Two Options: Stock Sale and Asset Sale
When buying a company, you have two options: buy all its shares or just the company’s assets. If you’re looking to sell your company, you may also choose to sell all of its shares or just its assets. There are pros and cons to stock sales or asset sales options. For example, if you own 100% of a company, you will receive all the proceeds from any future company sales. However, you’ll get less money if you sell only the company’s assets. It would be best to consider both types of transactions when making an investment decision.
An acquisition is a purchase of shares in a company. An asset transaction is when you buy something like a house or car. A stock transaction is when you buy shares in a company. When you buy shares in a corporation, you become a shareholder. You get all the rights that come along with that. If you buy 100 shares of XYZ Corporation, you will receive one share of XYZ Corporation. That means you own 1/100th of the company. You also get all the rights that accompany owning a piece of the company. For example, if the company owns a factory, then you get access to the factory.
This article has been prepared by a Denver business attorney and tax attorney to discuss section 338(h)(10) of the Internal Revenue Code.
In a stock sale, the company sells its shares to another company. The buyer buys all the shares owned by the sellers. The buyer also takes on all the debts and obligations of the company. The buyers gain full ownership of the company and become responsible for paying any debt or obligation incurred by the company. If the company does not have enough money to pay back the debts, the buyer must either sell off other assets or borrow money to pay them back.
Buyers should consider whether they are willing to assume the risks of buying a company’s stock. When selling a company, the seller must disclose any material facts about the company’s financial condition.
For example, if a company faces legal challenges, there could be a lawsuit against the company. If the company is facing environmental problems, the company could face fines or penalties. Employees could strike or go on strike if the company faces labor issues. All of these situations could cause the price of the company’s stock to drop significantly.
A stock sale will allow the owners to retain control of the company while still allowing them to sell shares to investors. If the company has many copyrights or patents or has significant government or corporate contracts that are difficult to assign, then a stock sale may be a better choice. A stock sale also allows the owners to reduce the risk of losing those contracts.
Sellers often prefer to sell stocks because all the proceeds are tax-free. Sellers also avoid paying taxes on any income earned while holding the shares. For example, if you sold your stock at $100 per share, you’d pay $20 in federal income taxes. If you held onto the stock until it reached $150 per share, you’d owe $50 in federal income taxes. But if you sold the stock worth $100, you’d owe nothing on the sale.
A deal structure can greatly impact the future of both the buyer and the seller. Other factors, including the company’s structure and industry, can also affect the decision. Buyers and sellers need to consult with their business intermediary, legal counsels, accountants, and others early in the process to ensure that all necessary information is gathered and understood before making a final decision.
When selling an asset, the seller remains the legal owner of the entity while the buyer purchases individual assets. For example, when selling a car, the seller keeps ownership of the vehicle while the buyer buys the engine, transmission, tires, etc. A typical asset sale does not involve buying the seller’s cash or paying off debts. Instead, the buyer pays for the assets individually. An asset sale is often called “cash-free” and “debt-free.”
Net Working Capital is usually included in an Asset Purchase Agreement. It includes items like Accounts Receivable, Inventory, and Accounts Payable.
Selling a corporation can have significant tax consequences for both the buyer and seller. Generally, sellers of corporate entities prefer to engage in a stock sale rather than an asset sale, while buyers choose to engage in an asset sale. However, it is not impossible to satisfy both parties to the transaction with a §338(h)(10) election.
If a purchaser pays for a target company’s stock, they receive a cost basis under §1012 for the value of the stock itself. On the other hand, buyers prefer an asset purchase over a stock purchase to increase their basis for depreciation purposes. The underlying assets held by the selling corporation retain the same basis as before, which does not create a benefit for the purchaser in terms of depreciation.
Asset Purchase Example
For instance, consider a corporation that holds a machine that costs $500. In years one and two, the corporation depreciates the machine by $100 per year, so the adjusted basis under §1012 is now $300. This also assumes that the seller holds the stock with a basis of $500, the total fair market value of the entity is $1,000, and there are no liabilities.
If the corporation engages in a stock sale, the purchaser will pay $1,000 for the stock since that is the fair market value. The buyer’s basis in the stock will be $1,000 under §1012. However, the machine retains the $300 basis. There is no adjustment to this underlying asset. The seller enjoys capital gains treatment on $500 of gain from the stock sale, which is the difference between the amount realized of $1,000 and the adjusted basis of $500 (§1001). Even though the buyer purchased the stock for $1,000, he may only use the machine’s basis of $300 for depreciation purposes. There is no step-up in basis allowed for underlying assets absent the §338 elections.
Limitations to Asset Purchases
Note that there are some limitations to asset purchases that make stock purchases more favorable. These include limitations built-in by contracts and other legal obligations. There could also be other liability issues that prevent sellers from engaging in an asset sale.
For these reasons, section 338 may provide an attractive alternative to satisfy both the buyer and seller in a business sale. Please discuss any specific business or tax matters directly with your business attorney or tax attorney.
To speak with a Denver business attorney or tax attorney, please contact The McGuire Law Firm at 720-833-7705.