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Asset sale or stock or equity sale: How should sellers plan early?
When you plan to sell your Texas business, the deal structure matters as much as the final price. Two common choices exist: an asset sale or an equity sale. Each option affects your taxes, your risk, and the deal timeline. Smart owners plan these details before they sign a Letter of Intent (LOI).
How asset sales and equity sales differ
In an asset sale, the buyer chooses specific assets to purchase, such as equipment, customer lists and inventory. The sellers keep the legal entity which formerly ran the business and may keep unwanted liabilities and assets. Buyers who prefer this option elect it because they easily step up asset values from their depreciated amounts to potentially reduce taxes later.
Depending on the structure of the target business, asset sales might result in a higher tax bill to the sellers. Income tax may be assessed at ordinary income rates on some assets rather than at the lower capital gains rates that apply to an equity sale (assuming the seller is not a pass through entity, such as a business filing annual tax returns on Form 1065 or 1120S) . This issue often occurs with inventory or equipment that has lost value over time. Also, under Texas law, if any tangible assets are excluded from an asset sale, franchise taxes may apply.
In an equity sale, the buyer purchases ownership of the entire company from its shareholders, partners or members. Depending on the structure of the business being sold, Sellers sometimes favor this structure to assure that long-term capital gains income tax rates apply to their proceeds. For certain transaction structures, Buyers can elect for an equity deal to be treated as an asset sale for tax purposes. That means Sellers need their agreements to be clear about the tax treatment they are agreeing to. Regardless of the structure, Buyers need to carefully craft equity purchase agreements to reduce risk associated with the business, such as old legal issues or unpaid bills.
Why planning early matters
Many owners wait too long to consider deal structure. After you sign an LOI, the buyer often holds more leverage. If you ask for a change to the deal structure late in the process, the buyer may push for a lower price or other concessions to balance its costs, such as loss of the step up in value of the assets.
Early talks with a lawyer who is a tax expert help you understand your options. You should review your entity type and consider potential transaction structures before marketing your business for sale. Early planning reduces surprises and supports a smoother exit from your business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
