Smith Holland M&A Resources
Stock sale deal structures aren't always best.
Unfortunately, the question of a stock sale or asset sale is not something that comes up early in transaction discussions. Most times the question is rushed into the equation, and then becomes a blocking factor to the deal -- rightfully so as this is a major decision the seller must commit to. Luckily, this can be avoided with proper preparation alongside your mergers and acquisitions firm, and like all good things, patience is required. Rarely does a top-of-mind solution exist to this conundrum and just like the levers to valuation, the levers to deciding on the type of sale are plentiful. Stocks or assets, how difficult can it be? This discussion will focus on stocks, with the antithesis to many pros being the reason to choose an asset sale.
The amount of seats at the stockholder table directly increases the difficulty needed to manage the sale. Wrangling fish might seem like an easier task. The presumption is a buyer wants to own a company outright, and if twenty shareholders exist, coming to a unanimous decision stands as the tallest order. Many deals hang on the shred of the will of one stakeholder, and if he or she has had qualms with fellow owners in the past, or simply has unrealistic expectations of valuation or the selling process, the deal should have a major red flag associated. One remedy can be a merger, where some stockholders remain and some positions are bought out by the new owner. This might work great for a company with a single-owner operator, where a share of ownership gives both parties skin in the game and gives the buyer peace of mind regarding customer staying power and those trade secrets with remain with the business.
One of the biggest monetary decisions between an asset and stock sales are tax implications. The weight of how a transaction is structured can play hugely when it’s time to pay Uncle Sam. Historically, assets sales are known to have more tax advantages. The first instinct of many sellers is an asset sale, as it's easy to translate line items into valuation, especially for equipment and inventory-heavy enterprises. Bigger sales teeter the scale in favor of a stock sale, as the switching of hands between assets can incur third party costs such as auditing.
To steer clear of the tax pitfalls in a stock sale is to be an informed transactor. A Section 338 election can be advised to provide the pros of an asset sale, but averts the other pain point of an asset sale (not involving tax).
Keeping a seller’s eye, they may lean towards a stock sale due to the fact a buyer will assume all liabilities of the company henceforth from closing. However, buyers are not fools, and many times they will seek indemnity from prior business dealings to the date of closing. Unforeseen or undisclosed issues are fair game to bring up after a sale, so it is a buyer’s best interest to remain transparent and truthful throughout diligence -- a good general practice for business as a whole.
Switching lenses, the buyer will likely have the opposite preference from that of the seller Hence the conundrum and yet another weight on the scale towards an equitable deal. An asset sale for the buyer means tax and liability advantages, and the company liabilities typically remain with the original owner. The buyer is literally buying the assets of the company. Usually, any outstanding debts are paid off by the seller with the proceeds from the sale, at the time of sale. This makes sense when a new owner wants to continue relationships with a current supplier or customer. The old owner pays off any debts to the supplier prior to the agreed closing date, and any monies owed from sales up until the closing date are to be transferred to the old owner. The day of ownership transition is a big day for either a stock or asset transition.
One of the more vanity-stealing disadvantages to a stock sale is the lack of cash involved. There is no lump-sum payment, no big checks to take pictures and post on social media. The stock itself is used as currency consideration in transactions for private companies and for private companies, the same may be true if growth numbers are outstanding. Alternatively, an asset sale can bring a similar euphoria to that of a garage sale, or inventory audit. It is a way for the current owner to bring out everything the business uses or creates, puts a value on it, and makes dollar signs spin in the eyes of a seller.
There are professional and specialists involved in the most successful M&A transactions. Accountants and Attorneys should not be ignored, nor should any party feel intimidated by seeking the expertise of these key players. Both the buyer and seller will feel confident in a deal knowing all considerations have been reviewed by entities who do this for a living -- day in and day out -- with an unbiased perspective and incentive to help all parties succeed.
One exercise that takes matters down to earth is a simple one. Take Johnny’s Apple Stand, a purveyor of fresh apple and baskets to carry them. The stand doesn’t have a physical location, Johnny is on the go. The stand doesn’t have loans or debts or marketing materials or anything nefarious to foot. The potential buyer is ecstatic about expanding the apple trade, especially because it will be an easy transaction. However, Johnny is adamant about a stock sale. The buyer pushes back, after all, the sale only involves apples and baskets -- but Johnny won’t budge and the buyer really doesn’t want to waste any more time -- so a stock sale it is. Three months down the road, life is great, business is booming, but then, the stock sale comes back to bite! Turns out Johnny’s apples weren’t his at all, he stole them from a local farmer and sold them as if they were his own. Guess what. Remember that a stock sale transitions the entire entity onto the new owner. That same stock sale brought all of Johnny’s liabilities to the new buyer, a problem has sprouted. In this example, Johnny’s criminal actions will likely exonerate the new owner from fault, but the evidence might not be as clear cut for other scenarios. Spending money on an attorney after going through an involved transaction process is the last thing a buyer wants to think about. So think early, and prepare for the tough asset versus stock sale decision when taking the steps to sell your business.
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