Considerations in Structuring the Sale of a Small Business

Interested in selling your business?

It is important to consider the appropriate structure for the sale of your business for both tax and liability purposes. Generally, there are two methods of selling a business: by selling the business assets (an “Asset Purchase”) or selling the ownership shares of the business (a “Stock Purchase”). Depending on your type of business entity, the tax consequences involved, and whether you are buying or selling the business, a stock purchase or asset purchase may be more favorable than the other.

Asset Purchase:

Identifying Assets

In an asset purchase the seller of the business sells each of its assets to a buyer and determines an overall purchase price for the sum of the assets.

Examples of Assets include both tangible assets, intangible assets, and real property:

  •  Goodwill
  • Customer Lists
  • Contracts
  • Accounts Receivable
  • Office Furniture
  • Real Estate

Generally, the type of asset determines the tax structure of the income derived from the sale. Intangible assets like customer goodwill and client lists are taxed as a capital gain. Tangible assets like office furniture are taxed as ordinary income. This may be an important consideration in structuring the sale of the business and determining the allocation of the purchase price because the capital gain tax rate is lower than the ordinary income tax rate.

 Flexibility of the Asset Purchase Agreement

When purchasing assets of the business, the buyer and seller can negotiate which assets should be sold. A seller may want to exclude an asset from the sale, whereas a buyer may want to limit the amount of liabilities or contracts they may be assuming.

In sum, the flexibility an asset purchase agreement provides may be more favorable to smaller businesses that seek to be more involved in determining which assets to sell in their small business.

Stock Purchase:

In a stock purchase, the seller sells their whole business entity to the buyer including all assets and liabilities. One advantage of the stock purchase is that the buyer will not need to re-title the assets or assign contracts because the buyer steps into the shoes of the previous owner.

Taxation of a Stock Purchase

For tax purposes, the whole sale of a business entity is taxed at a more favorable capital gains tax rate because the buyer is buying out the stock of the seller. While there is not as much scrutiny over allocating the purchase price over the assets, there is more analysis required to discover the health of the business itself.

Assessing the Health of the Business in a Stock Purchase

Unlike the asset purchase agreement where a buyer and seller can pick and choose what is being purchased and what is not, in a stock purchase the whole business is sold. This creates potential risk for a buyer who assumes the business in its entirety.

Final Tidbits on Selling a Business:

Understanding the structure of the sale of your small business and how it relates to your tax liability and other consequences of the sale are both important and complicated. If you are buying or selling a business, the attorneys at Kennedy & Ruhsam Law offices can help you understand the business transaction and structure the contract to minimize your tax liability.

If you are interested in selling your business and/or purchasing a business, the attorneys and Kennedy & Ruhsam Law Offices can help you understand both the legal and tax implications of the transaction.

This article is not legal advice. If you have any specific questions related to your business, please reach out to Kennedy & Ruhsam law offices for assistance.

Madeline Meyer, JD, MBA

Questions relating to your business can be directed to attorney Madeline Meyer at 651-262-2080.