Exit Fundamentals: Two ways to Sell a Business
This article introduces the two fundamental methods of transferring a 100% interest in a private business, a) an “Asset Sale” and b) a “Stock Sale”. Asset Sales account for more than 90% of small business transactions. By small I am thinking of businesses with up to $10 million in revenue.
Asset Sales
In an Asset Sale the seller sells all of the tangible and intangible assets of the business, and ends up retaining the legal entity, which the seller then winds down (or uses for another business purpose). The seller terminates the employees (and pays out any accrued vacation), and the buyer typically rehires substantially all of them. In effect, the buyer starts a new business using the assets purchased from the seller. When the buyer is a complementary or competing business, an asset sale often involves less than the seller’s entire basket of assets.
A company’s basket of assets typically includes: cash and equivalents, accounts receivable, inventory, work in process, deposits, equipment, trade fixtures, leasehold, leasehold improvements, contracts, business records, software and software licenses, licenses and permits, franchises, covenant not to compete, trade secrets, patents, intellectual property, trade name, customer lists, marketing materials, telephone numbers, web sites, URL’s, email addresses, sales order backlog and goodwill.
Leases and other contracts are assigned to the buyer, and certain liabilities may be assumed by the buyer. Often, the seller keeps any cash and deposits and pays off all liabilities of the business, delivering title to the assets free and clear of all liabilities.
Stock Sales
If the business is a corporation (or other legal entity) then the individual who owns the shares in the corporation can sell their shares to a buyer. This is a stock sale. The buyer buys the entire balance sheet. Debt remaining on the balance sheet is usually considered part of the payment of the purchase price. The most recent balance sheet or a target balance sheet is attached to the purchase offer (usually a letter of intent or LOI) and there is language in the offer that adjusts the price for any changes in net working capital or debt that occur between the LOI signing and the transaction closing.
Asset Sale Pro’s and Con’s
There are several advantages and disadvantages to the parties in an asset sale (versus a stock sale). Here are some of them:
| ADVANTAGES | DISADVANTAGES | |
| BUYER | □ “Step Up” in basis for depreciation and amortization □ Free of most contingent liabilities □ Can select assets to purchase □ Can change entity type, state of registration □ Due diligence less extensive | □ Transaction more complex □ Lose non-transferable rights □ Unable to carry over tax losses, if any □ Have to reestablish credit, licenses, permits, etc. □ Require consents to assign contracts |
| SELLER | □ Retain corporate entity □ Can keep certain assets (e.g. patents) □ Usually higher price | □ Double taxation (C Corp’s) □ Depreciation recapture □ Transaction more complex |
Buyers usually want to buy assets for two reasons:
1) They can write up the value of depreciable assets and depreciate them again, and amortize all of the goodwill value, and
2) They avoid any liabilities that might arise after closing that were caused by events that occurred before the transfer of ownership. Stock sale terms usually include the seller holding harmless and indemnifying the buyer against undisclosed or contingent liabilities, but what if the seller has already spent the money or refuses to pay! Of course you would do that, but that’s what worries buyers.
For the owner of a “C” corporation an asset sale (versus stock sale) normally has a far less favorable tax treatment. If you own a C Corporation, you should talk to your CPA about converting it to an S Corp.
This is a very basic introduction to this topic, and don’t take this as legal or tax advice. In addition to a broker/M&A advisor, you must always have experienced legal and tax experts on any transaction team and in any exit planning process. To discuss your circumstances, feel free to give us a call.
