Asset Sale vs. Stock Sale

Whether a deal is an asset sale or a stock sale is a major negotiating point in any transaction because it determines who pays what in tax, who bears the risk after closing, and how much work it will take to close. Buyers and sellers often have very different views.

Asset sale

In an asset sale, the buyer doesn’t buy the company. It buys a list of the company’s assets and agrees to take on a defined set of its liabilities. The seller’s legal entity stays behind, usually to be wound down or repurposed, while the operating assets (equipment, contracts, customer relationships, inventory, and intellectual property) move to the buyer.

Why buyers often like this structure. The buyer gets to pick what comes with it and what doesn’t. Old lawsuits, unknown tax exposure, contracts nobody wants, etc., can all remain with the seller’s entity. That protection isn’t absolute (certain tax, environmental, and employee benefit liabilities can still follow the business), but it is a significant benefit. The buyer resets the tax basis of what it buys to the price it pays (a so-called “step-up”). A higher basis means greater depreciation and amortization deductions in the years after closing, and the buyer can quantify that tax benefit.

Why sellers often prefer to avoid that structure. The tax bill is typically worse for the seller, and it’s worst with a C corporation. The company pays tax on the gain from the sale of its assets, and the owners pay tax again when the company pays the proceeds out to them. On top of that, every contract, license, or lease that transfers to the buyer is a separate transfer, and those that require the other party’s sign-off can really drag out closing.

What about S corporations and LLCs?

S corporations and LLCs taxed as partnerships generally won’t have that double layer of tax (the corporation level and the shareholder level) as the gains simply pass through. That doesn’t make an asset sale tax neutral for them, though. Part of the gain can be taxed as ordinary income rather than at capital gains rates, for example when equipment that’s already been depreciated sells for more than its tax basis. An S corporation that converted from a C corporation in the last five years can still be liable for corporate-level tax on the gains that accrued before the conversion. Your CPA will be able to tell you how much of that applies to your business.

Purchase price allocation

In an asset sale, the price is divided among the assets being sold, and that split matters to both sides. The IRS sorts the assets into seven classes, starting with cash and working through receivables, inventory, equipment, and identifiable intangibles, with whatever is left over landing in goodwill. The buyer and the seller each report the allocation to the IRS on Form 8594, and they’re expected to use the same numbers.

The tension is that the same dollar can be worth more to one party than the other. The buyer will want more of the price allocated to assets it can depreciate quickly, like equipment. The seller will want more allocated to goodwill (which is typically taxed as a capital gain) rather than to the assets which produce ordinary income. The allocation is negotiated as part of the price and has to be supported by the fair market value of each asset class, which is where a valuation comes in. The buyer may also need a separate fair value allocation under ASC 805 for its own financial statements, and the two don’t always match.

Stock sale

In a stock sale, the buyer takes the company as a whole. It purchases the ownership interests in the company. All the company’s assets remain where they are, and all the liabilities remain where they are. Only the owners change.

Why sellers often prefer this structure. The tax side is usually the easier of the two. The owner sells their shares, and the gain is generally taxed once at capital gains rates. That often works out better than an asset sale. The contracts, licenses, and permits stay where they are, so there’s no need to transfer them (the caveat being, of course, that a contract with a change-of-control clause may still require the other party’s consent).

Why buyers are often more cautious here. The company’s history comes along for the ride. Known liabilities, past tax positions, skeletons in the closet, and pending legal issues all stay with the business the buyer now owns. To protect themselves, buyers dig deeper in diligence and push for stronger representations and warranties (reps), indemnification, and sometimes an escrow or holdback to cover problems that surface after closing. And there’s usually no step-up in tax basis, because the company keeps its existing asset basis.

Why this becomes a negotiation

Buyers and sellers usually want opposite things here. Buyers typically prefer asset sales because of the tax benefit and the liability protection, while a stock sale tends to favor the seller, so structure is a negotiating point, not a formality.

There are ways to meet in the middle, though. If the business is an LLC taxed as a partnership, a buyer who acquires all ownership interests is generally treated as buying the underlying assets for tax purposes, so the buyer gets the step-up even though the seller is selling equity. For S corporations and corporate subsidiaries, a Section 338(h)(10) election lets a stock sale of at least 80% of the company be treated as an asset sale for tax purposes, but it needs a corporate buyer, and everyone has to agree to it. Many private equity funds and family offices aren’t corporations, though some buy through a corporate holding company that is. When the buyer isn’t a corporation, a similar Section 336(e) election may be available. Either way, the seller usually bears the tax cost of treating the deal as an asset sale, so these elections often come with a price adjustment.

This article is a general overview for educational purposes only and is not tax, legal, accounting, or investment advice. Every deal is different, so talk with your advisors before making decisions. If you don’t have the right team in place, reach out, and we can help you build one.

The bottom line

The best structure depends on entity type, tax position, the specific assets and liabilities involved, and what each side is willing to give up in exchange for wins elsewhere. Talk to your accounting, tax, and legal advisors before signing anything. Structure is hard to change once it’s already been negotiated.

ProDelta Advisors helps buyers and sellers understand the financial and valuation implications of deal structure alongside their tax, legal, and other advisors.