Asset v Stock Purchase: Which One is Better?

Whether to structure a business purchase as an asset sale or a stock sale is one of the most important decisions in an M&A transaction.
It’s important to consider a number of factors, including: liabilities; licenses, contracts, and relationships; tax implications; sales tax; and employee relationships.
The decision often comes down to:
- Liability transfer vs.
- Business continuation
The attorneys at G & G Law can help walk you through this big decision and ensure you’re structuring your business purchase appropriately from the early LOI stage.

Asset Sale vs. Stock Sale: Pros and Cons

Buying or selling a business involves a lot of decisions. One of the most complex legal decisions is whether to structure the purchase as an asset purchase or a stock purchase. The decision is high-impact – it affects: the amount of risk the buyer is taking on and the seller is retaining, how easy the transfer of the business will be (and how quickly and easily the buyer can be “open for business”), employee relationships, and what taxes need to be paid by the buyer and the seller.

We have a breakdown below of some of the main differences between an asset sale and stock sale and how you might evaluate them for your specific situation.

What is a Stock Purchase?

A stock purchase is probably what most people think of when they think of buying a business. In a stock purchase, or equity purchase, the buyer purchases the entire business entity, whether it’s an LLC, corporation, partnership, or other entity type. The buyer essentially steps into the seller’s shoes. Stock purchases usually provide more business continuity, as the buyer can often keep contracts, employees, and other parts of the business without the need for assignments, approvals, or additional negotiations. However, stock purchases also transfer many of the seller’s liabilities to the buyer.

What is an Asset Purchase?

In an asset purchase, the buyer only purchases the assets of the business, and the seller keeps the entity. This still allows the buyer to buy the business for the most part – the assets purchased in an asset purchase can include physical assets such as supplies, inventory, furniture, etc, but can also include intangibles such as the name, goodwill, customer lists, and similar. Asset purchases don’t automatically transfer things like contracts, leases, and employees, but also do not transfer most liabilities. For this reason, a lot of buyers tend to prefer asset purchases, so they can be selective about what liabilities they are taking on.

Is it better to structure an M&A deal as a stock sale or an asset sale?

How to structure a specific M&A deal depends on the specific circumstances of the business, the seller, the buyer, and the structure of the deal.

It’s often thought that an asset sale is better for a buyer. This is because buyers can avoid taking on the liabilities of the business that were incurred before they were responsible for the business.

However, there are circumstances where a buyer might prefer a stock sale. Some buyers could value continuity of the business more highly than avoiding liability risk. An example of this might be buying a restaurant. Restaurant buyers sometimes prioritize easy transfer of the business permits over avoiding liability – they want to get the restaurant up and running and making money as soon as possible.

Many other factors come into the decision. Read on for details on some of the considerations, including: liabilities; licenses, contracts, and relationships; tax implications; sales tax; and employee relationships.

How are Liabilities Treated in a Stock Sale vs. an Asset Sale?

Liabilities in a Stock Purchase: In a stock purchase, the buyer automatically assumes all liabilities (known and unknown), because they are buying the full business entity and taking over the seller’s role. The buyer must perform thorough due diligence to investigate the business because it inherits the company’s full risk (e.g., lawsuits, tax audits, environmental liabilities). The buyer will also want to make sure their purchase agreement has strong protections for any risks that the seller did not disclose to the buyer.

Liabilities in an Asset Purchase: The buyer typically does not assume liabilities in an asset purchase unless they explicitly agree to do so in the purchase agreement. However, some liabilities can still impact the buyer. For example, there are a few laws that transfer tax liabilities if the buyer is considered to be a “mere continuation” of the seller or if the buyer does not comply with certain laws during the purchase process. And any liability on the assets themselves, like a lien, may still impact the assets. While fewer liabilities transfer in an asset purchase, due diligence is still important for a buyer to confirm that there are no outstanding encumbrances, liens, or claims against the assets being purchased.

Transferring Licenses, Contracts, and Relationships in a Stock Sale vs. Asset Sale

Transfers in a Stock Purchase: Most contracts will automatically continue when the buyer takes over the business. However, some contracts may contain a “change of control” clause that allows the other party to the contract to terminate the agreement if the business ownership changes. The buyer should review all contracts during due diligence and may need to take steps to make sure the other party will not exercise their right to terminate in that case. Most licenses and permits will also transfer, although the agency that issues the licenses and permits may need to be notified of changes to owner information.

