Structuring the sale of your business
There are many considerations to contemplate when planning for the sale of your business. One of the most important is the structure of the sale. The structure encompasses the legal transfer of the store and the resulting tax implications for both the buyer and seller. There are primarily two options for structuring the sale – a stock sale or an asset sale.
In a stock sale, the seller is transferring their stock of the existing company that holds the operations for the store. Similar to a stock purchase on the New York Stock Exchange, a stock sale entitles the buyer to their respective share of the assets and liabilities of the company. As a stock owner you receive a share of the profits or losses that arise during your period of ownership, but you are also an owner of the existing liabilities and even potential preexisting liabilities of the company. So, while you may receive dividends or distributions from the company’s profits, you also have potential exposure to liabilities arising from the company’s operations. For instance, a previous owner of the company’s stock may have been behind on their tax obligations. Or, a lawsuit is being filed because a customer slipped in the parking lot. With the transfer of stock, those obligations are now the new stockholder’s responsibility.
In an asset sale, the seller is transferring specific assets and occasionally liabilities to the buyer of the business. Commonly, a seller may transfer the inventory, equipment, office furniture, the existing workforce and goodwill of the business. Thus, the seller keeps the existing cash, accounts receivable and interest bearing debt obligations. Other assets and liabilities of the company’s business are negotiable and vary with each transaction. Unlike the stock sale structure, with an asset sale exposure to potential liabilities by the buyer is minimized. Negotiating an allocation of the purchase price to specific assets is recommended, rather than having one party dictate the terms of the transaction.
Many small businesses tend to be transferred via an asset sale. Larger companies tend to be primarily stock sales. In the case of a Winmark franchisee, the sale of single store is typically structured as an asset sale, while the sale of multiple stores may be structured as either an asset or stock sale depending on the facts and circumstances.
There are benefits and disadvantages inherent to each of the two structures, which are often in conflict between buyers and sellers.
- The buyer can generally deduct the cost of certain assets of the business, typically over 3 to 15 years, that would otherwise be tied up in the cost of stock, which is not deductible until sold or liquidated.
- The buyer will need to consider the implications of retitling assets and of sales/ transfer taxes, which may be applicable in the state where the physical assets are located.
- The seller will have to pay a combination of ordinary and capital gain rates on the sale resulting in higher income tax rates to the seller. The seller of a C Corporation may face double taxation as the company is taxed on the sale of assets and the individual owner is subsequently taxed on the final distribution of the company’s proceeds.
- The seller keeps the business’ legal entity, while the buyer is generally free of any legal risks and liabilities resulting from the prior entity.
- The seller generally realizes more cash at closing in an asset sale, but there may be outstanding liabilities retained by the seller that reduce the true value of this perceived extra money.
- Insurance policies, contracts, leases and permits do not automatically transfer to the buyer.
- Stock Sales
- The seller primarily pays capital gain tax rates, which are often significantly lower than ordinary income rates.
- There is no step-up in basis of the company’s assets in a stock sale. Therefore, the buyer does not gain favorable expensing opportunities with the business’ preexisting assets as it would in an asset sale.
- The new buyer generally obtains legal risks and liabilities that may have resulted from the tenure of prior owners unless the transaction is structured properly to reduce this potential liability.
- Insurance policies, contracts, leases and permits generally transfer to the buyer.
- Stock sales are generally less complex legally, resulting in lower transaction costs.
If there is real estate in the business, it will usually be involved in a separate transaction via a rental or purchase agreement.
In general, the seller usually favors a stock sale, the buyer an asset sale. Typically, the tax implications to the two sides are factored into the price.
The existing entity type (C Corporation, S Corporation, Limited Liability Company, partnership etc.) of the business is integral to the discussion as well. You will want to work directly with your accounting and legal teams to find the best fit for your needs, because a Section 338(h)(10) election might be your best option. These advisors should be engaged at the beginning of the sale planning process to optimize your personal and financial goals.