Stock or Asset Purchase: Which is Right for You?

When determining the type of transaction, factors such as tax implications and potential liabilities are the foremost considerations. An asset sale involves acquiring specific assets and liabilities, whereas a stock sale entails purchasing the shares of a corporation's owner.

In an asset sale, the seller retains possession of the legal entity, and the buyer purchases individual assets of the company, such as equipment, fixtures, goodwill, leaseholds, licenses, trade secrets, trade names, telephone numbers, and inventory.

Asset sales provide buyers with the opportunity to "step up" the depreciable basis of the company's assets. By assigning higher values to assets that depreciate rapidly and lower values to those with slower amortization, buyers can realize additional tax advantages. This accelerates tax reduction, enhancing the company's cash flow crucially in its initial years. Moreover, asset sales are favored by buyers as they offer a more straightforward way to avoid inheriting potential liabilities, particularly contingent ones such as product liability, contract disputes, product warranty issues, or employee lawsuits.

For sellers, asset sales generate higher taxes because while intangible assets, such as goodwill, are taxed at capital gains rates, other "hard" assets can be subject to higher ordinary income tax rates.

Through a stock sale, the buyer purchases the selling shareholders' stock in the target entity. The buyer purchases all assets and liabilities associated with the target entity. Unlike an asset sale, stock sales do not require numerous separate conveyances of each individual asset because the title of each asset lies within the corporation.

With stock sales, buyers lose the ability to gain a stepped-up basis in the assets. The seller's basis in the assets at the time of sale sets the depreciable basis for the new owner. Additionally, buyers may be exposed to more risk by purchasing the company's stock due unknown or undisclosed risks. These potential liabilities can be mitigated in the stock purchase agreement through representations and warranties.

Sellers often favor stock sales because all the proceeds are taxed at a lower capital gains rate, and in C-corporations the corporate level taxes are bypassed. Likewise, sellers are sometimes less responsible for future liabilities, such as product liability claims, contract claims, employee lawsuits, pensions, and benefit plans. However, the purchase agreement in a transaction can shift responsibilities back to a seller.