What is the difference and which one is right for your exit?
There are generally two ways to sell your business: an asset sale or a share sale. Each option comes with key considerations you should keep in mind when you are preparing for an exit. We are here to help you understand the key differences as well as the pros and cons of each option.
What is an Asset Sale?
Think of your company like a home. An asset sale is similar to the most intensive garage sale you can imagine. A Buyer comes in and buys everything from your microwave to your baby pictures. You keep the empty shell of the house and an assortment of unwanted items like old newspapers and creepy clown wallpaper.
If you sell your business by conducting an asset sale, a Buyer will purchase most of (if not all) the assets that belong to your company while you retain possession of the underlying legal entity. Thus, an asset sale is actually an amalgamation of several individual sales of your company’s assets – including both intangible and tangible assets. Tangible assets are the parts of your business that you can touch or hold in your hand – inventory, computers, buildings, vehicles, machinery, and equipment all fall into this category. Intangible assets, on the other hand, are assets like contracts, goodwill, patents, social media accounts and customer lists.
By definition, an asset sale means the Buyer is not buying your entire company – just the pieces he or she wants. This means that you and the Buyer are going to need to negotiate exactly what you are selling and what you will be left with.
While asset sales are subject to a wide range of negotiation variables, cash is not usually included in these deals and the Seller typically retains long-term debt obligations. This arrangement is referred to as a “cash-free, debt-free transaction.” On the other hand, normalised net working capital is typically included in an asset purchase agreement. Net working capital includes items such as accounts receivable, inventory, and accounts payable.
What is a Share Sale?
If we still think of your company like a home, in a share sale, the Buyer buys the title to your house and keeps everything inside, including the wallpaper.
In a share sale, a Buyer purchases the selling shareholders’ interest in a company, thus obtaining ownership in the company and everything it owns. This means that there is no need for separate sales of the company’s assets. In this way, a share sale is much cleaner than an asset sale. However, as discussed later in the article, it can also be more complex.
Asset Sale or Share Sale? What’s Best for You?
Buyers tend to like asset sales for several reasons, but there are two main ones: 1) asset sales have some significant tax advantages for the Buyer and 2) Buyers can significantly decrease potential legal liabilities with an asset sale
On the other hand, Sellers typically prefer share sales, for the same reasons that buyers like asset sales: 1) Preferential tax treatment and 2) reduced liabilities
But it would be a gross oversimplification to say that asset sales are always better for Buyers and share sales are always better for sellers. There are a number of other factors that need to be taken into consideration when determining the best structure for both sides on a specific deal, and it is always important to balance these with the complexity different deal structures can create and the impact they can have on a transaction.
One of the most important factors in deciding between an asset sale and a share sale is the difference in what your eventual tax bill will look like. Your business’s legal structure has a lot to do with the exact amount of taxes you will pay after selling your business, but asset sales typically create higher tax liabilities for Sellers than share sales. See more information on this topic at the end of this article.
Another major consideration is legal liability: An asset sale allows Buyers to strip away any outstanding legal claims or possible future litigation, leaving the Seller – who still owns the underlying company – with all of that baggage. This means that any lingering issues, contract disputes, product warranty claims, or employment litigation are still the Seller’s responsibility.
But an important factor to keep in mind is the complexity and duration of the due diligence process: A share sale will likely lead a Buyer to conduct more lengthy and exhaustive due diligence to make sure that every element of your company passes scrutiny. As a consequence, using a share sale can make your entire exit process longer and more complicated. Additionally, you run the risk of a Buyer backing out of a share sale because of a nuanced issue ingrained deep in the inner workings of your company that would not have come up with an asset purchase.
Other elements of a business can also make one type of transaction preferable over another. For example, if your business relies on exclusive contracts, licensing agreements, or assets that are not readily assignable a Buyer may actually prefer a share sale over an asset sale to eliminate the headache of transferring those assets.
One final thing to keep in mind is that you can mitigate a lot of the issues we discussed above in the final purchase agreement. For example, if a Buyer insists on an asset sale – and you know this is going to make you pay a higher tax bill – you can counter by asking for a higher purchase price. Or, if you are afraid of being stuck with legacy legal issues after you have sold your company, you can ask for indemnification from the Buyer, which means that the Buyer will be obligated to assist you in defending litigation down the road. What is absolutely critical is that you know what issues you want to mitigate BEFORE entering into negotiations with a Buyer. Working with a skilled M&A advisor can help you do just that.
More about taxes(because we never hear enough about taxes)
We mentioned that one of the most important factors in deciding between an asset sale and a share sale is the difference in the resulting tax liability and we wanted to provide some additional context on this topic.
For example, in the United States, if you are selling a C-corporation through an Asset sale you will effectively be taxed twice. First, your company (remember, you keep your company in an asset sale) is taxed on the proceeds it received from the sale of its assets. Then, when you take the proceeds of your sale out of the company, you will be taxed individually for taking a distribution.
If you have organised your business as an S corporation, limited liability company, or partnership you will likely only be taxed once because income from these entities “passes through” to owners. With that said, you will pay taxes at the individual rate, which is higher than the capital gains rate that you would have to pay in a share sale.
Now let’s look at what this looks like in the case of a Share sale. Again, taking the United States example, If you sell your business via a share sale, you will only have to pay the capital gains rate on the profit. Moreover, if you own a C-corporation you will only be taxed once, as the corporate taxes are typically bypassed in a share sale. Also, you will have a somewhat reduced legal liability because you no longer own the underlying company. Technically, a share purchase means that the Buyer inherits all of your company’ future legal liabilities. However, in practice, most savvy Buyers will insist on an indemnification clause in your share purchase agreement that will require you to bear at least some of the burden of legal claims made against the company while it was under your watch.
Another tax-related reason Buyers love asset purchases is that every asset a Buyer purchases will have a valuation as of the date of the acquisition. This is known as the “stepped-up” cost basis. Buyers also receive a “restart” of depreciation and amortisation schedules. These two tax wrinkles alone can be immensely important to a Buyer because they allow a new owner to allocate values to different assets to take advantage of their respective depreciation rates. In other words, Buyers can use an asset sale to pay less taxes in the future. Buyers do not receive these same tax benefits with a share purchase.
Tax strategy is very important to your sales process and you should discuss your plans in detail with an expert in your country’s tax structure.
You should talk to a qualified tax attorney or accountant to make sure whatever method of sale you move forward with fits your business and tax needs. Nextoria works with hundreds of highly skilled professionals across the globe. If you’re looking to sell your eCommerce company, reach out for a conversation at email@example.com and let us know how we can help you today.