Asset Sales vs. Stock Sales: Advantages and Disadvantages

This article was prepared by Bill Barlow and James David Williams, two founding partners at Barlow & Williams. Mr. Barlow and Mr. Williams met at Harvard Law School and now offer an innovative fixed cost model for legal services in the lower middle market. We think this is very exciting for deals <$50m in purchase price to help ensure that professional fees don’t become a disproportionate % of the transaction.

There are two main deal structures in business acquisitions: an asset sale in which the buyer purchases some or all of the seller’s assets and a stock sale in which the buyer purchases some or all of the seller’s stock or membership units. These deal structures have different consequences that can greatly influence the success of a transaction.

Advantages and Disadvantages of Asset Sales

Buyer Advantages

In an asset sale, buyers are able to depreciate the purchase price and reduce their future tax burden by allowing a step-up in the tax basis of the purchased assets. IRS regulations set different depreciation schedules for different types of assets, but any reduction in taxes is a marginal gain for the buyer.

This structure also allows buyers to pick and choose which assets to acquire. While it is more common for a buyer to acquire all of a seller’s assets, a buyer could purchase just one business line or division. This can allow a buyer to acquire profitable assets without acquiring unprofitable ones. A similar logic can apply to employees. In an asset sale, the buyer can choose which of the employees to retain without being burdened with paying severance benefits to the others.

Asset sales also limit the amount of liabilities that the buyer assumes through the transaction. Back taxes, lawsuits, retirement plans, government investigations, and the like can often be left with the seller in an asset sale transaction. There are certain limitations to this (e.g. sales tax liability and certain labor law liabilities usually carry over), but this is often the most important motivation for buyers to prefer an asset sale.

Buyer Disadvantages

The biggest downside for buyers to an asset sale is often the potential disruption to the business.  In an asset sale, contracts with vendors, landlords, and customers will need to be assigned to continue in effect. Depending on the original contract language this can be problematic, even to the point of making a transaction impossible. For example, government or other large enterprise contracts often cannot be assigned without significant delays. A second way that business is commonly disrupted in an asset sale is if the business has licenses or permits that are difficult or impossible to transfer. If that is the case then the buyer will need to obtain those licenses or permits, and that can take a significant amount of time if the buyer does not already have them.

Other potential drawbacks to asset sales for buyers can include an inability to take advantage of any accrued net operating losses or other tax credits that the seller may have, a spike in customer churn upon finding out that the business has been sold, and customer churn if things like payment processing accounts need to be changed as a result of the transaction.

Seller Advantages

If a seller operates multiple business lines, then an asset sale is the easiest way to sell one line of business while continuing to operate the others. This may only apply to certain sellers, but is critical for those who operate multiple lines of business under a single entity and only want to divest a portion of the larger business.

Now for a few advantages that apply to sellers more broadly. Since buyers expect an asset sale, accepting an asset sale structure expands the buyer pool. Asset sales can create a higher enterprise value in the purchase agreement, even if some of that difference gets washed out through differential tax treatment. And since the potential of contingent liabilities is also lower in an asset sale, it is common that more of the total compensation is paid at closing instead of held back, either in an indemnification escrow or otherwise.

Seller Disadvantages

In an asset sale, the seller is often left with residual liabilities that may take years to wholly resolve. Certain portions of the purchase price can also be allocated to asset classes that result in less favorable tax treatment for the seller than would be the case in a stock sale. In distressed situations, an asset sale can even feel like the buyer is taking the crown jewels and leaving the rest. By the time that happens, though, a seller rarely has other options even if it is another psychological blow.

Advantages and Disadvantages of Stock Sales

Buyer Advantages

Stock sales can make for simpler transaction structures. There is no need to create what can sometimes be voluminous schedules of assets to be transferred and assets to be excluded. In a stock sale, the buyer takes everything as-is.

Stock sales are less disruptive to business operations. While some contracts may still need to be renegotiated depending on their language, most will not. There is also no need to transfer licenses or permits when a stock sale occurs as business is conducted using the same legal entity after the transaction as before.

Sometimes financing can make buyers want a stock sale. Under rules that went into effect in 2023, it is possible to obtain SBA 7(a) financing for a transaction even if the seller retains equity in the business (often 19% due to other rules applicable to SBA loans). Due to the mechanics of the loan, this particular arrangement a stock sale deal structure. It could also be the case that a buyer needs to make use of the seller’s prior financial statements for certain bank financing and depending on the bank it may be necessary for the buyer to purchase the seller entity.

Buyer Disadvantages

The biggest disadvantage to a stock sale for buyers is that buyers assume all of the seller’s liabilities, whether they be taxes, lawsuits, or something else, purchase purchasing stock. This means more risk for the buyer, and while there are ways to mitigate this increased risk it is unavoidable.

A stock sale is also often less tax advantageous for a buyer. In a stock sale, there is no step-up in the tax basis of any of the assets of the business. This means that if the assets were already mostly or fully depreciated then the buyer will not benefit from future tax savings nearly as much. A stock sale structure can lend itself more easily to holdouts from minority shareholders too. There are often ways around this, but it still drags out the process and can result in otherwise unnecessary complications. And if a seller has multiple lines of business or business units, then a stock sale forces a buyer to acquire all of those different parts of the seller’s business instead of picking and choosing which to buy and which to leave behind.

Seller Advantages

If applicable, the biggest advantage to a stock sale for sellers is Qualified Small Business Stock (QSBS) tax treatment. If all of the criteria are met and depending on when the seller company was formed, this could result in no federal income tax on the sale. Even if QSBS is not applicable, a stock sale still means that the whole amount of the purchase price receives capital gains tax treatment and that will almost always result in a lower tax burden for the seller. A stock sale also avoids the potential for double taxation that could result from a corporation selling its assets and then distributing the proceeds to its shareholders.

A stock sale also offers the seller a complete break from the business. While there will be some ongoing concern while the survival period for the representations and warranties is still active, there is no need for the seller to wind down the business after a stock sale since the business entity continues just as before. A more marginal advantage of stock sales for sellers is that the legal agreements tend to be simpler and cleaner. At the very least, it won’t be necessary to create an itemized list of the assets of the business to make it into a schedule to the purchase agreement.

Seller Disadvantages

Since a buyer takes on all of the seller’s liabilities, including liabilities that are unknown at the time of transaction, there are often larger holdback amounts and longer indemnification periods in deals that are structured as stock sales instead of asset sales. Depending on the size of the transaction, insurance products can reduce this deal feature but it will still exist.

Which Will Occur?

In general, buyers prefer asset sales and sellers prefer stock sales. That said, the default transaction structure is an asset sale in private market transactions. Stock sales tend to only occur if specific circumstances exist—significant tax benefits for one or both parties; non-transferable contracts, permits, or licenses that are key to the business; or multiple buyers bidding to give the seller negotiating leverage. Ultimately, each deal is unique and the final deal structure will vary. That is why it is so important to work with advisors who have experience with all sorts of deal structures so that they will be able to best help you navigate your situation.