Selling Shares or Assets
What is selling shares/assets?
Selling your business requires appropriate planning on your part. For example, you must take steps to prepare the business for sale and seek out prospective buyers. When you eventually find an interested party and begin to negotiate the terms of a sale, you will need to consider how to structure the transaction.
Assuming your business is a corporation, you can structure the sale of your business in one of two ways: (1) sale of assets or (2) sale of stock. The format chosen will play a large part in determining the overall value of the transaction for both sides and will depend on your individual situations. One issue to consider may be the nature of your business. An asset sale may make more sense and be more profitable if your business manufactures products and has many assets. Conversely, a stock sale may be the way to go if you own a service-oriented business with few assets. The format chosen may also hinge on the preferences of your buyer. For instance, if your buyer is reluctant to purchase your company's stock, you might have to either make certain concessions or agree to an asset sale.
Tax ramifications can be especially tricky, and the complexity of frequently changing tax laws requires that you seek additional resources (at the very least, an attorney and an accountant) to help you structure the transaction in a way that will reap benefits for both parties. In terms of tax implications, you may find that your particular circumstances favor an asset sale over a stock sale, or vice versa.
Asset sales
In an asset sale, the buyer simply purchases all or substantially all of your business's assets. The definition of assets may vary depending on the industry, so your contract with the buyer should specify exactly which assets you are selling. Assets generally include tangible property such as equipment, furniture, fixtures, and inventory but usually do not include your business's cash and liabilities (e.g., federal and state income taxes, payroll withholding taxes, and outstanding debts). After you sell your assets and use the proceeds to pay off all your business's short- and long-term liabilities, you are in a position to dissolve your business.
Stock sales
In a stock sale, you sell your corporation's stock to the buyer. Stock sales will generally involve the transfer of your business's assets and liabilities to the buyer as well, although you and the buyer may agree to exclude certain assets and/or liabilities from the transaction.
Be aware that a sole proprietorship is not a separate entity and that therefore your only option as a sole proprietor would be to structure a sale of your business's assets.
Also be aware that if your business is a corporation, such a sale will require shareholder approval.
When can you sell shares/assets?
You can sell shares/assets as long as you own a corporation, want to sell it, and can accomplish the sale either by selling off your corporate assets or by selling your company's stock. Existing financing or other obligations may limit or restrict the availability or method of such transfers.
Strengths
An asset sale is easier to complete because it favors the buyer
You will probably have an easier time finding a buyer if you opt for an asset sale, since most well-informed buyers will prefer this type of transaction. In general, an asset sale favors the buyer. One reason is that the buyer receives a new cost basis in the assets as a result of the purchase. Another reason for this preference is that purchasing assets enables the buyer to avoid future responsibility for your business's unknown or undisclosed liabilities.
A stock sale can be more expedient for both parties
A stock sale eliminates some of the more complex issues that typically arise when transferring control and provides a smoother transition between parties. Because stock sales simply transfer ownership and usually keep the corporation intact, they allow for continuity in relationships with suppliers and customers. They can also preclude the necessity of obtaining a new lease assignment when the lease is held in the name of the corporation and does not require an assignment in the event that the controlling interest of the corporation changes hands.
A stock sale transfers your liabilities
Stock sales transfer not only shares but also your business's assets and liabilities to the buyer, unless otherwise specified. Thus, structuring a stock sale can free you of the burden of your business's pre-existing liabilities.
The contract between you and the buyer may contain a provision allowing him or her to withhold payments owed to you in the event that undisclosed liabilities arise in the future.
A stock sale may mean less in tax liability
With an asset sale, a portion of the gain you realize may be taxable as a long-term capital gain, while another portion may be taxable at a higher rate as ordinary income recapture. With a stock sale, however, the entire gain is taxed as a long-term capital gain. Thus, a stock sale may allow you to pay less in total taxes. Consult a tax advisor for further information.
