Asset sale vs stock sale: what's the difference when you sell a small business?

What is an asset sale?

In an asset sale, the buyer purchases a list of things your company owns: equipment, vehicles, inventory, the customer list, the name, the website and the goodwill. (Goodwill is the value of your customers and reputation beyond the physical items.) The buyer takes only the assets, and any liabilities, that it names and agrees to assume. You keep the company and, usually, its debts, which you pay from the proceeds. Cash usually stays with you too, but whether it is included is part of the deal, and the contract may set a working capital level to leave in the business (see letter of intent).

Most small business sales are built this way. A 2016 valuation advisor's article, citing the Pratt's Stats deal database, put the asset share at 85%.

The catch is paperwork. Many of your leases and customer contracts are in your company's name. Most contracts say they cannot be handed to someone else without consent, so moving them to a buyer usually means asking the other side. That is why the documents buyers and lenders ask for are worth reading long before a buyer appears.

What is a stock sale?

In a stock sale, the buyer purchases your ownership of the company: its shares. The company carries on as it is. Contracts usually stay in place without being assigned, though some have change-of-control clauses that give the other side a say. Some licenses and permits rest on a named person (California's contractor licenses, for example), so check with your licensing board. The HVAC, plumbing and electrical guide shows how that plays out for a trades company.

The buyer also takes everything the company has done, including liabilities nobody has found yet. Because the buyer usually assumes more risk, its due diligence (its checking of your records, contracts and finances) is typically greater in a stock purchase.

Asset sale vs stock sale, side by side

	Asset sale	Stock sale
What the buyer purchases	The assets it chooses	Your ownership of the company
What you keep	The company and usually its debts	The proceeds. The company goes with the buyer
Liabilities	Mostly stay with the company you keep. The buyer takes the ones it agrees to assume	Go with the company, including unknown ones
Contracts and leases	Move by assignment, often with consent	Usually stay in place. Change-of-control clauses may apply
Tax, in general terms	The price is split across the assets, and some gain can be ordinary income	Usually one gain on the shares
Paperwork	Bill of sale, assignments, IRS Form 8594	Share transfer, deeper due diligence
Who often prefers it	Buyers, for the choice of what to take on	Sellers, who hand over the company and its obligations and, for a C corporation (taxed on its own profit), usually face one level of tax instead of two

The last row is a tendency, not a rule. It depends on your entity type and your numbers.

Why do buyers often ask for an asset sale?

Buyers often have two main reasons. The first is risk: an asset buyer has a lower risk of inheriting debts and claims it never agreed to take. The second is tax. In an asset purchase the buyer receives a cost basis in what it buys, a significant tax factor for buyers. Basis is the cost it can recover through deductions. The cost of goodwill, for example, is generally deducted over 15 years.

If the buyer is using an SBA loan, the SBA's current rulebook for lenders, SOP 50 10 8.1, lets a 7(a) loan (an SBA-backed loan) fund either a stock purchase or an asset purchase. The lender checks conditions either way, so structure is still a negotiation. See selling to a buyer with an SBA loan.

How is an asset sale taxed?

The IRS says the sale of a business is usually not a sale of one asset. Each asset is treated as sold separately, with its own gain. Selling inventory produces ordinary income. Capital gain can be taxed at a lower rate than ordinary income (IRS Topic 409). Trucks and equipment are depreciable business property, not capital assets. Gain up to the depreciation you took is "recaptured" as ordinary income, and the rest is generally treated under section 1231, which can produce capital gain. So one sale can produce several kinds of income, depending on how the price is split.

That split is the purchase price allocation. Buyer and seller generally each file Form 8594 with their tax returns for the year of the sale. It sorts the price into seven classes, in order, from cash and inventory to equipment and vehicles, customer lists and, last, goodwill, which gets whatever is left.

For example, say a buyer pays $500,000 for the assets of a made-up plumbing company. Inventory is worth $60,000 and trucks and equipment $140,000, and nothing else is valued separately. Goodwill takes the remaining $300,000. Buyer and seller may agree the split in writing, and the agreement binds both unless the IRS finds the amounts inappropriate. Ask your CPA and attorney when and how your deal should settle it.

If part of the price comes as a seller note (a loan from you to the buyer), depreciation recapture is still taxed in the year of sale, even if no payment arrives that year. See seller financing.

Your entity type matters too.

• A C corporation's profit is taxed to the corporation when earned, and again to shareholders when paid out as dividends, so an asset sale can mean two layers of tax.
• S corporations and partnerships pass their income to their owners, who report it on their own returns.
• Selling a corporation's stock, instead of its assets, usually produces capital gain or loss.

Which route leaves you with more after tax depends on your basis (what you have invested in the shares or assets, for tax purposes), your entity and your asset mix, so your CPA has to run the numbers.

Can you sell an LLC? How an LLC sale works

Yes, you can sell an LLC, in the same two ways. You can sell its assets, and the LLC stays with you. Or you can sell your membership interests, your ownership share, which is what stock is to a corporation. The buyer steps into your place and the LLC carries on.

An LLC is a legal structure, not a tax category. By default the IRS treats an LLC with one member as disregarded (part of its owner's tax return) and an LLC with two or more as a partnership. Either can elect to be taxed as a corporation.

How your LLC is taxed	What the IRS generally sees when one buyer buys all the interests	What to watch
One member, default	The IRS treats the LLC's activities as the owner's own business and the sale of a business as a sale of each asset, so generally an asset sale	The allocation and Form 8594
Two or more members, default	Each seller sells a partnership interest. The buyer is treated as buying the assets and files Form 8594	The part of the gain tied to receivables and inventory is ordinary income
Elected corporation or S corporation	Treated as a corporation, so the corporate rules above apply. An S corporation passes its income through to its owners	Whether a C corporation faces two layers of tax

Then there is the operating agreement, the document that sets the LLC's rules. It and your state's law decide who must approve a sale and how an interest transfers, so have your attorney read yours. After an asset sale the LLC still exists, with the proceeds and any debts, so closing it is a separate decision.

What to settle before you sign a letter of intent

Structure is usually raised early, in the letter of intent (the buyer's written offer). Settle your own position first.

• Find out how your business is taxed: sole proprietorship, partnership, S corporation, C corporation, or an LLC taxed as one of these.
• Read your operating agreement or shareholder agreement for transfer and approval rules.
• List every contract, lease, license and permit that would need consent to move, and who gives it.
• Ask your CPA to model an asset sale and a stock or membership-interest sale on your numbers.
• Ask your attorney what stays with you after an asset sale, such as debts and leases.
• Ask your CPA and attorney what the letter of intent should say about structure and price allocation.

What to do next

Start with your own paperwork. This week, find your operating agreement or corporate records and your last business tax return, and note your entity type, how it is taxed and who must approve a sale. Then ask your CPA to model both structures before a buyer asks, and bring the answers to your broker, if you use one. For the wider picture, see how to prepare a business for sale.

Keep reading

• Letter of intent to purchase a business: what's in it and what to negotiate
• Seller financing when you sell a business: how a seller note works
• Documents needed to sell a business: the due diligence list

This guide is general information, not tax, legal or valuation advice. Every business is different: talk to your accountant, lawyer and broker about yours.