Asset Sale vs. Stock Sale when selling a business [Transcript]
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[Plan Your Future Today]
[Laurie M. Lee, Business Attorney, CEO]
[ELEVATE Business Law, PA]
Laurie M. Lee:
So, there’s two types of sale. When you go to sell your business, you’re going to need to decide which type is best for you. The two types are an asset sale and an interest sale, sometimes it’s called a stock sale, depending on the type of business entity you have.
An asset sale, sometimes is referred to as selling the business, and selling the business means that everything the business has and everything the business owns, gets sold. In contrast, an interest sale, or a stock sale, means that you’re selling the business entity itself, and while you’re selling the business entity, everything inside that entity comes with it. So we’re going to talk about the two differences here. Keep in mind, when I say interest sale, I’m referring to the selling of an LLC. Because the ownership of an LLC is called an interest, sometimes it’s called a membership interest, I’m going to refer to it as interest. When I refer to a stock sale, I’m talking about a corporation. Because the ownership of a corporation is in stock, sometimes they’re called stockholders or shareholders as the owners of a corporation. I’m going to use them interchangeably because for discussions, they are the same.
So the asset sale, the first type of sale, and this is the most common for small businesses, if you take a look here at the seller and the buyer, the seller, has a business entity, I’m calling it, Seller, Inc, the buyer has a business entity and I’m calling this Buyer, LLC. The seller, Seller, Inc, is the current business that’s operating and that’s the one that’s for sale. The assets are inside the corporation, that’s why its assets are inside that box, everything the business owns, everything the business does, is inside that box. It’s the corporation box. The corporation owns it.
In an asset sale, what happens is, the buyer comes along and wants to buy the business. The buyer sets up its own entity, it could be an Inc or an LLC, and the transfer of the business takes the assets from inside Seller, Inc, takes them out and moves them over and puts them inside Buyer, LLC. So it’s just the assets that are moving. They come out of one entity and they move into the other entity. The buyer always has their own entity, it doesn’t matter if it’s an LLC or a corporation. And the seller, after the sale, still has its entity, either the corporation or the LLC. Now sometimes, keep in mind, that at the end of the sale, the seller could still end up with a completely empty entity. If all of the assets are being sold, then the seller keeps the entity, but the entity has no assets. It owns nothing. Now, most of the time, the seller is keeping something. There’s something that the buyer doesn’t want to purchase in that bundle. And so the seller retains the corporation or the LLC and whatever assets were not purchased.
So what are the assets? What is actually being sold? There’s three types of assets: there’s tangible property, there’s intangible property, and then there’s real property. And I’m going to discuss all three, very important. So when you’re deciding to sell, keep in mind what these three categories are and what types of property your business has and where they fit on these definitions. So the tangible property is everything you can feel and touch. It’s your furniture, it’s your computers, it’s your equipment, it’s everything that you pay a tax on, your tangible personal property tax, that’s what your tangible property is.
The intangible property, however, is much bigger. It’s things like your business name, your logos, the intellectual property your business might have, if you filed registered trademarks, that’s included, it’s the copyrights you have on your website, the things you’ve written, your manuals for your employees, your policies and procedures that you’ve written. All of those are intangible property. Your domain name, your telephone numbers, all the things that are really valuable in your company, but you can’t touch them, fall into the intangible property category. And then the third one is of course, real property, which is real estate. If you happen to own the building that you do business in, it may or may not be transferred in the sale. It can be transferred, sometimes buyers want to buy the building, sometimes sellers keep the building and rent it to the buyer. It just depends on the people.
So here’s some considerations for an asset sale. If you’re doing an asset sale, one of the most important things, is to list and define the assets that are being sold. And the transfer of those assets happen differently depending on if it’s a tangible property, in a tangible property, things that you can feel and touch, your equipment, your furniture, your computers, your files, those get transferred by a bill of sale. And so the bill of sale defines and the purchase agreement defines, what is actually being purchased, and that’s very important. Because if you think about it, sometimes it’s hard to list everything that the business owns. That’s something that’s going to take someone time to sit down and really think through what that list is. And if there’s something that the seller is not willing to sell, that has to make sure it’s very clear that it’s not included in the definition of assets.
