Asset sale vs. stock sale

There are three common structures for M&A transactions: a stock sale, an asset sale, and a merger. The specific motivations and circumstances behind each transaction will inform which of these structures a deal takes. Each of these three M&A structures can require different levels of due diligence, definitive documents, and types of formal consent from both shareholders and third parties.

What is an asset sale?

In the context of an M&A transaction, an asset sale is typically a transaction in which the target company sells all or substantially all of its balance sheet assets to the buyer. The buyer adds these assets to its own business, and then the target company typically pays off its remaining liabilities and dissolves. If the target company is a corporation, it pays the proceeds of the sale to its shareholders as part of the wind-down process. If the target is a limited liability company (LLC) or a partnership, the proceeds are typically distributed among members or partners. 

How an asset purchase works

In an asset deal, the buyer acquires some or all of the assets owned by the target company, but the buyer does not acquire the target entity itself. In many cases, the target dissolves after an asset sale and ceases to become a distinct legal entity. Alternatively, the target can continue to exist as a standalone entity with any assets that remain after the transaction. 

The benefit of an asset sale, from the buyer’s perspective, is that it can select which assets and liabilities to acquire in the deal, compared to a stock sale or merger, where the buyer acquires all the assets and liabilities of the target. Typically, a buyer will disclaim the assumption of any liabilities in an asset purchase.

It might help to think of an asset sale as similar to an estate sale: While the seller is parting with all or most of the assets that are contained within the house, they are retaining ownership of the house itself. 

Partial asset sales

An asset sale might not include all of the target’s assets and potential liabilities. The buyer could acquire everything that the target owns, or it could acquire just one division, business line, or strategic asset. In particular, the target often retains some or all of its long-term debt obligations. 

In some cases, partial asset sales can involve the acqui-hire of specific teams and the acquisition or license of associated intellectual property. Any parts of the target that were not sold off would continue to exist and operate without the acquired teams and associated IP.

It’s important to note that partial assets sales may not constitute a “change in control” as defined in the target’s charter or governing documents, such that it doesn’t trigger pre-negotiated liquidation payouts.

Asset purchase agreement

An asset purchase agreement is a legal contract between the buyer and target that formalizes the terms upon which the transfer of assets will occur. The asset purchase agreement defines the specific assets and liabilities included in the sale and any assets or liabilities that will remain behind with the target. The purchase agreement also includes other key deal terms, such as the purchase price, the terms for payment, closing conditions, and any relevant representations and warranties. 

There may be other documents required for the deal, as well. For instance, a bill of sale as a conveyance document, assignment and assumption agreement, IP assignment, or IP license. In an acqui-hire, the acquired teams will also need new employment agreements with the buyer.

What is a stock sale?

A stock sale is a type of M&A transaction in which the shareholders in a target sell their stock to the buyer, with the target typically becoming a wholly owned subsidiary of the buyer. An acquisition can only be structured as a stock sale if the target is a stock-issuing corporation. Partnership interests and LLC membership units are legally distinct from stock, so if the target is a partnership, an LLC, or a sole proprietorship, a transaction cannot be structured as a stock sale. Instead, the transaction may potentially be structured as an acquisition of the type of ownership interests applicable to those other types of entities.

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How a stock purchase works

In a stock deal, the buyer acquires stock in the target directly from shareholders and, as a result, becomes the legal owner of the target entity with the target typically becoming a wholly owned subsidiary of the buyer. The target could continue to operate as a distinct subsidiary, or it could cease to exist after integrating with the buyer’s business, in which case the buyer would bring all of the target’s prior operations and assets within the buyer’s business. 

Instead of acquiring individual assets, as in an asset sale, the buyer in a stock sale acquires ownership of all the target’s assets and all liabilities—including known and unknown liabilities. In some cases, the buyer may request that the target preemptively divest assets, pay off, or otherwise resolve liabilities that the buyer is not interested in acquiring or assuming.

To continue the previous analogy, if an asset sale is akin to an estate sale, with the buyer able to pick certain assets to acquire, then a stock sale is similar to buying the whole house, with all the assets still inside.

