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Advantages & Disadvantages of an Asset Sale Versus a Stock Sale

Posted by restrealty on September 30, 2014
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Asset Sale– Advantages

  • No legal liability for the corporation prior to the purchase. In California, when an escrow is utilized, a bulk-sales process assures that the buyer will get title to the assets free and clear of all liens and encumbrances.
  • No liabilities for employees –The seller’s employees are terminated at the close of escrow, even if the buyer is going to rehire all of them. This cuts off any liability the former owner had with the employees, such as back wages, payroll taxes, and vacation pay.
  • Costs paid for the assets are depreciable. A new, depreciable base is set up by the buyer, subject to the allocation of the purchase price he made at the close of escrow, so he can establish a new basis for depreciating assets. Assets can be depreciated as follows: furniture and fixtures–7 years; goodwill and covenant not to compete–15 years, and leasehold improvements–39 years.
  • Clean credit, reputation, workers compensation rating, etc. The new owner has a fresh start. If the prior owner had a high workers compensation risk rating, had a poor reputation for food quality and service, and/or had poor credit, the new owner will not be penalized for these items, and will start out with a clean record.

 

Asset Sale–Disadvantages

  • No established credit. When you’re starting a new business, unless you have had a prior business with a good credit history, initially it will be harder to get credit.
  • Rehire the employees. The employees don’t automatically roll over to the new owner unless he rehires them, although for a new owner, this feature has more advantages than disadvantages.
  • Negotiate transfer of leases and contracts. Leases and contracts have to be formally assigned by the landlord, and the new owners must be qualified both financially and operationally by the landlord and lessor before they can formally assume these leases. In some cases, a new premises lease must be negotiated per the requirements of either the landlord and/or tenant.
  • New licenses—all licenses need to be either newly applied for, or transferred.
  • Must comply with California Uniform Commercial Code–Bulk Sales, which can cause additional time to close, and requires mandatory public notification of sale.
  • Must pay sales tax on furniture, fixtures, and equipment.

 

Stock Sale – Advantages

  • Established credit. The buyer of the stock sale continues to do business with the same vendors, and enjoys the benefit of the credit story previously established by the seller.
  • Many times, no, or minimal, operating capital required. The cash flow of the business is already in place, and the business is up and running, so not as much capital is required when purchasing a stock sale.
  • Leases are in place. It is much easier to acquire the rights to leases of the business, such as a premises lease and equipment lease, if applicable, since the credit for these leases have already been established by the seller. If a below-market premises lease is being transferred to the buyer, this can be a big advantage because it could save him a lot of money in decreased rent payments.
  • Contracts are in place. Vendor, premises lease, and equipment lease contracts (as discussed above) are already in place, and in many cases, the cost of these contracts will be less expensive to the buyer than new contracts, as a result of the seller’s prior good credit history.
  • Employees are in place with worker’s compensation rate established. If the seller had a favorable workers compensation rating as a result of a history of low workers compensation claims, this low rating will transfer to the buyer, who will enjoy lower workers compensation insurance costs.
  • Licenses are in place. This will save the buyer money because he will not have to pay new license fees.
  • No public notification of the sale. In California, you don’ have to do a bulk sales publication to notify vendors, taxing authorities and others regarding a pending sale. This notification allows these entities to put claims in escrow against the seller prior to the close of escrow.
  • No sales tax on the fixtures, fixtures and equipment.
  • No deposits required.
  • Corporation, tax, and employment numbers and documentation are in place.

 

Stock Sale–Disadvantages

  • Legal liability for the corporation prior to the purchase. As a buyer of a corporation, you are at risk for all the liabilities of the corporation. Although the balance sheet of the business, as of the date you take over ownership of the corporation, is part of the sales documents, it is possible some liabilities are not included on the attached balance sheet. You need to get an indemnification and hold-harmless agreement from the seller, which says that you will be responsible for only for those liabilities indicated on the attached balance sheet, of the date of the sale. An indemnification and hold-harmless agreement is a document executed by the seller stating that the seller will be responsible for any liability that he does not represent to the buyer prior to the close of the deal. If necessary, after the sale, if some unknown creditors come after you, it might be necessary to press legal action against the seller to protect yourself. This is why you need an indemnification and hold-harmless agreement from the seller.
  • Assets are normally fully depreciated. When you buy the corporation, you inherit the seller’s depreciable base. There is a real disadvantage the seller in not being able to set up a new depreciable base based on the new purchase price you are paying for the business. One of the major reasons someone buys a business is to set up a meaningful depreciable base so they can shelter their income from taxes, which results in increasing the non-taxable cash flow of the business. This, and the unknown liabilities of the corporation (as discussed in number one above), are the two major reasons sellers don’t generally want to buy the stock of the corporation, and would rather do an asset sale.

From our experience in doing transactions we have found that in most cases a stock sale is a hard sell to accountants and lawyers (as shown by the reasons above), and make it hard to recommend stock sales to their clients. In the over 850 transactions that I have personally completed less than half a dozen have been stock sales for the reasons indicated above.