Clients interested in selling or buying a business often ask, “Should we do a stock sale or an asset sale?” The first step in answering this question is understanding the difference between the two. Choosing the correct transaction structure depends upon the needs and interests of the parties. While the transaction structure is sometime agreed upon without much fuss, other times it is heavily negotiated and can result in an impasse. This post briefly summarizes each type of transaction.
An asset sale is the purchase of individual assets (and sometimes certain liabilities). A stock sale is the purchase of the owner’s equity in the company, usually in the form of shares of corporate stock or membership interests in a limited liability company.
In an asset sale, the buyer purchases individual assets of the company, such as furniture, fixtures, equipment, real estate, intellectual property, licenses, goodwill, trade names, telephone numbers, and inventory. As part of the sale, the seller may also assign key contracts to the buyer, such as customer contracts, vendor agreements, real property leases, and independent contractor agreements. Certain assets – such as contracts, permits, licenses, real property leases, and intellectual property – may require third party consent prior to assignment. In an asset sale, the seller retains ownership of the company after the sale, and the seller also typically retains cash on hand and debt obligations. This is often referred to as a “cash-free, debt-free” transaction. The buyer and seller negotiate whether the sale includes accounts payable, accounts receivable, prepaid expenses, and prepaid deposits.
In a stock or “equity” sale, the buyer purchases the stock or membership interest of the company from the seller’s owners (i.e., from the seller’s shareholders or members), and in doing so the buyer becomes an owner of the seller’s legal entity. Because an equity sale transfers the company itself (rather than just the assets), the buyer is purchasing the company’s assets as well as its liabilities. Buyers sometimes insist that liabilities are paid down at closing, so that the buyer does not inherit debts and other liabilities. Equity sales do not require individual conveyances of assets, because the buyer is purchasing the company itself, which already holds title to the assets. While individual contracts are not transferred in an equity sale, third party consents may nevertheless be required when there is a change of ownership or control. For example, if a company has a commercial lease or has borrowed funds from a commercial lender, the prior written consent of the landlord / lender may be contractually required in order to transfer ownership or control of the company to the buyer.
Typically, sellers prefer to sell stock or equity in order to unload liabilities along with assets. Buyers, on the other hand, typically prefer to purchase assets to reduce risks of inheriting undisclosed liabilities, lawsuits, environmental and OSHA violations, employee issues, and other known and unknown liabilities of the company. There also are tax advantages and disadvantages to each type of transaction. All of these potential issues can be addressed and mitigated in a well-negotiated asset purchase agreement, stock purchase agreement or membership purchase agreement, as applicable, through representations and warranties, indemnification, and post-closing covenants. The parties’ legal, tax and accounting professionals must familiarize themselves with the nature of the business, the industry generally, and the parties’ needs and interests, in order to effectively negotiate the transaction and prepare the relevant transaction documents.
This article is not intended to provide legal or tax advice. You should always consult with legal, tax and accounting professionals when structuring the purchase or sale of a business.