Structure of the transaction
[For the next several posts, we are going to focus on the steps involved in purchasing a business, rather than starting one. Later we'll return to the topic of startups.]
One of the first considerations in negotiating for the purchase of a business is how the transaction will be structured, whether as an asset sale or a stock sale. Typically a seller will prefer a stock sale, and a buyer will desire an asset sale. For the seller, a stock sale allows for potential capital gains tax savings. Conversely, in a stock sale a buyer will not be able to capture a step-up in basis for the depreciable assets that are part of the transaction, and will therefore lose out on the benefit of depreciation expense write-offs thereafter. (see http://www.smallbiztaxadvisor.com/federal/top10.lasso)
Buyers also usually prefer asset sales because it is more feasible to limit their liability for the seller’s prior acts or omissions. Not that an asset sale is bulletproof in this regard- failure to comply with applicable laws, conduct due diligence and incorporate strong indemnification and other clauses in the sale contract may leave a buyer exposed to seller-created liability in spite of its structure as an asset sale. However, in a stock sale, the buyer typically gets the whole frog, warts and all. In an asset purchase, the buyer can carefully exclude any or all liabilities and build in protections in the event of a future claim- in the case of the frog, the buyer can select only the legs, and not the rest.
As a result of the competing interests of a buyer and seller, a business sold as a stock sale will commonly be at a lower price than would be the same transaction structured as an asset sale. This is an attempt by the parties to balance the tax implications of each, and to address the transfer of unknown future liability inherent in a stock sale, and depends on the relative bargaining power and sophistication of each. Once a purchase price has been agreed on, the primary substantive difference involves securities law implications. There are other aspects, such as whether title must be transferred on titled assets, but those are not as far-reaching as securities law compliance may be.
It's not uncommon to hear a buyer say something like “I’m not buying the business, just its assets.” But see https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Sale-of-a-Business for the IRS’ view on what constitutes a trade or business. And in California, for those transactions falling under the purview of the bulk sale statutes (California Commercial Code § 6101, et seq), the sale not in the ordinary course of the seller’s business of more than half the seller’s inventory and equipment will trigger bulk sale requirements. Also, in order for the buyer to avoid successor liability for seller’s unpaid employee withholding taxes or sales and use tax, they must obtain clearances or withhold a portion of the sales proceeds, and this applies to the sale of substantially all the assets of a business as well as to a stock sale.
Given that the decision about how to structure a transaction has the potential to have long term tax and legal implications, the buyer should bring their attorney and accountant on to the team early in the negotiation process, so that the accountant and attorney can assist in the decision about how to structure the deal before it is set in stone.