Partial stock sales

Not every stock sale involves 100% of a target’s shares. A transaction where a buyer acquires only a portion of the target’s shares may also be structured as a stock sale. In this case, the buyer would operate alongside the non-selling shareholders as the target’s owners. As noted above, partial stock sales may not be considered a change of control transaction under the target’s charter or governing documents. The target should consult with legal counsel to determine if the change of control provisions are triggered as a result of a partial stock sale.

Stock purchase agreement

A stock purchase agreement is a legal contract that formalizes the sale and transfer of stock in a stock sale. The parties in a stock purchase agreement are the buyer and any selling shareholders involved in the deal, which may or may not include the target itself. A stock purchase agreement usually defines key deal terms such as the purchase price, the terms for payment, closing conditions, and any relevant representations and warranties.

Asset sale vs. stock sale tax implications

The question of whether a transaction is structured as an asset sale or a stock sale can have important tax implications for the buyer, the target, and any other sellers involved in the deal. Companies and sellers should consult with a tax advisor or accountant to fully understand how a sale might impact their taxes. Here’s a brief look at how taxes can differ for an asset sale versus a stock sale: 

Asset sale taxes

After the completion of a transaction and the final determination of the purchase price in an asset sale, the buyer and target must allocate the purchase price across the assets involved in the deal and assign each asset a value. The target is then typically taxed on the gain or loss realized on each asset sold. To streamline the process, the assets involved in a sale are often grouped into classes of similar assets, rather than each being valued individually. An appraiser sometimes helps establish the value of the assets or classes of assets. 

The target in an asset sale is the first party to report a gain or loss for tax purposes. The tax treatment for those gains or losses depends on the target’s legal structure. 

C-corporation

If the seller is a C-corporation, it will likely have both ordinary gains and capital gains from the result of an asset sale. In this situation, income from an asset sale will be subject to double taxation if the proceeds will be distributed to the seller’s shareholders. The C-corp will pay taxes itself at the corporate level based on the gain and loss mentioned above, and shareholders may pay personal income tax on their share of the income once any proceeds are distributed. 

Pass-through entity

If the seller is structured as a pass-through entity such as an S-corporation or a partnership, then the shareholders or members will pay tax on their share of the profits, typically at the lower capital gains tax rate.

Buyer taxes

From the tax perspective of the buyer, an asset sale allows for a step-up in the tax basis of the assets acquired. This often allows the buyer to increase their depreciation and amortization deductions in the future, which can result in lower tax bills.

Conducting an asset sale with companies based outside the U.S. can be more complicated, as the tax implications can differ depending on treaties between the U.S. and the country in question.

Stock sale taxes

For the sellers in a stock sale, any profits are typically taxed as capital gains, regardless of the target’s legal structure. For the target, a stock sale is usually a nonevent from a tax perspective.

The buyer in a stock sale does not get a step-up in tax basis in the assets that comprise the target company, and thus is not able to increase their depreciation and amortization deductions in the same way as in an asset sale. 

In some instances, a transaction that’s legally structured as a stock sale may be treated as an asset sale for tax purposes. A 338(h)(10) election is one such way to recharacterize a sale. 

Which type of M&A deal structure is right for your startup?

There is no one-size-fits-all rule to determine the proper way to structure an M&A transaction. If your company is considering a sale or an acquisition, you should consult with legal and financial advisers to determine the best transaction structure.

As mentioned previously, a company structured as a partnership, LLC, or sole proprietorship cannot legally be the target in a stock sale per se, because it does not have stock. However, the equity of a partnership can be bought and sold in a similar way to the stock in a corporation. If a company is structured as a C-corp or S-corp, the parties can choose between a stock sale and an asset sale. 

Although not covered in this article, mergers are another common way to exit via M&A. Any structure of company can be involved in a merger, whether it’s a partnership, LLC, or corporation. That said, S-corps typically do not exit via merger, because it can be inefficient from a tax perspective. 

If the target company’s business involves significant intellectual property, patents, or contracts, an asset sale can end up being much more complicated than a stock sale. In an asset sale, the ownership of these acquired assets would change hands, with the buyer negotiating separately for each asset. In a stock sale, ownership of such assets does not change hands in the same way. The target still retains its ownership typically, even if the target has a new owner.