Asset Sale vs. Equity Sale: Key Considerations When Selling Your Business

Selling a business requires evaluating several factors beyond settling on the right price. The choice between an asset sale and an equity sale is one of the most crucial yet frequently overlooked aspects of selling a business. Both asset and equity sales present distinctive advantages and disadvantages that warrant careful consideration when selling a business and selecting a transaction structure. By choosing a transaction structure most suitable to your needs, you can optimize your returns and facilitate a smooth transition to your future business endeavors.

What is an Asset Sale?

An asset sale is a transaction structure for selling a business where the business entity transfers ownership of certain tangible and intangible assets to the buyer rather than transferring ownership of the business. Think of an asset sale like shopping at a grocery store where the buyer picks out only the assets that they want to purchase and leaves the rest with the grocery store. Assets purchased by the buyer may include real estate, equipment, inventory, licenses, trademarks, patents, customer lists, contracts, and other intellectual property. Any assets not purchased by the buyer remain with the seller and all liabilities stay with the seller unless assumed by the buyer.

Asset Sale Advantages

1. Flexibility: Asset sales offer sellers the opportunity to sell specific assets while retaining ownership of other assets they wish to keep. For instance, if a seller wishes to retain ownership of a truck or building following the sale, structuring the transaction as an asset sale will allow the seller to sell all other business assets while retaining ownership of the assets they want to keep.
2. Liability Retention: Asset sales allow sellers the ability to retain liabilities, which can be advantageous when sellers want to control the payment and settlement of those liabilities. Liabilities can also be included as part of an asset sale, but liabilities will not be assumed by the buyer unless the terms of the agreement provide otherwise.
3. Negotiable Pricing: Sellers have flexibility when negotiating the price of individual assets, enabling them to potentially achieve higher valuations for specific assets that may have strategic value for the buyer. There are also tax considerations for sellers when determining the price of individual assets, such as ordinary income and capital gain tax treatment.

Asset Sale Disadvantages

1. Tax Implications: Asset sales result in higher taxation for sellers compared to equity sales. The tax implications will depend on the business’s tax status (whether it’s a Partnership, C corporation, S Corporation), the assets involved, and how the purchase price is allocated among assets. Partnerships and S corporations must pay careful attention to depreciated assets, as depreciation recapture can trigger significant tax liabilities for unwary sellers.
2. Negotiation Complexity: Asset sales involve extensive negotiations and valuing individual assets and liabilities. Thus, asset sales are often more time-consuming and resource-intensive than an equity sale.
3. Continuation of Business: Following an asset sale, the existing business entity continues to survive except without the transferred assets. This means that the seller still bears responsibility for any outstanding debts and liabilities that were not transferred to the buyer and creditors now have access to the cash proceeds from the sale that may be used to satisfy any remaining debts or obligations. Following an asset sale, the business will continue to remain in existence until the owner dissolves the business, winds-up its affairs, pays off creditors, and distributes the remaining assets.

What is an Equity Sale?

An equity sale is a transaction structure for selling a business where current owners sell all of the outstanding shares or interests of the business to the buyer. Think of an asset sale like shopping at a grocery store, except the buyer purchases the company that owns the store instead of picking out certain groceries. With an equity sale, the buyer acquires ownership of the entire business entity, including all its assets, known and unknown liabilities, contracts, and obligations. Equity sales continue the existing business, just under new management.

Equity Sale Advantages

1. Tax Benefits: Equity sales almost always offer more favorable tax treatments for sellers compared to asset sales. Unlike asset sales, where the sale of certain assets can result in the recognition of ordinary income, equity sales allow sellers (who own their equity for more than a year) to receive long-term capital gains tax treatment on all proceeds received from the sale of their equity. In the example below, the seller could potentially save $850,000 in taxes by opting for an equity sale over an asset sale.
   • Example: Suppose a seller decides to sell their company for $10 million. The company has no operations, and its sole asset is equipment originally purchased for $7,000,000, but it has depreciated by $5,000,000 over the years. This depreciation has reduced the seller’s equity basis from the original $7,000,000 to $2,000,000. If the transaction is structured as an equity sale, the seller will have a capital gain of $8,000,000 and will owe $1,600,000 in taxes ($8,000,000 gain * 20% long-term capital gain rate). If the transaction is structured as an asset sale, the seller will owe $2,450,000 in taxes, with $5,000,000 of depreciation recapture taxable at the 37% ordinary income rate and the remaining $3,000,000 gain taxable at the 20% long-term capital gain rate.
2. Simplicity: Equity sales provides a more straightforward transaction structure for sellers compared to asset sales. Unlike asset sales, where each asset and liability must be identified, negotiated, and valued, equity sales involve valuing the entire business as a going concern. Equity sales allow for a more holistic and accurate determination of company value because intangible assets such as customers, goodwill, and brand recognition are converted into profits and losses that are reflected in the financials. Equity sales offer a streamlined approach to valuation that can save sellers considerable time and resources and allow them to close the deal more efficiently.
3. Comprehensive Transfer: Equity sales often allow contracts, licenses, and permits to be received by the buyer without the need for assignment or consent.
4. Complete Exit: Equity sales allow sellers to achieve a clean break from the business, as the buyer assumes all assets and liabilities, allowing the seller to fully disengage after the sale and focus on other ventures.

Equity Sale Disadvantages

1. Purchase Price Reduction: Sellers will usually receive a lower sale price on an equity sale because of the buyer’s foregone tax benefits. Unlike an asset sale, where the buyer can benefit from a ‘stepped-up’ tax basis on the acquired assets (increasing the basis of assets for tax purposes allows buyers to depreciate the asset and generate tax savings), equity sales do not provide such advantages to buyer. In an equity sale, the buyer simply assumes the business’s existing tax basis in the assets and only receives basis in the purchased equity that cannot be depreciated. As a result, buyers often negotiate for a lower purchase price to compensate for any foregone tax benefits.
2. Regulatory Approvals. There may be certain legal restrictions that prevent certain individuals from owning or controlling the business. For example, certain professional services firms (like law or accounting firms) might require owners to be licensed professionals. In these cases, an equity sale might not be feasible if the potential buyer doesn’t meet the necessary owner criteria. Depending on the industry, an equity sale may also require regulatory approval or clearance, which can lengthen the timeline and increase the complexity of the transaction.
3. Further Assurances: In an equity sale, the buyer assumes the risk of all unknown or undisclosed liabilities that come with the business. These could be future tax liabilities, pending lawsuits, or other contingent liabilities that weren’t identified or known during due diligence. As a result, buyers often require sellers to place a portion of the sales price in escrow or provide further assurances, such as indemnities or warranties, to protect against the risk of these potential unknown liabilities.

Conclusion

Selling your business is a significant event for any business owner and choosing the appropriate transaction structure is critical to protect your interests. Asset sales and equity sales offer unique advantages and disadvantages that must be carefully considered when deciding to sell a business. The choice between an asset sale and an equity sale largely depends on the specific circumstances of the parties, the assets and liabilities of the business, and the objectives of the parties. Ultimately, the decision between an asset sale and an equity sale is a strategic one that should be made carefully and in consultation with financial advisors, accountants, and legal professionals. Every business situation is unique, and it’s important to thoroughly understand and evaluate the implications of structuring your transaction as an asset sale or equity sale before making any strategic decisions.