When owners compare offers for their business, they usually compare the price. Buyers compare something else as well: how the deal is structured. The structure decides who keeps which liabilities and how the purchase price is taxed, and that can change what the seller keeps by a large amount.
The two basic structures
In an asset sale, the buyer purchases the business’s assets, such as equipment, inventory, customer lists and goodwill, and the seller’s company is left behind. In a stock sale, the buyer purchases the owners’ shares or membership interests, and the company itself changes hands with everything in it.
Why buyers usually prefer an asset sale
- Fewer inherited problems. The buyer chooses which assets and liabilities to take, and leaves unknown claims with the seller’s company.
- Tax deductions going forward. The buyer gets a new tax basis in the assets and can depreciate or amortize the purchase price, including goodwill over 15 years.
Why sellers often prefer a stock sale
- A cleaner exit. The company, its contracts and its history go with the buyer.
- Simpler tax treatment. Gain on selling stock is generally capital gain, and a C Corporation avoids the double tax that an asset sale can create.
The purchase price allocation matters
In an asset sale, the price is divided among the assets, and each category is taxed differently. Amounts allocated to goodwill are generally capital gain for an owner of a pass-through business. Amounts allocated to equipment can trigger depreciation recapture taxed as ordinary income, and inventory produces ordinary income as well.
Payments for a non-compete or a consulting agreement are generally ordinary income to the seller. Buyers and sellers often want opposite allocations, so this is a point to negotiate, not a detail to leave to the closing documents. Both sides report the allocation to the IRS, and they should report it consistently.
Entity type changes the math
- LLCs and partnerships: an asset sale is common and usually produces one level of tax, though the mix of capital gain and ordinary income still matters.
- S Corporations: gain passes through to the owners. In some deals, the parties can treat a stock sale as an asset sale for tax purposes, giving the buyer its tax benefits while keeping a stock deal legally.
- C Corporations: an asset sale can be taxed twice, once to the Corporation and again when the proceeds are distributed, which is why C Corporation owners often push for a stock sale.
What to do before you sign a letter of intent
- Compare offers on what you keep after tax, not on the headline price.
- Decide your preferred structure and allocation before you sign the letter of intent; leverage drops after that.
- Clean up records, contracts and ownership documents so a buyer’s due diligence goes smoothly.
- Plan the timing of the sale with your other income, and consider installment payments where they help.
Selling a business is usually a once-in-a-career event, and most of the value is decided in the structure. Learn how we help owners sell a business.
This article is general information, not legal or tax advice for your situation. Reading it does not create an Attorney-client relationship.