The big thing with an asset sale is contract transfers. So if you think back to the diagram I just showed you, Seller, Inc, is the one who’s doing the business. All the contracts for the business are with Seller, Inc. When the assets transfer, the company is now Buyer, LLC. Buyer, LLC is not on the contracts for the business. And so those contracts have to be transferred. Seller, Inc, has to come off of the contracts and Buyer, LLC, has to be put on them. And there’s a couple of ways that happens. But you can imagine, you need to make sure that the other party to the contract is informed, if it’s necessary to inform them, that you’re transferring that contract to a different entity. And sometimes that’s the key for an asset sale, sometimes that’s the hurdle. If you’ve got clients that you don’t want to approach and say, “Hey, I’m selling the business and I need to transfer your contract to the buyer.” Sometimes that can worry clients and customers. And so there, that’s a tricky scenario and it’s a case by case basis as to how we handle that.
One of the contracts, and I pulled this one out separately, one of the contracts is the lease. So if you don’t own your business or your building, where you’re operating your business, and you’re leasing it, that lease actually has to be transferred as well. Because Seller, Inc, is on that lease, Buyer, LLC, needs to be put on that lease, and ideally, Seller, Inc, needs to be taken off. Because the seller doesn’t want to continue to be responsible for the lease obligations after the buyer has taken over the business and is paying rent. Depending on the landlord, this could be easy, it could be hard.
The other thing you have to consider is the account changes. So the bank accounts of the business, again, are in Seller, Inc’s name. After the sale, Seller, Inc still has those bank accounts, Buyer, LLC, has to set up their own bank accounts. Accounts usually don’t transfer in an asset sale. Usually the seller keeps the bank accounts, the buyer sets up new bank accounts, sometimes money is transferred, as part of working capital, as part of accounts receivable, accounts payable, when you start working out who’s going to pay what before closing and after closing, sometimes money transfers, but most of the time, sellers keep their own bank accounts and buyers start their own.
One of the things that buyers particularly like about an asset sale is that they can take all the good out of the company and they can leave the bad with the seller. So if there’s liabilities that have happened, and liabilities can be anything, use your imagination. It could be employees, it could be customers, it could be vendors, there could be disputes with anybody that arise months, years later. And so when that happens, those obligations come back to Seller, Inc, they don’t necessarily transfer to Buyer, LLC. Sometimes they do, sometimes they don’t. This is where we have to be very careful as to the buyer gets the good, but is the buyer getting any of the bad or is seller keeping all the bad as well?
Another consideration, especially if you are a service provider, if you’ve got a liquor license, if you’ve got a professional license, any type of licensing for the business that you’ve had to go through a regulatory process, application and that license comes to you and is specific to this Seller, Inc, you need to look and make sure that those licenses can be transferred to the buyer. Sometimes the buyer has to apply for the licenses separately and independently. They have to apply and be able to qualify and stand on their own and get their own licenses, and then once the sale happens, the seller just terminates their license and the buyer continues on with their own. But sometimes those licenses can be transferred, and depending on what type of license it is determines how easy that is.
And then receipt of funds. One thing I want to make sure you understand is with an asset sale, who is the seller? The seller is Seller, Inc. It’s the corporation, it’s the business entity that is the seller. So it is the business entity that will receive the purchase price. The business entity, the business accounts will be where the purchase price goes. So when the buyer pays for the business, it goes into the business’s bank account, not the personal owner’s bank account, the business’s bank account. And this can sometimes be a determining factor as to what type of sale you want.
So the other type of sale, the interest/stock sale, this is how this happens, again, we’re still with Seller, Inc, same corporation, same assets, same business. But now we have another layer, and this layers underneath, this is the actual shareholder. So you see underneath, it says owner, and then it has John Smith. Well, John Smith, individually owns Seller, Inc, he’s the shareholder. Sally Jones comes along and she wants to buy the business. Sally’s not going to set up her own corporation or LLC this time, what she is going to do, she’s going to buy the stock, or the interest, from John Smith. And when that happens, Sally Jones now becomes the owner of Seller, Inc. She steps into the shoes of John, Seller, Inc, never changes. Seller, Inc, stays the same. It has the same contracts, it has the same assets, it carries on the same business it did the day before, the only difference is, Sally now owns the stock and John does not.
