Last month we highlighted the merits and risks of a stock sale. Below, we'll outline the general implications of an asset sale for a buyer and seller.
In an asset sale, the Buyer purchases individual assets (tangible and intangible) and liabilities of the Company in a new entity “NewCo” while the Seller retains the legal entity of the “OldCo”. Often, asset sales are cash-free, debt-free which means the Seller keeps the cash at closing and pays off any long-term debt. During an asset sale, it is common that contracts (like service agreements, purchase contracts, vendor agreements, leases, etc.) require assignment to the “NewCo” as of closing, which can slow down the transaction process.
Asset Sale: Liability and Tax Effects (Favor the Buyer)
Because the Buyer can selectively carve out assets and liabilities to assume or exclude (i.e. an active warranty claim, a specific piece of equipment), it is easier for the Buyer to mitigate the risk that comes from assuming liabilities taking place before his/her ownership. For example, if an environmental claim is made post-transaction for a spill that took place prior to the sale, the Seller/OldCo would likely be on the hook for this liability.
Asset sales afford the Buyer certain tax benefits that stock sales do not, as higher value can be allocated to assets that depreciate more quickly, such as equipment (3-7 year life), and lower value allocated to assets that amortize slowly, like goodwill (15 year life). This ability to step-up the tax basis of certain assets reduces tax payments and improves company cash flows in the critical first few years following the transaction. For the Seller, however, this stepped-up tax basis of certain assets has a negative effect, as many are subject to higher ordinary income tax rates as compared to the lower capital gains rates applied to some intangible assets such as goodwill.
Did you know?
According to recent research, 70% of all transactions are asset sales, as well as the vast majority of sales of privately-held companies. Larger deals are more likely to be structured as stock sales. Due to the lack of stock in their corporate entity, sole proprietorships, partnerships and limited liability corporations must be asset transactions. If the business is incorporated as a C-corp or an S-corp, either an asset sale or a stock sale may be instigated, and pros and cons should be heavily considered on both sides.