Stock sale versus asset sale

The two ways a business changes hands

In a stock sale, the buyer purchases your shares. The company continues to exist exactly as it did, and it keeps everything it had: its contracts, its licences, its employees, its bank accounts, and its liabilities, known and unknown.

In an asset sale, the buyer purchases the things the company owns rather than the company itself. Equipment, inventory, customer relationships, intellectual property, the name. Your entity remains yours, holding the sale proceeds and whatever liabilities were left behind.

Why buyers usually prefer an asset sale

Two reasons, and both are worth real money to them.

The first is liability. A stock purchase means the buyer inherits everything, including problems nobody knew about: an employee claim that has not been filed yet, a tax position that will not survive audit, a warranty issue on work done four years ago. An asset purchase lets them take the good and leave the rest.

The second is tax. In an asset sale the buyer gets a stepped-up basis in what they bought, which means they can depreciate it again and deduct it against future income. That deduction is worth a substantial amount in present value, and sophisticated buyers price it into what they are willing to pay.

Why sellers usually prefer a stock sale

Mostly tax, and the difference is not small.

In a stock sale, your gain is typically treated as long-term capital gain, taxed at the lower capital gains rate. Clean and simple.

In an asset sale, the purchase price is allocated across the assets sold, and different categories are taxed differently. Amounts allocated to equipment can trigger depreciation recapture taxed at ordinary income rates. Amounts allocated to a non-compete or a consulting agreement are ordinary income. Only the portion allocated to goodwill generally gets capital gain treatment.

If your business is a C corporation, an asset sale can also produce two layers of tax: once at the company level on the sale, and again when the proceeds are distributed to you. This is the single most expensive structural surprise in lower middle market M&A, and it catches owners every year.

How the gap actually gets closed

It is a negotiation, and there are several routes through it.

Price adjustment. If a buyer insists on an asset structure, the extra tax you will pay is a legitimate thing to price. Have your accountant model both structures with real numbers, so the conversation is about a specific figure rather than a principle.

Purchase price allocation. Even within an asset sale, how the price is allocated across categories is negotiated and stated in the agreement. Allocating more to goodwill and less to equipment or a non-compete favours you. Buyers want the reverse. This is worth real attention.

Elections. In certain circumstances an S corporation stock sale can be treated as an asset sale for tax purposes through an election, giving the buyer the step-up they want without the ordinary-income exposure a straight asset sale would create for you. Whether this helps depends entirely on your facts.

Escrow and indemnities. Much of the buyer's liability concern can be addressed with representations, an escrow and an indemnity cap, rather than by changing the structure. That is often the trade worth making.

When to think about this

Long before you have an offer. Entity type, how long you have held that entity type, and how your assets are carried on the books all affect the outcome, and several of them cannot be changed quickly. Some elections have multi-year look-back periods.

This is one of the few areas of a transaction where a conversation with your accountant two years early can be worth more than anything your advisor negotiates on the day.