Will You Sell Assets or Stock?

April 13, 2006

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If your business is incorporated, you have a very important decision to make: will you sell the assets of the business, or the stock? (Unincorporated businesses don't have this option, or this decision). In most cases, selling stock is better for you, but selling assets is better for the buyer. This is one of the most important terms in a sale of an incorporated business. If you agree to the buyer's demands for an asset sale, you should insist on a higher price because of the significantly higher taxes and liability risks you'll face.

With a C corporation, tax aspects are the main reason for the seller's preference for selling stock. Simply put, if you sell the stock, you'll pay capital gains tax on the sale, based on your tax basis in the stock (i.e., what you paid into the corporation in exchange for the stock). In contrast, if you sell the assets, you are essentially taxed twice: first, upon selling assets to the buyer, the corporation will pay capital gains tax on the value of the assets over their existing basis to the corporation. Second, when the corporation is liquidated, you'll personally pay capital gains tax on the excess of the net proceeds of the sale, over your existing basis in the stock.

With an S corporation, you can usually avoid this double tax. However, the other main reason that sellers prefer stock sales, while buyers prefer asset sales, does apply to both C corporations and S corporations. The reason is that with a stock sale, any unknown liabilities the company may have are transferred to the new owner. With an asset sale, the liabilities would remain with the seller. Some examples might be future product liability claims, contract claims, lawsuits by employees, pension or benefit plan liabilities, etc. stemming from seller's ownership of the company.

Now, with careful legal drafting, these general rules can be altered in the sales contract. For example, in an asset sale, the contract can state that the buyer will assume certain liabilities of the seller. Because third parties won't be bound by the terms of the contract, the contract can also include escrow arrangements or indemnification clauses that will remove some of the buyer's risks, by stating that the seller's money will be used to pay for claims. However, if the drafting is not perfect and anything is left out, the general rules will kick in.

There are some reasons why the buyer may prefer a stock sale in certain situations. If the corporation has a good credit rating, the buyer may want to buy stock. Certain contracts such as leases, supply contracts, or employment contracts may have been written between the corporation and the third party, and it will be easier for the buyer to maintain these contracts if the stock is transferred. Stock sales may also be simpler to carry out since there's no need to transfer and retitle every single asset.

In earlier years, stock sales used to be quite rare, particularly for smaller companies. However the trend is now in the opposite direction: the popularity of stock sales is increasing, with such sales comprising about 44 percent of transactions for midsize companies since 1995. The bottom line is that if the buyer insists on an asset sale, make sure you get paid for it!