side look for new ways to maximize value in mergers & acquisitions (M&A), it’s critical to understand the differences between different types of deal structures and which one makes the most sense for your situation.

The right structure for the transaction

There are multiple decisions that play into which type of deal structure is optimal for a given transaction. If the entity in question is a corporation (S-Corp or C-Corp) there are two options for the sale structure – an asset sale or a stock sale.  There are advantages and drawbacks to both.

A potential seller recently said to me that they can’t sell assets because they are a service business and have minimal assets to sell. I let them know that assets include not only the expected items like inventory, equipment, and property but also intangible assets like customer lists, trademarks, trade names, and patents. So, in most cases, you have the option to choose either structure.

What’s a stock sale?

A stock sale transfers ownership of the entity to the buyer. The assets and liabilities that transfer to the buyer include all assets and liabilities remaining with the Company at the time of the sale.

Sellers usually prefer a stock sale:

  • The proceeds will be taxed using capital gains tax rates, which are currently more favorable than ordinary income tax rates
  • Liabilities, contingencies, and unknown issues from the past all transfer to the buyer (unless they are specifically excluded in the sale terms).

Buyers may prefer a stock sale, but typically prefer an asset sale:

  • On the positive side, the EIN (Employer Identification Number), as well as all contracts in place (including leases, sales contracts with customers, and purchase contracts with vendors) remain in place, saving the buyer from the painstaking process of transferring these contracts, or determining if they can even be transferred.
  • On the negative side, buyers must consider that when they purchase company stock, they inherit all the “skeletons in the closet.” For example, environmental matters, employee issues, and lawsuits that could be brewing on past sales or customer relationships would now become the buyer’s responsibility.

It’s estimated that 30 percent of all M&A transactions are stock sales, and note that the larger the corporation, the more likely the transaction will be a stock sale.

What’s an asset sale?

An asset sale transfers individual, agreed-upon assets, like inventory, equipment, licenses, goodwill, customer lists, or accounts receivable. Selected liabilities are also assumed by the buyer.  The seller remains the legal owner of the business entity. Most asset sale transactions we see are cash-free and debt-free transactions, simply meaning that the cash held by the company does not transfer to the buyer and the long-term debt obligations are kept by the seller and paid off with proceeds from the transaction.

Buyers usually prefer an asset sale:

  • For tax purposes, the buyer can step up the basis on the assets (i.e., record the acquired assets at fair market value at the acquisition date, which would normally be higher than the assets’ net book value). The benefit to this is a higher depreciation expense deduction in the future for the buyer. Depreciation on short-term assets like computers or machinery will benefit the buyer more quickly (3 – 7 years) than the amortization that it would get on the purchase price allocated to goodwill (15 years).
  • Even if it is amortized over a longer period, an asset sale allows the buyer in some cases to allocate the purchase price to goodwill or other intangible assets, which provides tax benefit when amortized.

Sellers rarely prefer an asset sale:

  • Tax on the sale of assets may be at ordinary income tax rates.
  • If the seller is a C-corp, it will likely face double taxation, first on the sale of the assets to the buyer, and secondly when the proceeds from the sale are transferred to the C-corps’ owners
  • There are still tasks to complete after the sale, like liquidating non-purchased assets and paying off outstanding liabilities.

Terms and conditions can be added to the purchase agreement to address some of the benefits and/or drawbacks just discussed.

In some instances, there’s a middle ground between stock and asset sales – an IRS-approved alternative that allows an owner to sell stock and the buyer to record the sale as if it were an asset purchase. This option is found in the Internal Revenue Code (IRC) under 338(h)(10). It is not available in all circumstances, but when it’s an option, it can help avoid retitling assets, contracts, and other intangibles.

There are other considerations, including the BIG (Built-in Gains) tax applicable to some S-Corporations.

Contact Us

There are many additional considerations in determining the right deal structure for a transaction, and given the overall complexity, it’s important to consult with a qualified advisor who can guide you through the process. If you have questions or need assistance with transaction structuring, Barnes Dennig can help. For additional information, call us at 513.241.8313 or click here to contact us.  As always, we’re here to help.


Related Services

More Insights

Apply Now