Understanding the Difference Between Asset & Stock Transactions

When selling a business, the transaction can be structured as either an asset deal or a stock deal.  In order to explain them appropriately, let’s assume you own a company that provides outsourced IT services.  When you started the business, you set up a corporate entity as a sub chapter S corporation called Technology Ventures, Inc. but you operate under a fictitious business name called Bay Area Technology Solutions. 

In a stock transaction, the acquirer purchases Technology Ventures, Inc.  Upon close of the transaction, the seller signs over the stock certificates and anything that is owned by Technology Ventures, Inc. transfers to the buyer.  This includes everything on the balance sheet at the close, including any cash or debts owned by the company.  It is possible and often negotiated that cash will be removed prior to closing or that any cash that transfers will be acquired dollar for dollar by the acquirer.  The same goes for long term debt that is often paid off concurrent with the close or the price adjusted downward for any long term debt assumed. 

Buying the stock also means that purchasers get any liabilities that may not be on the balance sheet, also known as contingent liabilities.  This includes things like warranties for faulty product, litigation that ensued from acts occurring prior to the close such as wrongful termination, worker’s comp claims, etc.

In an asset transaction, a buyer does not acquire Technology Ventures, Inc.  Instead, the buyer sets up a new business entity if they don’t already have an operating company.  The purchase agreement between the buyer and seller would specify exactly which assets are being acquired, typically including but not limited to: Equipment, contracts, customer lists, trade secrets, marketing materials, phone numbers, websites, etc.  In the example above, they would acquire the fictious business name Bay Area Technology Solutions and despite the new entity, continue operating as if no transition took place.  Note that because there is a new entity, the buyer would need a new EIN number, EDD number, sales tax number, insurance policy, etc.  They seller would even need to terminate the employees and the buyer will subsequently hire them under the new corporate entity.  Contrary to a stock deal, in an asset transaction, the buyer is not acquiring the balance sheet or the contingent liabilities.

There are tax, legal, and logistical considerations regarding why a buyer or seller would want to structure a deal as an asset transaction or a stock transaction.  On the tax side, the structure impacts whether the seller is taxed at ordinary income tax rates, capital gains tax rates or somewhere in between and the tax benefits the buyer may or may not get associated with depreciation and amortization.  On the legal side, the structure impacts the liability to the parties and guides what logistical challenges need to be faced.  For example, an asset deal that includes the transfer of hard to obtain licenses or hundreds of contacts could be challenging or take considerable time but made a breeze in a stock transaction.  It could also expose the buyer to excessive liability from historical actions of the company.  The various opportunities and risks need to be weighed appropriately, negotiated by the parties, and likely balanced through the representations, warranties, and indemnifications agreed to by the parties in their purchase agreement.

Given the complexities of the deal structure, it is important for all parties to consult their corporate attorneys and CPAs to make sure their transaction fits the needs of the business and of the buyer and seller.