In earlier blogs we started our list of Things Every Businessperson Should Know Before Buying or Selling a Business. That first item was “No Pig in a Poke” and the second item was “Power of the Pen”. Here is the third one to keep in mind:
3. Separating Wheat from Chaff.
Fundamentally, acquisitions take the form of either a stock sale (either directly or by merger) or an asset sale. And fundamentally, the seller receives either cash or property (i.e., stock), or some combination. Everything else is a variation — sometimes complex — on one of those themes. A stock sale, however, is quite different from an asset sale, sometimes with far-reaching effects.
Sellers typically prefer stock sales. Foremost, unless the selling entity is a long-time S corporation, or LLC or partnership, sellers shun asset sales because of the risk of double tax on the sale proceeds (first upon the corporation’s receipt, next upon distribution to shareholders). Without proper planning, this can result in a tax catastrophe. Second, a stock sale allows the seller to shed the entity, but an asset seller keeps the entity, albeit as a shell, with its historical liabilities, known and unknown. Long after an asset sale, pre-closing creditors can claim directly against the seller entity, now rich with cash from the sale. And there are fewer papers and fewer consents in a stock purchase, as only the stock is moving to a new home, not each asset.
On the other hand, buyers prefer to buy assets because they can in effect “pluck out” the desirable assets and, as mentioned above, by law leave the seller with the entity shell and its historical liabilities. By contrast, in a stock sale the buyer takes both the “wheat and the chaff,” the known and unknown, all of course subject to negotiated indemnities and other express rights.
In the end, the tax tail often wags the structure dog and determines whether stock or assets are trading hands.
More to come in our next More Things You Should Know.