The goal of this Exit Strategies Newsletter is to help business owners understand the costs and benefits available in either a Stock or Asset sale of their business. As with all aspects of the exit planning process, careful evaluation of the impacts your sale will have on tax exposure is crucial to a successful exit, and towards generating enough passive income from the sale to meet your needs.
An exiting business owner can elect to sell either the assets of his/her company or the stock of the business to a potential buyer. As a general rule, buyers or successors prefer to purchase assets, while sellers (or exiting owners) want to sell their stock to achieve a lower tax threshold.
As a note, the term “asset sale” does not in any way affect the total selling price of the company. Discrepancy between the sum total of true business assets (i.e. machinery, land, buildings, office furniture, etc) and the sales price is termed “Goodwill,” or the intangible value of the business’ built-in customer base and reputation.
You, as the exiting owner, are most likely to benefit by selling the ‘stock’ of the business rather than its assets alone.
The sale of stock will typically be taxed at the ‘Capital Gains’ rate of 15% over the original cost, or ‘basis,’ of the company. This compares favorably with the corporate and income tax rates of up to 35% that could result from an ‘asset-only’ sale. More likely than not, however, your potential buyer will demand instead an ‘asset’ sale of the business, and depending upon the power dynamic that exists within your relationship, you, the seller, are likely to acquiesce for two key reasons:
1. The buyer holds the key, and the cash, to a successful business exit, and
2. There are simply more financial reasons for the buyer to demand an asset sale than there are for you, the seller, to demand a stock sale.
Asset sales account for the majority of business sales valued below $10 million in today’s marketplace due to buyer’s demands. Though both asset and stock transactions effectively finalize the sale of the entire business, several specific benefits exist for the buyer to purchase only the assets of the company rather than the company’s stock.
Buyer’s Benefits of an Asset Transaction
Through an asset sale, buyers technically purchase only the tangible property of the business, and do not assume the ‘known and unknown’ liabilities of the acquired business- such as the all contracts, rights, obligations, and pending or future litigation against that company. Conversely, a buyer purchasing the stock of a business is forced to assume any and all ‘known and unknown’ liabilities of that business. Thus, the purchase of the stock of a company represents greater ‘risk’ to the buyer than a purchase of the company’s assets alone.
Other than avoiding ownership of these potential liabilities, the buyer or successor will also be motivated to purchase the business’ assets for the buyer’s ability to ‘write-up’ the basis of the assets purchased (or to amortize the goodwill that is acquired) in an asset sale. The ‘basis’ of these assets can be written to reflect the purchase price, and as a result, the new basis in the assets can be depreciated by the buyer over time, providing for a non-cash deduction to the business. This results in increased cash flow through reduced taxation over many years. Buyers are reluctant to give up these valuable tax deductions only available through an ‘asset’ purchase of the company.
Examining the tax implications of your potential business sale is critical at every stage of the exit process, and it may make financial sense for the exiting owner to negotiate a lower selling price with the contingency that the buyer purchases the stock of the company rather than its assets- remember, it isn’t what you are paid for the business that counts, but rather what you keep. A business owner must take all tax and risk considerations of both the seller and buyer (or successor) into account in order to be properly educated and prepared when sitting down at the negotiating table. It is only through thinking like a prospective buyer that a business owner will be able to execute a successful business exit.
Pinnacle Equity Solutions © 2013
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