Tradeoffs
Your liabilities remain after an asset sale
Because asset sales do not transfer your liabilities to the buyer, you often must use the proceeds received from the buyer to pay off those liabilities yourself. Doing so may leave you with little or no cash afterward.
An asset sale may mean more in tax liability
The taxable gain on an asset sale may be broken down into long-term capital gains and ordinary income recapture. Because the ordinary income recapture would be taxed according to your regular tax bracket, an asset sale may require you to pay more in total taxes than you would in the case of a stock sale.
If your buyer insists on an asset sale, you can demand a higher sale price to offset the higher amount that you might have to pay in taxes.
A stock sale is more difficult to complete because it does not favor the buyer
Finding a buyer to purchase your stock may be more difficult because a stock sale does not give the buyer the advantages offered by an asset sale. Aside from possibly losing tax benefits, the buyer of stock must take the considerable risk of assuming all your business's liabilities, including those he or she may not even be aware of. The buyer's concerns about your business's unknown or undisclosed liabilities may cause him or her to shy away from a stock sale.
You can ease your buyer's mind by agreeing to include in your contract provisions that require you to indemnify the buyer, set aside funds in escrow to be used in certain situations, or give him or her the right to offset future payments to you in the event that he or she incurs undisclosed liabilities. In the alternative, you can simply negotiate a lower sale price to make a stock sale more attractive to the buyer.
If you are set on selling stock but are having trouble finding a buyer, there are other options. One is to sell your stock to your company's employee stock ownership plan (ESOP). This option might provide the best market for your shares and may have tax advantages as well. You could also sell your shares to the public through an initial public stock offering (IPO). However, while going public can make you a lot of money in a short time, most businesses are too small and undercapitalized to ever qualify for an IPO.
A stock sale opens you up to securities law
If you opt for a stock sale, be aware that the sale of the stock of a corporation is subject to state and federal securities laws. This means that your stock sale will be governed by Securities and Exchange Commission (SEC) regulations and restrictions. Consequently, you should disclose anything the buyer ought to know about your business, including all liabilities, to avert the possibility of securities fraud litigation. To ensure compliance with state and federal securities laws, you should consult an attorney who is knowledgeable of such matters.
How to do it
Hire an attorney and/or tax advisor to assist you with planning the sale. Take the necessary steps to prepare your business for sale. Determine the value of your business, perhaps through a professional appraisal. Find a buyer and negotiate the sale price as well as determine whether to structure the transaction as an asset sale or a stock sale. Once you have reached an agreement, have your attorney(s) draw up a contract outlining the terms.
Tax considerations
Capital gains tax
In the case of an asset sale, assuming you realize a gain, you will ordinarily have to pay capital gains tax on the difference between your basis in the assets and the price the buyer pays for them. Similarly, any gain realized through a stock sale will normally require you to pay capital gains tax on the difference between your basis in the stock and the price the buyer pays for the stock. Keep in mind that the gain on an asset sale may be broken down into long-term capital gains and ordinary income recapture (taxable at a potentially higher rate) and may therefore trigger more in total taxes than would a stock sale.
Depending on how the sale is structured, additional tax issues could arise. Consult a qualified tax professional to help you sort out the tax implications.
In certain cases, you may be able to structure a "C" reorganization or tax-free asset sale. To be eligible under Internal Revenue Service (IRS) regulations, you must exchange "substantially all" of your business's assets for voting stock in an acquiring corporation. With stock, you may be able to structure a "B" reorganization or tax-free stock sale whereby the IRS requires you to exchange at least the "controlling interest" of your corporation's stock for voting stock in an acquiring corporation. In either case, you can avoid or at least defer capital gains tax if your transaction qualifies for tax-free treatment.
New cost basis for buyer
In the case of an asset sale, the buyer receives a new cost basis in the assets purchased. For tax purposes, this new basis allows the buyer to start fresh with a new depreciation schedule and to take depreciation deductions that will act as a tax shelter against future earnings.
