When purchasing or selling an existing business, both the buyer and the seller must determine whether it is advantageous to structure the transaction as a sale and purchase of the assets of a business ("asset sale") or of the ownership interest of the business (a "stock sale"). Understanding the basic differences between the two is the first step to structuring a deal that is most beneficial to you, whether you are the buyer or the seller.

The benefits of asset sales

In an asset sale, only the assets of the business are sold while the ownership of the selling company does not change after the close of the transaction. Assets can encompass a wide variety of items such real estate, equipment, inventory, accounts receivable and client lists. Generally, an asset sale is beneficial to a purchaser because favorable assets may be bought while the liabilities that are unfavorable (for example, a risky contract, faulty equipment or an existing lawsuit) can be excluded. In addition, depending on how the purchase price is allocated, the purchaser generally receives a "stepped up" tax basis on the assets which can result in depreciation and amortization tax deductions in the future. A Seller may prefer an asset sale if it intends to sell one division of the company and retain another division as a going concern after the asset sale closes. In that instance, the selling company may use the proceeds from the asset sale to pay off debt or for working capital for the continued operation of the company.

The disadvantages of asset sales

Asset sales can be more time consuming than a stock sale. Each asset or class of assets generally must be transferred separately - this can be especially cumbersome if an asset is a "shared asset" within a subsidiary or division. Asset sales often require consents and assignments from third parties. For example, a landlord may have to provide consent to substitute the purchaser on the lease agreement.

The benefits of stock sales

In a stock sale, the purchaser buys some or all of the ownership interest of the company directly from individual shareholders and becomes the new owner. The legal status of the company remains the same after the transaction, but the selling stockholders generally "cash out" and are no longer associated with the company. After closing, the selling shareholders are free and clear from the obligations and liabilities (both past and present) associated with it, subject to any indemnification or other obligations contained within the stock sale agreement. A stock sale is usually a quicker transaction than an asset sale because the ownership interest in the company is the only thing being transferred and fewer (if any) third party consents/assignments are necessary. Lastly, from a tax perspective, a selling shareholder may receive a more favorable result with a stock sale.

The disadvantages of stock sales

When a purchaser buys the ownership interest of a company, they effectively buy the company "as-is." All of the obligations and liabilities of the company remain with the company. This can be a dangerous trap for purchasers who fail to perform adequate due diligence or who fail to structure the transaction documents in a way that obligates the seller to fully disclose the company's liabilities. The parties to a stock sale must also take care that they are in compliance with state and federal securities laws.

These are just some of the considerations for purchasers and sellers to contemplate before they begin negotiations. Factors in addition to those mentioned here will affect whether a transaction should be structured as an asset or stock sale, and in fact, there are many elements of the transaction documents for either type of sale that will greatly affect the relative benefits of the transaction to both parties. Future posts will discuss several of the elements of asset and stock sale agreements. To fully understand how the structure of a sale transaction and the documents involved can work to your best advantage, consult with legal counsel.