So here are the considerations for this. So as you can imagine, as Sally steps into Seller, Inc, she gets the good, the bad, the ugly, and the fantastic. Whatever is in the corporation, she gets it. She cannot pick and choose. The seller keeps nothing, the buyer gets everything. So in the due diligence process, this is why a stock or interest sale takes a little bit longer for due diligence. Because the buyer tends to dig deeper and longer to make sure they understand exactly what’s here, before they make this commitment. This is an easier transition. So an interest/stock sale is a much easier transition. You don’t have to transfer any contracts, the contracts stay in the name of Seller, Inc, you don’t even have to necessarily notify the other parties to the contracts, because nothing’s changing. The corporation is staying the same, the business is staying the same. Everything’s the same. The contracts carry on just as they had before the sale.
The bank accounts also stay the same. Seller, Inc, is still on the bank accounts. It’s still the business’s bank account. So sometimes this doesn’t change, we only change the signatories on the bank accounts. So Sally would be put on the bank account and John would be taken off of the bank account. Very smooth transition. The licenses are a different story, however. Because a lot of times licenses are not necessarily just tied to the seller entity. So, Seller, Inc, yes has its licenses, but when a regulatory agency looks at whether to not to grant the license, they’re looking at who’s actually running the business. So they actually looked at John, and they might’ve looked at John pretty hard to see, does he have a criminal background? Is he a good person? Does he qualify for this license?
And so for those types of licenses, they’re very difficult to transfer. Sally would have to go in and either do a change of ownership process or she would have to apply for those licenses individually, again, through Seller, Inc, but she would have to qualify personally for those licenses. Sometimes the license doesn’t go that deep and it’s easy to do. It just stays the same, it’s not a big deal. So the receipt of funds on this type of sale, if you remember the asset sale, the receipt of funds went into the business’s bank account because, Seller, Inc, was the seller. In this case, John Smith is the seller, so the proceeds, what Sally pays, when she pays the purchase price to John, the purchase amount is actually going to go in John’s personal bank account. Why does this matter? It matters for tax reasons, one. Two, it also matters because sometimes when it goes into your personal account, you feel it instantly, if it were to go in the corporations account, sometimes there might be other factors of withdrawing that money. So that’s a big consideration for the interest and stock sale.
So when you’re making a decision, what type of sale do you want? Here are the four things, the four big things, that really make a difference in that decision. Number one, is the buyer preference. You’re not going to force a buyer to buy the stock of the company, if all they want to do is buy the assets. So if the buyer comes in and they have a very strong preference for an asset sale, most likely it’s going to be an asset sale.
Number two, is the contracts and relationships. So imagine if you have a business that has… It’s a small business, and it might have three really big clients. And those contracts, they have a contract with each client, and many of those contracts last two, three, four years, maybe there might be a couple of million dollars a piece. Those three contracts are a huge part of the business revenue. If it is difficult to go to those clients and say, “I’m selling.” Sometimes we end up doing an interest or stock sale for that reason because they don’t want to rock the boat on those contracts. Or maybe they can’t. Maybe it’s not permitted. There’s no transfer provision, you can’t assign the contract at all. Then a stock interest purchase would be the option and the way to go. The relationships and keeping the relationships steady with those clients is a very important business consideration.
The third reason, the third decision making factor, is taxation. There’s going to be different tax effects from a asset sale than a stock/interest sale. The owner, the seller, John, could end up paying different amounts of taxes depending on what type of sale it is, same business, same purchase price, everything’s the same, but the way it’s structured could have a big difference in tax effect on that seller. And then the fourth one we talked about already, which is the licensing. If there’s a really necessary license, a critical license to the business, can it be transferred? And if it can’t, then maybe a stock/interest is okay, but if it can be transferred, then we’re looking at how the easiest way is to accomplish that. So those are the four decision-making considerations, when you decide how to sell your business.
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