Transfers in an Asset Purchase: Most legal documents and relationships are made with the business entity itself, like licenses, leases, permits, and contracts. They do not transfer automatically with an asset purchase, where the buyer isn’t buying the entity. The buyer must get consent from the other parties to a contract for it to transfer or be assigned to the buyer. The buyer will also need to follow the required process to transfer any licenses and permits that can be transferred, and in some cases may need to obtain entirely new licenses and permits.

Sales Taxes in a Stock Sale vs. an Asset Sale

Sales Tax Implications in a Stock Purchase: There is no direct sales tax or transfer tax on the stock itself in a stock purchase (there is still income tax). The buyer will typically inherit any tax liabilities of the seller. Therefore, the buyer will want to make sure that the seller is compliant with all required tax filings as of the closing date. Usually this is something the buyer checks during the due diligence process. Then, a business attorney can draft purchase agreement terms that make clear that the seller will indemnify the buyer if it turns out that taxes incurred before closing haven’t been paid. In that case, the seller will be on the hook for paying those tax liabilities, even after the buyer has purchased the business.

Sales Tax Implications in an Asset Purchase: Illinois and Cook County each have bulk sales tax laws that apply when a business sells a substantial portion of its assets outside of the course of ordinary business. Typically, this is paid by the seller, but the buyer may have successor liability for unpaid bulk sales taxes if they do not follow the proper notice and withholding procedures during the purchase process.

Other Tax Implications in a Stock Sale vs. an Asset Sale

Tax Implications of a Stock Purchase: Because the buyer is purchasing the entity altogether, the entity retains its historical tax basis. This means that the buyer is typically not able to deduct as much depreciation or amortization on their taxes as they could in an asset purchase. However, taxes are typically better for the seller in a stock purchase. The seller generally pays only capital gains tax on the sale of stock (federal and state), so the seller is only taxed at the more favorable capital gains rate with a few limited exceptions.

Tax Implications of an Asset Purchase: The buyer can “step-up” the tax basis of the purchased assets to fair market value, allowing the buyer to potentially take advantage of greater depreciation and/or amortization deductions for tax purposes. The seller pays tax on gains from the sale of the assets, but some of the purchase price from the sale will need to be allocated to the inventory and accounts receivables and treated as ordinary income, which is often taxed at a higher rate than capital gains.

It is important to note that in certain situations, a stock sale can be treated as an asset sale for tax purposes.

If you are buying or selling a business, you should talk to a tax professional as early as possible in the process to ensure you’re structuring the deal appropriately for your situation, from a tax standpoint.

What Happens to Employees in a Stock Sale vs. an Asset Sale?

Employees in a Stock Purchase: In a stock purchase, because the buyer takes over the business entity, employees typically remain employed unless the buyer chooses to terminate them. However, certain employment contracts or benefits plans may contain language that triggers notice or severance obligations for the company if an ownership change occurs. It is important to review all employment agreements, handbooks, benefits, and other employment documents because the buyer will be liable for those as the new owner of the business entity.

Employees in an Asset Purchase: The employment relationship is between the employee and the business entity, so an employment relationship does not transfer in an asset purchase. The buyer will typically need to rehire any employees, but this means that the buyer typically isn’t liable for any employment contracts or employer related liabilities of the seller. However, a typical purchase agreement will still have the seller warrant that they have taken care of all the taxes and liabilities to their employees. It is possible that liability can transfer to the buyer, even in an asset purchase. Make sure you work with an experienced business attorney to draft purchase agreement terms that prevent you from taking on any unexpected liability related to employees.

Summary: Pros and Cons of a Stock Sale vs. an Asset Sale

In short, here’s a general wrap up of the attributes of an asset purchase and a business purchase from the perspective of a buyer:

Stock Purchase Pros:

Easier transition.
More business continuity.
Greater risk because the buyer takes on all liabilities of the company.

Asset Purchase Pros:

Can pick and choose what assets of the business to purchase.
Can avoid many of the existing liabilities of the seller.
Contracts don’t automatically transfer.

As you can see, there are many factors to consider when deciding whether to structure an M&A deal as a stock purchase or an asset purchase. It’s typical to make this decision early in the process of buying or selling a business – the Letter of Intent (LOI) or Term Sheet usually specifies whether the deal will be structured as an asset sale or stock sale. Therefore, it’s important to get professionals lined up early in the business purchase process. A tax professional can help you understand the best structure for tax purposes and a business lawyer can help you evaluate the legal implications for your business.

Are you looking to buy or sell a business soon? We have more resources for you. Check out the links below and sign up for our newsletter for ongoing updates. And feel free to reach out if you’d like to see how we can help with your business acquisition or sale.