The question of what you are selling as your business seems like an easy question with an obvious answer, but is it? Many business owners new to the process of selling their business assume they will be selling the business “entity.” This is most often an S Corp, or possibly an LLC (Limited Liability Company). Older or larger companies may even be traditional “C” corporations. The fact is, most smaller businesses (those with less than $1 million in transaction value), will not being doing a sale of the stock of their company, but will instead sell in an asset sale. What does an asset sale involve?
An Asset Sale Versus A Stock Sale
When a seller first hears the term asset sale, he or she typically wonders, “does asset sale mean I am only going to get the market value of my tangible assets?” The answer to this question is a solid “no.”
An asset sale is differentiated from a stock sale primarily in the fact that the buyer is not acquiring the stock of the company (or membership interests, in the case of an LLC, which would not technically be a stock sale). When a buyer buys the stock of a company, they are typically buying all the assets of the business (cash, accounts receivable, equipment, etc.), as well as taking responsibility for all its liabilities (loans, accruals, accounts payable, etc.). They are also inheriting any “skeletons” or undisclosed liabilities in the company closet.
In a typical asset sale, the buyer acquires the tangible assets of the business plus some intangible assets like the trade name of the business, a website or intellectual property. The buyer, however, doesn’t automatically assume all liabilities like loans or accounts payable, or buy the cash, accounts receivable and the like, as they would in a stock purchase. The buyer is effectively creating a new business—probably with a new corporate entity—that acquires the selling company’s assets. The new entity with the new owner just keeps doing business the way the old owner did with the same trade name. If desired, additional assets or liabilities of the company, accounts receivable or payable, for example, can be acquired in an asset sale transaction.
A natural question at this point is: if I’m only selling the assets, how do I get “more” for the business than the market value of the assets? This is where something called “goodwill” enters the picture.
Goodwill
Imagine you have a transaction that involves tangible assets with a total market value of $900,000: $500,000 in equipment, $200,000 in vehicles, and $200,000 in leasehold improvements (leasehold improvements are the investments you have made in your leased space like bathrooms, building walls, installing carpet, etc.). Assume the business has $1,000,000 in cash flow. Because you’re “employing” the assets in a productive fashion and generating quality cash flow, you will most likely receive a premium for the business in excess of the market value of the tangible assets.
For example, if the buyer pays you $2,000,000 for the business (two times cash flow in this example), the buyer will have a balance sheet with $900,000 in tangible assets (500,000 + 200,000 + 200,000) and $1,100,000 in a newly created “intangible” asset called “goodwill” for a total of $2,000,000 in assets—the amount paid for the business. The goodwill is the difference between what you are paid for the business and the value allocated to the tangible assets. The buyer may also add additional assets to his or her newly created business such as cash for working capital.
The Transaction
Closing in a stock sale is relatively simple, athough a number of things happen to make that sale close. In addition, the way in which the parties arrive at the value of the stock can be quite complicated and contentious; the buyer basically pays you the agreed-upon value of the stock and simply now owns the corporation (or other entity) that you used to own. All of the assets that were owned by, and liabilities that were the responsibility of, the company stay with the entity that is now owned by a new buyer.
At closing in an asset sale, a Bill of Sale will transfer the tangible assets to the buyer or the buyer’s entity. Other assets (like a trade name or accounts receivable) will transfer by agreements that dictate the terms of the ownership transfer. The seller will have to pay off the liabilities associated with the business at or shortly after closing. The seller may then close down his or her entity, or continue to use it for other purposes. If the name of the seller’s corporation conflicts with the trade name being transferred (Acme, Inc. versus Buyer’s NEWCO d.b.a. Acme, Inc.), the name of the seller’s entity will be changed at closing.
Why Asset Sales on Smaller Businesses?
The primary reason asset sales are more common than stock sales on small businesses is that the business itself is typically fairly simple in structure. The buyer has no motivation to take on all the past legal liabilities of a corporate entity simply to acquire the tangible assets he most desires and the business name. If it is desirable to transfer other assets like accounts receivable, that can be done in an asset sale as well. More complicated business structures that involve numerous customer contracts, assumable debt or other benefits to the buyer relating to the seller’s entity may cause the benefits of a stock sale to outweigh the potential drawbacks.
Tax and Legal Implications
A number of factors, including tax implications, legal liability, ease of transfer and the specific needs of the seller or buyer, will dictate the best strategy. Always consult qualified tax, financial and legal counsel when determining the best form for your deal to take, asset sale or otherwise.